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Energy XXI (Bermuda) Limited (NASDAQ:EXXI)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

November 13, 2008, 10:00 am ET

Executives

Stewart Lawrence – VP, IR and Communications

John Schiller – Chairman and CEO

David West Griffin – CFO

Steve Weyel – President and COO

Analysts

Neal Dingmann – Dahlman Rose

Duane Grubert – CRT Capital Group

Richard Tullis – Capital One Southcoast

Nicholas Schneider – Morris Schneider

Evan Templeton – Jefferies & Co.

Anthony Marchese – Monarch Capital

Jason Late – Pall Mall Investment Management

Mike Gannon – Oryx

Ross DeMont – Midwood

Steve Berman – Pritchard Capital Partners

Operator

Ladies and gentlemen, good day. At this time, I’d like to welcome everyone to the Energy XXI first quarter fiscal year 2009 earnings call. During this presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the company’s formal remarks. (Operator instructions) I will repeat these instructions after management completes their prepared remarks. Today’s conference call is being recorded.

And now, I would like to turn the call over to Stewart Lawrence, Vice President of Investor Relations. Please go ahead, sir.

Stewart Lawrence

Thank you, Tina. Welcome to the call today, everybody. I am Stewart Lawrence. Presenting today, we have John Schiller, Chairman and CEO; Steve Weyel, President and Chief Operating Officer; and West Griffin, Chief Financial Officer. We’ll be available to answer questions at the end of the call.

Before we get started, I need to remind everyone that our remarks today, including answers to your questions, include statements that we believe to be forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated. Those risks include, among others, matters that we have described in our earnings release issued today and in our public filings. We disclaim any obligation to update these forward-looking statements. While the company believes these forward- looking statements are reasonable, they are subject to factors such as commodity prices, competition, technology, and environmental and regulatory compliance. Our drilling schedules, capital plans, and other factors may cause our results to differ materially. I urge you to read our 10-K and latest 10-Q to become better familiar with these risks and our company.

Now I’ll turn the call over to John.

John Schiller

Thanks, Stewart. Welcome everyone to our fiscal first quarter conference call. Before we get going, I’d like to report that we held our Annual General Meeting this morning, where our shareholders approved each of the Board of Director’s proposals. We want to thank our shareholders for their participation in this process.

Looking at this quarter, with two hurricanes and a global financial collapse distracting everyone since the end of the previous quarter, the focus of this call is going to be a little different than usual. We’ll cover the operational and financial highlights and keep the formal portion short to leave time for your questions. Stepping back and looking at the big picture, Energy XXI is in a good position considering everything that’s happened. Our employees safely handled two major hurricanes that slammed our production facilities, not to mention our homes and communities, and have done a great job bringing production back online and resuming normal operations.

First quarter volumes topped our expectations, and the ramp up at South Timbalier 21 should get us back to a solid run rate this month, with a few smaller fields still waiting on pipelines before they can resume production. Our hedge position is doing exactly what it was designed to do, protecting our cash flow in these volatile markets. Given our expected volumes and the hedges, we continue to believe we can execute a robust capital program, while staying within cash flow. We deferred some activities to achieve this goal, but most of these opportunities are held by production, so we can pursue them later.

Meanwhile, all of our high-impact exploration is moving ahead. While the storms created some problems for our exploration effort, we remain very optimistic that we will add significantly to proved reserves this year. We have assumed operatorship at Cote de Mer and are making good progress cleaning out the well bore following the operating difficulties encountered during the storms. At Blackbeard, we have completed drilling and are moving forward to test the well. Addressing the number one question we get these days, our liquidity position is solid. We see no problem funding a success case scenario to develop Blackbeard, Cote de Mer, Amazo, and any other high-impact exploration drilling that’s on our schedule over the next couple of years. One of the key things to remember is that Cote de Mer gets on production relatively fast. We would expect within six to eight months to have production there and generating significant cash flow to funds its own development drilling program.

On that note, I’ll turn it over to Wes who will provide some detail on our liquidity.

David West Griffin

Thanks, John. As always, we included all the key financial detail in the earnings release. Normally we would go through the data to identify noteworthy and unusual items. The hurricane-affected volumes make that a useless exercise this quarter, however, since operating costs tend to stay relatively fixed while the revenues drop alongside volumes.

So instead, let’s go straight to the liquidity detail. Since our last conference call on September 9, we’ve used $19 million of the cash we had at the Bermuda level to buy another 32.5 million face value of our high-yield bonds; bringing the total repurchase to 100 million of the bonds for a cost of a little less than $78 million. That left us with $59 million of cash at the Bermuda level as of October 31. As a reminder, this cash was from a warrant tender that we completed in June and is the only cash that we can use to buy bonds, equity, or warrants. The second cash number shown on the slide was drawn from the revolver at the operating subsidiary for basic needs, including hurricane repairs. So in total at October 31, we had $136 million of cash on the books and had $155 million of capacity remaining on the revolver. Given that our goal is to hold capital expenditures for fiscal 2009 to essentially match cash flow, this $291 million of total liquidity is a very comfortable level, providing a significant cushion for any unbudgeted needs, such as a major discovery and development project or an acquisition.

As for the balance sheet, our current total debt, net of cash and net of the repurchased bonds, is $805 million. That’s a 23% reduction from the previous year. Importantly, the bond repurchases have cut $10 million of interest expense off the annual bill for the high-yield notes, since we pay that to ourselves now. When we consider that we paid about $78 million for the $100 million of bonds, and we have 4.5 years left, we will save $45 million of interest expense over the remaining life of the bonds, plus a further $22 million on the repayment of the bonds. Essentially, the bond repurchases largely pay for themselves over the remaining life of the bonds.

With that, I will turn it over to Steve for the operations discussion.

Steve Weyel

Thanks, West. Let’s start with a quick review of the hurricane impacts before going to the capital program. As everyone knows, our operations took a one-two punch from hurricanes Gustav and Ike in September, shutting in our production and halting drilling operations for most of the month. We can’t say enough about the effort from our employees, even as they struggled to take care of their families with damage to their homes, extended power outages, gasoline shortages, and many other day-to-day challenges, they really came through for the company and helped us recover quickly on the operations side. The 18,800 Boe per day of production reported for the first quarter was solidly above our expectations.

Industry-wide, more than 25% of Gulf of Mexico production is still shut in. So the third-party pipeline outages that continue to restrict our volumes are not just an Energy XXI issue. As discussed in the earnings release, the Laphroaig discovery has reached pay off. The well performed so strong for so long, and at such high natural gas prices, we reached payout in just a year, and our net revenue interest dropped from 25% to 15%. In dollar terms, we invested $8.6 million as well and have already netted $36.3 million in cash flow. Our share of the well is $140 million of cash flow. The well continues to produce more than 41 million cubic feet of gas today and nearly 800 barrels per day of liquids. It’s a fantastic well.

On that note, let’s look at the new budget. We cut the budget significantly, not just relative to the last fiscal year, but even more from what was originally planned, and are looking to reduce our interest in certain exploration wells additionally. It was not an easy decision, but the guiding principle was that we didn’t want to hurt our longer-term growth potential by cutting exploration opportunities today. Our curtailed development projects will be kept in inventory and drilled when commodity prices and cash flows warrant. The reduction affects our production level this year, but we believe this budget achieves a nice balance between expected reserves growth and production volumes for this fiscal year. We would also suggest by staying within cash flow and retaining our liquidity, we have the opportunity to acquire growth at a lower cost than drilling for it. This isn’t something we can forecast, obviously, but the current budget positions us to make opportunistic acquisitions of assets into our companies.

Our key high-impact wells were unaffected by the budget reduction. Let me update the big ones currently in progress. North East Belle Isle is an Energy XXI prospect that McMoRan is currently drilling. We’ve retained a 30% working interest in this prospect, which is a look-alike to the Laphroaig discovery we drilled with McMoRan last year. This well has the potential to add net reserves equal to nearly 70% of our production last year. It’s currently drilling about 2,000 feet from its targeted depth, so we should know something within the next four to six weeks.

The Kaplan well, located onshore in Vermillion Parish, Louisiana, is designed as a deeper test in the prolific Kaplan field. The well’s primary target is to channelize Miocene (inaudible) B sand. The original well penetrated the K and B objective as predicted structurally, but was outside the channel in non-reservoir quality rock. Currently, the well is drilling a sidetrack location from the original hole. While drilling sidetrack 300 feet laterally from the original hole, we encountered channel sand that appears to be productive and not present in the original well bore. We are currently drilling at 16,800 feet, with a targeted depth of 18,100 feet.

We provide this regional slide to illustrate the settings for Cote de Mer. It’s clearly a great area, with the well in close proximity to several TCSIs-producing fields, including Freshwater Bayou. There is no question the structure exists. It’s massive, covering 1400 acres, making this a 500 Bcf-plus target. We drilled to within a few hundred feet of the targeted depth and have seen what we believe are hundreds of feet of hydrocarbon-bearing sand. The rig was pulled off location before the hurricanes, right before getting open-hole logs. When we got back to the well almost a month later, the operator experienced serious difficulties. As a result, Energy XXI became operator, and since that time we’ve made excellent progress recovering the well bore. As of today, we have cleaned it out down to 19,260 feet, and we have just a little bit more pipe to recover before we expect to sidetrack the well and drill the last 2000 feet or so. As such, we hope to have the well down-logged and cased before year-end. It’s difficult to convey how optimistic we are about the near-term potential of this prospect.

We are even more enthusiastic regarding the outcome of the Blackbeard well, which is moving to the completion and testing phase in one of the most significant geological discoveries for the industry in recent years. What we have been able to tell you about Blackbeard to-date is we’ve logged four separate potentially hydrocarbon-bearing zones below the salt between 30,000 and 33,000 feet. We are temporarily abandoning the well bore and are moving forward with completion and flow testing, and we fully expect drilling the down-dip well off the flanks of the structure to prove up a very large amount of reserves and production potential.

This is a cartoon you may have seen. It’s a compelling illustration of the concept. The targeted sands here are the same ones who have proved to be tremendously productive in the deepwater. What you don’t see here is the same sands have been big producers to the north also, including McMoRan’s Flatrock discovery and numerous old fields onshore. There is no reason to believe the sands won’t be productive here, they’re just tougher to get to. One of the key things to understand is this well was drilled on the very top of the targeted structure. The cross-section illustration depicts the concept, which has proved to be what we’ve seen with the larger deepwater discoveries in the same sand intervals. The top of this structure consistently has the thinnest sands and as you move out to the flanks, the sands thicken by two to three times, resulting in massive reserves potential.

The deepwater K2 field provides a prime example of this wedge theory. The initial discovery logged thin sands that didn’t appear commercial. Continued drilling out on the flanks proved up an oil column of about 5000 feet in thickness holding upwards of 4 billion barrels of oil in place. Bottom line, Blackbeard is working. The theorem of ultra-deep shelf deposits is geologically proven. Furthermore, while drilling operations posed real new frontier challenges, we’ve proven it can be done. The pending ultra-deep development will be made easier by the knowledge that we gained with this well. There will be a next well. The partners will decide whether the next location will be a Blackbeard West development well or a new ultra-deep prospect. McMoRan as operator has a two-year contract with Rowan-Mississippi that begins within a few days.

Prior to moving to the next ultra-deep well, this rig will drill a deep test at the Amazo prospect, in which we recently took a 20% working interest. The next few slides on Amazo were borrowed from McMoRan’s recent earnings call. Jim Bob Moffett did a better job explaining this prospect than we ever could, so you might want to go to their website to listen to the replay. Suffice to say for now that Amazo is the next big target along the same trend that has delivered the Flatrock, Hurricane, and Jim Bob Mountain discoveries. This prospect is on the shelf in just 25 feet of water with a targeted depth of 24,500 feet, and it’s a big TCF-class target. The well will spud in two weeks and will take four to five months to drill. Energy XXI’s net dry-hole cost is expected to be about $14 million. To put that into perspective, that’s less than what we paid for a development well at our South Timbalier 21 Field. This slide paints a clear picture of the sands we’re targeting compared with the sands McMoRan tapped with its big discoveries nearby. Amazo is definitely on trend. We are very enthusiastic about this prospect’s potential and the strengthening of our strategic alignment and joint efforts with McMoRan and Mr. Moffett.

Now before wrapping up the call, let’s review the strength of our current hedge position. Since the inception of our company, risk management has been key to our overall strategy. We’ve constructed and maintained a diversified hedge portfolio, utilizing a combination of fixed price swaps, costless collars, puts and put spreads to protect the economics of our asset base. Our hedge portfolio provides a desired asset protection, while also allowing participation in market upside. As a part of our risk management philosophy, we actively manage our portfolio to take advantage to changing market dynamics. For example, as the market rally in energy commodities stalled this summer and prices began to retreat, we bought put spreads in both crude and natural gas to layer on top of our existing positions.

These additional hedge positions have helped to further shield Energy XXI from the current downturn in the financial and commodity markets. Given the current environment, it is also important to recognize the strength of our hedge counterparties, which is a major benefit of our risk management program. We only execute hedges with members of our banking group, which provides the advantages of no margin requirement. We allow our banks to compete for hedge transactions in an auction-like manner, ensuring a very competitive market price while minimizing financial concentration with any one financial party. This delivered approach left us with very minimal exposure to the Lehman Brothers bankruptcy event and provided diversification of any future credit risk.

We provide these next few slides to illustrate the current hedge position. You will see for the remainder of fiscal 2009, we are about 80% hedged with effective gas hedge price at about $8.50 in Mcf and the effective oil hedge price at about $79 a barrel. With the recent pullback in commodity prices, the hedge portfolio is once again solidly in the money to the tune of about $80 million today. So it is clearly serving our purpose, protecting our cash flow.

Before I turn this back to John, I wanted to just update you on where we are today. We again are working through the issues related to the hurricane as quickly as possible. Clearly, our December quarter will once again be affected as we indicated previously. It will be a struggle to remain close to the first quarter production number, remembering that July and August were essentially normal, whereas October averaged only about 15,000 barrels per day. We currently have our production back a little bit over 18,000 barrels a day. We will get past these challenges and return production closer to pre-storm levels minus the 2,000 barrels a day at deferred long-term production loss due to platforms that are third-party operated.

At this time, I would like to turn this call back over to John. Thank you.

John Schiller

Thanks, Steve. As a quick wrap-up, it would be hard-pressed to find a more challenging time than the last few months that we put behind us. Energy XXI has met those challenges and is well positioned to succeed in the coming months and quarters. We have the cash flow, balance sheet, and liquidity. We have the professional staff, and we have the drilling opportunities to achieve great things, and we intend to do exactly that. Let’s go ahead and open up to questions, please.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) We will now take our first question from Neal Dingmann with Dahlman Rose.

Neal Dingmann – Dahlman Rose

Good morning, guys.

John Schiller

Good morning, Neal.

Neal Dingmann – Dahlman Rose

Say, John, could you or West, I want to make sure I get this clear as far as the $59 million Bermuda cash left, $291 million total liquidity, I was wondering, that plus upcoming cash flow; what you can use to pay down further debt, potentially buy back shares, and then potentially go after more acquisitions and just fund some of your projects with those funds and all.

David West Griffin

Yes, I mean on buying back shares and/or bonds, the easy answer is without getting waivers from the bank group or anything else, the $59 million at Bermuda is available for those purchases. With regards to successful development programs and everything else, we have the revolver in front of us to use for that.

Neal Dingmann – Dahlman Rose

Okay. And then it looks like the timing on both Kaplan and Cote de Mer, are both within weeks, it looks like, is that fair?

David West Griffin

Yes. Kaplan we’re actually making pretty good headway on, so absent any surprises, we’ll probably know something there a little bit sooner than Cote de Mer.

Neal Dingmann – Dahlman Rose

Okay. And then lastly, obviously you all are like everybody else, third party pipes and stuff continue to be down. Any more color on that as far as what you think timing behind some of that just to get some of that prior production back on line?

David West Griffin

Yes, that’s a good point. Essentially all our major repairs are done, all our infill gathering lines, our structures that needed some repair. I’ll give you a for instance. We’ve got a platform at South Timbalier 21 with about 1300 barrels a day production. It’s a tripod that we were drilling next to that had a little bit of damage. It’s been structurally repaired, and we are waiting on the MMS to give us the official approval that we can return it to production. Unfortunately with MMS, they don’t give you a ticket to tell you where you are in line, so it could come on tomorrow, and it could come on December 1, and that’s part of the difficulties you have with trying to project your volumes when you come back from these things. Everything else that’s shut in for most part is waiting on third-party pipelines, and what we will probably tell you there is history says they consistently move their date back.

Neal Dingmann – Dahlman Rose

Got it. So bottom-line is, most of the infrastructure platforms and all that you all could do, you’ve got that up where you need to be. It’s just more a matter of waiting on MMS and waiting on third party.

David West Griffin

Exactly. For instance, at South Timbalier, we lost a 14 inch line and an 8 inch line. All that work is done, and that’s what we prioritize with our lift boats. Now that that’s done, we’re going around to some individual wells that perhaps had a well panel knocked down and things like that. Those repairs are half-a-day type work. But we had the equipment focused on what got on the most amount of production. Now we’re going to deal with the little bitty wells, individual wells, not necessarily little bitty.

Neal Dingmann – Dahlman Rose

Got it. Okay. I will turn it to somebody else. Thanks, guys.

David West Griffin

All right.

Operator

And our next question comes from Duane Grubert with CRT Capital Group.

Duane Grubert – CRT Capital Group

Yes, John. Can you walk us through the logistics of the Blackbeard flow test? Basically the question being why does it take so darn long to get equipment and stuff?

John Schiller

Yes, let me tell you the first part of the logistics. Thursday morning in New Orleans, there’s going to be the first meeting of the completion teams to start working out all of that. We’ve got one of our key engineers, who has been with us previously in Apache. He was one of their big competition guys. Plains will be sending a guy over, and then we’ll be with the McMoRan guys and ENI. But you know, the basics of this, you’re dealing with a 30,000 pound tree. So the trees have been designed before, and one’s never been built. That’s one step of it. Give you some sense of the type of things you’re talking about, we ordered two joints of casing the other day to do some testing in for this, and the two joints of casing cost $260,000. So it’s some heavyweight still. The packers and things like that are actually a little bit more routine, where temperatures and differential pressure because you can put heavyweight behind the packers. Don’t really matter that much. So the packers won’t be as big an issue. It’s going to be the trees and the tubing. And those are just long-lead items.

Duane Grubert – CRT Capital Group

Okay. That’s very helpful. And on the taking over the operatorship at Cote de Mer, what do you think are the basic things that you bring to the table that should improve the way operations are going there?

John Schiller

I think essentially when you look at our staff, Duane; we’ve got several guys with over 30 years of South Louisiana experience. For those of you who don’t know, South Louisiana is unlike anywhere else in the world. The pressures you get, the drilling conditions you see, they just don’t occur in a lot of other places. And I think that you have to have a healthy respect for what you’re in, but you also can’t be scared or afraid to do things. And sometimes we see people in a lot of our different wells who get nervous over pressure, and it’s just part of the environment you have to live in. So a lot of years experience. We’re making a good headway there. We’re making one more trip right now to make another back off, and then we’ll probably wash over the last couple of hundred feet. We need to get to about 19,500 to set a sidetrack and start drilling that bottom part of the hole again. What we will probably do there is drill below that first pay sand that you’ve heard us talk about, set pipe, and then drill out through the main pay sand. And we think that will speed things up, because you’ve heard us talk in the past, we think we went through a pressure regression, and the big, 500-foot gross interval on the bottom took us forever to drill because we were so far overbalance. So when we get this other liner in there, that will help us drill the well a little bit quicker also.

Duane Grubert – CRT Capital Group

Super, and then on smaller wells. We tend to focus as a group on the big high exploration impact well. Can you just characterize work-overs and other programs, how that’s going?

John Schiller

Yes, a couple of things, that’s a good question. Golden Meadows, which is Apache operated, a deal we picked up from Castex that in general we have about 25 or so working interest. We just drilled a heck of a well there, two pay-sands; the bailout zone came in with over 70 feet of oil. The main target, which was Big Hum, came in with a 120 foot of gas. That well’s probably a couple of million barrels of oil and eight or nine to 10 Bcf of gas. That’s six wells in a row in that area that Apache has drilled successfully, just drilling some amplitudes. So we’ve been real happy with that. Our Joe McHugh field continues to make about 25 million a day gross between the two wells that Castex drilled that we’re 50/50 in. So all those little things keep adding up. We mentioned early on about East Cameron 334 area. We were successful with that re-completion. That is an old field with a Tcf of gas having tubed out of it, and yet we found a well bore that had not been depleted and had a lot of gas packed behind pipe and got it on at 9 million a day. And then today, one we didn’t really touch on, but the well we’re currently drilling at South Timbalier, the Barrio, we call it, it’s 82 sidetrack, that well’s hit every target sand all the way down, starting at the shallow S3, S4, and it’s hit the D2, the D3, the D4, the D7, and the D10, and all of them had more oil than we expected. So the nuts and bolts sort of things we do for a living continue to go very well for us.

Duane Grubert – CRT Capital Group

That’s really good. And then finally on reserve adds. I assume that you cannot or will not add reserves for the Blackbeard Prospect at the end of ‘08, and I assume that you could, if you have success at Cote De Mer and Kaplan. Can you just walk through what has to happen to make that right or wrong?

Steve Weyel

I would say your general assumption’s probably correct on those three wells. What I will tell you is, because of our fiscal year, Jim Bob’s going to have the lead on Blackbeard and that his December 31 year is coming up. He engages Rider Scott for his reserves, who also does ours. So he’ll take the lead on where he gets Rider Scott with regards to reserves, and then we’ll basically copy cat since they do our reserves also. And we’ll see. It’s all going to come down to tying the sands into the Miocene sands that have produced and whether you can show the ability to flow or not.

Duane Grubert – CRT Capital Group

Very good. Thank you.

Operator

And our next question comes from Mr. Richard Tullis, Capital One Southcoast.

Richard Tullis – Capital One Southcoast

John, good morning.

John Schiller

Good morning, Richard.

Richard Tullis – Capital One Southcoast

I know you guys are kind of preserving liquidity to remain flexible in the current environment. I’m assuming that includes maybe looking at acquisition opportunities. I just want to get your general feel for what kind of environment do you see out there right now, and what sort of opportunities might you come across?

John Schiller

We kind of see an environment where everybody is trying to figure out where commodity prices are and where stock prices are right now. We are probably going to sell in the neighborhood of 40 million of our assets, which are small things, some of which are long-lead item production items that the production’s out in the future on. And we feel pretty good, we have buyers for those. With regards, we would look at things all the time. We look at corporate deals, and we look at assets. We haven’t seen a particular asset package that blows us away right now. And so we kind of focus on what we do well within our own house and see where we go from here.

Richard Tullis – Capital One Southcoast

Okay. What about unit cost outlook for second quarter of ‘09, LOE and DD&A? Do you anticipate something similar to what we just saw in this past quarter?

John Schiller

Probably. We may improve a little bit. We expensed some stuff, right, from hurricane? We expensed some more stuff from our deductibles into this quarter, so that number should come down on a unit cost basis quarter-to-quarter. But they’re doing a lot of work to get things done out there, and sometimes it’s reimbursable, and sometimes you don’t get it all recovered, you know?

Richard Tullis – Capital One Southcoast

Sure.

John Schiller

Meaning that there is extra cost that don’t necessarily come in. But quarter-on-quarter, I mean year-on-year; we’re going to have a reduction in LOE for sure. Quarter-to-quarter unit cost, I would expect it to go down a little bit.

Richard Tullis – Capital One Southcoast

Okay.

John Schiller

But maybe not all the way back to where we were pre-storm.

Richard Tullis – Capital One Southcoast

Okay. And a final question on Cote de Mer. I know you guys are pretty enthused about the prospects there. How much, if successful, how much do you expect it would cost to develop the well?

John Schiller

In terms of the individual well itself or overall development?

Richard Tullis – Capital One Southcoast

I guess overall development.

John Schiller

We think probably, to get this well on is probably about six months. You’re looking for 20,000 pounds of equipment and tubing to get it tested and on production. So six to nine months as far as production. If it’s as good as we expect, the log makes it a no-brainer. We would probably look to spud a well before we actually even have that well on production. We’d probably drill at least two wells if it’s as big as we think. Basically, a well for every 100 Bs. So if it’s 500 Bs it’ll be five development wells eventually. And you’re looking at each of those wells, we think should be drilled, completed, hooked up for $40 million to $45 million.

Richard Tullis – Capital One Southcoast

I know it’s preliminary, but what sort of flow rate could you see out of?

John Schiller

These wells will be very similar to what you see at Laphroaig. I mean we should expect 40 million, 50 million a day sort of wells.

Richard Tullis

Okay.

John Schiller

With a decent amount of condensate, 10 million, 15 barrels a million like we’re seeing in Laphroaig.

Richard Tullis – Capital One Southcoast

Okay. All right, John, very good. I appreciate it.

John Schiller

All right. And Richard, remember, the well’s right across the fault from us at Freshwater Bayou. They’ve got wells there that have all cumed over a 100 Bcf and 1.7 million barrels of condensate.

Richard Tullis – Capital One Southcoast

Okay. Thank you, John.

Operator

And our next question comes from Nicholas Schneider with Morris Schneider Management.

Nicholas Schneider – Morris Schneider

Good morning, gentleman, and congratulations on a strong quarter in a pretty difficult environment.

John Schiller

Thank you.

Nicholas Schneider – Morris Schneider

I had a couple of quick questions. With the hedges, roughly what percent of your hedged volume has upside if prices rise?

John Schiller

We actually have Todd Reid here with us today. He’s our Senior Vice President of Risk Management, so we’re going to let him respond to that.

Todd Reid

As we put the slide with it. Let me flip through the pages real quick, look at that, make sure we give you the right number. Bear with us for a second.

Steve Weyel

I will tell you, Nicholas, a lot of our last hedges were put spreads for just this reason. They give us upside not to go back up, and we’re looking at, where’s the slide with the percent?

Todd Reid

About 25% of our portfolio is puts and put spreads, so that’s on the nat gas side. On the crude oil side, it’s more like 30%, so a little bit higher on the crude side. It’s a little bit more upside in our crude position than our nat gas position.

Steve Weyel

And we also maintain a large portion of collars and three-way collars that at these current price levels, we actually pick up additional benefit with upward price movement.

Todd Reid

That’s a good point, Steve.

Nicholas Schneider – Morris Schneider

And you’re talking about maybe 10 on natural gas and 80 or 90 on oil, roughly where the collar is?

Todd Reid

I mean nat, you’re more than 50%; and on crudes you’re closer to 75% potential upside between collars, three-way collars, and puts and put spreads.

Steve Weyel

From where we are today.

Nicholas Schneider – Morris Schneider

Okay. With regard to the long-lead items at Blackbeard, can you give some sort of a rough estimate as to when you could get these items and when you could develop a well?

John Schiller

Yes, I mean Jim Bob said a year and I think that’s in the right ballpark. Literally, Thursday we’ll start learning a lot more. The big item is the tree. And without telling you who, I’ll tell you there’s a major there who has designed a 30,000 pound tree. They’ve offered us the design if we’ll give them a copy of the Blackbeard logs. So, those are some of the things we’re working through right now to see how much that expedites the process. The tubulars, those are all going to have to be special milled. If drilling slows down and the mills open up quicker, then maybe we’ll get that a little bit quicker, but that’s why I tend to think the tree is going be the long-lead item. And I just, I mean I would love to tell you I know the exact date, but maybe a month from now we’ll be a lot more firm with you on how that’s all looking.

Nicholas Schneider – Morris Schneider

Okay. And you had mentioned possibly selling off an exploration project, and you mentioned $40 million in smaller assets. Would a portion of you interest in Blackbeard be on the table potentially?

John Schiller

No, no. This is things like our Platte Prospect and Banff. We have some people interested in taking a quarter of those. So we may do that just to, we’ve got 80% and 100% of those two wells right now, so that leaves us at $55 million and $75 million. We still got plenty of exposure in them.

Nicholas Schneider – Morris Schneider

Okay. And a question about the production that’s going to be out for 2009, I think that’s operated by Devon?

John Schiller

Correct.

Nicholas Schneider – Morris Schneider

The platforms that were knocked down?

John Schiller

Right.

Nicholas Schneider – Morris Schneider

What is your insurance deductible on that?

David West Griffin

The way our insurance works, we have $7.5 million per storm, so we got a total of $15 million in deductible, and then we have a total limit claim for the hurricane season of $175 million. And between re-drilling wells and repairing platforms, replacing platforms, we think we’ll tap that entire amount.

Nicholas Schneider – Morris Schneider

And could you potentially, is that contingent on you actually re-drilling the wells, or is that just cash to you?

David West Griffin

A lot of it is contingent on re-drilling wells. We’re going to look to do some global settlement, no promises on when that will occur, and it’s also, what we will tell you is not every well you lose needs to be re-drilled, right? I mean some of them don’t make sense to re-drill. So we’re comfortable that in particular Eugene Island 330 that you’re talking about, we get all the wells we need to drill there. You probably drill less than half the wells they lost and you get about 85% of the reserves.

Nicholas Schneider – Morris Schneider

So that can be, potentially, a source of significant cash flow in the coming year?

David West Griffin

Yes. I mean they just brought it back on a year ago, and it’s been steadily making as high as 1600 barrels a day; it was making 1300 when it went off.

Nicholas Schneider – Morris Schneider

No, I mean a global settlement in excess is what you need to re-drill there?

David West Griffin

Yes, I wouldn’t count on it that way, but -

Nicholas Schneider – Morris Schneider

Okay. I don’t want to ask too much about it. But one other thing I was wondering is you mentioned opportunistically buying assets or maybe even another company, and there are certainly opportunities out there. With your own stock trading at, looks like less than cash flow, more or less, what kind of a yardstick would you be using for acquisitions with your own stocks being such an attractive purchase.

Steve Weyel

This is Steve. Basically, the only way that we could pursue it would be to use obviously use equity as our currency, as you referred to, but it would have to be done on a kind of relative asset valuation basis. You’d have to look at underlying value of the assets, between the two potential companies and what cash flows are and come to an agreement on valuation in that way, as opposed to your equity price.

John Schiller

But the key thing is, we’re not looking to do anything with our equity before we get Kaplan and Cote de Mer down. We’ve said all along, Cote de Mer is like the well that won’t end; we’ve been with it now for 18 months. And it’s really, truthfully, we were talking about it last night with our Board. I mean it’s hampered some of things we have wanted to do because we always need it to tell us what the real value of our equity is. But we’re very close, and I think once we get that, we are set out, what I didn’t tell you guys today that we talked about last time is now that we’ve sold all the information, they’ve got all the analogies, they’ve seen the maps, they’ve seen the seismic, they’ve actually indicated ranges to us that we won’t, because I promised that we wouldn’t take it public, but once we have this log we will very quickly, probably when we make the announcement to you, tell you what the reserve impact is. And then I think you all as shareholders will have a good sense of where the equity should trade, and we’ll go from there.

Nicholas Schneider – Morris Schneider

Okay. Does that mean that you won’t be buying back debt in the meantime either, or at a 25-plus yield, is that still something you’d look at doing to sort of preserve future cash flow?

David West Griffin

I think we continue to look at all those options.

Nicholas Schneider – Morris Schneider

Okay. Well, thank you very much for answering all my questions and again, wish you continued good success.

John Schiller

Thank you.

Operator

And we’ll take our next question from Evan Templeton with Jefferies & Company.

Evan Templeton – Jefferies & Co.

Hey, guys, how are you?

John Schiller

Hey, Evan. How are you?

Evan Templeton – Jefferies & Co.

Pretty good. Just a quick question on the balance sheet; I guess as of October 31, the revolver draw was a little bit higher than anticipated at about $280 million. Were you putting just a little bit of extra cash on the pad, why so high?

John Schiller

I mean, if you listened to how much cash we got sitting in a bank, we just, we weren’t as ruthless as some of our friends, I guess who had pulled down their whole revolver, but we did pull down some of the revolver when things were going on and when we were looking at the hurricane damage. You guys know that there is usually a lag in getting that settled.

Evan Templeton – Jefferies & Co.

Right.

John Schiller

The markets appear to be calming down, and so my guess is over the next month West is going to pay some stuff back to the revolver.

Evan Templeton – Jefferies & Co.

Okay, great. That’s kind of what I was wondering. And also can you just, when’s the next redetermination for your borrowing base?

John Schiller

We’re just getting ready to have our bank redetermination this next week, bank being, and then it will be finally settled out by first part of December.

Evan Templeton – Jefferies & Co.

And any kind of, what’s your gut reaction so far? As is, or do you think it comes down or goes up?

John Schiller

I think it’s flat or maybe coming down a little bit. Some of it depends on what West does with Lehman when we bring somebody else into the group for their 15 million of capacity. That’s kind of what all we’ve been talking about the last few days.

Evan Templeton – Jefferies & Co.

Okay, great. And also just as a housekeeping item. Do you have the same, this revolver and high-yield and other outstandings as of the end of the quarter, so as of 9/30?

John Schiller

No. If you look at 9/30, we bought back some of the bonds after 9/30, and so the high-yield debt that you show as of 9/30 is higher than what it is as of October 31.

Steve Weyel

Also we had done on the revolver.

John Schiller

And then you have the difference, obviously, on the revolver, which bounces around.

Evan Templeton – Jefferies & Co.

Okay. Maybe I’ll give you a call offline and we can just go through it line by line.

Steve Weyel

Great. Okay.

Evan Templeton – Jefferies & Co.

But thank you very much, guys.

Operator

(Operator instructions) And we will take our next question from Anthony Marchese with Monarch Capital.

Anthony Marchese – Monarch Capital

Hi, good morning, guys. I have a two-pronged question. First, I would love to hear your opinions as to what do you think the market is missing in terms of your stock price? Because I’m baffled. You have incredible prospects, all of which as you pointed out, changed the face of the company, yet the stock barely trades above, basically trades with no premium whatsoever for any of your prospects. So I’d love to hear your opinion as to what it is people are missing? And secondly on Blackbeard, what, in your experience, and maybe there is none at this point, but in your experience, what is the likelihood that a flow test is going to show something dramatically different than your logs would indicate at this point?

John Schiller

All right. What people, I think that old adage about the baby got thrown out with the bathwater has a lot of truth here. People screen us, they see the leverage, that’s all they focus on. They don’t look at our profit margin per barrel, they don’t see how comfortable we are paying down our debt. I will tell you guys that as part of our Board meeting here in the last two days, we’ve run every number you can run, and we have no problem at almost any price scenario you can envision, cash flow in the company and paying down debt, so we’re very comfortable that the debt payments are going to be made. We do think it’s part of the leverage, that’s why you’ve seen us continue to buy back bonds, and I will tell you that that’s been at the encouragement of several of our large shareholders, all of which have voted the same way to do that. I think they like the exploration upside. I think they want us to show them 500 foot of pay at Cote de Mer with 25% porosity and 20% water saturation and tell you that it’s 400 Bcf with a check of approval by Netherland Sewell, and when that happens, then you have quantum leap in all the rest of your portfolio, and people support the portfolio and believe that you’re doing what you’re doing. Up till then, I think they think you’re arm waving and talking and you haven’t necessarily delivered. And the problem we have is trying to tell you what we’ve seen on the mud log and translate that into hard facts, which we can’t really do for you. So I think that’s the big part of what people miss.

With regards to Blackbeard, what I think the surprise will be is that we are very comfortable with the porosities, with what we’ve seen on the log. We know we have hydrocarbons there. The unknowns, and look, I’m starting to have my engineers crank some numbers and give me some theoreticals, but what we really don’t know on something like this is when you have that much pressure down there, what kind of rates can you get. So in other words, it could be little bit tighter than we expect, but with is much pressure as we have and as hard a rock as we have, maybe we can have a 5000 pound drawdown, and that’s a safe thing and it still gives us 40, 50, 100 million a day. Who knows? I think that’s what we’re looking for in the flow test is just how prolific can the flow rates be.

Anthony Marchese – Monarch Capital

Okay. So the likelihood that this is, would you say there is a significant likelihood, not to put words in your mouth, that this a commercial well, or is it still too early to determine that?

John Schiller

Yes, I would say there is more than a 50% chance it is commercial, and we will flow hydrocarbons at rate that commercial.

Anthony Marchese – Monarch Capital

Okay. Thank you very much.

Operator

And our next question comes from Jason Late with Pall Mall Investment Management.

Jason Late – Pall Mall Investment Management

Good morning. I just have two questions for you. The first one is, referring to, I think you were mentioning this on Slide 26 about the hedges, about 80% hedged out fiscal ‘09, should I continue to expect that’s kind of the ratio rolling forward, or might there be some material change in how much you have hedged for the next twelve-month period?

Second question I have is, when you talked about CapEx in the past, it was something like, don’t remember exactly, maybe 80%, 85% being spent on development, more on the singles, and then the remaining portion more on the homerun or swing for the fences type. Any change in kind of how you view that CapEx as well. I noted that it has been reduced overall, but I’m just wondering on the balance between the two. Thanks.

John Schiller

I’ll take the second question first. I think there might be a little confusion. What we’ve said in the past is that we would take 5% to 10% of our cash flow and put it towards high-impact sort of wells like Blackbeard, like Cote de Mer. But in the way the SEC defines exploration, when we go out like these Apache wells, and we drill amplitude in an area that’s a new fault block, those are still considered exploration wells. I would tell you they’re moderate and the risks are 35 to 50% that we’re going to have success, but they still get tracked as exploration dollars. So that may be why you’re thinking we’re spending a lot more dollars. It’s not necessarily high-impact wells. We’re pretty much living within that 10% sort of commitment on the big wells. It’s more like the wells we drilled at Lake Salvador, the Joe McHugh, both of those would have been exploration wells. But we had over 50% success on them because of how bright the amplitudes were. For the second question, for next year it’s 55% I think?

Steve Weyel

A general comment on risk management. I mean basically, we use risk management and hedging to protect our balance sheet and then to protect our budget. So you continue to see us do that, but for what Todd’s going to say we dropped down, I think, from -

Todd Reid

We dropped down to about 66% for next year, next fiscal year. But if some of our put spreads are deep in the money at this stage, we may look to monetize those. It’s the kind of things we’ve done in the past, which would have as little bit of impact on our overall hedge levels. So we normally target between 60% and 80% hedge levels as a rule. And if we feel nervous about the market we go up more toward the 80%-plus range, maybe even a little bit over that. If we think the economy’s bottoming out, you can look for us to probably reduce it down to more like the 60% level.

Steve Weyel

And again maintaining the upside with anything that we do, albeit we’re hedging.

Jason Late – Pall Mall Investment Management

Right. Okay. All right. Thanks for the clarification.

David West Griffin

Thanks, Jason.

Operator

And our next question comes from Mike Gannon with Oryx.

Mike Gannon – Oryx

Good morning, guys. Just a question on the bond repurchases. Obviously, that’s a positive sign as a bondholder. Question for you, what’s the company’s intent since you’ve bought back a $100 million? Reasonably, you’re going to be getting about $10 million of interest paid to yourself or paid to the hold co over the course of the next 12 months. What do you intend to do with those monies? Do you have a lot of G&A at the Bermuda level to compensate for, or what exactly? Or will you be downstreaming that back into the issuer or the drilling component of the business?

David West Griffin

Yes, good question. I mean part of it, we’re paying our dividends, but obviously the dividends are less than what we’re sending up there. We’ll capture some money there. We can send it back down. I think you’ll see, let’s get through all this liquidity crunch, get through where the market is, see where we are in development dollars, and then I will think you’ll see us start retiring some of that debt also.

Mike Gannon – Oryx

And then -

David West Griffin

Of the bonds.

Mike Gannon – Oryx

Right. I mean that’s a – I guess down the road you could reissue it if conditions ripened, if you will. But that’s one of the things you’re thinking about when the clouds clear, you may retire some of those repurchased bonds?

David West Griffin

Correct.

Mike Gannon – Oryx

But no promises.

John Schiller

We actually get, Wes will point out to you that we actually get credit back against our revolver, $0.30 on the dollar, for doing away with those bonds also.

Mike Gannon – Oryx

Okay. And the $155 million of availability under the revolver, I mean that’s pre-redetermination, correct?

David West Griffin

That’s correct.

Mike Gannon – Oryx

Okay. And when will that redetermination amount be made public? Will that be December, or –?

John Schiller

Yes. I mean -

David West Griffin

Scheduled on right now, early December.

Mike Gannon – Oryx

Okay. Great. Well, that’s it for me. Thanks, guys.

Operator

We’ll now go to Ross DeMont with Midwood.

Ross DeMont – Midwood

Hi, guys. Just a couple of quick questions. Any chance you’ll be able to clean out the entire well bore at Cote De Mer, or is that by definition going to be a sidetrack?

John Schiller

You got chuckles out of everybody. That’s the bet we’re making right now. We are going to find out here shortly.

Ross DeMont – Midwood

Okay.

John Schiller

I will tell you that we went in there last time, and we jarred pretty hard, and we couldn’t get it moving.

Ross DeMont – Midwood

Okay.

John Schiller

But we’re going to go in, we’re going to get a little bit lower and maybe wash over and see if we still can’t get it all to move. I mean that’s the grand slam. Getting to where we can sidetrack is a homerun. If we can get down there and everything starts coming, it’s a grand slam. We know we’re open. We still fight fluid losses, so we know we’re open at least down to the shoe.

Ross DeMont – Midwood

Yes.

John Schiller

We just don’t know how far down that open hole we might be able to get. Once we get to where we can sidetrack, then we just got to weigh the economics. Do we want to keep trying to gain some more into open hole or just start drilling again?

Ross DeMont – Midwood

Okay. And then I guess the original pre-drill estimate on this thing was 500 Bs. Does that still feel about right given that we know a lot more?

John Schiller

Yes, we’ve seen nothing to discourage us from that number, and we’ve actually seen some things now that tell us it could be a bigger number.

Ross DeMont – Midwood

Okay. And finally, are you guys going to do a mid-year, I mean I guess a December 31 reserve update? And if so, would you try to include Cote de Mer in there?

David West Griffin

Yes, exactly. As I said, we’ve already had Netherland Sewell look at everything.

Ross DeMont – Midwood

Yes.

David West Griffin

So we are actually, let’s just say a month from now or six weeks from now, we log the zone. By the time we go to tell you about in a day or two, we would fully expect Netherland Sewell to have said, here’s your crude reserve, here is your 2P number, and here’s your 3P number. And we would announce that to you.

Ross DeMont – Midwood

Okay, great. We look forward to it. Thanks for taking the question.

John Schiller

All right.

Operator

Our next question comes from Steve Berman with Pritchard Capital Partners.

Steve Berman – Pritchard Capital Partners

Good morning, guys. One question on your new CapEx plan, the $240 million to $260 million and taking your hedges into account, what kind of oil and gas prices are you assuming in there to get you so you’ll be operating within cash flow?

John Schiller

We’ve seen too many numbers in the last week, Steve. That’s essentially at $70 and $7.

David West Griffin

But it doesn’t vary much as you lower the actual market commodity price, if you go down to $60 and $6, it doesn’t move very much.

Steve Weyel

Right.

Steve Berman – Pritchard Capital Partners

Okay. That’s it. Thank you.

Operator

This concludes our question and answer session. At this time, I would like to turn the conference back over to Mr. Schiller for any additional or closing comments.

John Schiller

Thanks everybody for joining us today on Election Day. I encourage everybody to go out and vote. I know you guys already have. And we look forward to hopefully having a call before our next earnings to talk about some exploration success. Thanks.

Operator

This concludes today’s conference. We thank you for your participation. Have a nice day.

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Source: Energy XXI (Bermuda) Limited F1Q09 (Qtr End 09/30/08) Earnings Call Transcript
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