Warren Resources, Inc. Q3 2008 Earnings Call Transcript

Nov.20.08 | About: Warren Resources, (WRES)

Warren Resources, Inc. (WRES) Q3 2008 Earnings Call November 5, 2008 10:00 AM ET

Executives

Norman F. Swanton - Chairman, President, and Chief Executive Officer

Timothy A. Larkin - Chief Financial Officer and Executive Vice President

Kenneth A. Gobble - President and Chief Operating Officer of Warren E&P

Analysts

Leo Moriani - RBC Capital Markets

Derek Whitfield - Canaccord Adams

Duane Grubert - CRT Capital Group LLC

Operator

Good day ladies and gentlemen and welcome to the Third Quarter 2008 Warren Resources Earnings Release Conference Call. My name is Jamica, and I will be your coordinator today. At this time all participants are on a listen-only mode. We will conduct the question and answer session towards the end of this conference. (Operator’s instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Norman Swanson, Chairman and Chief Executive Officer. Please proceed, sir.

Norman Swanson

Thank you. Good morning everyone. Thank you for joining us for Warren Resources Third Quarter 2008 Financial and Operating Results Conference Call. I am here with Tim Larkin, our Executive Vice President and CFO. Ken Gobble, our COO and President of our Operating Subsidiary, Warren E&P, is also joining us from Wyoming to discuss our operating results. Before I turn the microphone over to Tim to cover the financial results, and Ken to discuss our operating results, I would like to briefly review some of our third quarter 2008 highlights.

From a production and cash flow perspective, Warren Resources had its sixteenth consecutive quarter of record production and operating cash flow since becoming a publicly-traded company in December 2004. During the third quarter of 2008 compared to the third quarter of 2007, oil and gas production increased 42% to a record of 2.5 BCFE and operating cash flow for the current nine months increased to 214% to $55.5 million compared to $17.7 million for last year.

Some of our operational accomplishments during the third quarter of 2008 were: one, successfully delivered drilling five additional horizontal tar wells D1A and DU Sands in California; two, drilling the top whole portions of three additional horizontal wells in the DU and the D1A Sands in the tar reservoir; three, completing the successful drawing of four horizontal producers and two horizontal water injection wells in the stratified ranger oil zone in the North Wilmington Unit; four, participating in the drilling of fifty addition coal-bed methane wells that appear to meet or exceed our expectations in the Sun Dog, Doty Mountain, and Catalina Units in the Atlantic rim project in Wyoming; and five, making significant progress in our California operations on the Alkaline-Surfactant-Polymer tertiary recovery project, zoning and environmental issues, and geological and reservoir work related to building property models for future development in the Wilmington Units.

In these unprecedented difficult financial times, we will continue to closely monitor our capital expenditures until we experience an improvement in commodity prices and capital markets. Based on the implications of these operating results, however, I believe we will continue to demonstrate the huge untapped potential of our oil reserves in the Wilmington Field Units in California, and the Natural Gas Reserves in the large, emerging Atlantic rim called the methane project in Wyoming. Additionally, despite short-term challenges, I believe that our long-term outlook has never been better. We will continue to build the foundation to deliver strong growth and the best in production, reserves and profitability for the years ahead in both of our core US drilling areas.

With that overview, I will turn the call over now to Tim Larkin, our CFO. Tim?

Timothy Larkin

Thanks Norman. Before I discuss the Company’s third quarter 2008 financial results released earlier today, I would like to remind you that all statements made during our conference call that are not statements of historical facts, constitute forward-looking statements and are made pursuing to the State Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Actual results could vary materially from those contained in the forward-looking statements; factors that could cause actual results to differ materially from those in the forward-looking statements are described in our forms 10-K and 10-Q and other periodic filings with the SEC and our press release.

As Norman mentioned, our third quarter was a very good quarter for us. We had net income of $15.8 million or $0.27 per share, which represented a 420% increase over the $3 million in earnings in 2007. Total production for the quarter was 2.5 billion cubic feet equivalent or 27 million cubic feet equivalent per day. This represents a 42% increase over 2007.

Gas production form our Sun Dog Unit in the Atlantic Rim Project increased significantly. As a result, overall gas production increased 129% to 906 million cubic feet during the third quarter, compared to 396 million cubic feet during 2007. Additionally, production from our two oil fields in California totaled 263,000 barrels, a 16% increase over the 226,000 barrels produced during third quarter of 2007. We achieved this growth primarily through the drill bit.

The average realized sales prices for the third quarter of 2008 were $107 per barrel and $6.42 per mcf, compared to 2007 prices of $67 per barrel and $4.22 per mcf. Total revenues for the third quarter increased 99% to $34.2 million compared to 2007. Oil and gas revenues increased 102% to $34 million compared to 2007. Total expenses increased 30% to $18.4 million during the third quarter of 2008 compared to 2007. DD&A and leased operating expense increased by 63% and 14% respectively primarily due to increases in production. Additionally, interest expense increased as we drew down our additional funds from our credit facility. We achieved these results despite having third quarter WTU production effectively capped due to the produced gas issue discussed in prior press release. We are continuing to work with the AQMD to permit the necessary equipment to resolve these issues. Our plan is to receive the permits and install the equipments in early 2009.

Recently, the WTU was producing approximately 3100 barrels per day until this Monday, November 3rd, when the heater treated developed a mechanical problem which will shut in oil production for approximately six days. In addition to the 3100 barrels of oil per day of production in the WTU, the company had approximately 280 barrels of oil per day offline, due to gas flare constraints and work over operation. For the first nine months of 2008, net cash provided by operating activities increased 214% to $56 million compared to 2007 cash flow from operations of $18 million. Our current borrowing based in over-allotment option was recently reconfirmed at $135 million under the $250 million credit facility. We have $97 million outstanding, as of today, leaving $38 million available under the facility.

We plan on funding the first half of 2009 capital expenditures primarily through cash flow from operations. The borrowing base will be re-determined again on or about April 2009. The reported fourth quarter and full year production guidance in our press release released earlier today.

Now let me turn over the microphone over to Ken who will provide you with the brief operational update. Ken?

Kenneth A. Gobble

Thank you Tim. Good morning folks. I would like update on Warren’s third quarter operational details. In the WTU, we drilled a total five horizontal wells in the Tar Reservoir. One of these wells was completed in the DU Sand which was located approximately 40 feet above the D1A Sand in the Tar formation. This will mark the first horizontal completion in the DU Sand in the WTU.

Warren also utilized the smaller rig that surfaced casing on two wells and seven and five-eighths casing through the curve on the third horizontal tar well during the quarter. For the remainder of the year, Warren has drilled one additional Tar D1A producer and anticipates completing one Tar D1A well that was drilled in Q3. As part of the Company’s effort to reduce capital expenditure levels to a more closely match internally generated cash flows, the instant drilling rate was released at the end of October.

Warren is forecasting a reduction of full year 2008 capital expenditures in its California Properties of approximately $4 million. The Company currently plans to resume drilling in the WTU in the second half of 2009 or when financial and commodity markets stabilize.

For full year 2008, the Company has drilled nine D1A Tar producers, one DU Tar producer, five Upper Terminal Producers, and four Upper Terminal Injectors for a total well count of 19 drilled wells in the WTU. The Company also re-completed an existing well under the shallow pale sand were used as a water source well. This well will provide additional water for enhancing the performance of the Upper Terminal in the Ranger Water flood project in the Unit. The Company continues to make progress in resolving two regulatory issues necessary for the future growth of the WTU.

On May 2, the Zoning Administrator held a hearing to review the terms and conditions of construction and operation set forth in the Zoning Administrators 2006 Zoning Order. This Zoning Order allows the Company to drill up to 540 wells from the WTU Central Facility. The Zoning administrator rendered her decision on this matter on October 2, 2008. The decision found that Warren has complied or substantially complied with all of the conditions of the 2006 Zoning Order and other related documents. The Zoning administrator made minor modifications and clarifications to the existing condition and added non-material changes to certain conditions. The Zoning Administrator went on to state that the Company had implemented additional mitigation measures that were not required by, and went beyond, the existing 2006 Order.

As expected, a local environmental group, the Community for a Better Environment filed an appeal of the Zoning Administrators’ decision. A hearing on the appeal has been scheduled for December 16, 2008 with the Harbor Area Planning Commission.

The second issue, the South Coast Air Quality Management District, or AQMD’s restriction, concerning compliance with air quality standards and permission to install the best available control technology is also progressing. As previously discussed, the AQMD requested that Warren prepare an environmental analysis or CEQA document that would cover the permit applications that the Company had submitted to the agency for approval. These permits would allow the Company to install new infrastructure for gas handling as well as construct and install equipment necessary to re-inject the produced gas from the WTU. A draft of the CEQA document was submitted to the AQMD on June 17. Warren and its environmental consultants have been working diligently with the AQMD to complete the necessary revisions to the CEQA document prior to posting it for a 30-day public comment period. After the comment period, the AQMD will answer comments brought forth by public. At which point, Warren expects the AQMD to process the Company’s permit application. The hearing board of the AQMD approved and Order of Abatement on August 13, 2008. The approval of the Order of Abatement effectively strengthen the Settlement Agreement under which the Company is operating the existing gas player and six microturbines until the permit applications covering the new equipment are processed by the AQMD. Additionally, Warren received approval to re-inject produced gas in the WTU from the California Division of Oil, Gas, and Geothermal Resources on October 22. Construction of the gas re-injection facilities will commence upon certification of the CEQA document and issuance of the necessary permits. Warren plans to re-inject produced gas from the WTU until such volumes reach the level that will make gas fills economical.

Laboratory work for the planned Alkaline-Surfactant-Polymer flood, or ASP, of the Upper Terminal Oil Zone of the WTU continues to show promising results. Sensitivity testing on rock permeability changing with injected fluid salinity variation has been satisfactory completed with good results. The linear core flood test or is now expected to be completed before the end of 2008. The linear core flood results continue to show encouraging incremental oil recoveries.

The Company expects this project to provide attractive investment returns in the current commodity pricing environment. During the third quarter, the company finished the four producing and two injector wells in the North Wilmington Unit or NWU. The project utilized horizontal wells to target proved and developed reserves in the Ranger formation. The four producers are averaging approximately 48 barrels a day of oil per well. The Company will continue to monitor production from this project carefully to determine the economics of additional development. If production results continue to be positive, Warren plans to expand the existing facility infrastructure to handle the forecasted production volume. This facility work is currently planned for the second half of 2009 and is expected to take between six to nine months to complete. Current production from the NWU is approximately 520 barrels of oil per day. Warren continues to deliver strong growth in gas production during the quarter. The Company’s gas production increased by 38% from the previous quarter. The majority of this growth occurred in the Atlantic rim coal-bed methane project in Carbon County, Wyoming. Gas production from the wells drilled in the Sun Dog in the Catalina Federal units late in 2007 and early 2008 continue to increase as all of the wells were placed online and began the dewatering process. Gross gas production from Sun Dog is currently 18.5 million cubic feet per day. Production in Sun Dog is currently constrained by compressor capacity in the unit. The next phase of compression facility expansion in Sun Dog should be completed in December. Addition compressor capacity expansions are currently planned for the Sun Dog unit in March and July of 2009. When completed, that worth will increase total compression capacity in the unit to approximately 32 million cubic feet per day. Warren’s current working interest in Sun Dog is approximately 43%. Gross gas production from the Catalina unit is currently averaging approximately 24.5 million cubic feet a day. Warren currently owns 7.3% working interest in Catalina and expects his interest to increase to approximately 17% as the project is fully developed. As part of the company’s efforts to reduce capital expenditure to more closely matched internally generated cash flows, the 2008 Atlantic rim development budget has been reduced by approximately $13 million net to Warren’s interest. Warren and its partners in the project are now forecasting a total gross well count for 2008 of 112 producers, 21 injectors and 2 pressure monitor wells. This total well count for 2008 includes the 28 wells drilled in the Sun Dog unit earlier in the year that are already producing gas. Warren expects to have approximately 70 additional new gross wells producing in the project early in 2009. The remaining wells drilled but not completed will be placed online after the while wide stipulation expires in July of 2009. Development efficiency in the Atlantic rim project has improved as the company is gaining experience in the play. Continued favorable conditions in the project area have also helped to reduce cost in comparison with last year’s development program. Two drilling rigs are currently active in Catalina and one drilling rig is running in the Sun Dog unit. Thirty new producing wells were drilled in the Sun Dog unit and eleven new producing wells were drilled in the Catalina unit during the third quarter. During the second quarter, Warren’s partners in the project began a fracture stimulation program in the existing 45 well Doty Mountain. Results from the program have improved both gas and water production rates. Gross gas production from the Doty Mountain is currently 3.4 million cubic feet per day. Warren’s partners are planning to stimulate an additional eight existing wells in the next two weeks. If production results continue to show potential, stimulation work will continue until all 45 existing wells have been treated. Warren currently owns approximately 36% working interest in the Doty Mountain Federal unit. Thank you and now I would like to turn the call back over to Norman.

Norman Swanson

Thank you, Ken. Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator’s instructions) You have a question from the line of Leo Moriani - RBC Capital Markets. Please proceed.

Leo Moriani - RBC Capital Markets

Yes, good morning guys. A couple of questions here on the California oil production. You talked about beginning some re-injection in early 2009. Can you tighten up that time frame up a little bit here? And when do guys anticipate getting your reconstruction finished on your re-injection equipment and when do you think will you be able to start putting gas back into the field of WTU?

Kenneth A. Gobble

Leo, we are still working on the revision of the CEQA document and that work is primarily in the hands of the AQMD out there. We believe we are close to having that document ready to be posted. We think that we are a month away, a 30-day public comment. Perhaps a week, two weeks, three weeks to answer the comment and issue permits that would put us somewhere ready to begin construction. End of January? I would think that is relatively doable. Of course, as we work through this process with the AQMD, there are really two phases of the work that remains to be done that is in the regulatory agency’s hands. And that is completing the revision and answering the comments. And the timing of that is more or less out of the Company’s control. But we believe the AQMD has shown the ability to get that done in a timely fashion.

Leo Moriani - RBC Capital Markets

How long does equipment installation take once you guys get your permit and …

Kenneth A. Gobble

Though the installation of the equipment will not take long, I would not think that it would take more than two or three weeks to get the new flare equipment in. Now, that would be the first step of the process and that will give us some room to grow gas production and grow oil production until we are able to get the gas re-injection equipment on. We will have to prepare a well to re-inject the gas. So that could take us two to three weeks additionally as well as installing the needed compressor. Though probably a couple of weeks to get your flaring equipment in that would give us an additional cap space on producing gas and additional oil production and then perhaps, an additional maybe even three to four weeks to really be ready to start injecting gas.

Leo Moriani - RBC Capital Markets

Turning to NWU, you guys talked about evaluating your results here and the potential to try to add more productive capacity in the field in the second half of 2009. What is your current production capacity out there? How much could you produce right now if you had the volume?

Kenneth A. Gobble

Really, the question is water-handling capacity over there and that is where we have an issue. But also on the oil side, our oil separating equipment could really stand to be upgraded there. So, we are pretty close to what the unit will do right now without additional reconditioning and expansion.

Leo Moriani - RBC Capital Markets

Just a followup to your earlier comments on the call, you talked about doing some construction out there in the second half of 2009 that would take six to nine months, does that mean that you guys are capped out for sometime in 2010 with increasing production out there?

Kenneth A. Gobble

I think that is realistic, at least late in 2009. It will.

Leo Moriani - RBC Capital Markets

Okay. Final question here on the Rockies. What do you guys getting for gas prices right now out there in Wyoming? And is that causing to influence your decision to drill out there in the next seven months.

Kenneth A. Gobble

It definitely is. We have since considerable weakness in Rocky Mountain basis pricing, and also in the southern mid-continent basis pricing. We continue to work on a long-term strategy to increase the value of our gas here with the pricing sensitivity work that we have done. And we still see very good return, a reasonable return, I should say, down into the low $4. As you probably are aware, Leo, recently, since September, the Rockies interstate pricing has been sub-three dollars on average. So, it continues to be an issue.

Leo Moriani - RBC Capital Markets

Okay, any thoughts as to what your long-term plan would be in order to improve that? And what kind of steps are you going to take to try to enhance take away out of there?

Kenneth A. Gobble

We are looking at entering into a consulting agreement with some research firms, not marketing firms but research firms, to help us develop that long-term strategy, I think. Ultimately, our best choice is probably lying in two directions: one, try to obtain firm space into the most preferable market as our volumes grow; and two, improve our risk management strategies.

Leo Moriani - RBC Capital Markets

Okay. Thanks guys.

Kenneth A. Gobble

Certainly.

Operator

Your next question comes from the line of Duane Grubert of CRT Capital Group, LLC. Please proceed.

Duane Grubert - CRT Capital Group, LLC

Yeah, guys. You mentioned you do have an effort on cutting back G&A. Can you give some specifics as to how material that might be or what would you be looking at other than just, sort of, the normal trying-to-run-leaner attitude?

Timothy Larkin

Duane, we are really in the middle of analyzing our G&A. And we will probably to comment on it more specifically on our next press release.

Duane Grubert - CRT Capital Group, LLC

Okay, that is fine. Relative to this appeal, can you give us the bullet points of what is this particular activist group saying? Maybe, who are they and what are the points they are making?

Kenneth A. Gobble

The Community for a Better Environment is a local Southern California group. And of course, they are appealing on the technical basis of the document. Duane, this is something you… We have been through approximately a dozen environmental quality documents primarily, of course, in the Atlantic rim area. We had to complete one for each and every pilot that we drilled in the Atlantic rim as well as in the Pacific Rim. So, we have been through this process several times. Every one of them has been appealed. And every time, the document has held up to that appeals process. So, this is just a further step that is expected in these types of environmental documents and I personally believe that the document will hold up through the hearing Board.

Duane Grubert - CRT Capital Group, LLC

Okay, and clearly, it is frustrating to you just as it is to investors that you are not able to grow within the next year out of California. Do you have any interest in looking at asset acquisitions, perhaps, in California or in Wyoming, given the sort of the hiatus of the ability to grow on your existing projects?

Kenneth A. Gobble

Duane, I disagree with your statement with no growth in California in 2009. I think that we have shown that we believe we will have the ability to grow in the WTU in 2009. And I would also say that we have shown significant growth on the gas side, in the Rocky Mountains. I guess, to more specifically answer your question, right now, in this pricing environment. There is considerable amount of opportunity out there. So, yes, we have some interest.

Duane Grubert - CRT Capital Group, LLC

So, you would be willing to look at asset acquisitions outside of your existing stuff.

Kenneth A. Gobble

Certainly.

Duane Grubert - CRT Capital Group, LLC

And then, on the North Wilmington Unit well, can you talk about the expectation you have for those wells compared to what you are getting? You mentioned 48 barrels a day. What were you looking for?

Kenneth A. Gobble

We had done a significant amount of reservoir simulation prior to drilling that project out there. The oil cut in the unit averages right around 6% to 6.5%. And we are seeing a little higher water cut in these wells than that. I believe, other than that, they have matched out expectations.

Duane Grubert - CRT Capital Group, LLC

Ok, thank you.

Operator

Your next question comes from the line of Derek Whitfield of Canaccord Adams. Please proceed.

Derek Whitfield - Canaccord Adams

Good morning, guys. Two questions for you on the WTU. In the first two quarters of next year, do you guys see enough uplift on your water flood operations in the Ranger and Tar to offset the primary production lost from the Tar?

Timothy Larkin

We have a couple of other issues that would help production, Derek. Once we get by the AQMD issue, we have wells that have been drilled but not completed that we are going to be able to place online. And then, we are going to have, obviously, the wells that have been drilled and have been intentionally taken offline due to the AQMD issue. So, that will certainly help offset any natural declines in existing production. But Ken, you want to maybe add something to that?

Kenneth A. Gobble

With the commodity pricing environment changing and being so volatile recently, of course, we are taking a very hard look at rates of returns on all our projects. And specifically to the WTU, I believe we have several areas that we would like to move forward with some growth and of course, that would be the tertiary flood projects, that looks as if we can leverage the capital that we have invested in both the upper terminal and Ranger, perhaps, formation into a very attractive rate of return and significantly grow our production. Now, we still have a lot of work to do before we get to the point of fulfilled implementation. But I believe even in the current conditions of constrained capital availability, that is something that we would choose to move forward with, perhaps, paced with regard to capital availability. And of course we work hard at the forward zone out there. We would very much like to drill a forward test well once we are able to handle the gas to test the economics there. So, moving forward, I think really, the overall plan is to carefully evaluate our best rate of return with the capital that we have available and deploy as responsibly as we can in that regard. But we do have several additional areas that we would like to test, specifically in the WTU.

Norman Swanson

This is Norman. I would just like to add one other comment that kind of bring this together. There is not much we can do sitting here about the credit crisis or commodity prices. But what we can do is to use this time to work on ASP, completing that process in the lab work, getting a good idea what the essential incremental recovery is, work to optimize the existing upper terminal water flood, and then, we have the water flood also in the NWU. And particularly, I want to use this time as a Company to develop our property models. We have been a little to close to the drill bit in terms of what we are drilling next and what this really allows us to do is to accelerate this work on the geological and reservoir side so we can build a large inventory of high impact wells when we get back to drilling.

Derek Whitfield - Canaccord Adams

Another quick question guys. On the ASP project, could you sort of set me through the timeline to get to the full scale project? And how long out do you think that would be?

Norman Swanson

I do not think we are ready to answer that yet. We have not completed the lab work, although we have completed certain aspects of it and it is very encouraging so far. I think with that project, we have got to the end of the lab work and have a pretty good idea what type of incremental production we could get from the existing flood and the potential floods. So, we are not ready to go in and construct a significant pilot with all the equipment necessary until we get to the end of this process. And I do not think that is going to be very long. I expect, by the end of this year, we can finish the task and we can then take a look at our 2009 and 2010 plans.

Derek Whitfield - Canaccord Adams

Ok, thanks that is all for me guys.

Norman Swanson

Thank you, Derek.

Operator

(Operator’s instructions) We do have a followup question from the line of Duane Grubert. Please proceed.

Duane Grubert - CRT Capital Group, LLC

Yes, just listening to the ASP comments, can you walk us through, first; you have mentioned on prior calls what kind of facilities you need for that. Are there specific permitting issues associated with the ASP? And the second question would be: as you anticipate both water flood to port, and in the future ASP benefits to your production, would you not expect that the gas cuts to be similar to what you have got now, or is there a way for you to manage gas such that, if you got early water flood response sometime in your term, what would you do to be able to increase overall production by cutting back gas sampling?

Kenneth A. Gobble

Duane, the facilities required for an ASP flood would be primarily bulk storage of polymer and associated chemicals, and of course, the mixing facilities to mix the chemicals with water and also the pumping equipment and then of course, the controls. And yes, there would be additional permits required. Any construction requires permitting. And generally speaking, our gas-to-oil ratios are very consistent in each particular zone. So for instance, in our upper terminal zone, we would expect the gas ratios to be similar with what we are seeing on water flood bases. So when we talk about what our expectation is of produced gas per barrel of oil, we would expect that to stay consistent with what we have seen by zone.

Timothy Larkin

I would like to add to that. Production would not be constrained at that point due to gas production since at that time we would be re-injecting gas. And so, we can re-inject as much gas as we want so it would not hamper our oil production in any way.

Duane Grubert - CRT Capital Group, LLC

Okay, good plan. Thanks.

Operator

There are no further questions in the queue. I would like to turn the call back to management for closing remarks.

Norman Swanson

Thank you. I would like to thank all of you for joining us today and for your interest in Warren Resources. I hope I have conveyed to you how exciting we are about executing on our operating plan and capitalizing on the enormous potential for us for the balance of 2008 and beyond. Thank you and good day.

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