CNX Gas Corporation Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript

CNX Gas Corporation (CXG)

Q3 2008 Earnings Call

October 22, 2008 10:00 am ET

Executives

Daniel J. Zajdel – Vice President, Investor Relations

Nicholas J. DeIuliis - President, CEO

Randall M. Albert - SVP Emerging Business Units

Analysts

Matt Doherty – Advisory Research

Scott Hanold – RBC Capital Markets

John Boland – Maple Capital Management

Brian Corales – SMH Capital

Troy Logan – [Castle Life] Management

Brad Pattarozzi - Tudor Pickering & Holt

David Diamond – Rovida Holdings

Joe Pavelich – Snyder Capital Management

Presentation

Operator

Good morning everyone and welcome to the CNX Gas third quarter 2008 results conference call. I’ll now turn the call over to Dan Zajdel, Vice President of Investor Relations.

Daniel J. Zajdel

Thank you, John. Good morning everyone and welcome to the CNX Gas Corporation third quarter 2008 conference call. With me today are Nick DeIuliis, President and CEO and the CNX Gas Management Team. Before we begin, let me remind everyone that various statements that we make during this call including the guidance we give and other statements that express a belief, expectation, or intention are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from these forward-looking statements. Information regarding the factors that may cause such differences is contained in our annual report on Form 10-K which has been filed with the Securities and Exchange Commission.

The SEC permits oil and gas companies in their filings with the SEC to disclose only proved results that a company has demonstrated by actual production or a conclusive formation test be economically and legally producible under certain existing economic and operating conditions. We use certain terms in this conference call such as unproved resources or reserves that the SEC’s guidelines strictly prohibit us from including in filings with the SEC. We also caution you that the SEC has used such unproved or resource or reserve estimates as inherently unreliable and these estimates may be misleading to investors unless the investor is an expert in the gas industry.

After the remarks by Nick DeIuliis, we will turn the discussion over to callers for a question and answer session with management.

Now I’d like to introduce Nicholas DeIuliis.

Nicholas J. DeIuliis

Thanks Dan and welcome everyone again to the CNX Gas third quarter earnings call. If you’ve read the release or even just had a chance to scan our headlines, you know that this was by far the best quarter CNX Gas has ever had. This now makes three consecutive quarters in 2008 where we posted record performance. Based on what we’ve done since our 2005 IPO, where we are today and where we’re going tomorrow, it’s time to start discussing what we’ll refer to today as the inevitability of the CNX Gas investment thesis.

To illustrate this concept of inevitability, just look at the scope of our performance. Our record results cut across just about every operational and financial parameter that we measure and this includes net income, production, growth and production, safety, returns on capital, and of course, margins. Furthermore, our outlook has never been brighter. We’re raising production guidance once again and that’s for both 2008 and 2009. At the same time, our wells have been coming in under budget, so we now expect 2008 capital expenditures of about $515 million instead of the previous estimate of $552 million.

Let me repeat this because it’s an important point: we’re raising production guidance while at the same time investing less capital. That’s of course a very good combination. This also could be the same story that we see for 2009. We’ve just raised production guidance for ’09 to 85 billion cubic feet and we estimate we can do it by spending less than $500 million in capital.

If that weren’t enough good news, we project that we can fund this ’09 capital budget entirely from cash flow from operations based on what the current NYNEX is trading at for ’09 and the amount of hedging that was done with our production book for ’09. So how many companies and in how many industries can you find an entity such as CNX Gas that can self-fund 15% growth? My guess would be not many.

Let’s also talk a little bit about liquidity and financial health since those things are front and center with regard to the macro issues we’re facing today. The news here is pretty simple and it’s very good. We have no credit issues. We don’t have accounts receivable issues, and we don’t have counter party issues. We have only $58 million drawn from our credit facility and not only did our executive team not need to liquidate CNX Gas holdings due to margin calls, we effectively have been holders of the stock since the IPO. Finally, we do not see the threat of knock out hedges.

On unit costs, we’re still the lowest in the Eastern United States and one of the lowest in all of the United States in total. We lead the peer group on all end unit margins and the production growth that I spoke about earlier coupled with our low cost and high margins is going to lead us to be the highest return on capital employed for an unconventional producer in the Eastern United States.

On the acreage footprint front, our footprint ran past the 4 million acre mark this past quarter. We’re the largest Appalachian gas producer today by revenue, and I expect we will very soon become the largest by net sales production volume as well. Despite all these great results, here we are sitting with a $20 stock price which is just above the $16 we started with in August of 2005. I know we might not be the first management team to lament about the share price but we feel the current situation is a compelling one and to make that point let’s just quickly if I can allow to recap how far we’ve come.

In 2005 we produced 48 billion cubic feet. Next year we’re going to produce 85 billion cubic feet, so if you do that math it’s an increase of over 75%. So in an industry where production growth matters, and at times we’ve argued it matters too much perhaps, we are delivering big time. Keep in mind that production is lower and lower in risk every day. The reduced risk is due to many reasons. The net result is going to show itself in three consecutive record quarters for 2008 and two straight production guidance increases. Statistically that is not an accident.

In 2005 our crude reserves were about 1.13 trillion cubic feet. If you look at the end of 2007, year end they were up 19% to about 1.34 trillion cubic feet. Don’t forget we’ve increased the weighting of PDPs versus PUDS in those reserves and that they also represent the most profitable crude reserves in the industry. Investors should be willing to pay a much higher price for our reserve base and the peer companies and our production is going to result in much higher income and returns.

In 2005 our acreage count was 1.1 million acres. Today it’s over 4 million acres. That’s just shy of a 400% increase. We’ve got the best footprint in Appalachia and I think the best in the eastern United States. We’ve locked up the coalbed methane rights from the two largest mining companies in the United States. We have an eastern shale portfolio just shy of 1 million acres, and that portfolio cuts across the Marcellus, the [Euron], the Chattanooga, and the New Albany shale plays.

On top of the CBM and shale footprints, we’re sitting with a very valuable midstream portfolio pipelines in processing infrastructure. If you go back to 2005 on the margin front, our unit margins were about $3.18 per Mcf all in. Next year when you look at a $7.00 NYMEX for unhedged production and about a $9.75 price for our hedge volumes, you assume $4.00 all end unit costs, our all end unit margin should be around $4.50 per Mcf. That’s over 40% higher than our ’05 margins so not only is production growing, but it’s much more profitable on a per unit basis than three or four years ago.

So you combine the 42% higher unit margins, 75% higher total company production, you can see that shareholder value has increased tremendously since our IPO. Let me do the math for you. With the shares held constant and 151 million shares outstanding, it means that each share in 2005 effectively owned a pre-tax margin stream of 48 Bcf divided by 151 million shares times a $3.18 all end margin. This comes out to just over $1 per share. By next year, each share will effectively own an assumed pre-tax margin stream of 85 billion cubic feet divided by the same 151 million shares times a projected $4.50 all end margin. This comes out to over $2.50 per share. That’s an impressive increase of 150% and of course if NYMEX gas prices strengthen, that number is going to increase as well.

So if we were a $16 stock in ’05 and we were oversubscribed 8 times over on the IPO, why aren’t we a $40 stock on a conservative basis or something even higher on a more reasonable basis today? We’ve had many conversations on this and the short answer we think is that investors aren’t differentiating currently between the risky companies that chase growth by borrowing until the credit market shut them out and companies such as CNX Gas that have growth but grown prudently and grown responsibly while generating a very high return on capital employed. This economic turmoil is going to give us a chance to differentiate ourselves and obviously it’s a chance we’re going to have to seize.

I’d also like to comment that we met with many investors the past few weeks and while I enjoy seeing investors, especially in individual settings, I think currently that investors and analysts are overly focused on the shale catalysts in our story and they might be ignoring to a certain extent the real 20 year catalyst that is CNX Gas. Now that 20 year catalyst obviously is at times an unglamorous and maybe underappreciated coalbed methane story and it might be unglamorous but it also happens to be the most profitable and accretive opportunity out there when it comes to incremental NAV earnings and returns.

To illustrate that point on how important coalbed methane is, it’s useful to compare what we’ve accomplished in the Mountaineer CBM play relative to what we’re hearing regarding the Marcellus. During the past three year period we’ve grown our Mountaineer coalbed methane effort from around 2 million cubic feet per day of sales to nearly 40 million cubic feet of sales today. We’ve invested cumulatively just under $200 million to do that, plus we haven’t had to wait three years to get the first dollar of revenue, so we’ve been getting the revenue throughout the last three years. Basically when you add all that up, I will stack up our Mountaineer CBM return on capital employed and MPV to the best Marcellus project anytime. This is coming from someone, keep in mind, who’s as excited about the Marcellus as anyone.

So what this comes down to is that a molecule of methane is a molecule of methane within a basin. If it sells for the same price, I want to be able to produce the lowest cost and the quickest to the sales meter molecule methane. That’s what’s going to drive revenue and that’s what’s going to drive profit, but in the investor community today, some molecules seem to have more intrinsic value than others, so for this call we focus on the real CNX Gas story, that’s the story of responsible growth and overall company achievement. We can do this knowing full well that we’re especially pleased with the early success we’ve achieved in our shale exploration program as outlined in our release this morning.

Let’s shift gears if we can to 2009. Give me a minute to summarize what we’re thinking for next year. Remember, we don’t yet have a border proof capital budget, but I can review for you at least our though process at this point. We can grow our production by 15% next year to 85 billion cubic feet and we’ll probably need to spend under $500 million to do that. This is going to be close to the projected cash flow from operations so we’ll effectively be self-funding for 2009.

There could be opportunities for us to seize because the debt-financed land grab phase of the industry frankly is over. Even though as I said CNX Gas significantly increased its acreage footprint by almost 400%, we did it prudently and we did it responsibly. Our debt levels never really increased significantly. Others who thought they had to pay a price and maybe any price whether it be through a bonus payment or high lease terms or drilling commitments to grab land are in our view going to pay a price. We don’t have to shop our prime acreage to raise liquidity whether it be to big oil or others with capital and we could pick up some bargains from companies that overspent. Those bargains could come from two avenues. One avenue of course would be the more traditional route which would be where a company looking to raise liquidity would sell assets directly to us.

The second avenue is also interesting and the second way we could acquire additional acreage could be from what we refer to as knock out leases. A knock out lease situation would be one where a company who acquired numerous lease holds within a shale play now is facing a large number of drilling commitments across a very wide acreage swat. Those drilling commitments are not only large in size, but they’re going to require substantial capital, they’re going to require drill rigs, pipeline infrastructure, well services, and so on. The company could get squeezed by these commitments in a very short period of time to fold on the lease terms and the lessor will have the opportunity to re-lease those rights. It’s going to be interesting to see what level of opportunity is created by this situation where basically companies bit off more than they could chew.

For nearly four years we took a lot of criticism for not loading up on debt but as I have said, CNX Gas has a catalyst and it’s a 20 year catalyst story. We’re not running this company for the short term. We’re going to create long term wealth for our shareholders with our expanding production and margins. We want to do this in a way we’re able to sleep at night. The one thing that does keep us up at night is always going to be safety.

In closing I’d like to report and I’m happy to report that we worked yet another quarter without a lost time accident from the employee base, no lost time accidents in this company since 1994. That’s a strong statement about our commitment to our employees and a strong statement about our focus on operational efficiencies. All of those things translate directly to shareholder value. If we keep executing at the level we have been for the past four years, we believe once again as we started this release or this discussion, the returns are going to be inevitable.

With that I’m going to turn the call back over to Dan.

Daniel J. Zajdel

Thanks, Nick. Just as a reminder to the folks on the call, I will be available after the call to review our early hedge book with you or answer any additional questions that you might have.

Now we’re ready to take questions from the audience. If you’ve dialed into this call as a member of the media, however, I’d ask you to hold your questions until after the call when I can speak with you individually.

John, could you please instruct the callers on the procedure for asking questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Doherty with Advisory Research.

Matt Doherty – Advisory Research

Just had a question regarding the planned development schedule for the Marcellus acreage. You’re running a vertical rig and a horizontal rig right now?

Nicholas J. DeIuliis

Yes.

Matt Doherty – Advisory Research

Do you anticipate keeping it at that pace or perhaps going up and increasing the rig count in ’09 or what are the thoughts there?

Nicholas J. DeIuliis

The thought with the Marcellus is going to be right now it’s somewhere between an exploration and a development program and with those rigs that we’ve deployed in the exploration capital we put to work there, the first tack is to get a feel for what a vertical versus what a horizontal application might look like and we’ve seen preliminary, and I’ll emphasize preliminary, success with both, but our lean right now is that we’re probably going to want to drill much more horizontals than verticals. Yes, there is upside with regard to that program. Again, if we see the results that we’re expecting relative to the first number of the test wells. The other side of that of course on timing is going to come down to how quickly we can tie in and get into the sales meter to the production from these wells. That’s an inherent advantage that we have relative to our asset portfolio because of the coalbed methane play. We’re operating right above the Marcellus and on the midstream infrastructure that we’ve capitalized and put in place to take advantage of that, so let’s see how those vertical and horizontal test wells come in.

As I said, preliminarily, they look very favorable, and then once we’ve got a feel for what the economics are, then we start to pick specific locations within our 180,000 plus acres of Marcellus which will allow us to not only drill those wells and get great economic production rates but more importantly get them tied into the sales meter so we can start generating some revenue.

Matt Doherty – Advisory Research

With the Chattanooga shale, can you talk a little bit about what you think is driving kind of the wide range of results you’re seeing down there and along the same lines, what kind of rates you would need to clear that project economic or go into full scale development and then kind of where you are right now in terms of where you think you need to be.

Nicholas J. DeIuliis

On the Chattanooga, it’s an interesting play. A couple things make it in some ways more similar to some of our coalbed methane plays than shale plays. The biggest reason I think it sort of gravitates in the spectrum towards the coalbed methane side is that the quarter of a million acres that we control down there are largely contiguous so in many ways it does look like a blanket operation from just an acreage control standpoint. There’s a lot of acres and they’re touching one another which is good from an operational synergy perspective if we look at midstream and processing and laying out well sites. Very different for example from the Marcellus where most companies including ours, ownership of Marcellus is a bit scattered. That creates some operational challenges. So that’s good.

I think from the results that we’ve seen so far on the horizontal wells that we’ve drilled in Chattanooga, I think we basically have an economic project. When you look at where it sits on sort of the dispatching of our projects within our portfolio, right now it’s probably projected based on what we’ve seen to be a little bit better than the Mountaineer coalbed methane play, but a little bit less economic than the Virginia and Nittany coalbed methane plays. It’s probably closer to the Mountaineer play overall. So I think we’ve got effectively an economic play. We’ve got a heck of a footprint there, and now it’s time to start laying out a development plan where we can optimize the NAV as a bad asset from everything from drilling to midstream.

Matt Doherty – Advisory Research

In terms of just kind of modeling out economics, do you guys own the minerals or are you paying a royalty on that?

Nicholas J. DeIuliis

We’re paying a royalty. Those are basically lease holds that we consolidated going back the project really started before we were spun out from CONSOL and then we built up on that by buying out our partner and bolting on additional acquisitions since then.

Operator

Your next question comes from Scott Hanold with RBC Capital Markets.

Scott Hanold – RBC Capital Markets

Nick I guess just kind of going back to your commentary, looking at the rest of the industry and leasehold and whatnot and you’re obvious ability to sort of capitalize on people’s ability not to drill, have you at all thought considering that your coalbed methane projects have no such great economics and really you’ve got a lot of infrastructure and focus as a way to sort of monetize the value of the market, not seeing it in some of the shale assets, doing some sort of a portion of those similar to other operators to basically recognize some of that value if there’s a larger player looking at getting in the play?

Nicholas J. DeIuliis

We look at that all the time, Scott. I mean, basically every asset that we control is in the company, including the company itself is always for sale. That’s our first thing we need to accept going into this type of a venture and the issue comes down to what will the market be willing to pay relative to what do we think we can do it internally? If you look at the Marcellus specifically, there’s obviously different factors that enter into what we end up doing with that project. I’ll give you an example. The horizontal well, we just drilled in the Marcellus that we spoke about in the press release. My suspicion is that’s probably to date the highest an NAV well in the history of the Marcellus. The reason it’s the highest NAV well in the history of the Marcellus might not be because of the IP rate or where we drilled it geologically because of the fact that we can get it in the line within a matter of days or a couple of weeks. That’s something obviously that’s an inherent advantage relative to us that might not be necessarily an advantage to another company.

That being said, there’s other things maybe with regard to strategic growth as you point out, coalbed methane versus shale or opportunities within our portfolio ahead of the Marcellus that others might not have where they might be willing to put more of a premium price on something like the acreage positions that we hold. So assuming that some of these folks get their balance sheets in order and the credit markets loosen up, if someone’s willing to drop a number on the Marcellus that is significantly above what we think we can do with it internally form an NAV perspective, we’ve got a duty to our shareholders to pull the trigger on that. That has not happened yet to date so our internal development plans are what we’re proceeding on and as I said, so far, it’s been really good, so good. That’s what we’ll stick on.

Scott Hanold – RBC Capital Markets

Okay, thanks, and I guess going to your point on infrastructure and your ability to get some of these wells on in the Marcellus for example, how is, broadly speaking, some of your infrastructure set up to be able to take the volumes or the high production rates into your system. Is there an issue with... are these low pressure lines and you’re bringing in some pretty powerful wells into there? Are you going to have to beef it up or twin it? What’s sort of the perspective there?

Nicholas J. DeIuliis

Bottom line is we have some inherent synergies, but I’m going to turn that over to Randy Albert, one of our Senior Vice Presidents of Operations to answer.

Randall M. Albert

Scott, we hear exactly what you’re saying. We’re in the process right now of a Marcellus well that we have that we started it off into our low pressure CDM system. We are laying steel line, a higher pressure system to tie into our intermediate pressure system so we can flow it at a much higher rate, so we are looking to both twin and to lay around some of our low pressure stuff with the [spin on the] results of the wells.

Scott Hanold – RBC Capital Markets

Okay, great, and what would you expect sort of a spending on that infrastructure if you look at the 2009, how much of a capital commitment would that be to sort of beef up that system to allow you to be more aggressive in some of the shales?

Nicholas J. DeIuliis

I think if you look at the impact on the [minsuring] capital as a result of success in the Marcellus, there will be incremental capital, but when you look at the incremental capital relative to the incremental production growth, I think it’s insignificant, and if anything, you could have situations where for example the same production growth target, you actually have less capital. Even though it’s creating some incremental [minsuring] capital on the Marcellus side because of the flow rate, that might be offsetting a processing capital or [minsuring] capital on the coalbed methane side. Remember, Mountaineer requires processing for the coalbed methane plant. So from a capital [minsuring] perspective, I think it’s basically a wash. I don’t see a significant change either way.

Scott Hanold – RBC Capital Markets

Really quick one on the Chattanooga, I guess you said you had a fifth well that was connected last week. Did you have a rate on that well, sort of an [IPRA?]

Randall M. Albert

We do not.

Scott Hanold – RBC Capital Markets

Okay. One last question on the financial side, LOE costs did pop up a little bit and I know you sort of rationalized the breakdown on that cost. Can you kind of just give us a flavor of what to expect in the coming quarter? Should we kind of sequentially see that improve or is that $0.70 plus kind of run rate a pretty good place to be?

Nicholas J. DeIuliis

I think the safe bet right now is to assume that same run rate. We will have, if you look at the production guidance and see where we’re heading, we should have some economy to scale because of higher production volumes, but some of the things that we’re doing that impact that cost, for example work overs and what not, that has an immediate benefit and that benefit effectively in some ways when you think about it isn’t so much expense but it’s really capital investment with regard to creating potentially or at least maintaining or preserving reserves, so I think the activity that you’re seeing that’s producing that cost result is activity we’re going to want to continue at least for the foreseeable future, so I think that the $0.70 number is a decent estimate moving forward.

Operator

(Operator Instructions) Your first question comes from John Boland with Maple Capital Management.

John Boland – Maple Capital Management

Quick question on the carbon credits. I didn’t see anything in the release and I didn’t hear you mention anything. Do you have any guidance you can shed on that, what they might be worth, does it have any impact on income before ’09?

Nicholas J. DeIuliis

The carbon credit story obviously is something we’ve been able to develop here the past six months or so and we continue to accrue and bank additional credits as we continue to capture methane off of the coal mining operations. CONSOL Energy, our major shareholder, we continue to split those credits 50/50 so that bank is growing. As to what they’re worth, that is the huge question mark. We’ve seen a lot of volatility on the price for these credits on the Chicago climate exchange, which we’re one of the members of, and I think it really comes down to two things. The presidential election and maybe not so much the presidential election as after the presidential election, what the President and Congress decide to do about climate change, and I think the devil will be in the details there with regard to setting that market price.

So right now we don’t have an immediate plan for monetizing those but we’re sitting on them, we’re continuing to inventory them, we continue to build the bank. We’ll see how these different proposed plans for climate change shape up before we make a strategy and a discussion about that.

John Boland – Maple Capital Management

And they don’t show on your balance sheet anywhere either, correct?

Nicholas J. DeIuliis

They do not.

John Boland – Maple Capital Management

Then the next question, and I don’t know if you’d be able to speculate on this, but we’ve seen a lot of predictions about where the underlying commodity and prices might be heading over the next year. If you really had to put a number on it, how low do you think you can get your breakeven price to?

Nicholas J. DeIuliis

If we want to go to what I’ll call turtle mode, the end of the world type of situation where for whatever reason, externally, internally, we just want to clamp down and conserve cash, I think our costs clearly by a mile become the largest in the eastern United States and I think we start to give the one entity that’s out there in the west on unit cost that gives us a run for our money and we’ll start to give them a run for their money. That price is easily I think under $3.00 on a cash cost basis. Then you’ve got your DD&A on top of it. So if you’re talking cash, under $3.00 is where we can operate at and probably sustain production, replace our decline curve, at that level. But that’s obviously not the strategy that we’ve employed. If you look at what gas price we need to continue our growth, basically to produce 85 Bcf next year, from a cash standpoint, if you don’t want to lever a dime, I think we’re good at the current NYMEX in our hedge book, so we’re in good shape there, which is basically a $7.00 or so number for the unhedged production, and if you’re looking at rate of returns, we can actually sustain a lower gas price than that and still get an economic return above our cost of capital from everything from Virginia to Nittany to Mountaineer on the CDM side and probably including the Marcellus because of those inherent advantages we have as well as the Chattanooga shales, so from an economic rate of return perspective, somewhere around $5.50 in gas price. From a cash not borrowing another dime next year perspective, I think we’re good at the current NYMEX if we hit the 85 Bcf, and if we just wanted to minimize our cash costs and go into turtle mode because the Apocalypse is here, I think under $3.00 is our only cash cost.

Operator

Your next question comes from Brian Corales with SMH Capital.

Brian Corales – SMH Capital

Trying to just get a better feel for the capital budget next year in just terms of percentage, what percent of the capital is going to each play. Should we look at growth in terms of more wills in Nittany, Mountaineer, and Virginia?

Nicholas J. DeIuliis

When you look at the portfolio, I think the number of wells in each play are going to be driven by different factors. The nice thing is in the big picture of good news is that on the prior question, following off of that, whether it’s Virginia or Nittany or Mountaineer or the Chattanooga play or the Marcellus, we can see a significant drop in gas prices and still have an economic rate of return above our cost of capital. That’s the most important point.

Once you get beyond that, in terms of how many wells we can drill within a given quarter or year across those plays and in total, those are going to come down to the specific issues in each play, so for example, if we go to the Mountaineer CBM play, we’ve gone from taking about 24 days to drill those horizontal coalbed methane wells a couple of years or 18 months ago, we’re drilling them under 10 days today. That’s putting tremendous strain on our permitting effort. Now because we can drill more wells with a given rig, we’ve got to go out and get a bigger bank of permits to stay ahead of the rigs.

So the bottleneck right now at Mountaineer is something very different than what the bottleneck might be for example in the Chattanooga play. In the Chattanooga play, I think the bottleneck is something like the midstream take away capacity. So right now I think from a capital financing perspective, we’re in great shape. From an economic rate of return perspective we’re in great shape across all those plays. The 85 Bs now is being set by what we see as the inherent bottlenecks play by play within the portfolio.

Brian Corales – SMH Capital

I guess in terms of the new shale plays with the Chattanooga and the Marcellus, it’s just safe to say you’re going to operate two rigs in Marcellus and one in Chattanooga and kind of leave the other areas somewhat flat, maybe flat increase?

Nicholas J. DeIuliis

I think that’s a good estimate for the Marcellus until we see more definitive results over time. The Chattanooga, I think it’s safe to say we’d be operating two rigs there.

Brian Corales – SMH Capital

You’ve always had the next play on the horizon, kind of in that expiration mode, can you maybe talk about the New Albany or a little of the shallower zones, the more conventional zones there, or other opportunities that you’re pursuing at these times?

Nicholas J. DeIuliis

If you look at where we’re out today, and it’s really an interesting question you raise. If you look at the past three years, Mountaineer came into its own and now it’s up to as I said about $40 million a day into the sales meters, so that’s a full-fledged development play. Nittany’s up and running. I think we’re easily going to drill 100 wells there this year up in the Nittany play. Chattanooga, as I said, looks very good. We think we’ve got an economic play moving forward. The next quarter or two should hopefully firm that. Marcellus is going to be more as I said of a surgical well by well type of a play where we want to drill them in the right spots, not just because of the geology that we see, but also because of the location relative to midstream to get that into the sales meter.

If you look at what’s next over the next quarter or year, the two biggies that pop to mind currently are going to be the [Euron] which we really haven’t said much about to date because we haven’t had much with regard to results and activity. That should be changing over the next two to three quarters as we start to execute that exploration program, and that would be likely a horizontal application similar to what you’ve heard some of the Appalachian peers out there talk about for the past two years. The other one out there of course is what I’ll call mid-continent, and I hesitate to say just New Albany shale because it really is more than that with regard to our control of the shallow conventional, the oil rights, and the coalbed methane.

So when you think of mid-continent out there, it’s very similar to what we control in Northern Appalachia, where we’ve got the coalbed methane control, we’ve got the low shale, and we’ve got between those two, shallow conventional rights as well. You start to think about those synergies there, it would be interesting to see what the prognosis is for mid-continent over the next 12 months.

Brian Corales – SMH Capital

Just one final question. In terms of the Marcellus, and I know there’s some infrastructure already in place, is infrastructure going to drive the drilling and kind of are you waiting for more results before you do try to put more take away in place?

Nicholas J. DeIuliis

On the take away front, I think we’re preparing for success in the Marcellus. For

example, if you look at not just the activities that Randy talked about with regard to what we’re doing within the [Michigan] that we own and operate, we’ve also been out there securing firm transport on the interstate pipeline system as well that would contemplate success in the Marcellus. The issue in the Marcellus is really two factors. One is going to be getting enough time to drill a handful of wells and again the focus there is going to be on the horizontal wells to get production history that we’re comfortable with and then the second issue is going to be once we have that comfort, drilling the next Marcellus wells and areas where we can hook them into the sales meter as quickly as possible and balancing that with the engineering and geology view of things as well.

Operator

Your next question comes from Troy Logan with [Castle Life] Management.

Troy Logan – [Castle Life] Management

Quick question. Given the opportunities that you guys obviously have and the lack of lease expiration issues that some other companies have, any thoughts of diverting some of the cash flow and buying back the stock?

Nicholas J. DeIuliis

You know you look at the operating cash flow and right now we’re secure with regard to our 85 Bcf [bogey] next year. I’ve never been a big proponent of the share buy backs with this type of an entity because of our growth prospects internally. On the same token I haven’t been a big proponent of acquisitions either because of the same reason. Those two things I think have changed quite a bit over the past couple of months because of what we’ve seen with regard to our share price, frankly, which to me is very frustrating and to our shareholders, but also with regard to what we’re seeing with regard to the liquidity crisis. In that effect we’ve seen with regard to things like knock out leases.

So I think what we need to do is we’ve got a nice funding base that could easily fund the 85 Bcf for next year based on what the projected operating cash flows are. We stick with that and we see how our share price performs and we see what level of duress we are viewing with regard to the peer group. Just like anything else, when we look at those opportunities, it comes down to a competition for capital. Do we drill that next well in one of our best plays? Do we buy back a share of CXG? Or do we go acquire 1000 acres because someone just has to part with it to raise liquidity? That’s the type of decisions we make each and every day. We think it’s the most critical decisions we make as management. That’s what we get paid for in a capital-intensive industry, and we’re ready for it with regard to 2009 and coming into year end ’08.

Troy Logan – [Castle Life] Management

So all of it’s on the table then.

Nicholas J. DeIuliis

It’s all on the table as some people like to say.

Operator

Your next question comes from Brad Pattarozzi with Tudor Pickering Holt.

Brad Pattarozzi - Tudor Pickering & Holt

You talked already a little about LOE costs going forward about $0.70. Could you provide some guidance on other unit costs, G&A, DD&A, how we should think going forward Q4?

Nicholas J. DeIuliis

Q4 I think a safe assumption is to basically take the run rate that we’ve seen for Q3 which I believe again just looking at the release is around $4.00 give or take all and including DD&A and the overhead costs, etc. So I think that’s a safe assumption for Q4. We don’t see much that would substantially change that one way or the other and again that is impacted relative to historical because of a lot of what we’re doing with regard to the read work and recomplete activity on our legacy production which we’re seeing very positive results from. I think in the release we said once again this is the second quarter in a row where the legacy production of our Virginia coal bed methane field has been higher than what it was a year or 18 months ago, so that’s not a decline, that’s obviously an incline, and work over program is having a marked effect, so we’re happy about that. We’re going to continue that definitely for the next quarter and I think into at least the first half of 2009.

Brad Pattarozzi - Tudor Pickering & Holt

Great and follow up, on the Marcellus, your first horizontal, $6 million, what do you expect going forward to average or what do you think in terms of doing a completion cost for Marcellus horizontal?

Randall M. Albert

We now have the second well drilled and it looks like it’s going to come in around $4.5 million so we think it will improve. We think that’s a good number. We’ve got some problems in the vertical section of the first Marcellus because of the [inaudible].

Nicholas J. DeIuliis

When you look at our history over the past 3.5 or 4 years, you should get some comfort that what Randy is stating will be the case. If you look at again what our Mountaineer coalbed methane which is a horizontal drilling program where we’re trying to drill horizontally in 5 or 6 foot bed of coal. 24 days was the average fill time two years ago. We’re down to under 10 days today, so we’ve demonstrated that again. It’s 5 to 6 foot thick coal, let alone 50 foot thick Marcellus shale. If you look at what we’ve experienced in the Chattanooga play with regard to horizontal drilling in the shale, same type of cost improvements we’ve seen here in the short time we’ve been in the Chattanooga shale. Frankly if you look at what we’re doing in Nittany which is vertical coalbed methane program, a little bit different than the Marcellus because we’re talking horizontals. A similar type of efficiency, so we’ve got a track record for both horizontal drilling and horizontal drilling in CBM and horizontal drilling in shale where initially we come in, get a feel for the signs and approach of this, and over time and it’s not a long period of time, we start to see some significant operational efficiencies.

Brad Pattarozzi - Tudor Pickering & Holt

So would we expect that $4.5 million for the second well to continue to trend down going forward?

Nicholas J. DeIuliis

I think for now $4.5 million is a good target but when you look at it over time I think your expectation should be that as we drill a half a dozen or a dozen of these things, they might trend down even lower than that.

Operator

Your next question comes from David Diamond with Rovida Holdings.

David Diamond – Rovida Holdings

I have two questions. The first relates to where you were able to drop your CapEx. You dropped your CapEx I guess about $40 million or $50 million and where do you see that going forward, the ability to cut CapEx. The second question is more of a statement, but I guess I’d be interested to get your comments, Nick, the example you gave on the call when you said in 2005 when you went public you never would have expected your stock to have been back to the same price, so is that given the great job that you’ve done operationally?

But you’re controlling shareholder, I would argue has done as equally as poor a job operationally in a lot of areas and it seems that you’re stock basically trades where there stock does and they’ve become more set in their ways in terms of keeping you as part of the company. In fact I don’t think any of us that invested back then would have expected you to still be part of the parent, so maybe you can give us your view on the situation, where your company is sort of excelling on all metrics, beating numbers, surpassing the street, where the parent is running into more difficulties. Do you think that makes it more or less likely that CNX will continue to own the 80% or so that they control today?

Nicholas J. DeIuliis

I almost forgot the first question because of the weightiness of your second. But let me go to the first one first, we’ll go to the second one in a minute here. The capital issue. Again, coming off the prior question, I think why you’re seeing the ability to reduce capital but yet increase production, the best example I can give of that within the company is Mountaineer on the coalbed methane side where it’s just simple operating efficiencies of either being able to drill wells quicker with regard to a given drill rig or taking advantage of things like midstream as we capitalize that early in the project and then the future wells benefit from it, so if we start to develop a Mountaineer play like we have and then we look at Nittany and then we look at Chattanooga.

Again talking about the Marcellus as the prior question as well, I think that reduced capital is largely driven by improved operational and drilling efficiencies and I think that’s a very good thing because operationally that is one of the key parameters that we should be focused upon. It’s got safety, you’ve got being as low cost as you can and as efficient as you can because you produce a commodity whether you like it or not, and then you’ve got the capital deployment decision from a big picture perspective, making sure you’re putting the capital in the right places. So yes, I’m happy to see that, I expected to see that, and now that it’s here, we’re definitely happy with the situation we’re in.

If you go to the bigger picture question you asked about the ownership situation and where we’re going with regard to that, frankly that’s a question that I can’t answer because we don’t control that state of affairs. What we do control is the production growth, the capital efficiency, and the safety of the company, so I’m as frustrated as anybody about the share price. We’ve got many theories as to what’s driving that macro, micro, internal, external, but I know one thing, if we keep producing like we are, it has to reflect itself in the share price at some point. I just hope that it’s sooner rather than later and the last couple of months have been again very frustrating and very disappointing from that perspective, especially when you compare it to the results that we’ve seen internally from the company.

David Diamond – Rovida Holdings

If the parent company were to go under some sort of financial duress, for example if coal prices were to continue to trend lower or there be some sort of debt issue or something like that, how would that impact CNX Gas if at all?

Nicholas J. DeIuliis

Historically, again history being 3.5 or 4 years of being stand alone, there’s been many ups and downs within not just the energy space but specifically the coal space and specifically CONSOL Energy. The good news there is that despite that volatility, they have effectively given us a free hand over the past 3.5 or 4 years to grow the company as we see fit, so when you look at the production growth for this year or the guidance or the capital for next year, those are basically numbers and projections and targets set by the management team at CNX Gas and approved at least with regard to this year and again we’ll get our capital budget in process for next year moving next month, approved by the Board of Directors.

So from our perspective with regard to how we’re running the company, no effect historically. I would hope that continues into the future with no effect as well.

Operator

Your next question comes from Joe Pavelich with Snyder Capital Management.

Joe Pavelich – Snyder Capital Management

I was wondering if you guys could provide a quarterly break down of your hedges in 2010.

Nicholas J. DeIuliis

2010 is looking into company total first. 22.1 Bcf total and the dollar per Mmcf is $9.61. If you look at the breakdown by quarter, roughly speaking first quarter is about 9 Bs in 2010, I’m sorry, 9.3 Bs in 2010 that are hedged about $9.70 an Mmcf. Second quarter is going to be just under 8 Bs, 7.9 some odd Bs that are hedged at $9.54, third quarter is about 5.1 Bs hedged at $9.70 and then the fourth quarter is the lightest of them all. It’s about 0.5 Bs hedged at $8.30 and again, the company total, I gave you 22.1, that’s actually millions of BTUs. The Bcf is 22.8.

Operator

With that, no further questions in queue.

Nicholas J. DeIuliis

Okay John, why don’t you go ahead and wrap up the call and provide the callers with the replay information.

Operator

Certainly. Ladies and gentlemen, this conference is available for replay. It starts today at 12 pm eastern time and it will last until October 29 at midnight. You may access the replay anytime by dialing 800-475-6701 or 320-365-3844. The access code is 962443. Those numbers again are 800-475-6701 or 320-365-3844 and the access code is 962443. Any closing comments?

Nicholas J. DeIuliis

Thanks very much everybody and I will be around for the rest of the day if anybody has any questions.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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