UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                          to                                         

Marathon Oil Corporation

(Exact name of registrant as specified in its charter)

Delaware		25-0996816
(State of Incorporation)		(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)

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ       Accelerated filer o       Non-accelerated filer o

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

There were 358,165,724 shares of Marathon Oil Corporation common stock outstanding as of July 31, 2006.

 

 

MARATHON OIL CORPORATION
Form 10-Q
Quarter Ended June 30, 2006

INDEX

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Income (Unaudited)			3
Consolidated Balance Sheets (Unaudited)			4
Consolidated Statements of Cash Flows (Unaudited)			5
Selected 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			33
Supplemental Statistics			34
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			36
Item 1A. Risk Factors			36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			36
Item 4. Submission of Matters to a Vote of Security Holders			37
Item 6. Exhibits			38
Signatures			39
Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
Computation of Ratio of Earnings to Fixed Charges
Certification Pursuant to Rule 13(a)-14 and 15(d)-14
Certification Pursuant to Rule 13(a)-14 and 15d-14
Certification Pursuant to 18 U.S.C. Section 1350
Certification Pursuant to 18 U.S.C. Section 1350

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, typically between 20 and 50 percent). Effective September 1, 2005, Marathon Ashland Petroleum LLC changed its name to Marathon Petroleum Company LLC. In this Form 10-Q, references to Marathon Petroleum Company LLC (“MPC”) are references to the entity formerly known as Marathon Ashland Petroleum LLC.

Part I — Financial Information

MARATHON OIL CORPORATION

		Second Quarter Ended								Six Months Ended
		June 30,								June 30,
(Dollars in millions, except per share data)		2006				2005				2006				2005
Revenues and other income:
Sales and other operating revenues (including consumer excise taxes)		$	15,962			$	12,009			$	28,862			$	21,796
Revenues from matching buy/sell transactions			1,806				3,565				5,012				6,374
Sales to related parties			411				368				723				651
Income from equity method investments			97				45				189				84
Net gains on disposal of assets			5				23				16				34
Other income			9				14				27				40
Total revenues and other income			18,290				16,024				34,829				28,979
Costs and expenses:
Cost of revenues (excludes items below)			11,628				9,255				21,387				16,936
Purchases related to matching buy/sell transactions			1,750				3,442				4,983				6,274
Purchases from related parties			47				63				98				119
Consumer excise taxes			1,277				1,210				2,442				2,294
Depreciation, depletion and amortization			369				321				769				631
Selling, general and administrative expenses			308				268				595				527
Other taxes			91				78				188				157
Exploration expenses			66				36				137				66
Total costs and expenses			15,536				14,673				30,599				27,004
Income from operations			2,754				1,351				4,230				1,975
Net interest and other financing costs (income)			(9	)			35				14				68
Minority interests in income (loss) of:
Marathon Petroleum Company LLC			—				314				—				384
Equatorial Guinea LNG Holdings Limited			(2	)			—				(5	)			(1	)
Income from continuing operations before income taxes			2,765				1,002				4,221				1,524
Provision for income taxes			1,281				334				1,966				533
Income from continuing operations			1,484				668				2,255				991
Discontinued operations			264				5				277				6
Net income		$	1,748			$	673			$	2,532			$	997
Per Share Data
Basic:
Income from continuing operations		$	4.11			$	1.93			$	6.21			$	2.86
Discontinued operations		$	0.73			$	0.01			$	0.76			$	0.02
Net income		$	4.84			$	1.94			$	6.97			$	2.88
Diluted:
Income from continuing operations		$	4.07			$	1.91			$	6.16			$	2.84
Discontinued operations		$	0.73			$	0.01			$	0.75			$	0.02
Net income		$	4.80			$	1.92			$	6.91			$	2.86
Dividends paid		$	0.40			$	0.28			$	0.73			$	0.56

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

MARATHON OIL CORPORATION

		June 30,				December 31,
(Dollars in millions, except per share data)		2006				2005
Assets
Current assets:
Cash and cash equivalents		$	3,026			$	2,617
Receivables, less allowance for doubtful accounts of $3 and $3			4,210				3,476
Receivables from United States Steel			21				20
Receivables from related parties			58				38
Inventories			3,817				3,041
Other current assets			173				191
Total current assets			11,305				9,383
Investments and long-term receivables, less allowance for doubtful accounts of $9 and $10			1,882				1,864
Receivables from United States Steel			510				532
Property, plant and equipment, less accumulated depreciation, depletion and amortization of $12,902 and $12,384			15,110				15,011
Goodwill			1,286				1,307
Intangible assets, less accumulated amortization of $65 and $58			192				200
Other noncurrent assets			165				201
Total assets		$	30,450			$	28,498
Liabilities
Current liabilities:
Accounts payable		$	6,140			$	5,353
Consideration payable under Libya re-entry agreement			212				732
Payables to related parties			166				82
Payroll and benefits payable			263				344
Accrued taxes			1,012				782
Deferred income taxes			438				450
Accrued interest			89				96
Long-term debt due within one year			456				315
Total current liabilities			8,776				8,154
Long-term debt			3,224				3,698
Deferred income taxes			2,114				2,030
Employee benefits obligations			1,263				1,321
Asset retirement obligations			754				711
Payable to United States Steel			5				6
Deferred credits and other liabilities			346				438
Total liabilities			16,482				16,358
Minority interests in Equatorial Guinea LNG Holdings Limited			479				435
Commitments and contingencies
Stockholders’ Equity
Common stock issued — 367,677,611 and 366,925,852 shares (par value $1 per share, 550,000,000 shares authorized)			368				367
Common stock held in treasury, at cost — 7,600,887 and 179,977 shares			(569	)			(8	)
Additional paid-in capital			5,150				5,111
Retained earnings			8,672				6,406
Accumulated other comprehensive loss			(132	)			(151	)
Unearned compensation			—				(20	)
Total stockholders’ equity			13,489				11,705
Total liabilities and stockholders’ equity		$	30,450			$	28,498

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

MARATHON OIL CORPORATION

		Six Months Ended June 30,
(Dollars in millions)		2006				2005
Increase (decrease) in cash and cash equivalents
Operating activities:
Net income		$	2,532			$	997
Adjustments to reconcile to net cash provided from operating activities:
Income from discontinued operations			(277	)			(6	)
Deferred income taxes			134				(33	)
Minority interests in income (loss) of subsidiaries			(5	)			383
Depreciation, depletion and amortization			769				631
Pension and other postretirement benefits, net			(41	)			33
Exploratory dry well costs and unproved property impairments			69				25
Net gains on disposal of assets			(16	)			(34	)
Equity method investments, net			(141	)			(25	)
Changes in the fair value of long-term U.K. natural gas contracts			(61	)			224
Changes in:
Current receivables			(833	)			(357	)
Inventories			(777	)			(643	)
Current accounts payable and accrued expenses			916				269
All other, net			(39	)			5
Net cash provided from continuing operations			2,230				1,469
Net cash provided from discontinued operations			69				51
Net cash provided from operating activities			2,299				1,520
Investing activities:
Capital expenditures			(1,308	)			(1,179	)
Acquisitions			(543	)			(497	)
Disposal of assets			49				63
Disposal of discontinued operations			832				—
Investments - loans and advances			(2	)			(36	)
- repayments of loans and advances			146				5
Investing activities of discontinued operations			(45	)			(47	)
All other, net			14				(16	)
Net cash used in investing activities			(857	)			(1,707	)
Financing activities:
Commercial paper issued			—				590
Debt repayments			(303	)			(4	)
Issuance of common stock			19				61
Purchases of common stock			(554	)			—
Excess tax benefits from stock-based compensation arrangements			14				—
Dividends paid			(265	)			(194	)
Distributions to minority shareholder of Marathon Petroleum Company LLC			—				(272	)
Contributions from minority shareholders of Equatorial Guinea LNG Holdings Limited			41				112
Net cash provided from (used in) financing activities			(1,048	)			293
Effect of exchange rate changes on cash:
Continuing operations			14				(13	)
Discontinued operations			1				—
Net increase in cash and cash equivalents			409				93
Cash and cash equivalents at beginning of period			2,617				3,369
Cash and cash equivalents at end of period		$	3,026			$	3,462

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

MARATHON OIL CORPORATION

1.		Basis of Presentation
		These consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair presentation of the results for the periods reported. All such adjustments are of a normal recurring nature unless disclosed otherwise. These consolidated financial statements, including selected 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 of prior year data have been made to conform to 2006 classifications. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the 2005 Annual Report on Form 10-K of Marathon Oil Corporation (“Marathon” or the “Company”).
2.		New Accounting Standards
		EITF Issue No. 04-13
		In September 2005, the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty.” The consensus establishes the circumstances under which two or more inventory purchase and sale transactions with the same counterparty should be recognized at fair value or viewed as a single exchange transaction subject to Accounting Principles Board (“APB”) Opinion No. 29, “Accounting for Nonmonetary Transactions.” In general, two or more transactions with the same counterparty must be combined for purposes of applying APB Opinion No. 29 if they are entered into in contemplation of each other. The purchase and sale transactions may be pursuant to a single contractual arrangement or separate contractual arrangements and the inventory purchased or sold may be in the form of raw materials, work-in-process or finished goods.
		Effective April 1, 2006, Marathon adopted the provisions of EITF Issue No. 04-13 prospectively. EITF Issue No. 04-13 changes the accounting for matching buy/sell arrangements that are entered into or modified on or after April 1, 2006 (except for those accounted for as derivative instruments, which are discussed below). In a typical matching buy/sell transaction, Marathon enters into a contract to sell a particular quantity and quality of crude oil or refined petroleum products at a specified location and date to a particular counterparty and simultaneously agrees to buy a particular quantity and quality of the same commodity at a specified location on the same or another specified date from the same counterparty. Prior to adoption of EITF Issue No. 04-13, Marathon recorded such matching buy/sell transactions in both revenues and cost of revenues as separate sale and purchase transactions. Upon adoption, these transactions are accounted for as exchanges of inventory.
		The scope of EITF Issue No. 04-13 excludes matching buy/sell arrangements that are accounted for as derivative instruments. A portion of Marathon’s matching buy/sell transactions are “nontraditional derivative instruments,” which are contracts involving the purchase or sale of commodities that either do not qualify or have not been designated as normal purchases or normal sales and therefore are required to be accounted for as derivative instruments. Although the accounting for nontraditional derivative instruments is outside the scope of EITF Issue No. 04-13, the conclusions reached in that consensus caused Marathon to reconsider the guidance in EITF Issue No. 03-11, “Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not “Held for Trading Purposes” as Defined in Issue No. 02-3.” As a result, effective for contracts entered into or modified on or after April 1, 2006, the income effects of matching buy/sell arrangements accounted for as nontraditional derivative instruments are recognized on a net basis as cost of revenues. Prior to this change, Marathon recorded these transactions in both revenues and cost of revenues as separate sale and purchase transactions. This change in accounting principle is being applied on a prospective basis because it is impracticable to apply the change on a retrospective basis.
		Transactions arising from all matching buy/sell arrangements entered into before April 1, 2006 will continue to be reported as separate sale and purchase transactions.
		The adoption of EITF Issue No. 04-13 and the change in the accounting for nontraditional derivative instruments had no effect on net income. The amounts of revenues and cost of revenues recognized in the second quarter of 2006 and subsequent periods will be less than the amounts that would have been recognized under previous accounting practices.

		SFAS No. 123 (Revised 2004)
		In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS No. 123(R)”) as a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” This statement requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. In addition, awards classified as liabilities are remeasured at fair value each reporting period. Marathon had previously adopted the fair value method under SFAS No. 123 for grants made, modified or settled on or after January 1, 2003.
		Marathon adopted SFAS No. 123(R) as of January 1, 2006, for all awards granted, modified or cancelled after adoption, and for the unvested portion of awards outstanding at January 1, 2006. At the date of adoption, SFAS No. 123(R) requires that an assumed forfeiture rate be applied to any unvested awards and that awards classified as liabilities be measured at fair value. Prior to adopting SFAS No. 123(R), Marathon recognized forfeitures as they occurred and applied the intrinsic value method to awards classified as liabilities. The adoption did not have a significant effect on Marathon’s consolidated results of operations, financial position or cash flows.
		SFAS No. 123(R) also requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting the statement. In November 2005, the FASB issued FASB Staff Position No. 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” to provide an alternative transition election (the “short-cut method”) to account for the tax effects of share-based payment awards to employees. Marathon elected the long-form method to determine its pool of excess tax benefits as of January 1, 2006.
		See Note 3 to the consolidated financial statements for the disclosures regarding share-based payments required by SFAS No. 123(R).
		SFAS No. 151
		Effective January 1, 2006, Marathon adopted SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4.” This statement requires that items such as idle facility expense, excessive spoilage, double freight and re-handling costs be recognized as a current-period charge. The adoption did not have a significant effect on Marathon’s consolidated results of operations, financial position or cash flows.
		SFAS No. 154
		Effective January 1, 2006, Marathon adopted SFAS No. 154, “Accounting Changes and Error Corrections — A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 requires companies to recognize (1) voluntary changes in accounting principle and (2) changes required by a new accounting pronouncement, when the pronouncement does not include specific transition provisions, retrospectively to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.
3.		Stock-Based Compensation Arrangements
		Description of the Plans
		The Marathon Oil Corporation 2003 Incentive Compensation Plan (the “Plan”) authorizes the Compensation Committee of the Board of Directors to grant stock options, stock appreciation rights, stock awards, cash awards and performance awards to employees. The Plan also allows Marathon to provide equity compensation to its non-employee directors. No more than 20,000,000 shares of common stock may be issued under the Plan, and no more than 8,500,000 of those shares may be used for awards other than stock options or stock appreciation rights. Shares subject to awards that are forfeited, terminated, settled in cash, exchanged for other awards, tendered to satisfy the purchase price of an award or withheld to satisfy tax obligations or that expire unexercised or otherwise lapse become available for future grants. Shares issued as a result of awards granted under the Plan are generally funded out of common stock held in treasury, except to the extent there are insufficient treasury shares, in which case new common shares are issued.
		The Plan replaced the 1990 Stock Plan, the Non-Officer Restricted Stock Plan, the Non-Employee Director Stock Plan, the deferred stock benefit provision of the Deferred Compensation Plan for Non-Employee Directors, the Senior Executive Officer Annual Incentive Compensation Plan and the Annual Incentive Compensation Plan (collectively, the “Prior Plans”). No new grants will be made from the Prior Plans. Any awards previously granted under the Prior Plans shall continue to vest and/or be exercisable in accordance with their original terms and conditions.

		Stock-Based Awards Under the Plan
		Stock options — Marathon grants stock options under the Plan. Marathon’s stock options represent the right to purchase shares of common stock at the fair market value of the common stock on the date of grant. Through 2004, certain options were granted with a tandem stock appreciation right, which allows the recipient to instead elect to receive cash and/or common stock equal to the excess of the fair market value of shares of common stock, as determined in accordance with the Plan, over the option price of the shares. Most stock options granted under the Plan vest ratably over a three-year period and have a maximum term of ten years from the date they are granted.
		Stock appreciation rights (“SARs”) — Prior to 2005, Marathon granted SARs under the Plan. Similar to stock options, stock appreciation rights represent the right to receive a payment equal to the excess of the fair market value of shares of common stock on the date the right is exercised over the grant price. Certain SARs were granted as stock-settled SARs and others were granted in tandem with stock options. In general, SARs that have been granted under the Plan vest ratably over a three-year period and have a maximum term of ten years from the date they are granted.
		Stock-based performance awards — In 2003 and 2004, the Compensation Committee granted stock-based performance awards to certain officers of Marathon and its consolidated subsidiaries under the Plan. Since that time, stock-based performance awards are no longer issued; however cash-settled performance units have been granted to the officers. The stock-based performance awards represent shares of common stock that are subject to forfeiture provisions and restrictions on transfer. Those restrictions may be removed if certain pre-established performance measures are met. The stock-based performance awards granted under the Plan will generally vest at the end of a 36-month performance period to the extent that the performance targets are achieved and the recipient is employed by Marathon on that date. Additional shares could be granted at the end of this performance period should performance exceed the targets. Prior to vesting, the recipients have the right to vote and receive dividends on the target number of shares awarded. However, the shares are not transferable until after they vest.
		Restricted stock — Marathon grants restricted stock and restricted stock units under the Plan. Beginning in 2005, the Compensation Committee granted time-based restricted stock to officers. The restricted stock awards to officers vest three years from the date of grant, contingent on the recipient’s continued employment. Marathon also grants restricted stock to certain non-officer employees and restricted stock units to certain international non-officer employees (together with the restricted stock granted to officers above, “restricted stock awards”) based on their performance within certain guidelines and for retention purposes. The restricted stock awards to non-officers generally vest in one-third increments over a three-year period, contingent on the recipient’s continued employment. Prior to vesting, all restricted stock recipients have the right to vote such stock and receive dividends thereon. The nonvested shares are not transferable and are held by the Company’s transfer agent.
		Common stock units — Marathon maintains an equity compensation program for its non-employee directors under the Plan. All non-employee directors other than the Chairman receive annual grants of common stock units under the Plan and they are required to hold those units until they leave the Board of Directors. When dividends are paid on Marathon’s common stock, directors receive dividend equivalents in the form of additional common stock units. Prior to January 1, 2006, non-employee directors had the opportunity to receive a matching grant of up to 1,000 shares of common stock if they purchased an equivalent number of shares within 60 days of joining the Board.
		Stock-Based Compensation Expense
		The fair values of stock options, stock options with tandem SARs and stock-settled SARs (“stock option awards”) are estimated on the date of grant using the Black-Scholes option pricing model. The model employs various assumptions, based on management’s best estimates at the time of grant, which impact the fair value calculated and ultimately, the expense that is recognized over the life of the stock option award. Of the required assumptions, the expected life of the stock option award and the expected volatility of Marathon’s stock price have the most significant impact on the fair value calculation. Marathon has utilized historical data and analyzed current information which reasonably support these assumptions.
		The fair values of Marathon’s restricted stock awards and common stock units are determined based on the fair market value of the Company’s common stock on the date of grant. Prior to adoption of SFAS No. 123(R) on January 1, 2006, the fair values of Marathon’s stock-based performance awards were determined in the same manner as restricted stock awards. Under SFAS No. 123(R), on a prospective basis, these awards are required to be valued utilizing an option pricing model. No stock-based performance awards have been granted since May 2004.
		Effective January 1, 2006, Marathon’s stock-based compensation expense is recognized based on management’s best estimate of the awards that are expected to vest, using the straight-line attribution method for all service-based

		awards with a graded vesting feature. If actual forfeiture results are different than expected, adjustments to recognized compensation expense may be required in future periods. Unearned stock-based compensation is charged to stockholders’ equity when restricted stock awards and stock-based performance awards are granted. Compensation expense is recognized over the balance of the vesting period and is adjusted if conditions of the restricted stock award or stock-based performance award are not met. Options with tandem SARs are classified as a liability and are remeasured at fair value each reporting period until settlement.
		Prior to January 1, 2006, Marathon recorded stock-based compensation expense over the stated vesting period for stock option awards that are subject to specific vesting conditions and specify (1) that an employee vests in the award upon becoming “retirement eligible” or (2) that the employee will continue to vest in the award after retirement without providing any additional service. Under SFAS No. 123(R), from the January 1, 2006 date of adoption, such compensation cost is recognized immediately for awards granted to retirement-eligible employees or over the period from the grant date to the retirement eligibility date if retirement eligibility will be reached during the stated vesting period. Stock compensation expense for the first half of 2006 included $3 million for such option awards.
		During the quarters ended June 30, 2006 and 2005, total employee stock-based compensation expense was $27 million and $20 million. The total related income tax benefits were $10 million and $7 million. During the second quarter of 2006, cash received upon exercise of stock option awards was $11 million. Tax benefits realized for deductions during the second quarter of 2006 that were in excess of the stock-based compensation expense recorded for options exercised and other stock-based awards vested during the quarter totaled $4 million.
		During the six months ended June 30, 2006 and 2005, total employee stock-based compensation expense was $50 million and $63 million. The total related income tax benefits were $19 million and $22 million. In the first six months of 2006, cash received upon exercise of stock option awards was $19 million. Tax benefits realized for deductions during the six months ended June 30, 2006 that were in excess of the stock-based compensation expense recorded for options exercised and other stock-based awards vested during the first six months of 2006 totaled $14 million. Cash settlements of stock option awards totaled less than $1 million during the quarter and six months ended June 30, 2006.
		Stock Option Awards Granted
		During the six months ended June 30, 2006 and 2005, Marathon granted stock option awards to both officer and non-officer employees. The weighted average grant date fair values of these awards were based on the following Black-Scholes assumptions:

		Six Months Ended June 30,
		2006				2005
Weighted average exercise price per share		$	75.68			$	50.28
Expected annual dividends per share		$	1.60			$	1.32
Expected life in years			5.0				5.5
Expected volatility			28	%			28	%
Risk-free interest rate			5.0	%			3.8	%
Weighted average grant date fair value of stock option awards granted		$	20.37			$	12.30

		Outstanding Stock-Based Awards
		The following is a summary of stock option award activity for the six months ended June 30, 2006:

						Weighted-
		Number				Average
		of Shares				Exercise Price
Outstanding at December 31, 2005			6,007,954			$	36.51
Granted			1,601,800			$	75.68
Exercised			(733,295	)		$	24.70
Canceled			(47,909	)		$	45.57
Outstanding at June 30, 2006 (a)			6,828,550			$	46.12

The intrinsic value of stock option awards exercised during the six months ended June 30, 2006 and 2005 was $34 million and $51 million. Of those amounts, $10 million in the six months ended June 30, 2006, and $27 million in the six months ended June 30, 2005, was related to stock options with tandem SARs.

The following table presents information on stock option awards at June 30, 2006:

		Outstanding												Exercisable
						Weighted-
		Number				Average				Weighted-				Number				Weighted-
Range of Exercise		of Shares				Remaining				Average				of Shares				Average
Prices		Under Option				Contractual Life				Exercise Price				Under Option				Exercise Price
$25.50 - 26.91			1,039,680				7			$	25.52				1,033,014			$	25.51
$28.12 - 30.88			480,134				5			$	28.37				475,134			$	28.35
$32.52 - 34.00			1,947,952				7			$	33.49				1,295,408			$	33.43
$47.65 - 51.67			1,758,984				9			$	50.22				548,196			$	50.08
$75.64 - 81.02			1,601,800				10			$	75.68				—				—
Total			6,828,550				8			$	46.12				3,351,752			$	32.99

		As of June 30, 2006, the aggregate intrinsic value of stock option awards outstanding was $254 million. The aggregate intrinsic value and weighted average remaining contractual life of stock option awards currently exercisable were $169 million and 7 years. As of June 30, 2006, the number of fully-vested stock option awards and stock option awards expected to vest was 6,388,997. The weighted average exercise price and weighted average remaining contractual life of these stock option awards were $45.16 and 8 years and the aggregate intrinsic value was $244 million. As of June 30, 2006, unrecognized compensation cost related to stock option awards was $40 million, which is expected to be recognized over a weighted average period of 2 years.
		The following is a summary of stock-based performance award and restricted stock award activity for the six months ended June 30, 2006:

		Stock-Based				Weighted								Weighted
		Performance				Average Grant				Restricted				Average Grant
		Awards				Date Fair Value				Stock Awards				Date Fair Value
Unvested at December 31, 2005			448,600			$	29.93				985,556			$	47.94
Granted (a)			67,848			$	76.82				123,160			$	77.31
Vested			(273,448	)		$	38.30				(178,176	)		$	39.49
Forfeited			(6,000	)		$	33.61				(25,656	)		$	51.58
Unvested at June 30, 2006			237,000			$	33.61				904,884			$	53.54

		During the six months ended June 30, 2006 and 2005, the weighted average grant date fair value of restricted stock awards was $77.31 and $47.25. The vesting date fair value of stock-based performance awards which vested during the six months ended June 30, 2006 and 2005 was $21 million and $5 million. The vesting date fair value of restricted stock awards which vested during the six months ended June 30, 2006 and 2005 was $14 million and $8 million.
		As of June 30, 2006, there was $33 million of unrecognized compensation cost related to restricted stock awards which is expected to be recognized over a weighted average period of 2 years.
4.		Discontinued Operations
		On June 2, 2006, Marathon sold its Russian oil exploration and production businesses in the Khanty-Mansiysk region of western Siberia. Under the terms of the agreement, Marathon received $787 million for these businesses, plus preliminary working capital and other closing adjustments of $56 million, for a total transaction value of $843 million. Proceeds net of transaction costs and cash held by the Russian businesses at the transaction date totaled $832 million. A gain on the sale of $243 million ($342 million before income taxes) is reported in discontinued operations for the quarter and six months ended June 30, 2006. Income taxes on this gain were reduced by the utilization of a capital loss carryforward as discussed in Note 8 to the consolidated financial statements. Exploration and Production segment goodwill of $21 million was allocated to the Russian assets and reduced the reported gain. The final adjustment to the purchase price is expected to be made before December 31, 2006 and could affect the reported gain. The activities of the Russian businesses have been reported as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows for all periods presented. Revenues applicable to discontinued operations totaled $74 million and $77 million for the second quarters of 2006 and 2005, and $173 million and $130 million for the six months ended June 30, 2006 and 2005. Pretax income from discontinued operations totaled $24 million and $6 million for the second quarters of 2006 and 2005, and $45 million and $7 million for the six months ended June 30, 2006 and 2005.

5.		Computation of Income per Share
		Basic income per share is based on the weighted average number of common shares outstanding. Diluted income per share assumes exercise of stock options, provided the effect is not antidilutive.

		Second Quarter Ended June 30,
		2006								2005
(Dollars in millions, except per share data)		Basic				Diluted				Basic				Diluted
Income from continuing operations		$	1,484			$	1,484			$	668			$	668
Discontinued operations			264				264				5				5
Net income		$	1,748			$	1,748			$	673			$	673
Shares of common stock outstanding (thousands):
Average number of common shares outstanding			360,860				360,860				347,075				347,075
Effect of dilutive securities			—				3,300				—				2,843
Average common shares including dilutive effect			360,860				364,160				347,075				349,918
Per share:
Income from continuing operations		$	4.11			$	4.07			$	1.93			$	1.91
Discontinued operations		$	0.73			$	0.73			$	0.01			$	0.01
Net income		$	4.84			$	4.80			$	1.94			$	1.92

		Six Months Ended June 30,
		2006								2005
(Dollars in millions, except per share data)		Basic				Diluted				Basic				Diluted
Income from continuing operations		$	2,255			$	2,255			$	991			$	991
Discontinued operations			277				277				6				6
Net income		$	2,532			$	2,532			$	997			$	997
Shares of common stock outstanding (thousands):
Average number of common shares outstanding			362,973				362,973				346,541				346,541
Effect of dilutive securities			—				3,325				—				2,687
Average common shares including dilutive effect			362,973				366,298				346,541				349,228
Per share:
Income from continuing operations		$	6.21			$	6.16			$	2.86			$	2.84
Discontinued operations		$	0.76			$	0.75			$	0.02			$	0.02
Net income		$	6.97			$	6.91			$	2.88			$	2.86

The per share calculations above exclude 1.6 million stock options for the second quarter and six months ended June 30, 2006, and 1.9 million stock options for the second quarter and six months ended June 30, 2005, as they were antidilutive.

6.

Segment Information

Marathon’s operations consist of three reportable operating segments:

	1)		Exploration and Production (“E&P”) — explores for, produces and markets crude oil and natural gas on a worldwide basis;
	2)		Refining, Marketing and Transportation (“RM&T”) — refines, markets and transports crude oil and petroleum products, primarily in the Midwest, the upper Great Plains and southeastern United States; and
	3)		Integrated Gas (“IG”) — markets and transports products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, on a worldwide basis, and is developing other projects to link stranded natural gas resources with key demand areas.

Effective January 1, 2006, Marathon revised its measure of segment income to include the effects of minority interests and income taxes related to the segments to facilitate comparison of segment results with Marathon’s peers. Income taxes were allocated to the segments using estimated effective rates for each segment. In addition, the results of activities primarily associated with the marketing of the Company’s equity natural gas production,

which had been presented as part of the Integrated Gas segment prior to 2006, are now included in the Exploration and Production segment as those activities are aligned with E&P operations. Segment information for all periods presented reflects these changes.

As discussed in Note 4, the Russian businesses that were sold in June 2006 have been accounted for as discontinued operations. Segment information for all presented periods excludes the amounts for these Russian operations.

														Total
(Dollars in millions)		E&P				RM&T				IG				Segments
Second Quarter Ended June 30, 2006
Revenues:
Customer		$	2,325			$	15,390			$	70			$	17,785
Intersegment (a)			187				2				—				189
Related parties			3				408				—				411
Segment revenues			2,515				15,800				70				18,385
Elimination of intersegment revenues			(187	)			(2	)			—				(189	)
Loss on long-term U.K. natural gas contracts			(17	)			—				—				(17	)
Total revenues		$	2,311			$	15,798			$	70			$	18,179
Segment income		$	659			$	917			$	17			$	1,593
Income from equity method investments			53				32				12				97
Depreciation, depletion and amortization (b)			221				137				2				360
Minority interests in income (loss) of subsidiaries (b)			—				—				(2	)			(2	)
Provision for income taxes (b)			716				564				(1	)			1,279
Capital expenditures (c)			463				200				70				733

														Total
(Dollars in millions)		E&P				RM&T				IG				Segments
Second Quarter Ended June 30, 2005
Revenues:
Customer		$	1,820			$	13,877			$	44			$	15,741
Intersegment (a)			131				41				—				172
Related parties			3				365				—				368
Segment revenues			1,954				14,283				44				16,281
Elimination of intersegment revenues			(131	)			(41	)			—				(172	)
Loss on long-term U.K. natural gas contracts			(167	)			—				—				(167	)
Total revenues		$	1,656			$	14,242			$	44			$	15,942
Segment income		$	504			$	316			$	—			$	820
Income from equity method investments			17				16				12				45
Depreciation, depletion and amortization (b)			206				105				2				313
Minority interests in income of subsidiaries (b)			—				309				—				309
Provision for income taxes (b)			272				198				4				474
Capital expenditures (c)			296				166				183				645

														Total
(Dollars in millions)		E&P				RM&T				IG				Segments
Six Months Ended June 30, 2006
Revenues:
Customer		$	4,433			$	29,280			$	100			$	33,813
Intersegment (a)			377				15				—				392
Related parties			6				717				—				723
Segment revenues			4,816				30,012				100				34,928
Elimination of intersegment revenues			(377	)			(15	)			—				(392	)
Gain on long-term U.K. natural gas contracts			61				—				—				61
Total revenues		$	4,500			$	29,997			$	100			$	34,597
Segment income		$	1,124			$	1,236			$	25			$	2,385
Income from equity method investments			106				58				25				189
Depreciation, depletion and amortization (b)			477				270				4				751
Minority interests in income (loss) of subsidiaries (b)			—				—				(5	)			(5	)
Provision for income taxes (b)			1,196				768				4				1,968
Capital expenditures (c)			821				304				164				1,289

														Total
(Dollars in millions)		E&P				RM&T				IG				Segments
Six Months Ended June 30, 2005
Revenues:
Customer		$	3,339			$	24,950			$	105			$	28,394
Intersegment (a)			275				83				—				358
Related parties			5				646				—				651
Segment revenues			3,619				25,679				105				29,403
Elimination of intersegment revenues			(275	)			(83	)			—				(358	)
Loss on long-term U.K. natural gas contracts			(224	)			—				—				(224	)
Total revenues		$	3,120			$	25,596			$	105			$	28,821
Segment income		$	838			$	390			$	22			$	1,250
Income from equity method investments			22				33				29				84
Depreciation, depletion and amortization (b)			403				209				4				616
Minority interests in income (loss) of subsidiaries (b)			—				376				(1	)			375
Provision for income taxes (b)			484				266				(1	)			749
Capital expenditures (c)			566				302				308				1,176

The following reconciles segment income to net income as reported in Marathon’s consolidated statements of income:

		Second Quarter Ended								Six Months Ended
		June 30,								June 30,
(Dollars in millions)		2006				2005				2006				2005
Segment income		$	1,593			$	820			$	2,385			$	1,250
Items not allocated to segments, net of income taxes:
Gain (loss) on long-term U.K. natural gas contracts			(10	)			(97	)			35				(130	)
Corporate and other unallocated items			(99	)			(70	)			(165	)			(144	)
Ohio tax legislation			—				15				—				15
Discontinued operations			264				5				277				6
Net income		$	1,748			$	673			$	2,532			$	997

7.		Pensions and Other Postretirement Benefits
		The following summarizes the components of net periodic benefit cost:

		Second Quarter Ended June 30,
		Pension Benefits								Other Benefits
(Dollars in millions)		2006				2005				2006				2005
Service cost		$	32			$	26			$	6			$	4
Interest cost			31				30				11				9
Expected return on plan assets			(29	)			(23	)			—				—
Amortization:
— net transition gain			—				(1	)			—				—
— prior service costs (credits)			1				1				(3	)			(3	)
— actuarial loss			11				15				2				3
Multi-employer and other plans			1				1				2				1
Net periodic benefit cost		$	47			$	49			$	18			$	14

		Six Months Ended June 30,
		Pension Benefits								Other Benefits
(Dollars in millions)		2006				2005				2006				2005
Service cost		$	66			$	57			$	12			$	9
Interest cost			63				58				21				19
Expected return on plan assets			(55	)			(46	)			—				—
Amortization:
— net transition gain			—				(2	)			—				—
— prior service costs (credits)			2				2				(6	)			(6	)
— actuarial loss			24				30				4				5
Multi-employer and other plans			1				1				2				1
Net periodic benefit cost		$	101			$	100			$	33			$	28

During the six months ended June 30, 2006, Marathon made contributions of $156 million to its funded pension plans. Of this amount, $14 million related to foreign pension plans. On July 21, 2006, Marathon made a contribution of $111 million to its U.S. funded pension plans and currently estimates additional contributions of up to $130 million, over the remainder of 2006. However, this contribution estimate may be revised pending analysis of the Pension Protection Act of 2006, which is expected to be signed into law in the third quarter of 2006. Contributions made from the general assets of Marathon to cover current benefit payments related to unfunded pension and other postretirement benefit plans were $3 million and $15 million for the first six months of 2006.

8.		Income Taxes
		The provision for income taxes for interim periods is based on management’s best estimate of the effective income tax rate expected to be applicable for the current year plus any adjustments arising from a change in the estimated amount of taxes related to prior periods. The following is an analysis of the effective income tax rates for continuing operations for the periods presented:

		Second Quarter Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
Statutory U.S. income tax rate			35.0	%			35.0	%			35.0	%			35.0	%
Effects of foreign operations			9.9				(1.1	)			10.4				(0.6	)
State and local income taxes after federal income tax effects			2.0				(0.4	)			2.0				1.3
Other tax effects			(0.6	)			(0.2	)			(0.8	)			(0.7	)
Effective income tax rate for continuing operations			46.3	%			33.3	%			46.6	%			35.0	%

Capital loss carryforwards were utilized in conjunction with the sale of Marathon’s Russian oil exploration and production businesses in June 2006, as discussed in Note 4 to the consolidated financial statements. The reversal of

the valuation allowance related to these capital loss carryforwards reduced income taxes attributable to discontinued operations by $79 million. The sale of the Russian businesses fully utilized the Company’s capital loss carryforward deferred tax asset.

Marathon is continuously undergoing examination of its federal income tax returns by the Internal Revenue Service (“IRS”). Audits of the Company’s 1998 through 2003 income tax returns have been agreed between Marathon and the IRS and sent to the Joint Committee on Taxation for approval. If accepted by the Joint Committee, the Company does not anticipate the conclusion of these audits would have a material impact on its consolidated results of operations or financial position. The Company anticipates that a refund of income taxes will be received by the end of 2006. This refund will include periods up to 2001; therefore, a portion of the refund in the form of tax sharing payments may be attributable to United States Steel. These payments will be handled in accordance with the tax sharing agreement between Marathon and United States Steel. See Note 3 to the consolidated financial statements, “Information about United States Steel,” in Marathon’s 2005 Annual Report on Form 10-K for additional discussion of this tax sharing agreement. Audits for tax years 2004 and 2005 are commencing in 2006. Marathon believes it has made adequate provision for federal income taxes and interest which may become payable for years not yet settled.

9.		Comprehensive Income
		The following sets forth Marathon’s comprehensive income for the periods indicated:

		Second Quarter Ended								Six Months Ended
		June 30,								June 30,
(Dollars in millions)		2006				2005				2006				2005
Net income		$	1,748			$	673			$	2,532			$	997
Other comprehensive income (loss), net of taxes:
Minimum pension liability adjustments			5				24				15				24
Change in fair value of derivative instruments			4				(9	)			4				(15	)
Total comprehensive income		$	1,757			$	688			$	2,551			$	1,006

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

		June 30,				December 31,
(Dollars in millions)		2006				2005
Liquid hydrocarbons and natural gas		$	1,918			$	1,093
Refined products and merchandise			1,725				1,763
Supplies and sundry items			174				185
Total, at cost		$	3,817			$	3,041

11.		Property, Plant and Equipment
		Exploratory well costs capitalized greater than one year after completion of drilling as of June 30, 2006 were $99 million, including $40 million added to this category during the first quarter of 2006 for wells in Equatorial Guinea (Corona, Bococo and Gardenia), where Marathon is evaluating various development scenarios for the discoveries around the Alba Field, including plans that would integrate the resources into the Company’s long-term LNG supply.
12.		Long-term Debt
		Effective May 4, 2006, Marathon entered into an amendment to its $1.5 billion five-year revolving credit agreement, expanding the size of the facility to $2.0 billion and extending the termination date from May 2009 to May 2011. Interest on this facility is based on defined short-term market rates. During the term of the agreement, Marathon is obligated to pay a variable facility fee on the total commitment, which at June 30, 2006 was 0.08 percent. At June 30, 2006, there were no borrowings against this facility. Concurrent with this amendment, the $500 million MPC revolving credit agreement was terminated.

13.		Commitments and Contingencies
		Marathon is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. Certain of these commitments are discussed below. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to Marathon’s consolidated financial statements. However, management believes that Marathon will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably.
		Contract commitments — At June 30, 2006 and December 31, 2005, Marathon’s contract commitments to acquire property, plant and equipment totaled $709 million and $668 million, respectively. During the first half of 2006, the significant changes to Marathon’s contract commitments were increases of approximately $90 million related to the potential expansion of the Garyville, Louisiana refinery, and other increases related to development in North America and Libya. Commitments related to the Equatorial Guinea LNG plant, the Neptune development in the Gulf of Mexico and the Alvheim project in Norway declined as construction progress continued on those projects.
		Guarantees — In conjunction with the sale of its Russian businesses as discussed in Note 4 to the consolidated financial statements, Marathon guaranteed the purchaser with regard to unknown obligations and inaccuracies in representations, warranties, covenants and agreements by Marathon. These indemnifications are part of the normal course of selling assets. Under the agreement, the maximum potential amount of future payments associated with these guarantees is equivalent to the proceeds from the sale.
14.		Stock Repurchase Program
		On January 29, 2006, Marathon’s Board of Directors authorized the repurchase of up to $2 billion of common stock over a period of two years. Such purchases are to be made during this period as Marathon’s financial condition and market conditions warrant. Any purchases under the program may be in either open market transactions, including block purchases, or in privately negotiated transactions. The repurchase program does not include specific price targets and is subject to termination prior to completion. Marathon will use cash on hand, cash generated from operations or cash from available borrowings to acquire shares. During the first six months of 2006, Marathon acquired 7.3 million common shares at an acquisition cost of $554 million, which were recorded as common stock held in treasury in the consolidated balance sheet.
15.		Supplemental Cash Flow Information

		Six Months Ended June 30,
(Dollars in millions)		2006				2005
Noncash investing and financing activities:
Asset retirement costs capitalized		$	20			$	8
Payments of debt assumed by United States Steel			21				8
Disposal of assets:
Asset retirement obligations assumed by buyer			9				3
Acquisition:
Debt and other liabilities assumed			14				5,105
Common stock issued to seller			—				955
Receivables transferred to seller			—				913
Commercial paper and revolving credit arrangements, net:
Borrowings		$	1,321			$	590
Repayments			(1,321	)			—
Net cash provided from operating activities included:
Interest paid (net of amounts capitalized)		$	56			$	88
Income taxes paid to taxing authorities			1,728				643

16.		MPC Receivables Purchase and Sale Facility
		On July 1, 2005, MPC entered into a $200 million, three-year Receivables Purchase and Sale Agreement with certain purchasers. The program was structured to allow MPC to periodically sell a participating interest in pools of eligible accounts receivable. During the term of the agreement MPC was obligated to pay a facility fee of 0.12%. In the first quarter of 2006, the facility was terminated. No receivables were sold under the agreement during its term.
17.		Accounting Standards Not Yet Adopted
		In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. Marathon is currently evaluating the provisions of FIN No. 48 to determine the impact on its consolidated financial statements.
		In June 2006, the FASB ratified the consensus reached by the EITF regarding Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation).” Included in the scope of this issue are any taxes assessed by a governmental authority that are imposed concurrent with or subsequent to a revenue-producing transaction between a seller and a customer. The EITF concluded that the presentation of such taxes on a gross basis (included in revenues and costs) or a net basis (excluded from revenues) is an accounting policy decision that should be disclosed pursuant to APB Opinion No. 22. In addition, the amounts of such taxes reported on a gross basis must be disclosed if those tax amounts are significant. The disclosure prescribed by this consensus is required in financial statements for interim and annual reporting periods beginning after December 15, 2006, but early application is permitted.
		In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets — An Amendment of FASB Statement No. 140.” This statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. Adoption of SFAS No. 156 is required as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Marathon does not expect adoption of this statement to have a significant effect on its consolidated results of operations, financial position or cash flows.
		In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — An Amendment of FASB Statements No. 133 and 140.” SFAS No. 155 simplifies the accounting for certain hybrid financial instruments, eliminates the interim FASB guidance which provides that beneficial interests in securitized financial assets are not subject to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and eliminates the restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Marathon is currently evaluating the provisions of this Statement to determine the impact on its consolidated financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Marathon Oil Corporation is engaged in worldwide exploration, production and marketing of crude oil and natural gas; domestic refining, marketing and transportation of crude oil and petroleum products primarily in the Midwest, the upper Great Plains and southeastern United States; and worldwide marketing and transportation of products manufactured from natural gas, such as LNG and methanol, and development of other projects to link stranded natural gas resources with key demand areas. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Selected Notes to Consolidated Financial Statements and the Supplemental Statistics.

     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 2005 Annual Report on Form 10-K.

     We acquired the 38 percent interest in MPC previously held by Ashland Inc. on June 30, 2005. Unless specifically noted as being after minority interests, amounts for the Refining, Marketing and Transportation segment include amounts related to the 38 percent interest held by Ashland prior to June 30, 2005.

     Marathon holds a 60 percent interest in Equatorial Guinea LNG Holdings Limited. The remaining interests are held by a company controlled by the government of Equatorial Guinea (25 percent interest), Mitsui & Co., Ltd. (8.5 percent interest) and a subsidiary of Marubeni Corporation (6.5 percent interest). Unless specifically noted as being after minority interests, amounts for the Integrated Gas segment include amounts related to the minority interests.

Overview and Outlook

Exploration and Production (“E&P”)

     Production available for sale during the second quarter of 2006 averaged 353,000 barrels of oil equivalent per day (“boepd”). Reported liquid hydrocarbon and natural gas sales during the quarter averaged 392,000 boepd. The difference between production available for sale and actual sales volumes is primarily attributable to the timing of liquid hydrocarbon liftings from our operations in Libya, Equatorial Guinea and the U.K.

     In Libya, our production available for sale for the first six months of 2006 was consistent with our expectations when we re-entered these operations at the end of 2005, and we are working with our partners to define growth plans for this business. In 2006, the United States restored full diplomatic ties with Libya. A United States embassy has been reopened and Libya has been removed from the list of state sponsors of terrorism.

     We continue to advance our major E&P projects. In Norway, the Alvheim project is 64 percent complete as of June 30, 2006, and is on target to deliver first production in the first quarter of 2007. As part of this project, development drilling commenced in the second quarter of 2006. Installation of pipelines and umbilicals (power and control lines) has been completed and additional subsea structures are being installed. The first phase of equipment placement onto the Alvheim floating production, storage and offloading (“FPSO”) vessel has been completed.and integration of all FPSO components is proceeding. Also, the Neptune development in the Gulf of Mexico is 28 percent complete as of June 30, 2006, and remains on target to deliver first production by early 2008. Development drilling began in the second quarter of 2006.

     In the first half of 2006, we completed leasehold acquisitions totaling approximately 200,000 acres in the Bakken Shale resource play. The majority of the acreage is located in North Dakota with the remainder in eastern Montana. We now own a substantial position in the Bakken Shale with approximately 300 locations to be drilled over the next four to five years.

     In the second quarter of 2006, we were awarded a 70 percent interest and will be the operator in the Pasangkayu Block offshore Indonesia. The 1.2 million acre block is located mostly in deep water, predominantly offshore of the island of Sulawesi in the Makassar Strait, directly east of the Kutei Basin oil and natural gas production region. A production sharing contract with the Indonesian government is being negotiated, with execution expected during the third quarter of 2006. We expect to begin collecting geophysical data in 2007, followed by exploratory drilling in 2008 and 2009.

     Also in the second quarter of 2006, we sold our Russian oil exploration and production businesses. Under the terms of the agreement, we received $787 million for these businesses, plus preliminary working capital and other closing adjustments of $56 million, for a total transaction value of $843 million. A gain on the sale of $243 million ($342 million before tax) is reported in discontinued operations for the quarter and six months ended June 30, 2006. The final adjustment to the purchase price is expected to be made before December 31, 2006 and could affect the reported gain. For all periods presented, the activities of the Russian businesses have been reported as discontinued operations in the consolidated statements of income and the consolidated statements of cash flows.

     We participated in two deepwater discoveries in the second quarter of 2006 in Block 31 offshore Angola, where we own a 10 percent interest. These two discoveries were the Urano prospect and a yet to be announced exploration well in the southeast portion of the block. Additional drilling/seismic analysis will be required to determine the commerciality of these two discoveries. Two exploratory dry holes were drilled during the second quarter of 2006: a well offshore Angola and the Abbott well in the Gulf of Mexico. Two other discoveries were announced in the first quarter of 2006: the Mostarda well on Block 32 offshore Angola, where we have a 30 percent interest, and the Gudrun well offshore Norway, in which we have a 28.2 percent interest. We expect to participate in another seven or eight exploration wells in 2006. Three to four exploration wells originally expected to be drilled in 2006 are now expected to be carried over to 2007. We are currently participating in an appraisal well at the Stones discovery in the Gulf of Mexico and three deepwater wells in Angola.

     We estimate our 2006 production available for sale will average between 350,000 and 370,000 boepd. This estimate reflects the impact of the sale of our Russian oil exploration and production businesses, but excludes the effect of any future acquisitions or dispositions. Reported volumes are based on sales volumes which may vary from production available for sale primarily due to the timing of liftings from certain of our international locations.

     In July 2006, we completed a leasehold acquisition of a long-life natural gas asset in the Piceance Basin of Colorado, located in Garfield County in the Greater Grand Valley Field Complex for cash of $354 million. The acreage is flanked by, and on-trend with, adjacent production. Our plans include drilling approximately 700 wells over the next ten years with first production expected in late 2007.

     We own an 18.5 percent interest in the outside-operated Corrib natural gas development project, located off Ireland’s west coast. Onshore development activities started in late 2004 but were suspended in 2005 pending resolution of issues raised by opponents of the project. The partners in this project recently accepted the findings of a government-commissioned independent safety review and an independent mediator’s report regarding the onshore pipeline associated with the proposed development. The partners now intend to proceed with this project.

     We discovered the Ash Shaer and Cherrife gas fields in Syria in the 1980s. We submitted four plans of development to the Syrian Petroleum Company in the 1990s, but none were approved. The Syrian government subsequently claimed that the production sharing contract for these fields had expired. We have been involved in an ongoing dispute with the Syrian Petroleum Company and government of Syria over our interest in these fields. On July 26, 2006, the president of Syria signed into law a new production sharing contract between us and the Syrian Petroleum Company. This new production sharing contract gives us the right to sell all or a significant portion of our interest in the Ash Shaer and Cherrife gas fields to a third party, subject to the consent of the Syrian government, and resolves the disputes between us and the Syrian Petroleum Company and the government of Syria over our interest in these fields. We have and will continue to comply with all U.S. sanctions related to Syria.

     The above discussion includes forward-looking statements with respect to the timing and levels of our worldwide liquid hydrocarbon, natural gas and condensate production, the development of the Alvheim field, the Neptune development, execution of the Indonesian production sharing contract, development of the Corrib field and anticipated future exploratory and development drilling activity. Some factors that could potentially affect these forward-looking statements include pricing, supply and demand for petroleum products, amount of capital available for exploration and development, acquisitions or dispositions of oil and natural gas properties, regulatory constraints, timing of commencing production from new wells, drilling rig availability, inability or delay in obtaining necessary government and third-party approvals and permits, unforeseen hazards such as weather conditions, acts of war or terrorist acts and the governmental or military response and other geological, operating and economic considerations. The foregoing factors (among others) could cause actual results to differ materially from those set forth in the forward-looking statements.

Refining, Marketing and Transportation (“RM&T”)

     We completed our ultra-low sulfur diesel fuel modifications on time and under budget during the second quarter of 2006 and began producing ultra-low sulfur diesel fuel prior to the June 1, 2006 deadline set by U.S. Environmental Protection Agency regulations. Also during the quarter, our RM&T operations benefited from refining margins (crack spreads) in the Midwest (Chicago) and Gulf Coast that were stronger than the comparable period of 2005. Primarily as a result of these improved margins, our refining and wholesale marketing gross margin averaged 29.78 cents per gallon in