A look behind the numbers shows that an accounting rule that took effect in January, and rising costs and taxes, are shaving a bit off the record-breaking first-quarter earnings reported by exploration and production companies and natural gas majors. In a few cases, these factors actually caused companies to report a loss for the quarter-despite soaring commodity prices and production volumes that are creeping upward. The bottom line: in good times like these, margins are adversely affected as costs escalate. Companies face rising drilling costs and lengthening wait times for drilling and completion rigs, frac jobs and other field services. But they also are experiencing rising lease operating costs and higher tax bills. And, if they compensate key employees based on rising production numbers or improved cash flow, then performance-based payroll checks are also getting bigger. When oil and gas prices and production volumes go up, so do state severance taxes and depreciation. Added to that is a new twist this year. In January the Financial Accounting Standards Board implemented Rule 133, which requires all companies to mark-to-market their hedging and derivatives positions at the end of each quarter. In a March 26 press release, El Paso Corp. warned that its noncash charges related to 133 might be as high as $1.27 billion, after taxes. About $821 million would be allocated to El Paso's hedging position and the balance to Coastal Corp., which it acquired recently. "These noncash charges do not affect reported earnings, but do directly impact stockholders' equity," the press release says. "...The charge largely represents the opportunity cost of natural gas hedges in place as of December 31, 2000...as these hedges roll off over time, these FASB 133 charges should be reduced." Indeed, when El Paso finally reported first-quarter results on April 24, the actual charges resulted in a net loss of $400 million for the quarter. El Paso blamed it on merger costs incurred in the Coastal transaction. Oil and gas revenues net of hedging activity rose 61% for Belco Oil & Gas Corp. However, the company's first-quarter net income was reduced by 13 cents per basic common share after accounting for FASB 133, to 82 cents per share. At Cross Timbers Oil Co. the effect of FASB 133 was similar. The primarily gas-producing company recorded a first-quarter, after-tax charge of $44.6 million, thereby reducing earnings by about half, from $1.14 per share to 59 cents per share. Pioneer Natural Resources took a mark-to-market charge of $8.8 million or 9 cents per share related to derivatives not treated as hedges. It also said production costs rose 11% over the prior quarter, to an average $5.59 per barrel of oil equivalent, primarily due to higher taxes and field fuel costs. Because of FASB 133, Newfield Exploration also took a noncash charge. That reduced earnings by $5.8 million or 11 cents per share, to $58.4 million-still far above the $15.2 million the Houston producer earned a year ago in the first quarter. Newfield's rising costs are typical. For the first quarter, certain costs per thousand cubic feet equivalent (Mcfe) rose 50 cents. Lease operating expense rose 3 cents per Mcfe over the prior-year's first quarter. Production taxes rose 13 cents to 18 cents per Mcfe. G&A expense, attributed to performance-based pay and increases in the company's staff due its acquisition of Lariat Petroleum in Tulsa, rose 7 cents per Mcfe. Depreciation, depletion and amortization rose 22 cents per Mcfe and interest expense was up a nickel per Mcfe.
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