Edgar Filing: MARATHON OIL CORP

form10q2010sep30.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Quarterly Period Ended September 30, 2010

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from _____ to _____

Commission file number 1-5153

Marathon Oil Corporation

(Exact name of registrant as specified in its charter)

Delaware	25-0996816
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

5555 San Felipe Road, Houston, TX 77056-2723

(Address of principal executive offices)

(713) 629-6600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of

Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x	Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting company)	Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

There were 709,911,592 shares of Marathon Oil Corporation common stock outstanding as of October 29, 2010.

MARATHON OIL CORPORATION

Form 10-Q

Quarter Ended September 30, 2010

	INDEX
		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Statements of Income (Unaudited)		2
	Consolidated Balance Sheets (Unaudited)		3
	Consolidated Statements of Cash Flows (Unaudited)		4
	Consolidated Statements of Comprehensive Income (Unaudited)		5
	Notes to Consolidated Financial Statements (Unaudited)		6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		36
Item 4.	Controls and Procedures		36
	Supplemental Statistics (Unaudited)		37
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings		40
Item 1A.	Risk Factors		40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		42
Item 6.	Exhibits		43
	Signatures		44

Unless the context otherwise indicates, references in this Form 10-Q to “Marathon,” “we,” “our,” or “us” are references to Marathon Oil Corporation, including its wholly-owned and majority-owned subsidiaries, and its ownership interests in equity method investees (corporate entities, partnerships, limited liability companies and other ventures over which Marathon exerts significant influence by virtue of its ownership interest).

Part I - Financial Information

Item 1. Financial Statements

MARATHON OIL CORPORATION

Consolidated Statements of Income (Unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In millions, except per share data)	2010			2009			2010			2009
Revenues and other income:

Sales and other operating revenues (including	$	18,407		$	14,335		$	52,673		$	37,509
consumer excise taxes)
Sales to related parties		36			27			88			68
Income from equity method investments		95			75			301			184
Net gain on disposal of assets		5			5			830			200
Other income		32			35			77			112

Total revenues and other income		18,575			14,477			53,969			38,073
Costs and expenses:
Cost of revenues (excludes items below)		14,291			10,963			41,464			28,080
Purchases from related parties		180			133			454			338
Consumer excise taxes		1,351			1,258			3,871			3,658
Depreciation, depletion and amortization		765			627			2,072			1,970
Long-lived asset impairments		-			3			467			18
Selling, general and administrative expenses		324			323			958			935
Other taxes		99			98			324			296
Exploration expenses		59			55			282			181

Total costs and expenses		17,069			13,460			49,892			35,476

Income from operations		1,506			1,017			4,077			2,597

Net interest and other financing costs		(27	)		(35	)		(75	)		(63	)
Loss on early extinguishment of debt		-			-			(92	)		-


Income from continuing operations before income taxes		1,479			982			3,910			2,534

Provision for income taxes		783			590			2,048			1,549

Income from continuing operations		696			392			1,862			985

Discontinued operations		-			21			-			123

Net income	$	696		$	413		$	1,862		$	1,108

Per Share Data

Basic:

Income from continuing operations	$	0.98		$	0.55		$	2.63		$	1.39
Discontinued operations	$	-		$	0.03		$	-		$	0.17
Net income per share	$	0.98		$	0.58		$	2.63		$	1.56

Diluted:

Income from continuing operations	$	0.98		$	0.55		$	2.62		$	1.39
Discontinued operations	$	-		$	0.03		$	-		$	0.17
Net income per share	$	0.98		$	0.58		$	2.62		$	1.56

Dividends paid	$	0.25		$	0.24		$	0.74		$	0.72

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Consolidated Balance Sheets (Unaudited)


	September 30,			December 31,
(In millions, except per share data)	2010			2009
Assets
Current assets:
Cash and cash equivalents	$	1,643		$	2,057
Receivables, less allowance for doubtful accounts of $18 and $14		5,363			4,677
Receivables from related parties		53			60
Inventories		3,969			3,622
Other current assets		572			221

Total current assets		11,600			10,637

Equity method investments		1,844			1,970
Property, plant and equipment, less accumulated depreciation,
depletion and amortization of $19,027 and $17,185		31,987			32,121
Goodwill		1,383			1,422
Other noncurrent assets		1,309			902

Total assets	$	48,123		$	47,052
Liabilities
Current liabilities:
Accounts payable	$	6,775		$	6,982
Payables to related parties		59			64
Payroll and benefits payable		362			399
Accrued taxes		1,407			547
Deferred income taxes		414			403
Other current liabilities		489			566
Long-term debt due within one year		98			96

Total current liabilities		9,604			9,057

Long-term debt		7,844			8,436
Deferred income taxes		3,940			4,104
Defined benefit postretirement plan obligations		1,846			2,056
Asset retirement obligations		1,166			1,099
Deferred credits and other liabilities		367			390

Total liabilities		24,767			25,142

Commitments and contingencies

Stockholders’ Equity
Preferred stock – zero and 5 million shares issued, zero and 1 million shares
outstanding (no par value, 26 million shares authorized)		-			-
Common stock:
Issued – 770 million and 769 million shares (par value
$1 per share, 1.1 billion shares authorized)		770			769
Securities exchangeable into common stock – zero and 5 million shares issued,
zero and 1 million shares outstanding (no par value, 29 million authorized)		-			-
Held in treasury, at cost – 60 million and 61 million shares		(2,681	)		(2,706	)
Additional paid-in capital		6,756			6,738
Retained earnings		19,379			18,043
Accumulated other comprehensive loss		(868	)		(934	)

Total stockholders' equity		23,356			21,910

Total liabilities and stockholders' equity	$	48,123		$	47,052

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)


	Nine Months Ended
	September 30,
(In millions)	2010			2009
Increase (decrease) in cash and cash equivalents
Operating activities:
Net income	$	1,862		$	1,108
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on early extinguishment of debt		92			-
Discontinued operations		-			(123	)
Deferred income taxes		(228	)		726
Depreciation, depletion and amortization		2,072			1,970
Long-lived asset impairments		467			18
Pension and other postretirement benefits, net		(65	)		(159	)
Exploratory dry well costs and unproved property impairments		122			48
Net gain on disposal of assets		(830	)		(200	)
Equity method investments, net		4			42
Changes in:
Current receivables		(668	)		(1,241	)
Inventories		(665	)		(184	)
Current accounts payable and accrued liabilities		757			1,141
All other operating, net		68			78
Net cash provided by continuing operations		2,988			3,224
Net cash provided by discontinued operations		-			84
Net cash provided by operating activities		2,988			3,308
Investing activities:
Additions to property, plant and equipment		(3,634	)		(4,749	)
Disposal of assets		1,370			573
Trusteed funds - withdrawals		-			16
Investing activities of discontinued operations		-			(69	)
All other investing, net		8			63
Net cash used in investing activities		(2,256	)		(4,166	)
Financing activities:
Borrowings		-			1,491
Debt issuance costs		-			(11	)
Debt repayments		(628	)		(43	)
Dividends paid		(526	)		(510	)
All other financing, net		8			(1	)
Net cash provided by (used in) financing activities		(1,146	)		926
Effect of exchange rate changes on cash:
Continuing operations		-			19
Discontinued operations		-			(2	)
Total effect of exchange rate changes on cash		-			17
Net increase (decrease) in cash and cash equivalents		(414	)		85
Cash and cash equivalents at beginning of period		2,057			1,285
Cash and cash equivalents at end of period	$	1,643		$	1,370

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Consolidated Statements of Comprehensive Income (Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In millions)	2010			2009			2010			2009
Net income	$	696		$	413		$	1,862		$	1,108
Other comprehensive income (loss)

Post-retirement and post-employment plans
Change in actuarial gain (loss)		(24	)		9			134			58
Income tax provision on post-retirement and
post-employment plans		10			-			(73	)		(31	)
Post-retirement and post-employment plans, net of tax		(14	)		9			61			27

Derivative hedges
Net unrecognized gain		1			19			5			22
Income tax benefit (provision) on derivatives		-			(4	)		-			(11	)
Derivative hedges, net of tax		1			15			5			11

Foreign currency translation and other
Unrealized gain (loss)		(1	)		-			(1	)		1
Income tax provision on foreign currency translation and other		1			-			1			-
Foreign currency translation and other, net of tax		-			-			-			1

Other comprehensive income (loss)		(13	)		24			66			39

Comprehensive income	$	683		$	437		$	1,928		$	1,147

The accompanying notes are an integral part of these consolidated financial statements.

MARATHON OIL CORPORATION

Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

These consolidated financial statements are unaudited; however, in the opinion of management, these statements reflect all adjustments necessary for a fair statement of the results for the periods reported. All such adjustments are of a normal recurring nature unless disclosed otherwise. These consolidated financial statements, including notes, have been prepared in accordance with the applicable rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. Certain reclassifications have been made to conform to current year presentation.

These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Marathon Oil Corporation (“Marathon”) 2009 Annual Report on Form 10-K. The results of operations for the quarter and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year.

2. Accounting Standards

Recently Adopted

Variable interest accounting standards were amended by the Financial Accounting Standards Board (“FASB”) in June 2009. The new accounting standards replace the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity. In addition, the concept of qualifying special-purpose entities has been eliminated. Ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity are also required. The amended variable interest accounting standards require reconsideration for determining whether an entity is a variable interest entity when changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lack the power from voting rights or similar rights to direct the activities of the entity. Enhanced disclosures are required for any enterprise that holds a variable interest in a variable interest entity. Prospective application of these standards in the first quarter of 2010 did not have a significant impact on our consolidated results of operations, financial position or cash flows. The required disclosures are presented in Note 3.

A standard to improve disclosures about fair value measurements was issued by the FASB in January 2010. The additional disclosures required include: (1) the different classes of assets and liabilities measured at fair value, (2) the significant inputs and techniques used to measure Level 2 and Level 3 assets and liabilities for both recurring and nonrecurring fair value measurements, (3) the gross presentation of purchases, sales, issuances and settlements for the rollforward of Level 3 activity, and (4) the transfers in and out of Levels 1 and 2. We adopted all aspects of this standard in the first quarter of 2010. This adoption did not have a significant impact on our consolidated results of operations, financial position or cash flows. The required disclosures are presented in Note 11.

Oil and Gas Reserve Estimation and Disclosure standards were issued by the FASB in January 2010, which align the FASB’s reporting requirements with the Securities and Exchange Commission (“SEC”) requirements. Similar to the SEC requirements, the FASB requirements were effective for us as of December 31, 2009. The SEC introduced a new definition of oil and gas producing activities which allows companies to include volumes in their reserve base from unconventional resources. The FASB also addresses the impact of changes in the SEC’s rules and definitions on accounting for oil and gas producing activities. Initial adoption did not have an impact on our consolidated results of operations, financial position or cash flows. The effect on depreciation, depletion and amortization expense subsequent to adoption, as compared to prior periods, was not significant.

3. Variable Interest Entities

The Athabasca Oil Sands Project (“AOSP”), in which we hold a 20 percent undivided interest, contracted with a wholly-owned subsidiary of a publicly traded Canadian limited partnership (“Corridor Pipeline”) to provide materials transportation capabilities among the Muskeg River mine, the Scotford upgrader and markets in Edmonton. The contract, originally signed in 1999 by a company we acquired, allows each holder of an undivided interest in the AOSP to ship materials in accordance with its undivided interest. Costs under this contract are accrued and recorded on a monthly basis, with a $1 million current liability recorded at September 30, 2010. Under this agreement, the AOSP absorbs all of the operating and capital costs of the pipeline. Currently, no third-party shippers use the pipeline. Should shipments be suspended, by choice or due to force majeure, we remain responsible for the portion of the payments related to our undivided interest for all remaining periods. The contract expires in 2029; however, the shippers can extend its term perpetually. This contract qualifies as a variable interest contractual arrangement and the Corridor Pipeline qualifies as a VIE. We hold a variable interest but are not the primary beneficiary because our shipments are only 20 percent of the total; therefore, the Corridor Pipeline is not consolidated. Our maximum exposure to loss as a

Notes to Consolidated Financial Statements (Unaudited)

result of our involvement with this VIE is the amount we expect to pay over the contract term, which was $832 million as of September 30, 2010. The liability on our books related to this contract at any given time will reflect amounts due for the immediately previous month’s activity, which is substantially less than the maximum exposure over the contract term. We have not provided financial assistance to Corridor Pipeline and we do not have any guarantees of such assistance in the future.

4. Income per Common Share

Basic income per share is based on the weighted average number of common shares outstanding. Diluted income per share includes exercise of stock options and stock appreciation rights, provided the effect is not antidilutive.

	Three Months Ended September 30,
	2010				2009
(In millions, except per share data)	Basic		Diluted		Basic		Diluted

Income from continuing operations	$	696	$	696	$	392	$	392
Discontinued operations		-		-		21		21
Net income	$	696	$	696	$	413	$	413

Weighted average common shares outstanding		710		710		709		709
Effect of dilutive securities		-		2		-		2
Weighted average common shares, including
dilutive effect		710		712		709		711

Per share:
Income from continuing operations	$	0.98	$	0.98	$	0.55	$	0.55
Discontinued operations	$	-	$	-	$	0.03	$	0.03
Net income	$	0.98	$	0.98	$	0.58	$	0.58

	Nine Months Ended September 30,
	2010				2009
(In millions, except per share data)	Basic		Diluted		Basic		Diluted

Income from continuing operations	$	1,862	$	1,862	$	985	$	985
Discontinued operations		-		-		123		123
Net income	$	1,862	$	1,862	$	1,108	$	1,108

Weighted average common shares outstanding		709		709		709		709
Effect of dilutive securities		-		2		-		2
Weighted average common shares, including
dilutive effect		709		711		709		711

Per share:
Income from continuing operations	$	2.63	$	2.62	$	1.39	$	1.39
Discontinued operations	$	-	$	-	$	0.17	$	0.17
Net income	$	2.63	$	2.62	$	1.56	$	1.56

The per share calculations above exclude 11 million and 12 million stock options and stock appreciation rights for the third quarter and the first nine months of 2010, as they were antidilutive. Excluded in the third quarter and the first nine months of 2009 were 11 million and 10 million stock options and stock appreciation rights.

5. Dispositions

Assets Held For Sale

In October 2010, we entered into definitive agreements to sell our Refining, Marketing and Transportation (“RM&T”) segment’s St. Paul Park, Minnesota, refinery (including associated terminal, tankage and pipeline investments) and 166 Speedway SuperAmerica retail outlets, plus related inventories. The fair value of the consideration is estimated to be approximately $900 million, which includes the estimated value of inventory and the fair values of (1) a retained preferred stock interest in the buyer with a stated value of $80 million, (2) a maximum $125 million earnout provision payable to us over eight years, and (3) a maximum $60 million of margin support payable to

Notes to Consolidated Financial Statements (Unaudited)

the buyer over two years. Cash proceeds at closing are estimated to be $700 million. The earnout and margin support provisions in the agreements are subject to certain conditions and any margin support paid may be recovered by an increase in the total earnout amount. We expect the sale transaction to close by yearend 2010, contingent upon the buyer meeting the conditions of their financing arrangements and other customary closing conditions.

As of September 30, 2010, the Minnesota assets and liabilities held for sale are reported in the consolidated balance sheet as follows:

(In millions)
Other current assets	$	308
Other noncurrent assets		512
Total assets		820

Deferred credits and other liabilities		3
Total liabilities	$	3

2010 Disposition

During the first quarter 2010, we closed the sale of a 20 percent outside-operated interest in our E&P segment’s Production Sharing Contract and Joint Operating Agreement in Block 32 offshore Angola. We received net proceeds of $1.3 billion and recorded a pretax gain on the sale in the amount of $811 million. We retained a 10 percent outside-operated interest in Block 32.

2009 Dispositions

In April 2009, we closed the sale of our operated properties in Ireland for net proceeds of $84 million, after adjusting for cash held by the sold subsidiary. A $158 million pretax gain on the sale was recorded. As a result of this sale, we terminated our pension plan in Ireland, incurring a charge of $18 million.

In June 2009, we entered into an agreement to sell the subsidiary holding our 19 percent outside-operated interest in the Corrib natural gas development offshore Ireland. An initial $100 million payment was made at closing. Additional fixed proceeds of $135 million will be received on the earlier of first commercial gas or December 31, 2012. Including contingent consideration, the fair value of $311 million at June 30, 2009, was less than book value. An impairment of $154 million was recognized in the second quarter of 2009 and reported as part of the loss on disposal of discontinued operations.

Existing guarantees of our subsidiaries’ performance issued to Irish government entities remain in place after the sales until the purchasers issue similar guarantees to replace them. The guarantees, related to asset retirement obligations and natural gas production levels, have been indemnified by the purchasers. The fair value of these guarantees is not significant.

In December 2009, we closed the sale of our operated fields offshore Gabon, receiving net proceeds of $269 million, after closing adjustments. A $232 million pretax gain on this disposition was reported in discontinued operations in the fourth quarter of 2009.

Our Irish businesses and our Gabonese businesses, which had been reported in our E&P segment, have been reported as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for the three and nine months ended September 30, 2009. Revenues, pretax income and the net pretax loss on these dispositions are shown on the table below.

		Three Months Ended		Nine Months Ended
		September 30,		September 30,
(In millions)	2009			2009
Revenues applicable to discontinued operations		$	65		$	186
Pretax income from discontinued operations			48			98
Pretax loss on disposal of discontinued operations		$	-		$	14

In June 2009, we closed sales of a portion of our operated and all of our outside-operated Permian Basin producing assets in New Mexico and west Texas for net proceeds after closing adjustments of $293 million. A $196 million pretax gain on the sale was recorded. Activities related to these properties had been reported in our E&P segment.

Notes to Consolidated Financial Statements (Unaudited)

6. Segment Information

We have four reportable operating segments. Each of these segments is organized and managed based upon the nature of the products and services they offer.

Exploration and Production (“E&P”) – explores for, produces and markets liquid hydrocarbons and natural gas on a worldwide basis;

Oil Sands Mining (“OSM”) – mines, extracts and transports bitumen from oil sands deposits in Alberta, Canada, and upgrades the bitumen to produce and market synthetic crude oil and vacuum gas oil;

Integrated Gas (“IG”) – markets and transports products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, on a worldwide basis; and

Refining, Marketing and Transportation (“RM&T”) – refines, markets and transports crude oil and petroleum products, primarily in the Midwest, upper Great Plains, Gulf Coast and southeastern regions of the United States.

As discussed in Note 5, our Irish and Gabonese businesses were sold in 2009 and have been reported as discontinued operations. Segment information for all presented periods of 2009 excludes amounts for these operations.

	Three Months Ended September 30, 2010
(In millions)	E&P			OSM			IG		RM&T			Total

Revenues:
Customer	$	2,343		$	156		$	38	$	15,870		$	18,407
Intersegment (a)		174			34			-		6			214
Related parties		15			-			-		21			36
Segment revenues		2,532			190			38		15,897			18,657
Elimination of intersegment revenues		(174	)		(34	)		-		(6	)		(214	)
Total revenues	$	2,358		$	156		$	38	$	15,891		$	18,443
Segment income	$	510		$	18		$	41	$	285		$	854
Income from equity method investments(b)		51			-			51		18			120
Depreciation, depletion and amortization (c)		491			28			1		234			754
Income tax provision (b)		579			2			21		170			772
Capital expenditures (c)(d)		586			191			1		273			1,051

	Three Months Ended September 30, 2009
(In millions)	E&P			OSM			IG		RM&T			Total

Revenues:
Customer	$	1,816		$	130		$	15	$	12,387		$	14,348
Intersegment (a)		148			37			-		8			193
Related parties		15			-			-		12			27
Segment revenues		1,979			167			15		12,407			14,568
Elimination of intersegment revenues		(148	)		(37	)		-		(8	)		(193	)
Loss on U.K. natural gas contracts(e)		(13	)		-			-		-			(13	)
Total revenues	$	1,818		$	130		$	15	$	12,399		$	14,362
Segment income	$	491		$	25		$	13	$	158		$	687
Income from equity method investments		40			-			21		14			75
Depreciation, depletion and amortization (c)		424			26			1		167			618
Income tax provision(b)		297			7			12		119			435
Capital expenditures (c)(d)		516			267			-		634			1,417

Notes to Consolidated Financial Statements (Unaudited)

	Nine Months Ended September 30, 2010
(In millions)	E&P			OSM			IG		RM&T			Total

Revenues:
Customer	$	7,144		$	461		$	98	$	44,970		$	52,673
Intersegment (a)		498			73			-		37			608
Related parties		41			-			-		47			88
Segment revenues		7,683			534			98		45,054			53,369
Elimination of intersegment revenues		(498	)		(73	)		-		(37	)		(608	)
Total revenues	$	7,185		$	461		$	98	$	45,017		$	52,761
Segment income (loss)	$	1,444		$	(59	)	$	109	$	469		$	1,963
Income from equity method investments(b)		128			-			142		56			326
Depreciation, depletion and amortization (c)		1,279			67			3		695			2,044
Income tax provision (benefit)(b)		1,741			(15	)		56		274			2,056
Capital expenditures (c)(d)		1,774			699			2		839			3,314

	Nine Months Ended September 30, 2009
(In millions)	E&P			OSM			IG		RM&T			Total

Revenues:
Customer	$	4,952		$	353		$	33	$	32,099		$	37,437
Intersegment (a)		390			91			-		25			506
Related parties		44			-			-		24			68
Segment revenues		5,386			444			33		32,148			38,011
Elimination of intersegment revenues		(390	)		(91	)		-		(25	)		(506	)
Gain on U.K. natural gas contracts(e)		72			-			-		-			72
Total revenues	$	5,068		$	353		$	33	$	32,123		$	37,577
Segment income	$	782		$	3		$	53	$	482		$	1,320
Income from equity method investments		77			-			91		16			184
Depreciation, depletion and amortization (c)		1,373			97			3		476			1,949
Income tax provision (benefit)(b)		910			(1	)		27		329			1,265
Capital expenditures (c)(d)		1,490			834			1		2,007			4,332

(a)	Management believes intersegment transactions were conducted under terms comparable to those with unrelated parties.

(b)	Differences between segment totals and our financial statement totals represent amounts related to corporate administrative activities and other unallocated items and are included in “Items not allocated to segments, net of income taxes” in the reconciliation below.

(c)	Differences between segment totals and our financial statement totals represent amounts related to corporate administrative activities.

(d)	Includes accruals.

(e)	The U.K. natural gas contracts expired in September 2009.

Notes to Consolidated Financial Statements (Unaudited)

The following reconciles segment income to net income as reported in the consolidated statements of income:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In millions)	2010			2009			2010			2009
Segment income	$	854		$	687		$	1,963		$	1,320
Items not allocated to segments, net of income taxes:
Corporate and other unallocated items		(106	)		(159	)		(178	)		(299	)
Foreign currency remeasurement of income taxes		(37	)		(114	)		33			(180	)
Gain (loss) on dispositions (a)		-			(15	)		449			107
Impairments(b)		(15	)		-			(303	)		-
Loss on early extinguishment of debt(c)		-			-			(57	)		-
Deferred income taxes - tax legislation changes(d)		-			-			(45	)		-
Gain on U.K. natural gas contracts		-			(7	)		-			37
Discontinued operations		-			21			-			123
Net income	$	696		$	413		$	1,862		$	1,108

(a)	Additional information on these gains can be found in Note 5.

(b)

Impairments include those based upon fair value measurements discussed in Note 11 and a $15 million pretax writeoff of the remaining portion of the contingent proceeds from the 2009 sale of the Corrib natural gas development, which was recorded in the second quarter of 2010, based upon new public information regarding the pipeline that would transport natural gas from the Corrib development.

(c)	Additional information on debt retired early can be found in Note 13.

(d)	A discussion of the tax legislation changes can be found in Note 8.

The following reconciles total revenues to sales and other operating revenues (including consumer excise taxes) as reported in the consolidated statements of income:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In millions)	2010			2009		2010			2009
Total revenues		$	18,443	$	14,362		$	52,761		$	37,577
Less: Sales to related parties			36		27			88			68
Sales and other operating revenues (including
consumer excise taxes)		$	18,407	$	14,335		$	52,673		$	37,509

7. Defined Benefit Postretirement Plans

The following summarizes the components of net periodic benefit cost:

	Three Months Ended September 30,
	Pension Benefits						Other Benefits
(In millions)	2010			2009			2010			2009
Service cost	$	27		$	36		$	4		$	4
Interest cost		44			42			10			11
Expected return on plan assets		(40	)		(41	)		-			-
Amortization:
– prior service cost (credit)		4			4			(1	)		(1	)
– actuarial loss (gain)		24			8			(1	)		(2	)
– net settlement		12			-			-			-
Net periodic benefit cost	$	71		$	49		$	12		$	12

Notes to Consolidated Financial Statements (Unaudited)

	Nine Months Ended September 30,
	Pension Benefits						Other Benefits
(In millions)	2010			2009			2010			2009
Service cost	$	81		$	108		$	13		$	13
Interest cost		131			126			29			31
Expected return on plan assets		(120	)		(121	)		-			-
Amortization:
– prior service cost (credit)		10			11			(4	)		(4	)
– actuarial loss (gain)		74			24			(2	)		(4	)
– net settlement/curtailment loss		12			18			-			-
Net periodic benefit cost	$	188		$	166		$	36		$	36

During the first nine months of 2010, we made contributions of $240 million to our funded pension plans. We expect to make additional contributions up to an estimated $2 million to our funded pension plans over the remainder of 2010. Current benefit payments related to unfunded pension and other postretirement benefit plans were $29 million and $26 million during the first nine months of 2010.

8. Income Taxes

The following is an analysis of the effective income tax rates for the periods presented:

	Nine Months Ended September 30,
	2010			2009
Statutory U.S. income tax rate		35	%		35	%
Effects of foreign operations, including foreign tax credits		17			25
State and local income taxes, net of federal income tax effects		-			1
Legislation change		1			-
Other		(1	)		-
Effective income tax rate for continuing operations		52	%		61	%

The Patient Protection and Affordable Care Act (“PPACA”) and the Health Care and Education Reconciliation Act of 2010 (“HCERA”), (together, the “Acts”) were signed in to law in March 2010. The “Acts” effectively change the tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide prescription drug benefits that are at least actuarially equivalent to the corresponding benefits provided under Medicare Part D. The federal subsidy paid to employers was introduced as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “MPDIMA”). Under the MPDIMA, the federal subsidy does not reduce our income tax deduction for the costs of providing such prescription drug plans nor is it subject to income tax individually. Beginning in 2013, under the Acts, our income tax deduction for the costs of providing Medicare Part D-equivalent prescription drug benefits to retirees will be reduced by the amount of the federal subsidy. Such a change in the tax law must be recognized in earnings in the period enacted regardless of the effective date. As a result, we have recorded a charge of $45 million in the first quarter of 2010 for the write-off of deferred tax assets to reflect the change in the tax treatment of the federal subsidy.

The effective income tax rate is influenced by a variety of factors including the geographic and functional sources of income, the relative magnitude of these sources of income, and foreign currency remeasurement effects. The provision for income taxes is allocated on a discrete, stand-alone basis to pretax segment income and to individual items not allocated to segments. The difference between the total provision and the sum of the amounts allocated to segments and to individual items not allocated to segments is reported in the Corporate and other unallocated items line of the reconciliation shown in Note 6.

Notes to Consolidated Financial Statements (Unaudited)

9. Inventories

Inventories are carried at the lower of cost or market value. The cost of inventories of crude oil, refined products and merchandise is determined primarily under the last-in, first-out (“LIFO”) method.

	September 30,		December 31,
(In millions)	2010		2009
Liquid hydrocarbons, natural gas and bitumen	$	1,555	$	1,393
Refined products and merchandise		2,046		1,790
Supplies and sundry items		368		439
Inventories	$	3,969	$	3,622

10. Property, Plant and Equipment

	September 30,		December 31,
(In millions)	2010		2009
E&P
United States	$	6,118	$	6,005
International		4,964		5,522
Total E&P		11,082		11,527
OSM		9,100		8,531
IG		35		34
RM&T		11,628		11,887
Corporate		142		142
Property, plant and equipment	$	31,987	$	32,121

Exploratory well costs capitalized greater than one year after completion of drilling were $158 million as of September 30, 2010, an increase of $8 million from December 31, 2009.

The offshore Gulf of Mexico Shenandoah appraisal well, located at Walker Ridge Block 52, was added to this category in the first quarter of 2010 at a cost of $28 million. The Shenandoah costs were incurred primarily during 2009. Appraisal drilling for the Shenandoah prospect is in our near-term plans. The results of the appraisal well program will be used to evaluate the commercial viability of the project.

In the first quarter of 2010, a detailed study of the commerciality of the Gardenia well in Equatorial Guinea concluded that development of the area was uncertain; therefore, we wrote off $20 million in costs associated with the well. The remaining $10 million of exploration well costs in Equatorial Guinea are associated with the Corona well which were incurred in 2004. Efforts to develop these reserves continue and we are evaluating both a unitization with existing production facilities and stand-alone development.

Notes to Consolidated Financial Statements (Unaudited)

11. Fair Value Measurements

Fair Values - Recurring

The following table presents assets and liabilities accounted for at fair value on a recurring basis as of September 30, 2010 and December 31, 2009 by fair value hierarchy level.

	September 30, 2010
(In millions)	Level 1			Level 2			Level 3		Collateral		Total
Derivative instruments, assets
Commodity	$	149		$	23		$	1	$	90		263
Interest rate		-			45			-		-		45
Foreign currency		-			-			1		-		1
Derivative instruments, assets		149			68			2		90		309
Derivative instruments, liabilities
Commodity	$	(207	)	$	(1	)	$	-	$	-		(208	)
Derivative instruments, liabilities		(207	)		(1	)		-		-		(208	)

	December 31, 2009
(In millions)	Level 1			Level 2			Level 3			Collateral		Total
Derivative instruments, assets
Commodity	$	133		$	11		$	12		$	63	$	219
Interest rate		-			-			7			-		7
Foreign currency		-			1			2			-		3
Derivative instruments, assets		133			12			21			63		229
Derivative instruments, liabilities
Commodity	$	(125	)	$	(12	)	$	(10	)	$	-	$	(147	)
Interest rate		-			-			(2	)		-		(2	)
Derivative instruments, liabilities		(125	)		(12	)		(12	)		-		(149	)

Commodity derivatives in Level 1 are exchange-traded contracts for crude oil, natural gas, refined products and ethanol measured at fair value with a market approach using the close-of-day settlement price for the market. Commodity derivatives, interest rate derivatives and foreign currency forwards in Level 2 are measured at fair value with a market approach using broker price quotes or prices obtained from third-party services such as Bloomberg L.P. or Platt’s, a Division of McGraw-Hill Corporation (“Platt’s”), which have been corroborated with data from active markets for similar assets and liabilities. Collateral deposits related to both Level 1 and Level 2 commodity derivatives are in broker accounts covered by master netting agreements.

Commodity derivatives in Level 3 are measured at fair value with a market approach using prices obtained from third-party services such as Platt’s and price assessments from other independent brokers. The fair value of foreign currency options is measured using an option pricing model for which the inputs are obtained from a reporting service. Since we are unable to independently verify information from the third-party service providers to active markets, all these measures are considered Level 3.

Interest rate derivatives, formerly in Level 3, are reported in Level 2 beginning second quarter because we now corroborate the interest rates used in the fair value measurement.

Notes to Consolidated Financial Statements (Unaudited)

The following is a reconciliation of the net beginning and ending balances recorded for derivative instruments classified as Level 3 in the fair value hierarchy.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In millions)	2010			2009			2010			2009
Beginning balance	$	(3	)	$	(29	)	$	9		$	(26	)
Total realized and unrealized gains (losses):
Included in net income		4			19			23			63
Included in other comprehensive income		-			-			4			-
Transfers to Level 2		-			-			(30	)		-
Purchases		-			1			2			1
Sales		-			-			-			(23	)
Issuances		-			-			-			(44	)
Settlements		1			8			(6	)		28
Ending balance	$	2		$	(1	)	$	2		$	(1	)

Related to the derivatives in Level 3, net income for the third quarter and first nine months of 2010 included unrealized gains of $3 million related to instruments held at September 30, 2010. Net income for third quarter and first nine months of 2009 included unrealized gains of $4 million and unrealized losses of $20 million related to instruments held on those dates. See Note 12 for the income statement impacts of our derivative instruments.

Fair Values - Nonrecurring

The following tables show the values of assets, by major class, measured at fair value on a nonrecurring basis in periods subsequent to their initial recognition.

		Three Months Ended September 30,
		2010					2009
(In millions)		Fair Value			Impairment		Fair Value		Impairment
Equity method investment	$	-	$		25	$	-	$	-

		Nine Months Ended September 30,
		2010					2009
(In millions)		Fair Value			Impairment		Fair Value		Impairment
Long-lived assets held for use	$	146		$	467	$	5	$	15
Long-lived assets held for sale		-			-		311		154
Equity method investment		-			25		-		-

In the third quarter of 2010, we fully impaired our Integrated Gas segment’s equity method investment in an entity engaged in gas-to-fuels related technology. This investment was determined to have sustained an other than temporary loss in value. Based upon recent financial information, the fair value was measured with an income approach using internally developed estimates of future cash flows. These cash flows are Level 3 inputs.

In March 2010, we completed a reservoir study which resulted in a portion of our Powder River Basin field being removed from plans for future development in our E&P segment. The field’s fair value was measured at $144 million, using an income approach based upon internal estimates of future production levels, prices and discount rate which are Level 3 inputs. This resulted in an impairment of $423 million.

As a result of changing market conditions, a supply agreement with a major customer was revised in June 2010. An impairment of $28 million was recorded for a plant that manufactures maleic anhydride. The plant was operated by our RM&T segment. The fair value was measured using a market approach based upon comparable area land values which are Level 3 inputs.

Notes to Consolidated Financial Statements (Unaudited)

Several other long-lived assets held for use in our E&P segment were evaluated for impairment in the nine months ended September 30, 2010 and the comparable period of 2009 due to reduced drilling expectations, reduction of estimated reserves or declining natural gas prices. The fair values of the assets were measured using an income approach based upon internal estimates of future production levels, prices and discount rate, which are Level 3 inputs.

The impairment charge recorded on assets held for sale in the second quarter of 2009 related to the sale of the Corrib natural gas development offshore Ireland and was based on a fair value of anticipated sale proceeds (see Note 5). Fair value of anticipated sale proceeds includes (1) $100 million received at closing, (2) $135 million minimum amount due at the earlier of first gas or December 31, 2012, and (3) a range of contingent proceeds subject to the timing of first gas. The fair value of the total proceeds was measured using an income method that incorporated a probability-weighted approach with respect to timing of first commercial gas and an associated sliding scale on the amount of corresponding consideration specified in the sales agreement: the longer it takes to achieve first gas, the lower the amount of the consideration. Because a portion of the proceeds is variable in timing and amount depending upon timing of first commercial gas, the inputs to the fair value calculation were classified as Level 3 inputs.

Fair Values – Reported

The following table summarizes financial instruments, excluding the derivative financial instruments, and their reported fair value by individual balance sheet line item at September 30, 2010 and December 31, 2009: