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Encore Acquisition Company (NASDAQ:EAC)

Q3 2008 Earnings Call

October 29, 2008 10:00 am ET

Executives

Jonny Brumley - President & CEO

Ben Nivens - SVP & COO

Analysts

Joseph Allman - JP Morgan 

Operator

Good morning. Welcome to the Encore Acquisition Company and Encore Energy Partners LP conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session.

This presentation includes forward-looking statements. Forward-looking statements give Encore's current expectations or forecasts of future events based on assumptions and estimations that management believes are reasonable given currently available information.

However, the assumptions by management and the future performance of Encore are both subject to a wide range of business risks and uncertainties and there is no assurance that these statements or projections will be met.

Actual results could differ materially from those presented in the forward-looking statements. Encore undertakes no obligation to publicly update or revise any forward-looking statements. Further information on risks and uncertainties is available in Encore's filings with the Securities and Exchange Commission.

I would now like to turn the call over to our host, Mr. Jonny Brumley. Thank you very much. Mr. Brumley, you may begin your conference.

Jonny Brumley

Alright, thank you. Thanks for Encore third quarter 2008 conference call. In the room with me today to help answer questions is Kevin Treadway, Senior VP of Land; John Arms, Senior VP of Acquisitions; Ben Nivens, our Chief Operating Officer; Jon Brumley, our Chairman; Bob Reeves, our Chief Financial Officer.

We have a lot to go over on the call so I’ll be brief on the third quarter financial highlights because those are in the release. After we go over the Encore Acquisition Company third quarter, we will go over Encore Energy Partners third quarter, then we’ll go over the 2009 budget, and then finally we will go over the reasons behind the Rights Plan.

The results were really good for the third quarter of 2008. Our EBITDAX was over $200 million. We beat the high-end of production guidance. And I think also it’s really important with not only beating production guidance was the 7% growth over the third quarter of 2007.

The best part of the third quarter was out enhanced success in the Bakken Sanish play in North Dakota. The company has amassed 300,000 acres. We have 700 drilling locations and we’re starting to see increasingly better results. Our 250,000 per well model, which our economics are run on, is a well that produces about 220 barrels of oil equivalent per day average for its first 30 days of production.

Our actual results are much better. We brought on four wells. Their average IP was 650 barrels a day and they produced about 515 barrels of oil equivalent per day for the first 30 days, so really, really good strong wells that showed a lot of staying power.

So, that’s meeting our estimates and that’s exciting. Another important part of the Bakken program is our refract opportunities. We refract three wells in Murphy Creek during the quarter and we’ve increased production 95 barrels per day per well.

That’s also better than what we’ve run our aFes on. And these are really, really exciting projects because they only cost half-a-million dollars and they increased reserves by 80,000 barrels of oil equivalent.

So we’re excited about having these high, high return projects really do well. We think that this will improve the play well beyond what most people are predicting. And it’s pretty easy to summarize the pocket. We have more acreage, the wells are bigger, and the refracts will continue to improve the economics which are already good. So it’s a great situation all around.

Now let me brief you on the west Texas JV with Exxon Mobile. This is the JV where we earned 30% of the upside potential in Exxon’s biggest gas fields in west Texas. We’ve brought on 20 wells in the Midland basin at an average rate of about 3.2 million.

We’re concentrating now on Pegasus. Pegasus is the biggest field in the Midland basin. We have over 100 potential drilling location in the Midland basin and the Pegasus wells are coming in at about 4.2 million cubic feet a day.

Remember last quarter we drilled that 13 million a day tie-up well? That well is still holding in very strong. It’s holding in at around 8.5 million cubic feet a day and we’ll offset it in the first quarter of 2009, so very excited about that and getting a rig out there and drill another well similar to the one that we brought on in the second quarter.

All in all, the JV’s performing better than we’d expected, especially once we go out of the commitment phase and into the development phase. The wells are bigger and there’s more of them. So just like the Bakken, it’s bigger and better than we though.

Our Arcotex region is also doing well. We brought on our largest Travis Peak well since starting the program in 2006 during the third quarter of 2008. It’s the Wheeler number 3, it IPed at 6.2 million cubic feet a day. So that’s really a big well considering that these wells only cost $2.5 million to drill and complete.

We’ll be spanning our first Haynesville Well in the fourth quarter of 2008. That’s exciting as well and ready to get that going. We have top-notch Haynesville acreage. Most of our acreage is in north Louisiana in between Elm Grove and the state line area, so right at the epicenter of the Haynesville and other companies might have more acreage than we do in the Haynesville, but no company has better acreage than we do in the Haynesville.

Now I’ll brief you a little bit on the TMS project. That’s the Tuscaloosa Marine Shale. We’re still waiting to complete the Weyerhaeuser well. That’s the third well that we drilled in the Tuscaloosa Marine Shale. The reason why we’ve had to wait so long is high strength profit has been tough to get.

We finally got our hands on some and so we’ll be fracking that well in early November, so excited about that. If you remember this is the well where we go the full horizontal lateral in the well.

We got out 4,100 feet. So we have more to work with and really pleased to see what this zone will do. This zone is pretty much untested because the first well was not drilled very well and the second well the casing parted on us, so excited to see what we have in the Tuscaloosa Marine Shale.

From a drilling and volume standpoint, we couldn’t be more pleased with how the third quarter went.

Now, I’ll shift gears. I’m going to start talking about Encore Energy Partners. The partnership announced the distribution at $0.66 per unit for the third quarter of 2008. Production was around 6,189 barrels of oil equivalent. Even with this robust distribution, our coverage ratio was 1.5 times. We are pleased with how the properties are doing operationally because the properties decline at such shallow rates, we are able to have these large distributions during high commodity price environments.

Another important thing to point out in the properties is that in 2009 about 75% of the crude oil’s flooded at $110 per barrel. An important item to discuss it the LOE. The LOE ballooned to $15 a barrel during the third quarter. That’s mainly due to high gas prices. These water floods utilize a lot of gas for their electricity generation so when gas prices go up, the lease operating expenses go up. Now we’ve already seen that subside with natural gas prices decreasing and we’re expecting to be under $13 per barrel for the fourth quarter of 2008.

We had a really exciting project at Elk basin. We installed the Nitrogen Membrane Unit. That was a $700,000 capital expenditure. But what makes it such a great investment was that it will save us $1.6 million a year in fuel. And that’s a great payout. All in all, the MLP is performing very well.

Let’s talk about the 2009 budget. I’m excited about 2009. It’s times like these when quality shines through and Encore is really going to look good. I’m very happy that 65% of our production comes from long-life waterfloods. We’ve always had big long-life as a core part of our strategy and when prices drop, that’s when you notice the difference. Longevity is important.

In 2009, our budget will allow us to do a lot. It will allow us to grow production 3 to 5% organically. Our budget will allow us to repurchase $40 million of stock. Our budget will allow us to pay back $55 million of debt.

And it will also allow us to increase our Bakken and Haynesville acreage. And we couldn’t do that if we weren’t long-life. The budget’s only $460 million, $356 million is allocated to drilling and 50 million is set aside for work-overs and the land budget is around 50 million.

The geographic breakdown is Bakken Sanish, 164 million; Haynesville, 88 million; west Texas JV, 82 million; Mid-continent, 63 million; other Rockies, 48 million; and other west Texas 15 million.

This 2009 budget is low-risk and it’s low-risk for the following reasons. One, our hedging program protects the revenues. If oil prices continue to drop, we will still have plenty of revenues to fund this budget.

Second, we’ve already de-risked the Bakken and the west Texas JV. That’s what we worked on in 2008, so it’s less risky from a reservoir and geologic standpoint. And third, the budget is much simpler from a drilling standpoint.

We know the areas where we go over aFes. And we’ve eliminated those out of the budget. So that is exciting to have this high-quality budget and this low of a risk of a budget during this time.

Another thing I’d like to point out is that we’re estimating that the capital budget using the third quarter 2008 capital estimates. So for our 2009 budget, we are basically playing like costs are going to be the same as they are now and costs will probably be less in 2009 than they were in the third quarter of 2008.

This is a time when casing is very high, drilling rigs are high, and well services area high. When prices begin to subside, we ought to be able to do the same work for less or more work for the same, but we’ve tried to be conservative with the budget.

Now let me talk about the 2009 hedges. We’ve purchased 11,630 barrels a day of puts at $110 shrike prices. We’ve swapped 6,000 barrels at $86.21 for 2009 and forwarded 8,000 barrels a day at $80 for 2009.

This is our consolidated hedging program for both EAC and ENP on a consolidated basis. We have 11 hedging counterparties, about 75% of our exposure is with the following companies, BNP Paribas, Calyon, UBS, and Fortis. The other 25 is spread between seven others.

Discretionary cash flow is expected to be between $550 to 600 million and that’s around $80 oil. If you take oil down to $60 per barrel, the discretionary cash flow actually increases because severance tax goes down and then increased hedge settlements more than make up for it. But $60 oil, the hedge book would generate around $260 million of cash flow.

In the Bakken, we plan on operating three rigs through 2009. This will allow us to hold our acreage and be very efficient. We plan on dropping our most inefficient rig in the fourth quarter if ’08 and picking up a better, more efficient rig in the first quarter. And this is what you can do to improve your operation when other companies are cutting their budget.

We’re also excited about our new areas in the Cherry Creek area and the Charleston area. And we’ll be testing out 70,000 acre block in the Almond area in the first quarter of 2009, excited about that as well.

All in all, 2009 will be a great year for Encore. We have plenty of projects we’ll improve the balance sheet and show good growth per share. Management feels good that we’ve protected our revenue and we haven’t hamstrung the company with a lot of long-term rig contracts. As oil field services drop, we should be able to procure more efficient and better services.

A quick update on the repurchase program, we’ve repurchased $17 million worth at $27.68.

Now, let me discuss the reasons for the Rights Plan, because our stock is trading well below its proved NAB and a very large discount to its 3P NAB. We felt it was prudent to protect the shareholders from somebody using unfair techniques to pick up the company on the cheat.

When we began looking at our peers, it was clear that about 67% have this Rights Plan protection and other protections that we don’t have. We felt that our shareholders need to be protected as well. We believe that this mismatch between equity values and NAV values will be solved within three years. And that is why we chose a three year plan as opposed to most of our peers which have 10 year plans.

Thanks for being on the call. Now we can open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question or comment comes from Joe Allman with JP Morgan. You have the floor.

Joseph Allman - JP Morgan 

Thank you, good morning everybody.

Jonny Brumley

Good morning.

Joseph Allman - JP Morgan 

Hey Jonny, when looking at the economics for the middle Bakken Three Forks Sanish, could you just talk about what you’re thinking there? Do you factor in your hedges when you think about the economics?

And I know you said you’re using a model of 250,000 BOE/EURs ,given the results have you upped that EUR estimate in your model and are you using something like a $5 million cost? Can you just kind of take us through your thinking there, and at what point did you keep those numbers in your model, what point might that play not be very economic?

Jonny Brumley

Well, we believe the play will be economic at least down to $50 a barrel, but we are contemplating in certain areas taking that model up from 250,000 barrels, especially as we're seeing better and better results in our new area. So you could see that increase especially as we keep getting results like.

And then, the third-party accretion we don't really use the hedges on the AFE economics because we're going to get that cash flow from the hedges regardless of whether we do the project or not.

Joe Allman - JP Morgan

Yes, that's helpful. And on the cost side, what are recent costs looking like? And what do you use in your model?

Jonny Brumley

Recent costs have been $5 million a well. We drilled three different types of wells, but basically they’re $4.5 million to $5.5 million. That’s about $600,000 or $700,000 a well higher than at the beginning of 2008 and we expect to see prices probably get closer to that 2008 level, but we're not budgeting for that in case they don't.

Joe Allman - JP Morgan

Okay. That's good. And then is the recent focus on more middle Bakken or more on Three Forks Sanish?

Jonny Brumley

Both. We've drilled -- I think it's -- the recent focus has been on the Sanish, but I think that that's more coincidence. In the third quarter three of the four were Sanish, but we still think the world of the Middle Bakken too.

Joe Allman - JP Morgan

Got you. Okay, and then in terms of play, what plays look less economically attractive here given the current pricing and the current costs and which ones kind of just -- which ones do you think are most marginal in your portfolio?

Jonny Brumley

I think some of the unconventional gassier plays might be tighter. The West Texas JV really looks good because that's a conventional pretty big time play in all fields in low risk. So I think that looks okay. The Bakken hangs in. The Travis Peak hangs in because the wells are so cheap. I think that the Haynesville would be one that is still economic, but we’re having to watch the economics on it.

Joe Allman - JP Morgan

Got you. And then last one, Jonny. I noticed third quarter oil production was pretty much the same as the second quarter, you got a big bumped up in natural gas. Is there something that's offsetting the increase in the Bakken production?

Jonny Brumley

No, that was just really basically for all those wells came on in September.

Joe Allman - JP Morgan

Okay. Got it. So the timing issue?

Jonny Brumley

Yes, I think that -- but let me be clear on the Haynesville. The Haynesville still makes economic sense right now. If the Haynesville will make a lot of money if casing prices drop.

Joe Allman - JP Morgan

Okay, so given the current costs in Haynesville works down to what gas price do you think?

Jonny Brumley

About 550 or 6.

Joe Allman - JP Morgan

Got you. . Okay. All right. Thank you very much. Very helpful.

Operator

Your next question comes from the line of Noel Parks with Ladenburg Thalmann. You have the floor.

Noel Parks - Ladenburg Thalmaan

Good morning.

Jonny Brumley

Good morning, Noel.

Noel Parks - Ladenburg Thalmaan

I just have a couple of questions on some of the various items in the quarter that we saw. There was a mention with the Tuscaloosa Marine Shale about the -- you did take an impairment charge on that and you mentioned that in your discussion also. So could you talk a little bit more? You said that you have couple of mechanical problems. You mentioned the casing in the second one. Can you just give us sense of what the engineering challenges are on the play at this point?

Jonny Brumley

Well I think that this play, it is difficult drilling. We took about $25 million charge and that was because the wells at this $13 million rate, which the first two were drilled, and that's an average, I'm sure that both worth $13 million, but the $13 million average or $12.5 million average per well was it is not economic at these prices and at the low rates that they came on at. And so when we did our impairment test, the wells don't hold out to the test.

Noel Parks - Ladenburg Thalmaan

Okay, so largely a function of just how steeply we've seen prices pull back in the quarter.

Jonny Brumley

And how expensive the wells were and that we didn't get good completions on either one of the wells.

Noel Parks - Ladenburg Thalmaan

Okay.

Jonny Brumley

So that's why this third well is so important because we do have the lateral length to test this correctly. It's a very important well. If this really works well and gives you a Bakken-type rate, you'd be very excited, if it doesn't, you'll be disappointed.

Noel Parks - Ladenburg Thalmaan

Okay. And also another bit of housekeeping. On the exploration expense item this quarter, can you just tell me what was included in that?

Ben Nivens

Noel, this is Ben. We had three wells primarily made up that exploration expense and we had an unsuccessful well in New Mexico, and then we participated in two exploration wells in the Williston basin to test the Red River that were both unsuccessful as well.

Jonny Brumley

They were non-operated.

Ben Nivens

Right.

Noel Parks - Ladenburg Thalmaan

Okay and in the Bakken, I just wondered if you, having drilled as many wells as you have, do you have any thoughts on what the decline curves might look like especially for the Bakken and incorporating the Sanish where you've done that? I mean, do you have any further insights now that we're another year further in the your drilling program there?

Jonny Brumley

I think that we fell real good about the 250,000 barrel number and think that it's conservative because we're getting into better and better areas. So we're pleased that at least our model is going to be this good and it could be better.

Noel Parks - Ladenburg Thalmaan

Okay and I wondered did you do any drilling during this quarter, either operated or non-op in the Stanley Field area and just wondered if you have any comments on what you see in that part of the play?

Jonny Brumley

No, we did not.

Noel Parks - Ladenburg Thalmaan

Okay and, also, I want to ask you about the Madison program, just maybe an update on it. Are you still looking at a one to two rig program out there coming this 2009?

Jonny Brumley

We'll drill some Madison wells in ‘09 but if you remember, all that is held by production and so, with this lower budget, we've got to hold some Bakken and acreage, so it will be more concentrated in the Bakken.

Noel Parks - Ladenburg Thalmaan

Great. And then just one more on the Bakken, I noticed that the acreage count is up again, looks like 300,000, I think the last number I remember hearing was about 265,000. Are those incremental acres, are they part of new focus areas, you've done the acquisition on in the play or are you merely filling in where you've already had positions?

Jonny Brumley

Pretty much filling in where we already have positions. We feel better about these areas since we've de-risked a nice chunk of the Bakken acreage. Really, the only part that we haven't de-risked is the Almond area, so we’re excited to get on that in the first quarter. But we were able to pick up a lot of acreage in our core areas and then even a little bit more in Almond.

Noel Parks - Ladenburg Thalmaan

Okay and then just the last one for me, I noticed you talked about the Stockman area in East Texas and something you haven't said a lot about over the last year or so. I know, last quarter, you mentioned there's Bossier potential in the area and then you mentioned the 6.2 million a day, Travis Peak well.

The very nice rate there, is that a result mostly of completion techniques or just a better target in that particular well?

Ben Nivens

Just a better target. We continue to tweak our completion techniques, but we haven't made a major change. All the wells we've drilled this year have performed well out there but this one was particularly good.

Noel Parks - Ladenburg Thalmaan

Okay great. That's it for me, thanks.

Operator

Your next question comes from the line of Scott Wilmoth with Simmons & Company

Scott Wilmoth - Simmons & Company

Hey, guys, just one follow-up. On the Bakken economics I know you said it was economic down to $50 a barrel. Is that --

Operator

This Simmons and Sons.

Scott Wilmoth - Simmons & Company

Excuse me?

Jonny Brumley

Scott, you there?

Scott Wilmoth - Simmons & Company

Can you guys hear me?

Jonny Brumley

Yes, I can hear you. I just had some feedback.

Scott Wilmoth - Simmons & Company

Okay. Just a follow-up on your Bakken economics. I know you guys said it was economic down to $50 a barrel, now is that based on actual results or based on your model expectations?

Jonny Brumley

Well, our actual results are better than our model, but it's really based on our model.

Scott Wilmoth - Simmons & Company

Okay. That's all I needed to know. And then looking at '09 CapEx, is anything planned for Tuscaloosa Marine Shale in '09?

Jonny Brumley

Yes. We will be working on that later in the year. I think that one of the things that we want to do is make sure that if the third well goes well, man, you are just excited about this. But if it doesn't, we need to re-look a new science to do this.

I mean we'll have done a completion and gotten off a good completion on a long horizontal lateral and so we need to figure what we're doing wrong. Because we know the oil down there and we know that oil is over pressured and we know what we'll produce and actually produce at a pretty reasonable decline curve from this other two wells. We just sit (inaudible) if we can get a long lateral with a high rate.

Scott Wilmoth - Simmons & Company

As far as higher rate, what is your kind of threshold where you'd be pleased with the rate?

Jonny Brumley

I think anything over 400, you would be pleased and say yes something to work with.

Scott Wilmoth - Simmons & Company

Okay. And then moving to A&D, I know you guys had a couple of packages, maybe you're looking to sell. Any update on those?

Jonny Brumley

Yes. I mean, just in light of what's to going on with the financial market, we're not pushing those out there ready to roll. We are talking to a group about one of them, but we're not trying to push on a rope here and think that maybe things ought to clean up in a few months and so be ready to look at it then.

Scott Wilmoth - Simmons & Company

So assuming that things get better, and just hypothetically, if you guys could get those closed in '09, what uses of those cash -- do you increase drilling or what plans would you have for that cash?

Jonny Brumley

Well, I'd pay down debt with it.

Scott Wilmoth - Simmons & Company

Okay. And then one last question, just with the acreage acquisitions you guys are looking at making in the Bakken and in Haynesville, is that more like a 50-50 split and can you talk about preference of one over the other and maybe current cost? I know they've come down significantly, that you're seeing in the areas.

Jonny Brumley

Yes, well we can't really talk about costs because we are working on fields and they're competitive, but you’re right, costs have come down significantly especially in the Haynesville, where they got up so high.

I think that we will be really concentrating more on the Bakken than the Haynesville, we think that that's a very, very good play. We see a lot of things that are improving the play that aren't in our numbers. So we're really, really excited about the Bakken and we like being on oil. I mean oil is just a lot higher margin than gas.

And so, we're not having to struggle near as bad as gas companies are right now because of that. And oil has always been a premium product to gas and so that's where our focus is. We like the Haynesville and we will be leasing in the Haynesville but the Bakken is where will be growing.

Scott Wilmoth - Simmons & Company

Alright. That's all I have.

Jonny Brumley

Alright. Thanks, Scott.

Scott Wilmoth - Simmons & Company

Thanks.

Operator

Your next question or comment comes from the line of Aaron Levinoff with Chesapeake Partners. You have the floor.

Aaron Levinoff - Chesapeake Partners

Good morning. I guess, Jonny, my question is looking at the rights program, why did you limit it to 10%? It just seems that in this environment if you want to give shareholders an opportunity to buy shares you have large shareholders who are near that level and it just seems that 10% is just too restrictive in this sort of environment. I want to get your thoughts here.

Jonny Brumley

Well, we just looked at the range and 10% was a fairly common percentage and so we picked it.

Aaron Levinoff - Chesapeake Partners

Okay. Thank you.

Operator

Your next question comes from the line of Pavel Molchanov with Raymond James. You have the floor.

Pavel Molchanov - Raymond James & Associates

Hi. Good morning, guys.

Jonny Brumley

Hello, Pavel.

Pavel Molchanov - Raymond James & Associates

Quick question about drop downs. You have not had a drop down into ENPs since I guess it was last December. Can you give us your thoughts on your strategy on that regard?

Jonny Brumley

Yes. We will have a drop down, it'll either be late this year or early next year.

Pavel Molchanov - Raymond James & Associates

Any sense of the geography of the assets or the size of the drop down at this point?

Jonny Brumley

It'll probably be -- it will be less than $100 million.

Pavel Molchanov - Raymond James & Associates

Okay. Same geography as it was last year or slightly different?

Jonny Brumley

I mean it will be a little bit different, but it'll be a long life, make a lot of sense. We have a royalty package we're looking at putting in so, that will make sense because that will really improve Encore Energy partners and it's not big enough to really show up at Encore Acquisition Company. So, it's kind of spread out, it's a first class set of royalties that ought to really, really look good into Encore Energy Partners.

Pavel Molchanov - Raymond James & Associates

Sounds good. Thanks very much.

Jonny Brumley

Thank you.

Operator

You're next question comes from the line of John Kang with RBC Capital Market.

John Kang - RBC Capital Market

Hi and good morning. I have a quick question for you regarding your strategy for hedges. I know in the past you have spoken to being one-third swap, one-third protected with puts, and one-third open to the market.

I assume your -- what's your current thinking? Are you trying to get back to that level by purchasing some swaps from the MLP? Obviously it's not a great environment to do it, but just I kind of want to get your take on it again.

Jonny Brumley

Now, that's still pretty typical of what we want to do. I think when we trade these things or when we hedge the MLP, it's not huge. So, if you put in like a 1,000 barrel a day hedge and just do an even contract, that might push that one-third up to 40%, 45%., so when you add it together, you're 75% as opposed to 67%. I think that that has more to do with the size of MLP than really our being over, you know, wanting to over or under hedge it.

John Kang - RBC Capital Market

Right. And then as you look out into the out years like 2010 and 2011, if the prices cooperate, would you look to add more swaps to have more stability?

Jonny Brumley

Yes, but we're at two-thirds in 2010.

John Kang - RBC Capital Market

Okay.

Ben Nivens

Yes, we're already out in those years.

Jonny Brumley

So, we've already done that.

Ben Nivens

We've got our minimum state quarterly distribution protected out through those years.

John Kang - RBC Capital Market

Okay. And I guess with the hedges just wondering, what would the cost of the puts and if you're able to separate it between the MLP and EAC?

Jonny Brumley

They're fairly similar because we did them pretty close with the same amount of time. But I think I could at 2010, I mean a $2,910 put when we bought it cost anywhere between $11 to $12. Now some of that we've sold some $80 puts that we already owned and rolled up that strike price and I think that that cost $7 to $8 when we did that.

John Kang - RBC Capital Market

Okay. And then I guess just to follow up on that drop down question. For about $100 million, what's your plan to fund it? Will EAC take units or are you trying to fund it mostly with borrowings on your credit facilities? What would be the plan there?

Jonny Brumley

Can you repeat the question?

John Kang - RBC Capital Market

As a follow up to financing the drop down at the MLP level, will the Encore, the parent, take units or obviously trying to raise funds by--

Jonny Brumley

Really I think -- I was probably trying to be a little bit more vague on the drop down because we haven't negotiated that deal with the MLP, but it's going be less than 100. I would think it's going to be closer -- it will end up being closer that $50 million mark, so there's plenty of credit for the MLP to handle that. And so, we're not going to diminish MLP's liquidity all that much by the size of the drop down.

John Kang - RBC Capital Market

Alright. And I guess just a last question from me is that it looks like some of your oil and natural gas price differential guidance for the fourth quarter are a bit higher. Just any comments other than current market conditions on those?

Jonny Brumley

Well, the Rockies differentials usually widen out in the winner.

John Kang - RBC Capital Market

Right.

Jonny Brumley

That's a the historical deal and so that will happen. And then space is pretty tight up in the Rocky Mountains too and so we're having to work hard to market that oil and we've been doing a good job of it. But that's really -- you have two things working against you, one the historical pattern of price and then two, it's just an active growing area.

John Kang - RBC Capital Market

Okay. Great. Okay, thanks.

Operator

Your next question comes from the line of Adrayll Askew with Hartford Investment. You have the floor.

Adrayll Askew - Hartford Investment

Yes, let me ask a question as it relates to your philosophy on hedging. I noticed you guys have 90% of the oil production hedge. What about on the natural gas side, what's the thinking there?

Jonny Brumley

Yes. We are big put-buyers. That's really important for us because we like to have the upside, prices increase. So you'll see that most of our hedges will be with puts but we do use some swaps, but mainly with put.

And I think that we just look at the environment and what the company needs. We stay hedged about 15 to 18 or 15 to 12 months out, so we're always looking at that. So really, it consists -- once we're consistent hedgers, we're put-focus and when we saw prices over a $100, we said this is a time to really, really lock in and take advantage of this.

So, that was -- and we hedged probably even more than we do typically, but that was because prices were at such high levels. So, we really wanted to take advantage of that. So we purposefully set the company up to take advantage of this high-priced environment by locking in our revenues or protecting our revenues and also we fought the drilling companies off really hard by not locking in those extremely high day rates that were in the center. and I think we're going to benefit from both of those decisions in 2009.

Adrayll Askew - Hartford Investment

Let me drill down a little bit. So on the oil side, you guys are aggressively hedged. What what is your philosophy on natural gas side and what are your hedges in place there for 2009?

Jonny Brumley

On natural gas at EAC, we don't have any gas, it's about 25% of our portfolio. And for one, because it is so much less, we don't concentrate on it as much. And secondly, we like having some of this gas exposure.

We have so little that when gas prices increase, it's nice to have some exposure. So that's really why we don't concentrate on gas as much is because it is little, we don't understand it as much as we do oil, and the exposure that -- the little exposure that we do have, we don't really mind having.

Adrayll Askew - Hartford Investment

So, how much of -- what percentage of production is it for you guys? I'm looking at it, it's like about -- based on this quarter's results looks like about 32% of production.

Jonny Brumley

Yes, that's probably right. I was speaking to reserve.

Adrayll Askew - Hartford Investment

Yes. Okay. Alright. So 25% is reserved around 30% of production. I mean are you guys are still comfortable with running that kind of unhedged position in natural gas even at these levels? I mean obviously, you can't go back and hedge at higher levels, but I'm just trying to get the philosophical view from you guys as to the risk appetite there.

Jonny Brumley

Yes, that brings up a good point on our hedging philosophy.

Adrayll Askew - Hartford Investment

Yes.

Jonny Brumley

The worst thing you can do is hedge into fear.

Adrayll Askew - Hartford Investment

Yes.

Jonny Brumley

Well, you do not want to do that, you do not want to be hedging right now, that is a big mistake. You always want to hedge into strength. And when you get scared, you waited too late and you're probably better off just riding it out, because what is going to happen, these prices are going to come back, drilling's going to slow way down supply is going to fall, prices would come back, and when you're scared, it's too late.

Adrayll Askew - Hartford Investment

Yes, I understand that. Okay, alright. Thanks for the color.

Jonny Brumley

Thanks.

Operator

Ladies and gentlemen, this concludes the portion of our Q&A conference. I will now turn the call back over to Mr. Jonny Brumley.

Jonny Brumley

Well, thanks for being on the call. We're excited about 2009. I know prices have dropped but we've done a good job of protecting that. We have a good budget it's lower risk than '08, it's going to be more efficient, we're going to pay down a good part of debt, buy back shares, and grow production all within cash flow. So, it's pretty exciting.

And also, we have a pretty decent land budget too, so, we're going to be buying acreage in the Bakken area and a little bit in the Haynesville area. So, we're really set up well to improve the company in 2009 and I think that's a unique situation. I think most of our peers are in survival mode and we're in improvement mode and so I think that that's really going to be important for 2009 and important for you too. So, thanks for being on the call.

Operator

This concludes today's conference. You may now disconnect.

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