10-Q 1 form10q2012q1.htm MARATHON OIL CORPORATION FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012 form10q2012q1.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 June 30, 2012

OR

[   ]
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 Street, 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 þ 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 þ 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    þ  
Accelerated filer            o
Non-accelerated filer       o        (Do not check if a smaller reporting company) 
Smaller reporting company        o   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).         Yes þ No o
 
There were 705,432,356 shares of Marathon Oil Corporation common stock outstanding as of June 29, 2012.
 




 
 
 
 


MARATHON OIL CORPORATION
 
Form 10-Q
 
Quarter Ended June 30, 2012


 
INDEX
 
 
Page
PART I - FINANCIAL INFORMATION
Item 1.
Financial Statements:
 
 
Consolidated Statements of Income (Unaudited)
2
 
Consolidated Statements of Comprehensive Income (Unaudited)
3
 
Consolidated Balance Sheets (Unaudited)
4
 
Consolidated Statements of Cash Flows (Unaudited)
5
 
Notes to Consolidated Financial Statements (Unaudited)
6
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
18
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
30
Item 4.
Controls and Procedures
30
 
Supplemental Statistics (Unaudited)
31
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
33
Item 1A.
Risk Factors
33
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
33
Item 4.
Mine Safety Disclosures
33
Item 6.
Exhibits
34
 
Signatures
35

 
Unless the context otherwise indicates, references in this Form 10-Q to “Marathon Oil,” “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 Oil exerts significant influence by virtue of its ownership interest).

 
1
 
 
Part I - Financial Information
Item 1. Financial Statements
 
MARATHON OIL CORPORATION
Consolidated Statements of Income (Unaudited)
 

 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 30,
   
June 30,
 
(In millions, except per share data)
 
2012
   
2011
   
2012
   
2011
 
Revenues and other income:
 
 
   
 
   
 
   
 
 
   Sales and other operating revenues
  $ 3,718     $ 3,680     $ 7,495     $ 7,336  
   Sales to related parties
    13       14       27       29  
   Income from equity method investments
    60       120       138       237  
   Net gain (loss) on disposal of assets
    (28 )     45       138       50  
   Other income
    21       6       26       22  
             Total revenues and other income
    3,784       3,865       7,824       7,674  
Costs and expenses:
                               
   Cost of revenues (excludes items below)
    1,302       1,667       2,709       3,071  
   Purchases from related parties
    56       71       119       127  
   Depreciation, depletion and amortization
    580       564       1,154       1,199  
   Impairments
    1       307       263       307  
   General and administrative expenses
    130       130       250       267  
   Other taxes
    67       53       145       111  
   Exploration expenses
    173       145       315       375  
            Total costs and expenses
    2,309       2,937       4,955       5,457  
Income from operations
    1,475       928       2,869       2,217  
   Net interest and other
    (57 )     (13 )     (107 )     (32 )
   Loss on early extinguishment of debt
    -       -       -       (279 )
Income from continuing operations before income taxes
    1,418       915       2,762       1,906  
   Provision for income taxes
    1,025       617       1,952       1,153  
Income from continuing operations
    393       298       810       753  
Discontinued operations
    -       698       -       1,239  
Net income
  $ 393     $ 996     $ 810     $ 1,992  
Per Share Data
                               
 
                               
   Basic:
                               
       Income from continuing operations
  $ 0.56     $ 0.42     $ 1.15     $ 1.06  
       Discontinued operations
  $ -     $ 0.98     $ -     $ 1.74  
       Net income
  $ 0.56     $ 1.40     $ 1.15     $ 2.80  
   Diluted:
                               
       Income from continuing operations
  $ 0.56     $ 0.42     $ 1.14     $ 1.05  
       Discontinued operations
  $ -     $ 0.97     $ -     $ 1.73  
       Net income
  $ 0.56     $ 1.39     $ 1.14     $ 2.78  
   Dividends paid
  $ 0.17     $ 0.25     $ 0.34     $ 0.50  
 
                               
   Weighted average shares:
                               
       Basic
    706       713       705       712  
       Diluted
    709       717       709       716  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
2
 
 
MARATHON OIL CORPORATION
Consolidated Statements of Comprehensive Income (Unaudited)
 

 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 30,
   
June 30,
 
(In millions)
 
2012
   
2011
   
2012
   
2011
 
Net income
  $ 393     $ 996     $ 810     $ 1,992  
    Other comprehensive income
                               
         Postretirement and postemployment plans
                               
            Change in actuarial loss
    (3 )     64       10       97  
            Spin-off downstream business
    -       968       -       968  
            Income tax benefit (provision) on postretirement and
                               
               postemployment plans
    1       (403 )     (4 )     (415 )
                  Postretirement and postemployment plans, net of tax
    (2 )     629       6       650  
         Derivative hedges
                               
            Net unrecognized gain
    -       1       -       10  
            Spin-off downstream business
    -       (7 )     -       (7 )
            Income tax benefit (provision) on derivatives
    -       3       -       (1 )
                  Derivative hedges, net of tax
    -       (3 )     -       2  
         Foreign currency translation and other
                               
            Unrealized loss
    (1 )     (1 )     -       (1 )
            Income tax provision on foreign currency translation and other
    -       -       -       -  
                  Foreign currency translation and other, net of tax
    (1 )     (1 )     -       (1 )
Other comprehensive income (loss)
    (3 )     625       6       651  
Comprehensive income
  $ 390     $ 1,621     $ 816     $ 2,643  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
3
 
 
MARATHON OIL CORPORATION
Consolidated Balance Sheets (Unaudited)
 
 
 
 
 
   
 
 
 
 
June 30,
   
December 31,
 
(In millions, except per share data)
 
2012
   
2011
 
Assets
 
 
   
 
 
Current assets:
 
 
   
 
 
    Cash and cash equivalents
  $ 452     $ 493  
    Receivables
    2,047       1,917  
    Receivables from related parties
    17       35  
    Inventories
    335       361  
    Prepayments
    101       96  
    Deferred tax assets
    87       99  
    Other current assets
    215       223  
            Total current assets
    3,254       3,224  
Equity method investments
    1,319       1,383  
Property, plant and equipment, less accumulated depreciation,
               
   depletion and amortization of $17,777 and $17,248
    26,001       25,324  
Goodwill
    525       536  
Other noncurrent assets
    1,151       904  
            Total assets
  $ 32,250     $ 31,371  
Liabilities
               
Current liabilities:
               
    Commercial paper
  $ 550     $ -  
    Accounts payable
    2,158       1,864  
    Payables to related parties
    25       18  
    Payroll and benefits payable
    120       193  
    Accrued taxes
    1,440       2,015  
    Other current liabilities
    211       163  
    Long-term debt due within one year
    187       141  
            Total current liabilities
    4,691       4,394  
Long-term debt
    4,513       4,674  
Deferred income taxes
    2,534       2,544  
Defined benefit postretirement plan obligations
    761       789  
Asset retirement obligations
    1,489       1,510  
Deferred credits and other liabilities
    477       301  
            Total liabilities
    14,465       14,212  
                 
Commitments and contingencies
               
                 
Stockholders’ Equity
               
Preferred stock – no shares issued and outstanding (no par value,
               
          26 million shares authorized)
    -       -  
Common stock:
               
     Issued – 770 million and 770 million shares  (par value $1 per share,
               
          1.1 billion shares authorized)
    770       770  
     Securities exchangeable into common stock – no shares issued and
               
         outstanding (no par value, 29 million shares authorized)
    -       -  
     Held in treasury, at cost – 65 million and 66 million shares
    (2,646 )     (2,716 )
Additional paid-in capital
    6,667       6,680  
Retained earnings
    13,358       12,788  
Accumulated other comprehensive loss
    (364 )     (370 )
Total equity of Marathon Oil's stockholders
    17,785       17,152  
Noncontrolling interest
    -       7  
            Total equity
    17,785       17,159  
            Total liabilities and stockholders' equity
  $ 32,250     $ 31,371  
 
 
The accompanying notes are an integral part of these consolidated financial statements.




 
4
 
 
MARATHON OIL CORPORATION
Consolidated Statements of Cash Flows (Unaudited)
 

 
 
Six Months Ended
 
 
 
June 30,
 
(In millions)
 
2012
   
2011
 
Increase (decrease) in cash and cash equivalents
 
 
   
 
 
Operating activities:
 
 
   
 
 
Net income
  $ 810     $ 1,992  
Adjustments to reconcile net income to net cash provided by operating activities:
               
    Discontinued operations
    -       (1,239 )
    Loss on early extinguishment of debt
    -       279  
    Deferred income taxes
    75       (51 )
    Depreciation, depletion and amortization
    1,154       1,199  
    Impairments
    263       307  
    Pension and other postretirement benefits, net
    (22 )     22  
    Exploratory dry well costs and unproved property impairments
    174       264  
    Net gain on disposal of assets
    (138 )     (50 )
    Equity method investments, net
    7       (21 )
    Changes in:
               
          Current receivables
    (107 )     78  
          Inventories
    (18 )     46  
          Current accounts payable and accrued liabilities
    (450 )     372  
    All other operating, net
    (6 )     122  
               Net cash provided by continuing operations
    1,742       3,320  
               Net cash provided by discontinued operations
    -       1,090  
               Net cash provided by operating activities
    1,742       4,410  
Investing activities:
               
   Additions to property, plant and equipment
    (2,181 )     (1,702 )
   Disposal of assets
    218       371  
   Investments - return of capital
    21       36  
   Investing activities of discontinued operations
    -       (493 )
   Property deposit
    -       (100 )
   All other investing, net
    (59 )     15  
               Net cash used in investing activities
    (2,001 )     (1,873 )
Financing activities:
               
   Commercial paper, net
    550       -  
   Debt issuance costs
    (9 )     -  
   Debt repayments
    (111 )     (2,843 )
   Dividends paid
    (240 )     (356 )
   Financing activities of discontinued operations
    -       2,916  
   Distribution in spin-off
    -       (1,622 )
   All other financing, net
    20       126  
               Net cash provided by (used in) financing activities
    210       (1,779 )
Effect of exchange rate changes on cash
    8       2  
Net increase (decrease) in cash and cash equivalents
    (41 )     760  
Cash and cash equivalents at beginning of period
    493       3,951  
Cash and cash equivalents at end of period
  $ 452     $ 4,711  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
5
 
 
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.
 
 
As a result of the spin-off (see Note 2), the results of operations for our downstream (Refining, Marketing and Transportation) business have been classified as discontinued operations in 2011.  The disclosures in this report are presented on the basis of continuing operations, unless otherwise stated. Any reference to “Marathon” indicates Marathon Oil Corporation as it existed prior to the June 30, 2011 spin-off.
 
 
These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Marathon Oil Corporation (“Marathon Oil”) 2011 Annual Report on Form 10-K.  The results of operations for the second quarter and first six months of 2012 are not necessarily indicative of the results to be expected for the full year.
 

2.      Spin-off Downstream Business
 
On June 30, 2011, the spin-off of the downstream business was completed, creating two independent energy companies: Marathon Oil and Marathon Petroleum Corporation (“MPC”).  On June 30, 2011, stockholders of record as of 5:00 p.m. Eastern Daylight Savings time on June 27, 2011 (the “Record Date”) received one common share of MPC stock for every two common shares of Marathon stock held as of the Record Date.
 
 
The following table presents selected financial information regarding the results of operations of our downstream business which are reported as discontinued operations.  Transaction costs incurred to affect the spin-off of $57 million and $74 million for the second quarter and first six months of 2011 are included in discontinued operations.
 
 
Three Months Ended,
 
Six Months Ended
 
 
June 30,
 
June 30,
 
(In millions)
2011
 
2011
 
Revenues applicable to discontinued operations
  $ 20,760     $ 38,602  
Pretax income from discontinued operations
    1,244       2,012  

 
3.      Accounting Standards

Recently Adopted
 
In September 2011, the Financial Accounting Standards Board (“FASB”) amended accounting standards to simplify how entities test goodwill for impairment.  The amendment reduces complexity by allowing an entity the option to make a qualitative evaluation of whether it is necessary to perform the two-step goodwill impairment test.  The amendment is effective for our interim and annual periods beginning with the first quarter of 2012.  Adoption of this amendment did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
The FASB amended the reporting standards for comprehensive income in June 2011 to eliminate the option to present the components of Other Comprehensive Income (“OCI”) as part of the statement of changes in stockholders' equity.  All non-owner changes in stockholders’ equity are required to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In the two statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of OCI, and total comprehensive income.  The presentation of items that are reclassified from OCI to net income on the income statement is also required.  The amendments did not change the items that must be reported in OCI or when an item of OCI must be reclassified to net income.  The amendments are effective for us beginning with the first quarter of 2012, except for the presentation of reclassifications, which has been deferred.  Adoption of these amendments did not have a significant impact on our consolidated results of operations, financial position or cash flows.
 

 
6
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

 
In May 2011, the FASB issued an update amending the accounting standards for fair value measurement and disclosure, resulting in common principles and requirements under accounting principles generally accepted in the U.S. (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”).  The amendments change the wording used to describe certain of the U.S. GAAP requirements either to clarify the intent of existing requirements, to change measurement or expand disclosure principles or to conform to the wording used in IFRS.  The amendments are to be applied prospectively for our interim and annual periods beginning with the first quarter of 2012.  The adoption of the amendments did not have a significant impact on our consolidated results of operations, financial position or cash flows.  To the extent they were necessary, we have made the expanded disclosures in Note 13.
 
 
4.      Variable Interest Entity
 
 
The owners of 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 and Jackpine mines, 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 $3 million current liability recorded at June 30, 2012.  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 Variable Interest Entity (“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 by Marathon Oil.  Our maximum exposure to loss as a result of our involvement with this VIE is the amount we expect to pay over the contract term, which was $703 million as of June 30, 2012.  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.
 

5.      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 June 30,
 
   
2012
   
2011
 
(In millions, except per share data)
 
Basic
   
Diluted
   
Basic
   
Diluted
 
Income from continuing operations
  $ 393     $ 393     $ 298     $ 298  
Discontinued operations
    -       -       698       698  
Net income
  $ 393     $ 393     $ 996     $ 996  
                                 
Weighted average common shares outstanding
    706       706       713       713  
Effect of dilutive securities
    -       3       -       4  
Weighted average common shares, including dilutive effect
    706       709       713       717  
Per share:
                               
    Income from continuing operations
  $ 0.56     $ 0.56     $ 0.42     $ 0.42  
    Discontinued operations
  $ -     $ -     $ 0.98     $ 0.97  
    Net income
  $ 0.56     $ 0.56     $ 1.40     $ 1.39  
 
 
 
7
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
(In millions, except per share data)
 
Basic
   
Diluted
   
Basic
   
Diluted
 
Income from continuing operations
  $ 810     $ 810     $ 753     $ 753  
Discontinued operations
    -       -       1,239       1,239  
Net income
  $ 810     $ 810     $ 1,992     $ 1,992  
                                 
Weighted average common shares outstanding
    705       705       712       712  
Effect of dilutive securities
    -       4       -       4  
 Weighted average common shares, including dilutive effect
    705       709       712       716  
Per share:
                               
    Income from continuing operations
  $ 1.15     $ 1.14     $ 1.06     $ 1.05  
    Discontinued operations
  $ -     $ -     $ 1.74     $ 1.73  
    Net income
  $ 1.15     $ 1.14     $ 2.80     $ 2.78  
 
The per share calculations above exclude 10 million and 9 million stock options and stock appreciation rights for the second quarter and first six months of 2012, as they were antidilutive.  Excluded for the second quarter and first six months of 2011 were 5 million and 6 million stock options and stock appreciation rights.
 
 
6.      Acquisitions
 
In April 2012, we entered into agreements to acquire approximately 20,000 net acres in the core of the Eagle Ford shale. The smaller transactions closed during the second quarter of 2012.  The largest transaction, with a value of $750 million before closing adjustments, closed on August 1, 2012.
 

 7.      Dispositions
 
2012
 
In May 2012, we reached an agreement to relinquish our Exploration and Production (“E&P”) segment’s operatorship of and interests in the Bone Bay and Kumawa exploration licenses in Indonesia.  A $36 million payment will be made upon government ratification of the agreement, to settle all of our obligations related to these licenses, including well commitments.  This amount was accrued and reported as a loss on disposal of assets in the second quarter of 2012.
 
 
In April 2012, we entered into agreements to sell all of our E&P segment’s assets in Alaska.  One transaction closed in the second quarter of 2012 with proceeds and a net gain of $7 million.  The remaining transaction, with a value of $375 million before closing adjustments, is expected to close in the second half of 2012, pending regulatory approval and closing conditions.  Assets held for sale are included in the June 30, 2012 balance sheet as follows:
 

(In millions)
 
 
 
Other current assets
  $ 60  
Other noncurrent assets
    187  
     Total assets
    247  
Deferred credits and other liabilities
    87  
     Total liabilities
  $ 87  

 
In January 2012, we closed on the sale of our E&P segment’s interests in several Gulf of Mexico crude oil pipeline systems for proceeds of $206 million.  This includes our equity method interests in Poseidon Oil Pipeline Company, L.L.C. and Odyssey Pipeline L.L.C., as well as certain other oil pipeline interests, including the Eugene Island pipeline system.  A pretax gain of $166 million was recorded in the first quarter of 2012.
 

 
8
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

2011
 
 
In April 2011, we assigned a 30 percent undivided working interest in our E&P segment’s approximately 180,000 acres in the Niobrara shale play located within the DJ Basin of southeast Wyoming and northern Colorado for total consideration of $270 million, recording a pretax gain of $39 million.  We remain operator of this jointly owned leasehold.
 
 
In March 2011, we closed the sale of our E&P segment's outside-operated interests in the Gudrun field development and the Brynhild and Eirin exploration areas offshore Norway for net proceeds of $85 million, excluding working capital adjustments.  A $64 million pretax loss on this disposition was recorded in the fourth quarter of 2010.
 

8.      Segment Information
 
We have three 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; and
 
 
·  
Integrated Gas (“IG”) – produces and markets products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, in Equatorial Guinea.
 
 
Information regarding assets by segment is not presented because it is not reviewed by the chief operating decision maker (“CODM”).  Segment income represents income from continuing operations, net of income taxes, attributable to the operating segments. Our corporate general and administrative costs are not allocated to the operating segments. These costs primarily consist of employment costs (including pension effects), professional services, facilities and other costs associated with corporate activities, net of associated income tax effects.  Foreign currency transaction gains or losses are not allocated to operating segments.  Impairments, gains or losses on disposal of assets or other items that affect comparability (as determined by the CODM) also are not allocated to operating segments.
 
 
Differences between segment totals and our consolidated totals for income taxes and depreciation, depletion and amortization represent amounts related to corporate administrative activities and other unallocated items which are included in “Items not allocated to segments, net of income taxes” in the reconciliation below. Total capital expenditures include accruals but not corporate activities.
 
 
As discussed in Note 2, our downstream business was spun-off on June 30, 2011 and has been reported as discontinued operations in 2011.
 
   
Three Months Ended June 30, 2012
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
Revenues:
                       
    Customer
  $ 3,383     $ 335     $ -     $ 3,718  
    Related parties
    13       -       -       13  
        Total revenues
  $ 3,396     $ 335     $ -     $ 3,731  
Segment income
  $ 417     $ 51     $ 13     $ 481  
Income from equity method investments
    38       -       22       60  
Depreciation, depletion and amortization
    521       50       -       571  
Income tax provision
    1,110       17       5       1,132  
Capital expenditures
    1,184       43       1       1,228  
 
 
 
9
 
 

MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
   
Three Months Ended June 30, 2011
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
Revenues:
                       
    Customer
  $ 3,220     $ 447     $ 13     $ 3,680  
    Intersegment
    15       -       -       15  
    Related parties
    14       -       -       14  
        Segment revenues
    3,249       447       13       3,709  
    Elimination of intersegment revenues
    (15 )     -       -       (15 )
        Total revenues
  $ 3,234     $ 447     $ 13     $ 3,694  
Segment income
  $ 601     $ 69     $ 43     $ 713  
Income from equity method investments
    66       -       54       120  
Depreciation, depletion and amortization
    501       49       1       551  
Income tax provision
    598       23       17       638  
Capital expenditures
    749       80       -       829  

   
Six Months Ended June 30, 2012
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
Revenues:
                       
    Customer
  $ 6,781     $ 714     $ -     $ 7,495  
    Related parties
    27       -       -       27  
        Total revenues
  $ 6,808     $ 714     $ -     $ 7,522  
Segment income
  $ 894     $ 92     $ 17     $ 1,003  
Income from equity method investments
    102       -       36       138  
Depreciation, depletion and amortization
    1,037       99       -       1,136  
Income tax provision
    2,146       31       6       2,183  
Capital expenditures
    2,185       95       1       2,281  

   
Six Months Ended June 30, 2011
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
Revenues:
                       
    Customer
  $ 6,506     $ 753     $ 77     $ 7,336  
    Intersegment
    41       -       -       41  
    Related parties
    29       -       -       29  
        Segment revenues
    6,576       753       77       7,406  
    Elimination of intersegment revenues
    (41 )     -       -       (41 )
        Total revenues
  $ 6,535     $ 753     $ 77     $ 7,365  
Segment income
  $ 1,269     $ 101     $ 103     $ 1,473  
Income from equity method investments
    124       -       113       237  
Depreciation, depletion and amortization
    1,087       86       3       1,176  
Income tax provision
    1,211       33       43       1,287  
Capital expenditures
    1,417       200       1       1,618  

 
10
 
 
 
MARATHON OIL CORPORATION
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
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(In millions)
 
2012
   
2011
   
2012
   
2011
 
Segment income
  $ 481     $ 713     $ 1,003     $ 1,473  
Items not allocated to segments, net of income taxes:
                               
     Corporate and other unallocated items
    (65 )     (24 )     (109 )     (153 )
     Gain (loss) on dispositions (a)
    (23 )     24       83       24  
     Impairments(b)
    -       (195 )     (167 )     (195 )
     Tax effect of subsidiary restructuring
    -       (122 )     -       (122 )
     Loss on early extinguishment of debt(c)
    -       -       -       (176 )
     Deferred income tax items
    -       (50 )     -       (50 )
     Water abatement - Oil Sands
    -       (48 )     -       (48 )
         Income from continuing operations
    393       298       810       753  
         Discontinued operations
    -       698       -       1,239  
               Net income
  $ 393     $ 996     $ 810     $ 1,992  
(a)
Additional information on these gains and losses can be found in Note 7.
(b)
Impairments are discussed in Note 13.
(c)
Additional information on debt retired early can be found in Note 15.
 
 
The following reconciles total revenues to sales and other operating revenues as reported in the consolidated statements of income:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
(In millions)
2012
   
2011
 
2012
 
2011
 
Total revenues
  $ 3,731     $ 3,694     $ 7,522     $ 7,365  
Less:  Sales to related parties
    13       14       27       29  
    Sales and other operating revenues
  $ 3,718     $ 3,680     $ 7,495     $ 7,336  

 
9.      Defined Benefit Postretirement Plans
 
The following summarizes the components of net periodic benefit cost:
 
   
Three Months Ended June 30,
 
  
 
Pension Benefits
   
Other Benefits
 
(In millions)
 
2012
   
2011
   
2012
   
2011
 
Service cost
  $ 13     $ 10     $ 1     $ 1  
Interest cost
    16       16       3       4  
Expected return on plan assets
    (16 )     (16 )     -       -  
Amortization:
                               
    – prior service cost (credit)
    2       2       (1 )     (1 )
    – actuarial loss
    13       12       -       -  
Net periodic benefit cost
  $ 28     $ 24     $ 3     $ 4  
 
 
 
11
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

   
Six Months Ended June 30,
 
  
 
Pension Benefits
   
Other Benefits
 
(In millions)
 
2012
   
2011
   
2012
   
2011
 
Service cost
  $ 25     $ 23     $ 2     $ 2  
Interest cost
    32       33       7       8  
Expected return on plan assets
    (32 )     (33 )     -       -  
Amortization:
                               
    – prior service cost (credit)
    4       3       (3 )     (3 )
    – actuarial loss
    25       25       -       -  
Net periodic benefit cost
  $ 54     $ 51     $ 6     $ 7  
 
During the first six months of 2012, we made contributions of $68 million to our funded pension plans.  We expect to make additional contributions up to an estimated $50 million over the remainder of 2012.  Current benefit payments related to unfunded pension and other postretirement benefit plans were $6 million and $8 million during the first six months of 2012.
 

10.           Income Taxes
 
The effective income tax rate is influenced by a variety of factors including the geographic and functional sources of income and the relative magnitude of these sources of income.  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 “Corporate and other unallocated items” in Note 8.
 
 
Our effective tax rate in the first six months of 2012 was 71 percent.   This rate is higher than the U.S. statutory rate of 35 percent primarily due to earnings from foreign jurisdictions, primarily Norway and Libya, where the tax rates are in excess of the U.S. statutory rate.  An increase in earnings and associated taxes from foreign jurisdictions, primarily Norway, as compared to prior periods caused an increase in our valuation allowance on current year foreign tax credits.  In Libya, where the statutory tax rate is in excess of 90 percent, limited production resumed in the fourth quarter of 2011 and liquid hydrocarbon sales resumed in the first quarter of 2012.  A reliable estimate of 2012 annual ordinary income from our Libyan operations cannot be made and the range of possible scenarios when including ordinary income from our Libyan operations in the worldwide annual effective tax rate calculation demonstrates significant variability.  As such, for the first six months of 2012, an estimated annual effective tax rate was calculated excluding Libya and applied to consolidated ordinary income excluding Libya and the tax provision applicable to Libyan ordinary income was recorded as a discrete item in the period.  Excluding Libya, the effective tax rate would be 64 percent for the first six months of 2012.
 
 
Our effective tax rate in the first six months of 2011 was 60 percent which is higher than the U.S. statutory tax rate of 35 percent primarily due to earnings from foreign jurisdictions where the tax rates are in excess of the U.S. statutory rate and the valuation allowance recorded against 2011 foreign tax credits.  In addition, in the second quarter of 2011 we recorded a deferred tax charge related to an internal restructuring of our international subsidiaries.
 

 
12
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)


The following table summarizes the activity in unrecognized tax benefits:
 
 
Six Months Ended June 30,
 
(In millions)
 
2012
   
2011
 
Beginning balance
  $ 157     $ 103  
     Additions based on tax positions related to the current year
    2       2  
     Reductions based on tax positions related to the current year
    -       (2 )
     Additions for tax positions of prior years
    69       53  
     Reductions for tax positions of prior years
    (55 )     (8 )
     Settlements
    (7 )     (9 )
Ending balance
  $ 166     $ 139  
 
If the unrecognized tax benefits as of June 30, 2012 were recognized, $117 million would affect our effective income tax rate.  There were $16 million of uncertain tax positions as of June 30, 2012 for which it is reasonably possible that the amount of unrecognized tax benefits would decrease during the next twelve months.
 

11.           Inventories
 
Inventories are carried at the lower of cost or market value.
 
 
June 30,
 
December 31,
 
(In millions)
2012
 
2011
 
Liquid hydrocarbons, natural gas and bitumen
  $ 99     $ 147  
Supplies and sundry items
    236       214  
        Total inventories, at cost
  $ 335     $ 361  

 
12.           Property, Plant and Equipment
 
   
June 30,
   
December 31,
 
(In millions)
 
2012
   
2011
 
E&P
           
    United States
  $ 20,353     $ 19,679  
     International
    12,954       12,579  
          Total E&P
    33,307       32,258  
OSM
    10,031       9,936  
IG
    38       37  
Corporate
    402       341  
          Total property, plant and equipment
    43,778       42,572  
Less accumulated depreciation, depletion and amortization
    (17,777 )     (17,248 )
          Net property, plant and equipment
  $ 26,001     $ 25,324  
 
In the first quarter of 2011, production operations in Libya were suspended. In the fourth quarter of 2011, limited production resumed.  Since that time, average net sales volumes have increased to 44 thousand barrels per day (“mbbld”) in the second quarter of 2012 and 30 mbbld in the first six months of 2012.  We and our partners in the Waha concessions continue to assess the condition of our assets in Libya and uncertainty around sustained production and sales levels remains.
 
 
Exploratory well costs capitalized greater than one year after completion of drilling (“suspended”) were $254 million as of June 30, 2012.  The net increase in such costs related to changes in two areas.  Norway exploration costs of $55 million incurred between 2009 and 2011 have now been suspended for greater than one year, pending commencement of Boyla development which was submitted to the Norwegian government for approval June 2012.  Drilling on the Shenandoah prospect in the Gulf of Mexico resumed in June 2012.  Costs of $28 million related to Shenandoah are no longer suspended.
 

 
13
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

13.           Fair Value Measurements
 
Fair Values - Recurring
 
 
As of June 30, 2012 and December 31, 2011, balances related to interest rate swaps accounted for at fair value on a recurring basis were noncurrent assets of $16 million and $5 million. Foreign currency forwards accounted for at fair value on a recurring basis were current liabilities of $15 million at June 30, 2012.  See Note 14 for the income statement impacts of our derivative instruments.
 
 
Interest rate swaps are measured at fair value with a market approach using actionable broker quotes which are Level 2 inputs.  Foreign currency forwards are measured at fair value with a market approach using third-party pricing services, such as Bloomberg L.P., which have been corroborated with data from active markets for similar assets and liabilities, and are Level 2 inputs.
 
 
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
 
Six Months Ended
 
 
June 30,
 
June 30,
 
(In millions)
2012
 
2011
 
2012
 
2011
 
Beginning balance
  $ -     $ (1 )   $ -     $ (2 )
          Included in net income
    -       1       -       -  
     Settlements
    -       (2 )     -       -  
     Spin-off downstream business
    -       2       -       2  
Ending balance
  $ -     $ -     $ -     $ -  
 
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 June 30,
   
2012 
   
2011 
(In millions)
 
Fair Value
   
Impairment
   
Fair Value
   
Impairment
Long-lived assets held for use
$
 
$
 
$
226 
 
$
282 
Intangible assets
$
 
$
 
$
 
$
25 
 
 
   
Six Months Ended June 30,
   
2012 
   
2011 
(In millions)
 
Fair Value
   
Impairment
   
Fair Value
   
Impairment
Long-lived assets held for use
$
75 
 
$
263 
 
$
226 
 
$
282 
Intangible assets
$
 
$
 
$
 
$
25 
 
Our E&P segment’s Ozona development in the Gulf of Mexico began production in December 2011.  During the first quarter of 2012, production rates declined significantly and have remained below initial expectations.  Accordingly, our reserve engineers performed an evaluation of our future production as well as our reserves which concluded in early April 2012.  This resulted in a 2 million barrel of oil equivalent reduction in proved reserves and a $261 million impairment charge in the first quarter of 2012.  The fair value of the Ozona development was determined using an income approach based upon internal estimates of future production levels, prices and discount rate, all Level 3 inputs.  Inputs to the fair value measurement included reserve and production estimates made by our reservoir engineers, estimated liquid hydrocarbon prices based on the Louisiana Light Sweet 12-month price range, as we think production will not be significant beyond twelve months, adjusted for quality and location differentials, and forecasted operating expenses for the remaining estimated life of the reservoir.
 
 
In May 2011, significant water production and reservoir pressure declines occurred at our E&P segment’s Droshky development in the Gulf of Mexico. Consequently, 3.4 million barrels of oil equivalent of proved reserves were written off and a $273 million impairment of this long-lived asset to fair value was recorded in the second quarter of 2011.  The $226 million fair value of the Droshky development was determined using an income approach based upon internal estimates of future production levels, prices and discount rate, all Level 3 inputs.
 

 
14
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 
In the second quarter of 2011, our outlook for U.S. natural gas prices indicated that it was unlikely that sufficient U.S. demand for LNG would materialize by 2021, which is when our rights lapse under arrangements at the Elba Island, Georgia regasification facility.  Using an income approach based upon internal estimates of natural gas prices and future deliveries, which are Level 3 inputs, we determined that the contract had no remaining fair value and recorded a full impairment of this intangible asset held in our Integrated Gas segment.
 
 
Other impairments of long-lived assets held for use by our E&P segment in the second quarter and first six months of 2012 and 2011 were a result of reduced drilling expectations, reduction of estimated reserves or declining natural gas prices.  The fair values of those assets were measured using an income approach based upon internal estimates of future production levels, commodity prices and discount rate, which are Level 3 inputs.
 
 
Natural gas prices began declining in September 2011 and have continued to decline in 2012.  Should natural gas prices remain depressed, additional impairment charges related to our natural gas assets may be necessary.
 
 
Fair Values – Reported
 
 
Our current assets and liabilities include financial instruments, the most significant of which are accounts receivables and payables.  We believe the carrying values of these current assets and liabilities approximate fair value.  Our fair value assessment incorporates a variety of considerations, including (1) the short-term duration of the instruments, (2) our investment-grade credit rating, and (3) our historical incurrence of and expected future insignificance of bad debt expense, which includes an evaluation of counterparty credit risk.  An exception to this assessment is the current portion of our long-term debt, which is reported with long-term debt and discussed below.
 
 
The following table summarizes financial instruments, excluding trade accounts receivables and payables and derivative financial instruments, and their reported fair value by individual balance sheet line item at June 30, 2012 and December 31, 2011:
 

   
June 30, 2012
   
December 31, 2011
 
   
Fair
   
Carrying
   
Fair
   
Carrying
 
(In millions)
 
Value
   
Amount
   
Value
   
Amount
 
Financial assets
                       
     Other current assets
  $ 131     $ 136     $ 146     $ 148  
     Other noncurrent assets
    198       198       68       68  
          Total financial assets  
    329       334       214       216  
Financial liabilities
                               
     Long-term debt, including current portion(a)
    5,447       4,643       5,479       4,753  
     Deferred credits and other liabilities
    122       121       36       38  
          Total financial liabilities  
  $ 5,569     $ 4,764     $ 5,515     $ 4,791  
(a)      Excludes capital leases.
 
        Fair values of our remaining financial assets included in other current assets and other noncurrent assets and of our financial liabilities included in deferred credits and other liabilities are measured using an income approach and most inputs are internally generated, which results in a Level 3 classification.  Estimated future cash flows are discounted using a rate deemed appropriate to obtain the fair value.
 
 
Over 90 percent of our long-term debt instruments are publicly-traded.  A market approach based upon quotes from major financial institutions is used to measure the fair value of such debt.  Because these quotes cannot be independently verified to an active market they are considered Level 3 inputs.   The fair value of our debt that is not publicly-traded is measured using an income approach.  The future debt service payments are discounted using the rate at which we currently expect to borrow.  All inputs to this calculation are Level 3.
 

14.           Derivatives
 
 
As of June 30, 2012, our outstanding derivative positions were fair value hedges.  Interest rate swaps with an asset value of $16 million are reported in Other noncurrent assets and foreign currency forwards with a liability value of $15 million are located in Other current liabilities on the consolidated balance sheet.
 
 
As of December 31, 2011, our derivatives outstanding were interest rate swaps that were fair value hedges, which had an asset value of $5 million and are located on the consolidated balance sheet in Other noncurrent assets.
 
 
 For information regarding the fair value measurement of derivative instruments, see Note 13.
 

 
15
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

 
Derivatives Designated as Fair Value Hedges
 
 
As of June 30, 2012, we had multiple interest rate swap agreements with a total notional amount of $600 million at a weighted average, London Interbank Offer Rate (“LIBOR”)-based, floating rate of  4.72 percent.
 
 
As of June 30, 2012, our foreign currency forwards had an aggregate notional amount of 3,310 million Norwegian Kroner at a weighted average forward rate of 5.825. These forwards hedge our current Norwegian tax liability and have settlement dates through December 2012.
 
 
In connection with the debt retired in February and March 2011 discussed in Note 15, we settled interest rate swaps with a notional amount of $1,450 million.
 
 
The pretax effect of derivative instruments designated as hedges of fair value in our consolidated statements of income are summarized in the table below.
 
     
Gain (Loss)
 
     
Three Months Ended
   
Six Months Ended
 
     
June 30,
   
June 30,
 
(In millions)
Income Statement Location
 
2012
   
2011
   
2012
   
2011
 
Derivative
                         
     Interest rate
Net interest and other
  $ 12     $ 3     $ 12     $ (1 )
     Interest rate
Loss on early extinguishment of debt
    -       -       -       29  
     Foreign currency
Provision for income taxes
  $ (32 )   $ -     $ (40 )   $ -  
Hedged Item
                                 
     Long-term debt
Net interest and other
  $ (12 )   $ (3 )   $ (12 )   $ 1  
     Long-term debt
Loss on early extinguishment of debt
    -       -       -       (29 )
     Accrued taxes
Provision for income taxes
  $ 32     $ -     $ 40     $ -  

 
15.           Debt
 
 
At June 30, 2012, we had no borrowings against our revolving credit facility, described below, and $550 million in commercial paper outstanding under our U.S. commercial paper program that is backed by the revolving credit facility.
 
 
In April 2012, we terminated our $3.0 billion five-year revolving credit facility and replaced it with a new $2.5 billion unsecured five-year revolving credit facility (the “Credit Facility”).  The Credit Facility matures in April 2017 but allows us to request two one-year extensions.   It contains an option to increase the commitment amount by up to an additional $1.0 billion, subject to the consent of any increasing lenders, and includes sub-facilities for swing-line loans and letters of credit up to an aggregate amount of $100 million and $500 million, respectively.  Fees on the unused commitment of each lender range from 10 basis points to 25 basis points depending on our credit ratings.  Borrowings under the Credit Facility bear interest, at our option, at either (a) an adjusted LIBOR rate plus a margin ranging from 87.5 basis points to 162.5 basis points per year depending on our credit ratings or (b) the Base Rate plus a margin ranging from 0.0 basis points to 62.5 basis points depending on our credit ratings.  Base Rate is defined as a per annum rate equal to the greatest of (a) the prime rate, (b) the federal funds rate plus one-half of one percent and (c) LIBOR for a one-month interest period plus 1 percent.
 
 
The agreement contains a covenant that requires our ratio of total debt to total capitalization not to exceed 65 percent as of the last day of each fiscal quarter.  If an event of default occurs, the lenders may terminate the commitments under the Credit Facility and require the immediate repayment of all outstanding borrowings and the cash collateralization of all outstanding letters of credit under the Credit Facility.
 
 
In the second quarter of 2012, we retired the remaining $23 million principal amount of our 5.375 percent revenue bonds due December 2013.  No gain or loss was recorded on this early extinguishment of debt.  During the first quarter of 2012, $53 million principal amount of debt carrying a 9.375 percent interest rate was repaid at maturity.
 
 
During the first quarter of 2011, we retired $2,498 million aggregate principal amount of debt at a weighted average price equal to 112 percent of face value. A $279 million loss on early extinguishment of debt was recognized in the first quarter of 2011.  The loss includes related deferred financing and premium costs partially offset by the gain on settled interest rate swaps.
 
 

 
16
 
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

16.           Incentive Based Compensation Plans
 
Stock Option and Restricted Stock Awards
 
 
The following table presents a summary of stock option award and restricted stock award activity for the first six months of 2012:
 
   
Stock Options
   
Restricted Stock
 
         
Weighted
         
Weighted
 
   
Number of
   
Average
         
Average Grant
 
   
Shares
   
Exercise Price
   
Awards
   
Date Fair Value
 
Outstanding at December 31, 2011
    21,370,715     $ 24.41       3,703,978     $ 25.88  
  Granted
    1,462,779 (a)     35.06       1,219,174       34.59  
  Options Exercised/Stock Vested
    (906,193 )     18.73       (310,575 )     20.94  
  Cancelled
    (293,478 )     27.77       (161,439 )     27.41  
Outstanding at June 30, 2012
    21,633,823     $ 25.33       4,451,138     $ 28.55  
(a)    The weighted average grant date fair value of stock option awards granted was $11.62 per share.
 
 
Performance Unit Awards
 
 
During the first quarter of 2012, we granted 13 million performance units to executive officers.  These units have a 36-month performance period.
 


17.           Supplemental Cash Flow Information
   
Six Months Ended June 30,
 
(In millions)
 
2012
   
2011
 
Net cash provided from operating activities:
           
     Interest paid (net of amounts capitalized)
  $ 113     $ 83  
     Income taxes paid to taxing authorities
    2,317       1,351  
Commercial paper and revolving credit arrangements, net:
               
     Commercial paper - issuances
  $ 4,252     $ -  
                                     - repayments
    (3,702 )     -  
          Total
  $ 550     $ -  
Noncash investing activities:
               
     Debt payments made by United States Steel
  $ 14     $ 14  
     Change in capital expenditure accrual
    159       (54 )

18.           Commitments and Contingencies
 
We are defendant in a number of lawsuits arising in the ordinary course of business, including, but not limited to, royalty claims, contract claims and environmental claims.  While the ultimate outcome and impact to us cannot be predicted with certainty, we believe the resolution of these proceedings will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.  Certain of these matters are discussed below.
 
 
Litigation In March 2011, Noble Drilling (U.S.) LLC (“Noble”) filed a lawsuit against us in the District Court of Harris County, Texas, alleging, among other things, breach of contract, breach of the duty of good faith and fair dealing, and negligent misrepresentation, relating to a multi-year drilling contract for a newly constructed drilling rig to be deployed in the U.S. Gulf of Mexico.  We filed an answer in April 2011, contending, among other things, failure to perform, failure to comply with material obligations, failure to mitigate alleged damages and that Noble failed to provide the rig according to the operating, performance and safety requirements specified in the drilling contract. Noble is seeking an unspecified amount for damages.  We are vigorously defending this litigation.  The ultimate outcome of this lawsuit, including any financial effect on us, remains uncertain.  We do not believe an estimate of a reasonably probable loss (or range of loss) can be made for this lawsuit at this time.
 
 
Contractual commitments At June 30, 2012 and December 31, 2011, Marathon’s contract commitments to acquire property, plant and equipment were $1,021 million and $664 million.
 

 
17
 
 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
We are an international energy company with operations in the U.S., Canada, Africa, the Middle East and Europe.  Our operations are organized into three reportable segments:
 
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Exploration and Production (“E&P”) which explores for, produces and markets liquid hydrocarbons and natural gas on a worldwide basis.
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Oil Sands Mining (“OSM”) which 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.
w
Integrated Gas (“IG”) which produces and markets products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, in Equatorial Guinea.
 
Certain sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations include forward-looking statements concerning trends or events potentially affecting our business.  These statements typically contain words such as “anticipates,” “believes,” “estimates,” “expects,” “targets,” “plans,” “projects,” “could,” “may,” “should,” “would” or similar words indicating that future outcomes are uncertain.  In accordance with “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, these statements are accompanied by cautionary language identifying important factors, though not necessarily all such factors, which could cause future outcomes to differ materially from those set forth in the forward-looking statements.  For additional risk factors affecting our business, see Item 1A. Risk Factors in our 2011 Annual Report on Form 10-K.
 
 
Key Operating and Financial Activities
 
 
In the second quarter of 2012, notable items were:
 
·  
Net liquid hydrocarbon and natural gas sales volumes of 407 thousand barrels of oil equivalent per day (“mboed”), of which 66 percent was liquid hydrocarbons
 
·  
Net international liquid hydrocarbon sales volumes, for which average realizations have exceeded West Texas Intermediate (“WTI”) crude oil, were 66 percent of total liquid hydrocarbon sales
 
·  
Production from Libya increased over the first quarter of 2012, with average net sales of 44 mboed and production available for sale of 44 mboed in the second quarter
 
·  
Bakken shale average net sales volumes of 27 mboed, a 69 percent increase over the same quarter of last year
 
·  
Eagle Ford shale average net sales volumes of 21 mboed, an increase nearly 50 percent from the first quarter of 2012
 
·  
Turnarounds at our operated assets in Equatorial Guinea and Norway were completed in less time and at lower cost than originally anticipated
 
·  
Signed a new production sharing contract for an exploration block adjacent to the Alba field offshore Equatorial Guinea
 
·  
Cash-adjusted debt-to-capital ratio of 21 percent
 
·  
Replaced existing revolving credit facility with a new $2.5 billion facility expiring April 2017
 
Some significant third quarter activities through August 3, 2012 include:
 
·  
Re-entered Gabon with a non-operated 21 percent working interest in an exploration license
 
·  
Agreed to pursue exploration activities in Kenya and Ethiopia
 
·  
Closed farm out agreements on 35 percent working interests in the Harir and Safen blocks in the Kurdistan Region of Iraq
 
·  
Closed the largest previously announced acquisition in the Eagle Ford shale
 

 
18
 
 
 
Overview and Outlook
 
 
Exploration and Production
 
 
Production
 
 
Net liquid hydrocarbon and natural gas sales averaged 407 mboed during the second quarter and 395 mboed in the first six months of 2012 compared to 337 mboed and 368 mboed in the same periods of 2011.  The resumption of sales from Libya in the first quarter of 2012 after production had ceased there in February of 2011 was the most significant cause of our increased sales volumes.  Net liquid hydrocarbon sales volumes increased in the U.S. for both the quarter and first six months of 2012, reflecting the impact of the Eagle Ford shale assets acquired in the fourth quarter of 2011 and our ongoing development programs in the Eagle Ford, Bakken and Anadarko Woodford unconventional resource plays. In addition, net liquid hydrocarbon sales volumes from the U.K. were higher in the second quarter of 2012 than in the same period of 2011 due to the timing of liftings.
 
 
We continue to ramp up operations in the core of the Eagle Ford play in Texas where we had 20 operated rigs drilling and four hydraulic fracturing crews working as of June 30, 2012.  During the second quarter and first six months of 2012, we drilled 61 gross and 107 gross wells, with a total of 72 gross (50 net) wells brought to sales in the first six months of 2012. We have realized significant efficiencies in drilling over the past few months, reducing the average drilling time per well to 23 days.  With these gains in efficiencies, we believe we can reduce our operated rig count to 18 for the balance of 2012 and drill the 230 to 240 wells originally planned for 2012, along with 11 incremental wells associated with the acreage acquired on August 1, 2012.
 
 
To complement drilling and completion activity in the Eagle Ford shale, we continue to build infrastructure to support production growth across the operating area.  Approximately 210 miles of gathering lines were installed in the first six months of 2012, while four new central gathering and treating facilities were commissioned.  Five additional facilities are under construction.  We are now able to transport approximately 70 percent of our Eagle Ford production by pipeline.
 
 
 Average net sales volumes from the Bakken shale were 27 mboed and 26 mboed in the second quarter and first six months of 2012 compared to 16 mboed and 15 mboed in the same periods of 2011.  Our Bakken shale liquid hydrocarbon volumes average approximately 95 percent liquid hydrocarbons.  During the second quarter and first six months of 2012, we drilled 26 gross and 47 gross wells, with a total of 44 gross (37 net) wells brought to sales in the first six months of 2012.  We are reducing our operated rig count in the Bakken shale from eight to five in response to continued commodity price volatility and lower domestic liquid hydrocarbon prices. With this five-rig program, we expect to maintain our previously projected production levels over the next 12 to 18 months and to retain our core Bakken acreage.
 
 
In the Anadarko Woodford shale, net sales volumes averaged 6 mboed and 5 mboed during the second quarter and first six months of 2012 compared to 2 mboed and 1 mboed in the same periods of 2011.  Recent performance improvements are being driven by results in the Knox area.  During the second quarter of 2012, eight gross (five net) wells were brought to sales, with 17 gross (13 net) brought to sales in the first six months of 2012. In response to the continued decline in natural gas liquids prices and low natural gas prices, we are reducing our rig count in the Anadarko Woodford play from six to two.   We expect to maintain our projected 2012 production level and retain our core acreage in the play with this two-rig program over the next 12 to 18 months.
 
 
Our Ozona development in the Gulf of Mexico began production in December 2011.  During the first quarter of 2012, production rates declined significantly and have remained below initial expectations.  Accordingly, our reserve engineers performed an evaluation of our future production as well as our reserves which concluded in early April 2012.  This resulted in a 2 mmboe reduction in proved reserves and a $261 million impairment charge in the first quarter of 2012.
 
 
In the first quarter 2011, production operations in Libya were suspended. In the fourth quarter of 2011, limited production resumed so that during the second quarter and first six months of 2012, net sales volumes averaged 44 mboed and 31 mboed.  Some uncertainty concerning the sustainability of production and sales levels in Libya remains.  We and our partners in the Waha concessions continue to assess the condition of our assets.