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Executives

Louis G. Baldwin - EVP and CFO

Keith A. Hutton - President

Bob R. Simpson - Chairman and CEO

Analysts

Subhash Chandra - Jefferies & Co

Michael Hall - Stifel Nicolaus & Co.

Brian Singer - Goldman Sachs

David Heikkinen - Tudor Pickering & Associates

Scott Hanold - RBC Capital Markets

Kent Greene - Boston American Management

Tom Gardner - Simmons & Co.

Joe Allman - J.P. Morgan

XTO Energy, Inc. (XTO) Q3 FY08 Earnings Call November 5, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the XTO Energy Third Quarter 2008 Earnings Conference Call. My name is Arita and I will be the operator for today. At this time all participants are in listen-only mode. We will have a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder, this conference call is being recorded for replay purposes.

XTO management will be making forward-looking statements during this call. Risks associated with such forward-looking statements may have been outlined in our latest 10-K and 10-Q and news release. Actual results may vary materially. The company undertakes no obligation to publicly update or revise any forward-looking statements.

At this time, I would now like to turn the call over to Mr. Louis Baldwin, Executive Vice President and Chief Financial Officer. Please proceed, sir.

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

Thank you for joining us today to hear our discussion of XTO's third quarter financial and operating results. Participating today in Fort Worth are Bob Simpson, our Chairman and CEO; Keith Hutton, President; Vaughn Vennerberg, Senior Executive Vice President and Chief of Staff; and Tim Petrus, Executive Vice President of Acquisitions.

To start I'll briefly discussed our third quarter financial results and guidance for the fourth quarter. Next, Keith and Tim will review operations for the quarter and finally Bob and Vaughn will give an update on their views. I will note that our third quarter operations review is available on our website.

XTO had a solid third quarter, leading slightly our first call EPS estimates and blowing away cash flow estimates. Compared to the same quarter of 2007, production was up 24%, revenues up 50%, GAAP EPS up 26%, cash flow up 66% and cash flow per share up 47%.

We expect to have a record year for 2008 and record cash margins. Given current commodity price strips and our current hedges, we also expect another record year for 2009. Production, cash margins per unit, cash flow and net income are currently expected to beat all records for next year. The bottom-line for 2009 will be substantial free cash flow generation.

Looking in more detail at third quarter financial results, our earnings per share on an adjusted basis were $0.99. That compares to the first call estimate of $0.98. Adjusting items were $24 million non-cash derivative fair value of loss and EPS on a GAAP basis was $0.95 on a basic basis and $0.94 diluted.

Looking at production, natural gas production was up 25% compared to the same quarter of last year, oil production up 21%, natural gas liquid was up 23% and overall production up 24%, as I mentioned.

Of the 24% year-over-year growth, 14% of that came from acquisitions and 10% came from development. Quarter-over-quarter Mcfe growth was 9%. 6% of which came from acquisitions, 3% came from development. Average gas price was $842 realized to the company, $93.40 of oil per barrel and natural gas liquids $53.65 per barrel.

Looking our hedging, we have given a brief update. We have about 1.5 Bcf a day hedge for the fourth quarter and a price of $873 and about 60,000 barrels of oil at $97.18. So a Mcfe 1.86 Bcf a day hedged at just over $10.

For next year we've increased slightly our production hedges on gas to $1.64 Bs a day at a price rate $8.91. Oil $62,500 barrels a day at a price of almost $119 per barrel. So on an Mcfe basis we have just over 2 Bs a day, more than 70% of our expected production hedged at a price of $10.94.

Looking our into 2010, I think Bob will talk about hedging strategy later. We have significantly increased our hedges to about 650 million feet of gas today at the price of $872. 27,500 barrels of oil a day at $126.65 per barrel, given us over 800 million cubic feet a day hedge at an equivalent price of $11.23.

If you look at revenues and cash flow for the third quarter, $2.215 billion in revenues, operating cash flow $1.52 billion and we have a significantly increased cash flow margin. If you look for the nine months, cash flow was $3.8 billion or 66% margin to total cash margin to total revenue.

Looking at our operating cash flow per share, our first call estimate was $2.30. We had $2.75 on a diluted basis. So beating that by about 20%.

We look at our gas gathering, processing and marketing margin, almost $20 million of that was up pretty much sharply, $18 million for that margin.

Looking at our unit cost analysis and guidance, production expense was higher than expected $1.19 per Mcf. Most of this increase came from one time charges in compression and other. Those charges went up by $0.08 compared to last quarter and about $0.06 of this was a one time compression expense associated with acquisitions.

We expect compression charges to drop significantly in the next quarter and also expect lower power and fuel cost due to lower commodity prices. Keith will also address the workover and maintenance. Going forward, our guidance will be $1.07 to $1.12 per Mcfe on production expenses.

Giving you that breakout in production expense, labor and overhead $0.24 per Mcfe. That compares to $0.25 for last quarter. Maintenance and workover $0.64 per Mcfe compares to $0.60 last quarter. Power and fuel $0.21 equal to last quarter $0.21. And then as I mentioned compression and other $0.10 per Mcfe, up from $0.02 and again most of that was one-time that will come back down.

Our taxes, transportation and other expenses were $0.94 within guidance and with the lower commodity prices going forward. We're reducing our guidance based on $7 natural gas and $70 oil to $0.75 to $0.80 per Mcfe.

Exploration costs were up higher than expected, $0.14 and this had to do primarily to the seismic cost a good deal of which was associated with the Hunt acquisition. Going forward, we continue to expect between $0.05 and $0.10 per Mcfe of exploration cost. DD&A $2.27 within guidance and we expect the fourth quarter to be between $2.35 and $2.40.

Asset retirement obligation, $0.03 per Mcfe within guidance. Cash G&A, $0.21 significantly below guidance, $0.25 to $0.30 per Mcfe and we're reiterating that guidance for the fourth quarter.

Looking at non-cash, stock based G&A, $0.17 per Mcfe within guidance and on going guidance of $0.12 to $0.18 per Mcfe.

Interest expense was $0.60 per Mcfe, we are increasing that guidance to $0.65 to $0.70 due to the long notes that we placed in August of $2.25 billion slightly higher short-term borrowing cost an increase principle outstanding.

Looking at income tax rates, that was slightly higher for the quarter, 37.8%. We expect that to go back to 37 in the fourth quarter and we did have a negative current income tax as we stood in lower commodity prices into our estimates and found that we were over crewed on current taxes.

Going forward, we reduced our guidance from 30%, current portion down to 15%. This will generate substantial additional cash flow. As we look at our statement of cash flows and investing activities, one thing we're able to do with the slightly later earnings release is to give you comprehensive balance sheet and statement of cash flows which you have there.

Property acquisitions, including acquisitions, corporations for the quarter $4.8 billion. Development cost for the quarter $819 million and other property and asset additions of $203 million for the quarter.

If we look at our balance sheet very briefly, $34.5 billion in total assets, long-term debt of $11.1 billion. So if we look at our stockholder's equity of $15.4 billion net debt to total capitalization was about almost 42%, 41.9% and if you exclude other comprehensive income that number is 43.5%.

With that I'll turn it over to Keith Hutton to address the operations for the quarter.

Keith A. Hutton - President

Thanks Louis. If you look at all of our regions, we were up in production across the board and before we get in too much detail I'd like to kind of step back for a minute, talk a little about operating expenses and capital costs.

If we look at how many wells we have taken out of the company since the beginning of the year, we had about 13,000 operated wells. We're currently closing on 18,000 operating wells. 4,000 of those operated wells we took over during this third quarter. That will be the land acquisition Headington and Hunt.

If you look at our operating expenses, they were up this month, this quarter on remedial and maintenance workovers and we as a company have always jumped on top of the acquisitions as soon as we get them and start working on the wells as fast as we fast as can increase production.

We had several things happen during this quarter. First, most of these companies that we're selling, if known they were going to sell for year. Which means in general I have stopped all maintenance and our remedial workovers in order to cut into their cash flow.

So we're going to have a really fast bills and maintenance remedial workovers for this quarter and maybe into the fourth quarter a little bit. It should slow down after that as we get all those things fixed.

In addition, Ike and Gustav road right over the top of the majority of our operated properties in North Louisiana, East Texas, Offshore Gulf Coast and Arkoma which got phenomenal rain fall up in the area Woodford. All of those things tended to run up our remedial and maintenance stuff would rose and locations and so fort.

So, I think if you look at our guidance it was 107 to 112 for the fourth quarter on operating expenses. I would expect to see that mid-year next year approach a dollar or less on Mcfe. As we get all of this done on these acquisitions and from that work I think you'll also see the production increase than what we originally forecasted on these acquisitions which is our normal maneuver.

If we move from operating expenses to capital cost. You are seeing people dropping rigs at a fairly fast right at the moment. If you saw back and look at just natural gas rigs in particular, they peaked at around 1600 rigs operating on land and the August timeframe or so they've been putting off at 13 rigs a week. Until this last week, it looked little strange but it popped back up.

But I think what you're going to see is rig count is going to drop from 1600 to approaching 1400 by the end of the year, almost 200 rig drop. I think it accelerates here in the fourth quarter. You saw Pioneer come out today and say they were dropping some rigs, out in West Texas as well.

If you go and look at 2005, the last time the rig count kind of stabilized before it build up to the 1600, it was in the 1200 to 1250 range. I really think you've got a chance in the first half of next year to see rigs drop all the way into the 1250 count on gas rigs.

That's going to make a big dip in capital costs, as there will be a lot of rigs floating around and people trying to find homes with them. We have already seen in some of our operating areas, rig costs dropped from $20,000 a day to $17,000 a day. That's a 15% drop.

Pipe or steel costs are already off 30% from the peak. We're not seeing that impact cost yet but you will. We're starting to see some dent in that. I think you'll probably see that in first half of next year. Where I'm going with all this is I think you can easily see 10% capital cost drop for next year. Potentially it works its way to 15%, depending on how the bad situation gets for a lot of these companies.

And what that does for us, it that it reminds us of what we did in 2001, when gas price went from $4 or so in 2000 to $10 in January 2001 and all the way back to $1.83 in October. We went in hard and hedged that year, almost 80% of our production and drilled into those dropping capital cost.

We're set up for exactly the same answer here, where we are hedged at 70% for next year. I think capital starts dropping and we will be able to drill our well for last with into those hedge numbers and increase our margins.

So, we've run a great play and then we're setup for a good 2009. After we work through that and look at each of the regions, Freestone Trend in particular results 4% quarter-to-quarter. We're currently running 27 rigs, but average $712 million on a gross basis; $524 million on net basis.

We are currently making $740 million a day. I've had a very hard October from production standpoint. Expect that we can our Freestone Trend up to a B a day over the next two years. That's about a 15% clip of growth in the next two years. And we have the trading facility in place once we finish our key plan, which should come on in the first quarter of next year to be able to take that.

If you look at well performance in Freestone Trend, I would point toward the horizontals that we're drilling in the Farrar/Bear Grass Field, which are our deep horizontals. We brought another one of those on the Beddingfield 6H, which was 8 million a day.

Last quarter, we announced two Gail-King wells that were canned at 20 million a day. We now have five or six of these deep horizontals on, and they average about 9 million a day, 10 million a day average initial production. We think the reserves are around 10 Bcf for a cost of about $7 million of phenomenal rates of return. 5,500 in acres that we thought from hunt and the Freestone Trend on a net basis or direct offsets to all three of these horizontals. We still think that potentially just on that 5,500 acres that we bought Freestone Trend, there is 300 to 400 net upside to an acquisition that was only a T in total announced reserves.

That's why we are excited about the Hunt acquisition. If you look at two other things that were happening in the Freestone Trend on the Southern Ball Curry Field. We have done a farm out with another company down there that adds to our acreage position and we've hit a number of lime wells down there over the last couple of quarters.

I think you will see our production grow rapidly. We are waiting to lay a 20-inch, which we should have in service December 1st or so, which will allow us to bring on a number of wells that we've been sitting on down there in the southern area.

If we flip from Freestone Trend then to the eastern side, East Texas, the Sabine Uplift in Cotton Valley, we'll continue our development there and Tri-Cities Field, wells that came in around $3 million a day, couple of wells for the quarter. Those wells are $2.5 to $3 million wells for 2.5 Bs or so very good economics.

Cotton Valley field which we took over from Marathon in 2002 and the tray has grown from $20 million to over $50 million a day today and we've... our last two wells, the two part E-wells that are on our offshore port are about $5 million a day wells. Those are the best two wells that we've drilled. So, we've continued to learn on how to drill and frac them better and drill the right spots.

In addition to that we have spudded our first two horizontal Haynesville wells on acreage that we acquired during the year. This acreage surrounds the Hunt acreage that we acquired. And we did not put any value in for Haynesville when we bought Hunt.

And so it's nice layer on, but I would tell you our first well is about 2,500 feet out into to the lateral on a 5,000 foot lateral current drilling over 15.8 pound per gallon mud, which is very high mud weight in this particular area. And whenever we actually trip pipe, we're getting 60 to 70 foot flares, REX having a hard time hanging on to this well. So, at least anecdotally, first data says we've got a good shot at very nice Haynesville well.

We expect those two wells... those two rigs then to move on to Hunt acreage and surrounding area in the fourth quarter.

If we flip from Freestone Trend to eastern area to Barnett Shale, we were up 5.5% quarter-to-quarter, very nice wells in the Barnett averaged up 660 million a day, gross production 488 million a day net for the quarter. We're currently making 730 million a day, so big part of that is the recent acquisition that we made in the from a small independent.

But a lot of that is just a production from our base wells as we drill them. If you look at the operations, we have a number of wells that that are IPing anywhere from 4 million to 6 million a day in the core. 18 of our 20 rigs are in the core two or tier one. And the better area of tier one.

We will drop some of those rigs on to that recent acquisition leases because two of our better offset wells, the 6 million a day wells are directly offset to that acreage that we acquired in October.

Barnett shale also should approach a B a day over the next several years much like Freestone Trend. They are on about the same growth trajectory.

As we flip from Barnett Shale to Permian region currently have five rigs drilling. That includes the two offshore rigs that we have from the Hunt acquisition; one in South Texas and two in Permian Block 9, Goldsmith and Russell are still our main fields. All of them growing slightly quarter-to-quarter and everything looking good in Permian.

If we flip from the Permian actual region to South Texas and to offshore, we've drilled our first two wells in on Dominion Lapino field, which were on the midst of the big fields that we bought in Dominion. Those wells came in at $3 million a day from the first zone. And then we have multiple re-completions of those wells at the home.

The big announcement that we put out in the press release was on our first well Main Pass 125-2 that Hunt was drilling when we took over. We have now completed that well from the lowest zone at $17 million a day and 500 barrels a day.

To give you an idea of what that means, that type of wells at 20 to 30 B wells for about $30 million to $35 million. So it's very good funding cost, very good rates of return. That well should be on in sometime in mid December. In addition to that, we have recently tested a well on South Marsh Island platform as well, 44C2. We tested it around 14 million a day and 900 barrels a day. That's probably sustained rate of 12 and 600 or so. That's a well that's into $15 million to $20 million range and 10 Bcf. So again very good economics and a very good start for our offshore properties and Hunt.

Turning to the San Juan region, everything is pretty much on forecasts. We're currently running six rigs, drilling in certainly in To lades and in Raton Basin, and three of those rigs are an attributes which we acquired from Dominion. Everything looks to be on target there. And then in the Piceance Basin we will not get our plan-up until probably the very end of the fourth quarter, early first quarter. So, we have one rig drilling. We started eight wells down and we have three that are producing the benefit, produce until because we are limited on volume. So we'll be probably completing those wells in the first quarter so you can get a better look at what Piceance is like.

If we flip from that to the Mid-Continent region, we are currently running 20 wells in the Mid-Continent... 20 rigs in the Mid-Continent region. Two that are in the Overthrust and Fairway trend where we continue to drill the type of normal wells we drilled. The rest of them are in the Woodford shale, Fayetteville shale and Bakken shale. We operate the current Bakken shale out of the Mid-Continent region in Oklahoma City.

If we look first at Woodford; we have a 120,000 net acres in the Woodford with six rigs drilling. If you look at our operations report, we've got three wells on that that were averaging about 3 million a day. In our press release we talked about an additional well that we just bought online at $4 million and $4.5 million a day. The Churchill 1-26, which is on some acreage that we recently acquired. It's kind of in the North Eastern portion of the play. We have a lot of acreage up there. We haven't drilled too many wells, but we've seen some other independents come in and drill some very good wells. When I say very good wells that average $4 million a day first month. Those types of wells are 4 to 4.5 Bcf for a cost of $4.5 million to $5 million to drill. We have most of our Woodford acreage now shot with 3D, which means we can home in on the best areas to drill and I think you'll see the Woodford wells get better with cost coming down over the next year.

If we put the map at Fayetteville; we have seven rigs drilling at Fayetteville. We've taken our acreage position at Fayetteville up to 380,000 acres this year. We have five wells, we just brought online at the very end of the third quarter averaging 2.5 million a day. Those are 4,000 foot laterals with about 7 to 9-stage fracs. Looks like to me as we worked our way along, the Fayetteville wells keep getting better. I think you've seen from other operators saying their average wells are probably in the 2 to 2.2 Bcf range per well. We agree with that. And these types of well that 2.5 million a day start right, look more like 2.5 Bcf wells. And in is this particular area which is little shallow, where they will cost us about $2.5 million to $2.7 million to drill. So you're looking to $1.50 or less finding costs and very good rates of return.

If we flip from that to the Bakken shale. We've four rigs drilling we completed our first 5 wells up there all in North Dakota. If you'd step back and think about what we did the Headington acquisition. What I'd tell you is we bought it, looking at Elm Coulee Field which is on Montana, and it made up of 80% of the value of that acquisition both producing and PUDs. And we put a little value, 20% out of that on North Dakota because we weren't quite sure how big North Dakota could be. Now our first five or six wells are averaging 670 barrels a day, which would say those wells are in a 300,000 to 400,000 barrels range.

On middle Bakken, our first Three Forks/Sanish discovery which was the real wildcard over there in North Dakota came in at 1750 barrels a day. Equivalent that well is probably in the 600,000 to 700,000 barrel range on reserves. We have a second well testing now that only had the first two zones completed. At 550 barrels a day out of the Sanish/Three Forks I think that wells is going to be just as good as the Angelo's well, once we get it fully completed and is on line.

So, if we step back and look here, Fayetteville, Woodford and Bakken are all on target. All the wells look good. And we think that especially in Bakken, where we're stepping out in North Dakota, we have a lot of acreage we didn't put any value on. These first couple Sanish/Three Forks wells and we are really excited about their potential for the future.

With that let me turn it over to Bob Simpson to wrap it up

Bob R. Simpson - Chairman and Chief Executive Officer

Thanks Keith. Thanks everyone for joining us on our conference call for the third quarter. Let me talk a little bit about where we are in economic cycle and then I'll give XTO's key outlooks, our position within it.

Cash flow at the moment is keying, and so what you'll see us doing is protecting that and assuring economic returns and managing our business within that. The activity of the year set us up for a record cash flow machine, the acquisitions that we did which I'll talk about a little bit more that were significant, very attractive in multiple years of growth now. We're going to turn to drill that area having wrapped up a very successful acquisition effort that gave the company, in my opinion, the best set of assets it's ever had, with the most visible and longest growth I've ever seen. And so we'll now actualize that and turn to drill bit.

So turning to the drill bit, we've set a budget and we've got to protect our cash flow to fund it. And so we'll do that first. In 2001, we saw a similar circumstance where you had the opportunity to hedge the fairly robust prices and then capture... what we call the trap ply. It's actually our strategy year-over-year is defined to capture what we now see. I think you'll see a period of greater than normal rates of return for the owners during this; that's what we experienced in 2001-2 which launched us to a multiyear growth for the equity owners and I think we're experiencing the same play.

So, what I normally told you is we had half to two-thirds. In times like this, expect me to take that higher. We're 70 now, property goes somewhat and again it's the nature of cash flow machine of why you take advantage of an economic situation which allows lower cost or funding cost and greater expense of your franchise with your dollar that you normally see. And so we will do that.

And to give you a flavor of that last time I did it with you, hedging for '09 was 15% of production and now it's over 70. And so we have been adroit since the last meeting. Things changed rapidly, they changed faster than I thought. I didn't foresee it six months ago. I thought they tend to last longer. But one thing we do is respond to what we see and what we saw was a rapidly changed environment and one that we rapidly secured the financial future for this period. And that is what we do. We are responding. We will be increasing '10 as we go through it.

I think proceeds for '10 will be one of recovery. The downturn will leave the higher gas prices as we've experienced before, because the natural gas industry is a self-correcting industry. It wasn't that long ago when a clout mentality will start to pervade our industry. I think you'll see that alb as the ebb as the finding cost of natural gas is once again exposed below $8, it's not a surplus. We think the price is $8 to $10 to have a bountiful supply in America is really the final result. And with that and with our finding cost and other costs, there is very good business were our owners; and so we're positioned for it. So you'll see us protect our cash flow. We're setup for this. We've got the best drilling inventory we have ever had and we will turn to it.

I think you saw us on the first fruits with today's releases of what we can start showing you. You will be seeing this kind of flavor instead of acquisition flavor because that's what led to this. And now it's time to show you the fruits. And I am very excited about the Bakken. One thing I would say about is one other things and it's a fair question at the moment that we have overpay for this asset effort of the year.

Largest dollar amount, not the biggest activity in terms of incremental growth as percentage for base, we've done before. But certainly a headlines dollar amount. So, it's a fair question; I mean you brought it. You've large assets coincident with high commodity prices, frankly have you overpay? And it's a fair question, I would ask it. While I would respond to you and give you some flavor for it as I am not sure [ph] we didn't our base economics are low teens for acquisitions and frankly the prospect that was used in this acquisitions is $8 gas and $8 raw.

Now what we saw was given the current strips at the time and prices at the time, you've had rates to return approaching 20%. And I've never seen that in my career where you could do that size. You could actually buy an asset, producing asset and achieve a 23 rate of return, but how could you do that by hedging. And so the... the oil deal we did, the Headington deal is a good example. We hedged that all for a couple of years and you've seen ... you see the numbers in front of you. So when we try to return in first couple of years on that acquisition is below 20 and it's protected. But, and beyond that we think we'll... probably we will recover by the end, but if it were to be at 80% ... $80, we're still at good rate of return on the base production and hopefully, by the end of production and Headington will be significantly more.

And so that's going to be an excellent acquisition. On the gas acquisitions, we also protect the economics on those acquisitions and they too had similar situations where base of dollars as bought over the... on average of 9 and so we're going to be experiencing rates return higher than our base case. And so what I would tell you is we didn't overpay.

Now another way to measure that is when we made those acquisitions, where we're paying about four times cash flow given the strip. And those are very long-lived acquisitions. We also got $1.4 million net undeveloped acres this year and very high quality shale plays. Some of those acres were $25,000 of PB and not just market value but the way we look at it. So we paid a little over four times cash flow strip for all of those acquisitions in aggregate. That tells you we didn't pay strip. Alright. That type of liaison should pay closer to seven times cash flow.

So I would submit that as visible proof that beneath the waters, we were using a much lower price stick for our owners. And then we protected lot of with hedging. So we didn't overpay, so don't feel that way. I want you to know that and understand that and it's fair to ask, because the activity coincided with very high commodity prices. And so with that discussion, I'll talk a little bit more about the hedging. As I said, look for us to move it higher and cash flow is going to be a record, given the current strip in '09.

One thing we haven't talked about for a second is P&L. The first thing people will be inclined to do, is say we'll what do I trade XTO's cash flow at. Is it anomalous? Is it a hedge cash flow that's not worthy of capitalizing. What happens after that? If you look at '010 already given the hedges we already have, which are roughly 25% or a little higher percent of production for OTN, and the strip for OTN that exists, now you'll see us reiterate... at least reiterate next year's cash flow. Okay. Well that's kind of a thought that we haven't had. So the cash flow is sustainable given the lower commodity prices, yes it is. And so that's an interesting feature. Now the reason it's sustainable is because of next year's growth and the year growth thereafter. And so and given XTO's margins.

And so because of the machines that's set out to grow at low cost, we have a sustainable cash flow at lower commodity prices and that's important to note. If you look at the returns we're going to get, that'll be all of our drilling economics are based and always have been base cases of these kind of commodity prices are lower, so they're still going to be very high. And so we're setup for this environment.

Now, if you look at the overall cash flow machine, you say well what about your budget? If you looked at our budget we talked about this summer, we released it around when we were doing our last secondary that was necessary for acquisition effort and the one that patted it up. We talked about a budget or announced a budget of $4.6 billion for our development and exploitation and about $700 million for infrastructure. Now we will address this budget in the next Board meeting in a couple of weeks, and we will give you a new number. But to give you a flavor of what we are going to do, the directional flavor, if you think us to going to come down 10% next year and we do, will revise our budget with that anticipation. And you say, Well, okay, what's your other parameter?

Well, if you think past 12, mid-6s and you want to cash flow machine that has a couple of billion beyond that or so on $1.5 billion to $2 billion, well then you would envision cutting the budget roughly $1 billion. And so what does that mean? Well, that would be 10% for inflation that isn't going to happen. And maybe another 10%, so you'll have more free cash flow will be contemplated. A lot of analysts are going to look at it. So what does that mean? Well, growth next year is 22%. Would it matter if it is 20%? I would submit 20% is great. And maybe I have to contemplate that and cut my budget another 10%. So I can have that free cash flow. So what I would say is whatever free cash flow machine $1.5 billion to $2 billion next couple of years is what we are going to set it out for.

And we'll review this with the Board and go through the numbers and we are still going through them. But that's kind of I believe an abstract thought of direction. So you won't be clueless as of what XTO is doing over here. But who else can put up 20% growth of a couple of $1.5 billion to $2 billion cash flow; that's how machine at work. Now, within that the free cash flows, we want to reduce at least $1 billion. Now we'll have the flexibility within this approach to be more free to choose or to buy assets or whatever else makes sense within the environment, but we'll have the financial flexibility to do it out of free cash flow.

And so that's the way we are going to run it, and we're running with that financial discipline and it's also tiered with hedging. And so we can have borrow [ph] on it and deliver this financial program in a rather difficult time for the world and so that's why we have this approach is for years like this. Hedging doesn't always make money, I think we generally have. One thing it does, if you look at our earnings this year and even now compared with last year, most companies have a much more volatile number than we do. Hedging tends to smoothen your financial results. And so what you are trying to do over time is smooth your cash flow and returns and keep as steady as you go, growth vehicle well funded, your people steady at work and not be running a business tied to the volatility, the most volatile commodity in the world, which happens to be natural gas, and that's what we do.

So our earnings aren't going to be as volatile, but our returns are going to be more stable and more visible and so is our growth. And so we have got to set up for that for the coming year. So we have that secured. We've got a wonderful set of assets and we look forward to this next year. One thing I would probably announce, we have some personal stock wells since we last met last month. We never liked the sales stock. The owners are... it's always outward for us.

We've always had the vast majority of our net worth in XTO coming into what we saw as a possible systemic meltdown. We don't know, but it didn't happen; hope it never happens. Three of us felt like we have balance sheets that didn't have enough liquidity and some debt. Now, what we've done is we now have virtually debt-free balance sheets, with stockpile and liquidity. And we did not have a margin cull I will make that clear, particularly in light of what happened to others. I'm worried about we don't want one. Now what we'll do, given the new world is run our balance sheets as a group personally and as a group relatively debt free, virtually debt free, and we'll make that pledge.

With that, we'll open it for questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Subhash Chandra with Jefferies. Please proceed.

Subhash Chandra - Jefferies & Co

Yes. Hi, good morning.

Bob R. Simpson - Chairman and Chief Executive Officer

Good morning.

Subhash Chandra - Jefferies & Co

First of all, I was curious if there are any acquisitions out there still pending to close?

Bob R. Simpson - Chairman and Chief Executive Officer

Yes, there is no significant acquisitions that are closed. We filed the last significant October, the 1st, which is all sold.

Subhash Chandra - Jefferies & Co

Okay. Any revised thoughts on peak rig count? You might have offered some thoughts in prior quarters. You are 93 now of the number that vastly higher, and so any kind of revised expectations?

Keith A. Hutton - President

I think you'll see us hold at 93. We've got a couple of more coming, so we maybe, we go to 95, but that's really it. I think we were talking maybe 100, Subhash. And what we did was basically say look, there's some rigs that are drilling in areas where we can't bring the wells on for three or four, or five months. So we just dropped out there. Not going to hurt us on volumes, not going to hurt us on anything that does cut our capital spend. We might as well wait. Look, if brick prices and pipe are coming down, you should hold off on picking up any rigs for three months and pick them up later, because you're going to catch them at the 15% less price. So, that's kind of our thought process.

Bob R. Simpson - Chairman and Chief Executive Officer

One other things that you have with XTO's flexibility is it's a large company now, but it's still run by people that ran small company and so you're going to have flexibility. Well, I'm talking about this budget reduction, if things changed by the middle of next year or something, we will adjust to it. And so what we are viewing is a free cash flow model that you can fine-tune as you go forward and we will adjust the circumstances. It doesn't mean that we won't revise on as circumstances change.

Subhash Chandra - Jefferies & Co

As an industry, do you think that... let's say winter gas prices we get $8 to $9 or something like that? Is this... this new foundry spun industry-wide... do you think it turns on a dime or do you think that what's been happening with the rig drops is sort of stepping stone for 2009?

Bob R. Simpson - Chairman and Chief Executive Officer

I think the... if you look at the industry in general, one of the things, one of the reasons we didn't think we were going to drill ourselves into a glide... meaning much lower prices about three months ago, when we were talking to people, is because this is through sustained production in this industry, you probably... at $8 even, probably mean to have raise outside capital beyond cash flow, which is not widely appreciated. I think people think we all have enough cash flow to sustain our production and I submit, we don't as an industry.

And so, because the outside sources of the capital dried up in all manners including equity, bonds, whatever you want to phrase it, for drilling; I think the cuts in the budget are going to be significant enough to sustain a drop in rigs because people are going to have to live within their means and there is not cash flow at current prices to sustain production and so... or this level of activity. So, I think you will see... I think, it's casting stone.

Subhash Chandra - Jefferies & Co

Basis differentials, probably, one of the worst quarters yet. Any thoughts on how temporary that is nationwide?

Bob R. Simpson - Chairman and Chief Executive Officer

Basis differential, anytime you see a blow out, they tend to comeback during cold weather or during the winter. Now, we protected our basis on our hedging at 100% level for the next six months. And beyond that, we're at 70% or 80% and we'll raise that as we get there. So one thing our hedging program does is bringing... you don't really have a hedge until you get basis. And so we do both, we work at both. But usually when you see basis blow out significantly, it's anomalous. And it's another way of saying gas prices are lower than it's thicker. And so it creeps up on and if you're watching NYMEX, it creeps up on you. But in my career, it generally passes as you get into winter.

Subhash Chandra - Jefferies & Co

Okay. And then one final one; something I couldn't find the ops update at least. Thoughts on the Marcellus, what the level of activity there is? And what do you think about any sort of updated opinion on Three Forks potential in Elm Coulee?

Keith A. Hutton - President

First let's take Marcellus, Subhash. I did mention it. We have a rig that's coming in probably going to be early January; it was going to be December, but we pushed that up a little bit. It's a big rig serving drilled horizontals. Most of those wells, we have about 15 wells slated for next year potentially, and you know it's in good spot, up against to a range in Chesapeake and others have announced a very good well. The anecdotal data you hearing out of West Virginia and Pennsylvania is the wells are pretty good.

Obviously it will take sometime to get top lines and so forth. But yes that we're hearing of wells that make 5 million or 6 millions a day. So, obviously it is hard to get data up there, hard to know but we're going to simply trust fairly well. So I would say Marcellus looks pretty good. It's going to be hard for the industry in general to grow the volume real fast, but since we have a lot of HPT leases and long five-year plus five-year ticker-type leases, we've got time to figure it out.

If we go from that to Sanish/Three Forks, I've heard people talking about trying it under Elm Coulee, we're thinking about it as well. Obviously, you have to drill some deep wells through and see if the Sanish/Three Forks actually has reservoir enough or fracture enough under Elm Coulee to work. I don't know why in general it wouldn't in some spots. The overall basin does span as you have in the Elm Coulee. But we've talked about trying them in Elm Coulee and Sanish/Three Forks as well.

Subhash Chandra - Jefferies & Co

Terrific guys. Thanks so much.

Operator

Your next question comes from the line of Michael Hall with Stifel Nicolaus. Please proceed.

Michael Hall - Stifel Nicolaus & Co.

Thank you. I guess, as you think about your budget and as you talk about reducing the budget perhaps in 2009, any idea that maybe the market's not paying up for more than 20% growth as opposed to paying there more debt, and how do you think about share buybacks, instituting a kind of aggressive share buyback program?

Bob R. Simpson - Chairman and Chief Executive Officer

I think you should always consider a share buyback program in your allocation of capital. I think at this time given that everything I know at the moment, I would protect my balance sheet first. And that might change but you got ... I think the beauty down the free cash flow is you just do what smart when you get there and my readings might change, but I think at the moment given the situation of the world I would protect our liquidity of balance sheet first.

Michael Hall - Stifel Nicolaus & Co.

Fair enough. And then as you talk about cost, maybe as we look industry wide, breakeven cost; how sticky do you think the breakeven cost maybe for the industry or how quickly can that adjust to the new cost environment, you talked about on the operating and capital cost front?

Bob R. Simpson - Chairman and Chief Executive Officer

A 10% drop in service cost is not going to change it all that much. I mean if the industry has got ... if you think it takes around $7 now and you drop 10% that would be in the midst 6s or lower so it's not... I don't think it changes the outcome for that, for 10%. If settlement have or something you might change it for quarter but I think 10 is just a ringing a bit that was... a lot of it was funded by excess capital and capital chasing capital. And so when you take that out of the equation and people say not really you have to be bear with what comes in the door everybody's headed to changes. And I don't think it chases down the finding costs of --. Louis what's your thinking?

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

I agree. I think your ops cost might come down the same answer in the 15% and that is probably not going to squeeze enough excess cash to serve the people any much different. It's not going to change finding costs that much.

Michael Hall - Stifel Nicolaus & Co.

Okay, great. That's. Thank you.

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

Thanks.

Operator

Your next question comes from the line of Brian Singer with Goldman Sachs. Please proceed.

Brian Singer - Goldman Sachs

Thank you, good morning.

Bob R. Simpson - Chairman and Chief Executive Officer

Hey Brian.

Brian Singer - Goldman Sachs

Following up on the last question there. When you think about your own operating cost and production cost, you highlighted in your comments some of your one time issues relating to acquisition, work overs et cetera. So if we put everything together and think about what a real going forward operating cost would be. What do you think that number would be relative to your third quarter or fourth quarter guidance?

Keith A. Hutton - President

Well, I stated Brian and this is going to be our target to shoot for buck or less [ph]. We should be able to get there and I think that's our goal.

Brian Singer - Goldman Sachs

Anything that's set and that's achievable in the second quarter of '09.

Keith A. Hutton - President

Probably a good way to look at it.

Brian Singer - Goldman Sachs

Okay and then how are you thinking about oil versus gas, now that you've got some greater optionality when you think about putting together your programs for next year an how nimble can you be in terms of allocating capital. Whether it's Rockies gas versus Bakken versus East Texas as opportunities come up?

Keith A. Hutton - President

You can be very nimble. I think one of the problems you got in Bakken is that there's not many as rigs to pick up. So, you can get the five or six rigs, but if you are drilling the kind of wells we are right now that could be a pretty big kick in your oil volume. Remember our oil only 20% of our total volume. So even if we pick it up 30%, it doesn't move the number all that much. But what about Rockies gas? Sure, I mean if the Rockies gas is the lowest priced one, wherever it is, we'll slow those rigs down and pick them up in the place that's got better prices. And a nice part of that what Bob said, is we all think that way including our scout in the district. So if we call, say look guys we're going to dropout, you either pick up somewhere else, they will move very fast.

Brian Singer - Goldman Sachs

Great. And I just wanted to go back to your comments on how to think about the budget for next year and to make sure that I got it correctly. I think it was ultimately a 20% drop in the budget, 10% to reflect lower costs and 10% to reflect lower activities or did I miss here?

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

I would say 15% to 20%. That's what we'll be looking at. If you want a broad range on it.

Bob R. Simpson - Chairman and Chief Executive Officer

Because that's as part as I should give it because the Board has addressed it but I would say look at our numbers like 15% to 20% are off in our cash flow, free cash flow more than $1.5 billion to $2 billion, that's all what we'll be targeting.

Brian Singer - Goldman Sachs

Given that that will probably happen over time, how do you think that sets you up for thinking and I know this is way out here but thinking about 2010 given that the... really the impact would be rather modest on 2009 growth. Should we expect that 2009 is a meanly drilling year albeit maybe lesser activity than maybe you're currently forecasting and then a bit more on the acquisition front in 2010 to get to a 20% type of growth rate?

Bob R. Simpson - Chairman and Chief Executive Officer

About 20% is not something at our size we are promising. I think what I would say is we have the ability to do 10% organic in 2010 and that would be our first step for it would be to secure that by... in addition to other measures, hedging. I think 2010 already reflects the higher price that '09. I think the markets correctly anticipate it better, situation after of this downturn and if you like our hedging, we been growing that and so what we'll do is secure a situation for 2010 where we could see a 10% organic growth rate. Now whether or not we supplement that with acquisitions will depend of the market at that time and other factors, but we're not targeting or promising a 20% compound growth rate for this size.

Brian Singer - Goldman Sachs

Great, thank you.

Operator

Your next question comes from the line of David Heikkinen with Tudor Pickering Hope. Please proceed.

David Heikkinen - Tudor Pickering & Associates

Just a couple of questions on East Texas, North Louisiana. First on the A&D market, I've heard about deals not closing and terms being renegotiated. Can you give us any of your thoughts on what's going on in that market right now?

Keith A. Hutton - President

Yes what's happening. We're here that anecdotally quite a bit.

David Heikkinen - Tudor Pickering & Associates

What changed?

Keith A. Hutton - President

Well on the leasing side, it's just because what prices dropped down, nobody is paying what they were paying before. So, can get out of the deal...on the acquisition side, I don't know as much more about. It's more about... it's the fact that nobody has got a capital market to go get money. I mean if you can't get it then you can't grow. So I mean, I think that some of those kind of things are happening.

Bob R. Simpson - Chairman and Chief Executive Officer

David I think the primary change is... again the question would be is there a fundamental change or in the value, intrinsic value would be... I believe is what I hear you asking.

David Heikkinen - Tudor Pickering & Associates

Yes.

Bob R. Simpson - Chairman and Chief Executive Officer

We haven't seen a fundamental change in the value in the deals we're looking at. Now it could have been a little bit of above or maybe people were too aggressive and assuming what fundamental value was and that is what the... how much gas they were going to find. So it may have gotten overheated. But assuming you saw the same reserves, let's set that aside and we can debate that for a while. I know we saw it in the Barnett Shale. We're not debating whether or not gas went away in the Barnett Shale. A lot of this leasing was funded by capital raised elsewhere. It wasn't out of cash flows. Stock sales or borrowings or whatever. When that dries up, and has, people say we'll protect first. Well in general, if you're sitting in our shoes and you have limited cash flow, you are going to protect the leases you already own and so... Alright. So you're going to protect to drill the best part. And so your leasing is just going to go burnt and it takes two to make a half price. And so, with that competition and lack of capital, you're going to see ... you'll probably see intrinsic bargain by buyers and that will make it more interesting and that will be for those who have capital.

David Heikkinen - Tudor Pickering & Associates

Okay. And then just detailed question. Were you drilling your Haynesville horizontals, can you talk about is it Texas Louisiana or any specific?

Keith A. Hutton - President

I don't really want to talk about it at the moment. Once we get them online, we'll tell you.

David Heikkinen - Tudor Pickering & Associates

And then on the Bakken. What did you guys do differently than Headington to get such better results?

Keith A. Hutton - President

Headington was part of the original group that did trilateral and dual laterals, bow-ties, all these different styles of horizontal completions, where literally they do the single frac and try to split that frac up just by rate and dropping sand or some kind of gel to get some kind of diversion. We, like EOG and others that came out of the Barnett and other shale plays say hey, why don't you just set a liner and set packers and do individual fracs in individual zones and I think that's really what's making all the wells better.

David Heikkinen - Tudor Pickering & Associates

Okay. Thanks, guys.

Operator

Your next question comes from the line of Scott Hanold with RBC Capital Markets. Please proceed.

Scott Hanold - RBC Capital Markets

Yes, thanks. It's Scott Hanold. On operating costs, you have you obviously addressed it a little bit and you have seen the trends over the last several quarter has been going up. Can you kind of talk with your recent acquisitions, lot of it did come with higher LOE cost. Where are you sort of in the name of the game, relative to other acquisitions as far as becoming much more efficient and tightening the belt a little bit and improving the cost structure?

Keith A. Hutton - President

I think it's kind of the question Brian asked and I really whenever you take over our acquisitions like we had at this pace and this number of wells, and guys knew they were going to sell, obviously they let all the maintenance go. And so you get to do it all. So what you're seeing as an accelerated maintenance pick up for the first five months or so of an acquisition and then you pretty well call back up. So what I'd say is you saw a little higher LOE in this quarter. It will stay up at a little bit forth and then it should start dropping rapidly and again our target is a buck and you'll see it for less as we work our way into next year and I think it's very achievable target.

Scott Hanold - RBC Capital Markets

Okay. So, does that imply generally you're looking at that sort of five month range and that's typically what you've done so, these latest acquisitions have been no different?

Keith A. Hutton - President

They've been no different. We just took on 4,000 operating wells in the third quarter. I mean that's just ... way from 13,000 operating wells at the start of the year to 18,000 operating wells now. And so when you put that number in perspective and figure out that they had a fixed roads, they had fixed a lot of wells they are having fixed time batteries. I mean you are doing a lot of work at a very rapid pace which you should do to get it all in line and get your production back up and be able to go forward at the much lower operating expense.

Bob R. Simpson - Chairman and Chief Executive Officer

One thing I would add is that play we've got question, we didn't buy production that inherently was different than the base of XTO. It's long lived, low cost. Now what we are saying is that because of it was in the sales process, some maintenance was neglected that we had to catch up on. But again, you look at in context, we are not blending in high-lifting cost with low-lifting cost. It is relatively low-lifting cost are properties that have some non-recurring expenditures initially or catch up expenditures. Now if you look at, as you go forward any year you have a lot of acquisitions you are blending in you are going to have a little of that. If you look at next year, or the year of the drill bit we call, you are going to have very low of that. And most of your drilling programs is flowing wells at low lifting cost wells. So, give you a chance. You are an over all aggregate lower-lifting cost for the company and that's why we are hopeful it is going to go under a dollar next year, between the two concepts. But the quality at we bought was similar quality drove production base, so we did not disturb that.

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

Scott, keep in mind that all the properties you bought offshore, you denominated change, because of the hurricane-related shut-ins for last quarter and this quarter. So that's going to improve as you have those volumes come on a per-unit basis.

Keith A. Hutton - President

Okay. You've got the operating call for no volume. So, that's to be able to end up itself.

Scott Hanold - RBC Capital Markets

Okay, I appreciate the color. Turning to the Bakken, it's obviously been a high topic here this morning for you guys and industry has seen some tremendous results over the last week. Can you talk about... you're running what four rigs right now. I know rigs are tied up there, but realistically even if you were to sort of trim your CapEx budget, based on what you've seen so far; would the Bakken be one of the last place if you do that and could you actually add activity there or is there other constraint besides rigs, like takeaway capacity that would limit activities for you at this time.

Keith A. Hutton - President

You wouldn't drop your Bakken rate. Obviously with those kinds of rates, your rates were turned up phenomenally even at $65. But the... you do have a capacity a takeaway capacity constraint; that's going to get fixed in 2010. So in '09, I think we can drill with five or six rigs and probably not get in the trap. But beyond that you're going to need net new volume takeaway. So it's making goodwill, so it will get done.

Scott Hanold - RBC Capital Markets

Okay, so presumably, you could get to five or six rigs on average next year?

Keith A. Hutton - President

We could.

Scott Hanold - RBC Capital Markets

Okay. And Keith you talked about Three Forks/Sanish versus the Bakken just in general drilling. Do you have any color on based on what you've seen on your acreage so far, would you expect to become more active in one or the or the other?

Keith A. Hutton - President

I would say since we've only drilled a couple of Sanish wells and Three Forks wells and they look pretty good, we're probably doing with us. And I think the industry in general is... and I think it will get spread out over a larger area, everybody try like good rate, where nobody has really tried one. We'll be doing all of that. Obviously, really the Sanish/Three Forks are no different middle Bakken. It's another series of formation that lie below the lower Bakken Shale, which is actually thicker than the upper Bakken Shale. And so if it's got reservoir quality rock and fracture, and I'll let just like middle Bakken. So, I mean it will a while to answer to figure that out. But it's definitely going to open up the game up there over a larger area.

Scott Hanold - RBC Capital Markets

Okay. I appreciate it. Thank you.

Keith A. Hutton - President

You bet.

Operator

Your next question comes from the line of Kent Greene with Boston American Management.

Kent Greene - Boston American Management

Yes, just another question about the financial position of the company. Would you say that you would buyback shares, but you are looking for acquisitions, which you have prioritize that and then also the dividend side, put that in perspective?

Bob R. Simpson - Chairman and Chief Executive Officer

Yes, the one I would play, Kent at the moment, we are not particularly looking for acquisitions and so we're certainly not looking for generic acquisitions and so we're out of that business. Right now our priority is to protect the balance sheet and pay down some debt. The next level is certainly we would stack up buying, leasing properties against buying the stock in and if we get...when we get to that level. And so that the...stock is so cheap now...buying significant other assets wouldn't make any sense. I agree with that. But there within we'll protect that. We'll review it at the next board meeting whether or not we'll change it. We will let you know at that time.

Kent Greene - Boston American Management

And then kind of another question on your costs and on the total industry where natural gas is at. Do you really think that there would be enough reduction in rigs that it will put pressure particularly, if we have a normal weather not understand weather effect you are seeing on that?

Keith A. Hutton - President

Yes I think the rig count is coming down regardless of the weather somewhat. Now certainly the winter will effect how far they go and whether or not it reaches into the 1200 count...1200 or 1300 count will be influenced by weather. So if we have a really cold weather that will mitigate it some. But I think people are living within cash flow now and have to and I think there is an inherent drop coming that's already in the cards and we will just see in it.

And another thing within that is natural gas production wants to come down. We thought we were in the low 30s or so decline rate coming into the drilling over the last couples of years and that's worse because these new wells, all of these shale plays and come down at 70% to 80% the first year. And so the industry's poise require a little tightening in supply. But it takes a moment because you got to work through the ones that are already drilled and the completion is going to help that. So there is probably a three to six months lag, but it's coming.

Kent Greene - Boston American Management

Thank you.

Keith A. Hutton - President

You're welcome.

Operator

[Operator Instructions]. Your next question comes from the line of Tom Gardner with XTO. Please proceed.

Tom Gardner - Simmons & Co.

With XTO. Did I get promoted?

Bob R. Simpson - Chairman and Chief Executive Officer

I didn't know you're working for us.

Tom Gardner - Simmons & Co.

My secret agent status has been given up. Alright here's a real softball. To follow-up on Kent's question, about the gas market, we're seeing these publicly-traded companies announce capital reductions and yet kicking up or at least continuing with their effort, growth... production growth guidance. So, who gets squeezed out of the system to balance the gas market? That's my question.

Bob R. Simpson - Chairman and Chief Executive Officer

We're using expenditures and not production guidance?

Tom Gardner - Simmons & Co.

Exactly. Well, not correspondingly. I mean on the average we see publicly-traded company taking down CapEx north of 20% and yet we're still seeing they are guiding production year-over-year increases. So I'm just wondering, is it the privates that squeezed or what's the story there?

Bob R. Simpson - Chairman and Chief Executive Officer

Yes, I think certainly that privates... we don't get down certainly with basis right now and their issues. I suspect they are laying down rigs. Those are the best wells being some of the better shales, you'll see some effort going on. But in our case we would set up, we are talking about some cost reduction and then maybe a minor adjustment to our growth target. But that is inherent in our game plan and the way we're set up. About others, I really don't know exactly the situation that you were talking about; whether or not they are just tumbling the way to growth, as what level they were going to drilling and they're still drilling.

But I think, obviously there will be some companies that still grow. But as an industry, I think you just follow the rig count. If the rig count is coming down, supply is will be coming down, that's what we watch. You know you cant write-down on rigs and not affect the block. And so we think that's happening and going to happen and then the flavor what you're looking at really would just invite you in expected coming situation there will be companies who could still grow but as an industry I don't think so.

Tom Gardner - Simmons & Co.

So the overall efficiency gains won't, in your view, make up for the lack of rig count reduction. And then given next XTO has, I guess represents the first set of eyes on the Gulf of Mexico, wanted to get your view on the opportunity set out there which respect to your onshore opportunity base. I mean is the Gulf of Mexico an attractive place to be?

Keith A. Hutton - President

It is if you're in the right fields and I think that's the reason we're attracted to Hunt. There are some kind of allocated style plays in the Gulf of Mexico when you're hitting an old well at oil sands that had gas but the time they didn't want to set a platform, now people have moved platforms in close enough, you can set up single well case and then tie back to it. There are number of plays like that, that really looks like onshore develop plays for us.

Remember you are only making $75 million a day or something. Offshore sell, you know if you drill on 17 million or 20 million a day type wells then take the remaining to maintain your production and the way I'll tell you, we look at offshore. We are not really trying to grow it. We're just trying to maintain it and use 30% of cash flow or something to do that and it is really good cash cal for us to use to develop our onshore properties.

Bob R. Simpson - Chairman and Chief Executive Officer

We have set of assets offshore that are long-lived and they are concentrated and so our view of those assets, we are not an offshore company. We don't think offshore plays will achieve growth. What we think we've got in our situation cash cals that will nurture with a fraction of cash flow to supplement our growth elsewhere. We have got an asset off shore cash some similar bought in 1998 paid about $45 million for it, last year's cash flows probably 100. And so... but productions were up a little bit since we owned it, but it's cash cap. And so long live cash cal has be offshore. It's not a strategy change, nor does it interest to us know distract us something it's about 2% or 3% of the company and a nice source of cash.

Tom Gardner - Simmons & Co.

Just one last question and you mentioned Bob, intrinsic bargains out there and you're pretty much out of the acquisition game for a while. But are you looking to do sort of bolt-on leasing if you will or drill to earn opportunities. At what level have you dialed back that sort of accretive activity?

Bob R. Simpson - Chairman and Chief Executive Officer

We wont get back certainly drill debt activity. If you look at the acquisition market in leasing, what part would reduce our leasing activity by two-thirds or something for a while. And again, it's not the total direction of the company, but we think prices are coming down, there's no reason to support that market, while it's in transition. And then when you sum the acquisitions, frankly I haven't seen any great cash flow assets go by the board. I mean that's the last thing people sell. Their cash flows, what they're trying to hang-on, they're trying to sell non-cash flow assets first and then activity. So, I haven't seen, I have an acquisition guide I'll be sitting on both ends for a while because that's my nature, but I'm going to do that because it's the thing to this moment... this company has taken on a nice great set of assets, organization has done a wonderful job but are both full for the moment and for valid reasons this time.

But I still watch it and I can't report to you that I am seeing a lot of bargains and producing properties go by the way. If I act in my career with something down his third year. The cash flow assets will add sale. By the way great asset... that part is where bargain is going to be. You won't buy great cash flow assets on the cheap, it didn't happen. Now what you will buy for cheap is maybe a lease of 25, somebody release for two. Those have to just help them out here and something and that should be a part. And definitely not the real bargain. And so what we will do is if we're drilling on the well [Inaudible]. That's the bolt-on for and that's what we should be. No, we are not going to completely stall but we are going to reduce... to really true-up things at the moment, while we maintain this cash flow machine.

Tom Gardner - Simmons & Co.

Thanks guys. And I don't know what I'll going to doing now that I've been given up. Bye.

Operator

Your next question comes from the line of Ronnie Eisemann with J.P. Morgan. Please proceed.

Joe Allman - J.P. Morgan

Thank you. Actually Joe Allman here. Good morning everybody. The... you might have said this and I might have missed it. With your expected cut in the budget in 2009, would you be expecting to drop some rigs?

Keith A. Hutton - President

Actually Joe, we would probably have to raise the rigs a little bit from where we are but not a lot. Our original budget took us up to that 20 rigs in a year. But you cut back 20% and you're going to be close to where you are on recounts. Now if you see as pick up at some place and drop another, but it won't change your current rig count a lot.

Joe Allman - J.P. Morgan

Okay got you. And then just thinking about cutting the budgets and I know you guys are one of the more efficient operators but our economics and rates return factor here. I mean, I know you're expecting cost to drop at giving current costs in given, current price decks. If you look across our portfolio, there are some areas where just given the economics that they're just not hitting the hurdle rate and you're probably going to slowdown in some of those particular areas?

Keith A. Hutton - President

In general, right now everything is okay. We aren't hedged really hard to begin with but if you just look at current prices, obviously we set the company up to be able to deliver most of these areas at $5 or $6 cash. And obviously there are some areas that have lower rates of return than others that will move rigs around and not drill those.

Bob R. Simpson - Chairman and Chief Executive Officer

In response another way to look at that question. If we said we'd look at 20% or 30% rate of return, we could probably drill twice our cash flow on the cut-off. And so it's not an economic cut-off. It's a relative way to return the designated.

Joe Allman - J.P. Morgan

Okay. That's helpful and then Bob you mentioned about the privates in one of the last questions. I mean are you seeing some avenues that the privates are maybe just you wanted to partner within some areas. Are you seeing some evidence that they are not participating or don't have the money or you're seeing less activity or you're seeing some avenues of that?

Bob R. Simpson - Chairman and Chief Executive Officer

Yes, you'll see that. You will see people that look for partner to develop, take the handfill those are very expensive wells and a lot of that acreage is going to be drop throughout the family that the ... $72 million drill and there'll be some rig count that comes along but we are not and I mean it's early so we are not... it's not a big line of business.

Joe Allman - J.P. Morgan

Okay that's helpful. And then in the Bakken there are some capacity constraints there, pipeline capacity so could you just talk about your ability to increase your oil production. How you're doing that through pipes, through trucks, through rail and what about natural gas production?

Keith A. Hutton - President

You know most of our production is through already. Obviously every now and then you need to drill step up well you may have to track it which will hurt you on your margin for a while. But in general, we haven't seen really big pass decrements up there in those. I'm sure that's coming a little bit if everybody gets a little too hot. Headington in general, set it's pipelines that puts us in a pretty good situation for decrements. Natural gas, another issue, we have a plant that Headington built, that's not big enough so will probably end outside that plant. That 1300 Btu gas, that is really good stuff from a price standpoint. And you will see us do the next ...

Joe Allman - J.P. Morgan

Okay and then the capacity increases that you...I mean, you mentioned that I think 2010 keys. I mean what you're looking at between now and then, any capacity increase in terms of pipe or that gas plant is that can be between now and then or?

decrements The gas plant between now and then. There is a consortium of operators talking about trying to figure out a way, the pipeline is there. I am sure that will take lives during 2009, but probably won't affect the overall game until 2010 and 2011 as well. Obviously, the more people drill good wells, the more you will have a third-party pipeline company, want to come in and lay a pipe. It's going to be worth your time. And that happens out in the future as well.

Joe Allman - J.P. Morgan

Okay, great. Very helpful. Thank you.

Operator

At this time, there are no additional questions. I would now like to turn the call back over to Mr. Louis Baldwin for closing remark.

Louis G. Baldwin - Executive Vice President and Chief Financial Officer

Thank you for listening and asking good questions. Just to reiterate Bob's comments. We're going to a period of little bit growth where free cash flow is key. We look at 2009, 2010 being able to generate substantial free cash flow between the $1.5 billion and $2 billion in each year. So we feel like we're well positioned in a pretty turbulent time. So, thank you very much.

Bob R. Simpson - Chairman and Chief Executive Officer

Thanks everybody.

Operator

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you. .

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Source: XTO Energy Inc. Q3 2008 Earnings Call Transcript
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