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Executives

Rick McCullough - President and CEO

Bart Brookman - SVP of Exploration and Production

Analysts

Michael Hall - Stifel Nicolaus

Leo Mariani - RBC

James Ackerman - Sloan Securities Corporation.

Philip Mcpherson - Global Hunter Securities

Petroleum Development Corporation (PETD) Q3 2008 Earnings Call September 6, 2008 4:00 PM ET

Operator

Greetings, ladies and gentlemen. Welcome to the Petroleum Development Corporations' third quarter 2008 earnings release conference call.

(Operator Instructions)

It is now my pleasure to introduce your host Mr. Rick McCullough, President and Chief Executive Officer for Petroleum Development Corporation. Thank you, Mr. McCullough, you may now begin.

Rick McCullough

Thank you, Chris. Good afternoon and welcome everyone to PDC's third quarter earnings call. I am joined today by Bart Brookman, our Senior Vice President of Exploration and Production.

During the course of our presentation we will be outlining our third quarter results, both financially and operationally, and we will also try to answer some of the questions you might have in light of the current US financial markets.

I would caution you that we will be making forward-looking statements, there is a disclaimer on page two of the presentation, and will encourage you to review that.

A great deal has occurred since our last quarterly call, and even though our stock like other small-cap E&P companies is trading at historically low levels, relative to our operating and financial metrics, our fundamentals have never been better.

PDC has just completed another great quarter, with production of 10.2 Bcf, right on target with our 2008 guidance, and 32% higher than comparable second quarter 2007 levels and up 16% over the last quarter, but perhaps even more impressive was another great quarter for realized pricing, which averaged $9.49, an increase over comparable third quarter 2007 pricing levels of $5.76.

This along with our increased production drove another exceptional quarter of cash flows, which as you can see here was in the $60 million range or almost $4 per share.

Our aggressive hedging earlier this year and the dramatic drop in pricing in the last 90 days, resulted in us recognizing a $172.2 million unrealized gain on our derivatives position. And this led to an almost $127 million in quarterly net income, but more importantly these hedges will ensure we see less volatility in our future profitability and cash flows and I will cover this later.

However, we believe one should exclude these non-cash gains in evaluating our quarterly operating performance. As shown on page 24 of this presentation, on this basis we again had a very strong quarterly results of $16 million of net income or $8 per share on this adjusted basis.

As you can see oil & gas sales were up substantially. We talked about the average realized pricing of $9.49 and again I am pleased to say that our costs are generally, continue to be inline with expectations.

Another important update that we have previously issued in our press release is the naming of Gysle Shellum, as our new Chief Financial Officer, affective next week. We are delighted to have Gysle joining our organization. He brings almost 30 years of energy experience, including extensive E&P experience in accounting, finance, planning and M&A, and we know he will make a valuable contribution in our future.

As expected, the high quarterly realized pricing yield, it was another strong quarter of per Mcfe metrics is shown on this chart. As you can see, we have posted three consecutive quarters of EBITDA in excess of $5 per unit of sales, and another quarter of almost $6 a unit in cash flows per Mcfe.

As shown on the next chart, increased production drove reduced per unit reductions in G&A and our lifting cost. DD&A has remained in the $2.50 range over the last four quarters now, and was up slightly in the quarter. And production taxes as you would have expected dropped with the decrease in realized pricing over the second quarter amount, and was $0.68 per Mcfe.

As a result of financial market conditions that have existed and continue to exist, we like other companies had recently taken a very hard look at our liquidity levels, financial status of our commercial banks, the quality of our hedging counterparties and general business partners. Based on this review, we believe PDC is especially well situated to deal with the tough financial and economic markets.

As you can see here, we have approximately $225 million in liquidity today. And we are within days of executing a $75 million upsizing of the line to $375 million. As you can see we do not have any debt principal payments due until of 2016, and our bank line which includes the participation of 11 banks is not due to expire until late 2010.

During the recent upsizing affords we were very pleased with the response we received from the banks during this process. Not only did we get strong support from our existing banks, but we received a large new money commitment from a large energy lender. We believe this increase in our liquidity to approximate $300 million is a strong testament to the quality of our operating assets.

Over the next slides I will try to address the markets in which we sell our gas, what our average economics would look like under various pricing assumptions and how we are positioned for 2009 and '10 as a result of our hedge position.

Those of you that follow the company have seen this type of slide before, it shows that while we have 80% plus of our assets in production in the Rockies, we enjoy a very diverse sales mix. We continue to enjoy strong performance from our Wattenberg assets due to high oil and liquids content.

This next slide is a pro-forma look that our economics at various assumed pricing levels. For purposes of this presentation we have basically assumed cost and production at third quarter 2008 levels of 40 Bcfe annualized. This shows approximately how much operating margin we make at various wellhead pricing range. As you can see we have very low operating expenses.

While we will let you draw inferences from what this analysis shows you, we believe this clearly indicates we can withstand very low prices before we begin considering reductions in either CapEx spending or shutting in production. If you assume our three year F&D cost of $1.35 per unit, or use our 2007 F&D cost of $1.25 you assume that these are relevant in lifecycle cost evaluations. You can see that we will cover these total costs at the $5.50 price range.

This next chart hopefully helps you evaluate the impact of our present hedge positions in this decisions. As you can see, we have broken out our weighted average hedge prices for the remainder of this year and 2009, and 2010. The range we show includes the impact of averaging in our collars. So the forward pricing of $9.45, $8.73 and $10.09 is really the low end of our future pricing, and the ceiling pricing amounts represent the potential we could realize if prices move up strongly again in the future.

We have used the floor pricing in our weighted average computations. If you use our $9.30 '08 exit production levels our hedges in place today cover approximately 60% of our 2008 to 2009 production and 19% of 2010 production. If you weight in the average forward curve pricing that existed as of 10/31/08, in other words the weighted average of our sales mix with no assumed increase or decrease in pricing, our average pricing for the fourth quarter, as you could see, would be in the $8 range. And it would increase to almost $8.50 in 2010.

If you assume that our 2009 and 2010 production grows by 20%, our average pricing drops slightly, but is still in the $8 range. This suggests to us that without any improvements in pricing, we should continue to make good margins and cash flows for 2009 and 2010.

We caution you that this is not intended to be construed as any form of guidance, but rather a financial prediction of hedge position related to today's forward prices.

And the final slide that I want to share with you this afternoon simply shows the relative organic production growth we have seen over the last three years at various levels of CapEx spending. While we have not finalized our 2009 CapEx budgets, we like others are considering decreases below our 2008 levels in light of the US financial economic conditions.

Likewise, you see we are projecting a slight reduction of approximately $14 million in CapEx spending below our previously announced $319 million budget levels for 2008.

So with that I want to turn the remainder of the presentation over to Bart fro an update on our third quarter operating results.

Bart Brookman

Thank you, Rick. Once again PDC has had an outstanding quarter. We are extremely pleased with our production growth, status of our reserves and very pleased with overall production results, project results on a basin-by-basin level.

Let me start with the production, 32% improvement, as Rick noted, third quarter year-on-year. Just a quick breakout by basin, 32% matching the corporate level in the Rockies and that is really due to steady growth in our three primary areas in the Rockies, the Piceance, Wattenberg and Northeast Colorado assets, which I will refer to as NECO.

In Appalachia we experienced some 55% improvement. This is due to organic development, drilling and recompletion programs both in West Virginia and Pennsylvania, and also due to the fact we added the Castle acquisition in the fourth quarter of 2007. We did experience a slight decline in our Northern Michigan interim production.

Overall, the company had 10.2 Bcfe for the quarter and getting a record for the company and slightly above guidance or forecast. That number is a 16% improvement above our second quarter of 2008 levels.

Before we headed in the fourth quarter, prior guidance was 39 Bcf projected for the year, we are anticipating production will in the 38 to 39 Bcf level. Currently, PDC is experiencing curtailments at our Piceance operations. Our primary gather in the basin has experienced delays on a compression station in a key pipeline that is the discharge for that station. We anticipate, that these problems or issues will be resolved 8th December of this year or early January of 2009.

Overall, what's happened is, it's resulted in a 10% to 15% reduction in the total Piceance Basin production, wellhead pressures, for what we call our mesa top production have increased from 250 PSI level to approximately 400 to 500 PSI since September of this year. Approximately 10 million a day of production is our estimate of the current curtailment level on the overall basin. If the curtailments were not there, our engineering does show that our production levels would be equal to or slightly better than guidance or forecast.

The next two tables and I'll start on the lower one, really shows how we're doing overall in the nine months relative to forecast. Let me start on the Wattenberg Basin in the Rocky Mountain table, 12% over. This is really due to two things. First is an acceleration of projects, primarily refracs and recompletes from plan this summer and as we headed into the fall. But more importantly is that our projects, we are very, very pleased with overall performance on a well-by-well basis, they are performing better than our engineering forecast.

Grand Valley, you can see is right on plan for the nine months, NECO area was 13% under forecast, primarily one reason is less drilling than we anticipated. This was intentional. We currently are in production test on several very exciting prospects on the Kansas side of this play. We are going to conduct these production tests to ensure quality of the future drilling.

Top to the upper table, again Rocky Mountain is a 103% above forecast, Appalachia 7% below. One driving factor here and that was delays in getting drilling rigs in Pennsylvania this summer. I believe we had delivery of our first rig about three months behind plan.

Overall, you can see company total for the nine months right on forecast or the guidance. Again the totals on the far right, you can see, we are anticipating the 38 to 39 Bcf level for the full year.

Talk about drilling, PDC is on pace for 375 gross wells, 341 net wells in 2008. This is less than the 440 previously recorded. Three things to talk about here, first in Wattenberg, we had a delay on our directional rig. We on our second month, anticipate delivery of that rig some time late in November.

In NECO, I touched on, while we intentionally backed off on our drilling as we conduct production testing on several, very encouraging prospects, and then in Appalachia we intentionally delayed the delivery of the third rig in Pennsylvania really in consideration of the current capital markets.

So how does this impact our overall budget? We are currently at an estimate, we will come in for the year at $305 million again this is approximate based on our current modeling of our frac schedule of $305 million for CapEx for 2008. This is less than the $320 million that was previously recorded.

A quick update on the reserves, nothing major new to report here from the last call, but mid-year we are at 797 Bcf equivalent proved that was a 15% improvement just under 1.2 Tcf of 3P and that does not include any Barnett or Marcellus.

Early three trends right now to talk about in the reserve side, as we're heading into the year-end process. First is, I think everyone is aware the mid-year pricing environment versus the year end. It will change dramatically. We do anticipate some downward revisions to these numbers due to pricing on December 31st, but we also are encouraged by some of the new projects in downspacing where we're booking additional reserves, and then we will have additional reserves in our proved category due to the continued expansion of some of our primary basins.

An update on our Marcellus in a little more detail than last time, 11,000 net acres in Central PA, 25,000 net acres in West Virginia, an exploration play that we entered into over a year ago. There is a deeper horizon; we did encounter what we're calling a shallow Marcellus in New York. This is a little bit different animal, 3,000 foot depth. It will be under pressured and we anticipate lower reserves per well in the core fairway of the Marcellus play.

Majority of our Pennsylvania and West Virginia acreage is HBP. We really like this. It gives us flexibility and time to watch other operators and dean our own technical knowledge on the play. We will commence our first drilling in the Marcellus next week in West Virginia, and then we do have four vertical tests planned in fourth quarter this year, and first quarter next year.

Just to note, Marcellus will have the utmost technical focus from the geosciences, drilling and completion standpoint in the company as we head into 2009.

Just to roll-up some of the key developments for the quarter, again, a modest slowdown in our drilling in Wattenberg, in Northeast Colorado relative to guidance or plan. We're experiencing these curtailments in Piceance. We are working closely with our primary gather, but again we're about 10 million a day off mark from our deliverability at the current time.

Drilling will begin next week in West Virginia on the Marcellus test. We do anticipate nice production gains in Appalachia as we head into winter due to lower line pressures in colder weather. We continue to experience outstanding results in Wattenberg. Credit to the production team and our operations group out there, but also the engineering and some of the completions where we're getting better results on a project-by-project basis.

Construction is underway and start-up is anticipated in mid 2009 for two major processing plan expansions in Wattenberg. This will accommodate some of our future growth in production in that basin. The Barnett we are fracing fourth well this week. We're closely monitoring production reserves, and pricing. We would classify our early results, due to the current pricing environment, as marginal, but we are working diligently on some alternative completions and keeping our on pricing as we evaluate display.

And last, we have entered into a joint-venture, for our remaining acreage in the Bakken in North Dakota and this is in Burke County, and it is approximately 50,000 acres where we were at minimal capital commitment, but we are going to drill up to four Bakken tests. We classify this as exploration. We anticipate this drilling will occur over the next six months.

So with that, I will turn this back to the operator, and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions).

Our first question comes from the line of Michael Hall with Stifel Nicolaus. Please proceed with your question.

Michael Hall - Stifel Nicolaus

Thanks. Rick you, understanding you don't want to pin down on any guidance yet, but looking at the 2009 outlook and the comment about the 20% production growth. I mean, is that in the ballpark, where you're thinking, maybe just directional comments, higher, lower, any color there?

Rick McCullough

Michael, I would say that, as you said, we have not finalized our CapEx budgets. We are looking at those presently even as we speak, but I think, the intend of the slide showing the organic growth that we have experienced at different capital levels is that, I think with where we are exiting 2008 and particularly because of some of the later half of 2008 capital expenditures, if you remember we revised our budget twice during the year in 2008. And we have not seen that production in line as yet and won't see that until 2009. So, I think even with decline in CapEx, we still expect to post pretty good growth numbers in 2009.

Michael Hall - Stifel Nicolaus

Okay. And then in the Piceance with the curtailments, any expectations for those to be alleviated by the end of the year, is that really just line pressures coming down with the winter. Is that a thought there as to why it becomes a alleviators or is there some infrastructure coming on?

Bart Brookman

It's actually a lack of compression, so it's additional pressure in the infrastructure and expanded capacity on the discharge line of this compressor station that we are waiting on. Again, the delays were not anticipated. There were some delays in the compression delivery, but also a series of rock formations they got into on the right way for the pipeline and blasting that had to occur that pushed the project back by three to four months.

Michael Hall - Stifel Nicolaus

And then on Piceance, any impact from the recent changes in the Colorado rules in your Piceance operations?

Rick McCullough

The answer is yes. From a headache paperwork and I would call it modest costs standpoint we're being proactive in our permitting, because there is additional requirements with notifications and such. We do have some pit requirements that have come to be, which are more costly, but overall regulations and particularly the wild life rigs we feel they are going to have or we anticipate minimal impacts.

We have done some early surveys on wild life in our acreage position, it came back very favorable as far as raptor, sage-grouse, elk migration and I think I can name multiple other animals we researched. So right now the story is we think its minimal impacts to our ability to implement our capital programs.

Michael Hall - Stifel Nicolaus

Okay. That's helpful and encouraging. And then one last one on the JV up in the Bakken, can you talk about who the partner is there and what the terms are? I mean is this kind of a farmout type arrangement?

Bart Brookman

Really can't go into the terms due to the agreement.

Michael Hall - Stifel Nicolaus

Okay.

Bart Brookman

All I can say is it is one party that we've entered into this agreement. We classified this exploration like I said, and we have the ability to drill up to four Bakken test and again a lot of that is based on results.

Michael Hall - Stifel Nicolaus

And then what sort of capital do you expect to be exposed to for those four well?

Rick McCullough

We will have minimal exposure.

Michael Hall - Stifel Nicolaus

Okay. Helpful. Thank you.

Operator

Our next question comes from the line of Leo Mariani with RBC. Please proceed with your question.

Leo Mariani - RBC

Yeah, thanks. It's a good afternoon here guys. Question for you folks on the Barnett, I guess you are kind a testing your fourth well now. It sounds like you kind of made the calendar results little bit marginal. Are you guys getting any production from those wells at this point? Is there any infrastructure nearby that you can hook into or you would be just kind of testing the wells and then sort left them all for now?

Bart Brookman

We reported last time on the last call, the first well had just come on at a level I believe 800 Mcf a day. So we have three wells on line currently. The average IP on those wells was somewhere around a 1 million cubic feet a day. And again, I am going off of the top of my head. I don't have the exact number in front of me, but we're watching the decline on those wells and most importantly the reserves.

The reserves have come in slightly lower than expectation. It is a play we got into in an $8 environment and price has jumped up to $10. And if prices were still in that range its something we would be more excited about. So given the current price environment and where the reserves are coming that's why I used the term marginal.

Leo Mariani - RBC

Okay. Got you. I guess turning to the Marcellus, question on infrastructure, you sort of compartmentalized your different tracks of acreage here. Can you talk about infrastructure in each of those areas and have quickly you will be able to bring some new Marcellus wells to sales?

Bart Brookman

When you say infrastructure you're talking about pipeline infrastructure?

Leo Mariani - RBC

Yeah, gathering and pipeline and processing if maybe.

Bart Brookman

And the answer is probably two parts, short-term when we're testing and kicking off, call it the pilot programs, we will have capacity. We have localized infrastructure because of our legacy properties. If successful and once you take it through the extreme, very successful, yes we will have to be all over our game, and be in here and reengineering some of our infrastructure. I think everyone knows the legacy wells up there are more a like quarter Bcf wells with IP around a 100 Mcf a day. We're very hopeful the Marcellus will do much better than that.

So short-term we've got capacity, in long-term we are going to have to reengineer and really look at the total infrastructure picture. As far as localized transmission and takeaway we have looked at that and we are encouraged that we've got takeaway capacity, it's more the gathering side and compression side.

Leo Mariani - RBC

Okay. I know that you haven't finalized your 2009 budget at this point. Could you folks just kind of prioritize what's plays you think would get the most capital, is there a way to kind of put that up real quick?

Bart Brookman

Yeah. I would say right now, Wattenberg would be priority for us, it is the oil component. It's diversified, we've got NGLs. Its part of our production stream and it's the somewhat the "never say die" basin. So recompletions, Niobrara work and drilling in the Wattenberg. Northeast Colorado, because it sells into Mid-Continue, it is a better pricing environment, so we would probably put that next. And then equal consideration, I would say, for Piceance and the eastern assets based on really just project economics.

Its correct, we were still encouraged by our margins in all those basins its really where we have permits, where we have land access, where we have drilling rigs and so its going to be a balance of really all four of those basics.

Leo Mariani - RBC

Okay. Thanks a lot for you help.

Operator

Our next question comes from the line of Jim Ackerman with Sloan Securities Corporation. Please proceed with your question.

James Ackerman - Sloan Securities Corporation.

Thank you very much. Good afternoon, everybody. Considering how well the company looks like its doing, but the stock price has going from $79 to today it closed at $16.84, has management considered a buyback program to buy stock back at this level. It looks like it could be an awfully good investment. And has management considered paying a cash dividend, it looks like cash flow is pretty strong?

Rick McCullough

Jim, I think we definitely have looked at the stock buyback opportunity. We had a stock buyback program like a year and half ago. Certainly with the more depressed pricing, we have reconsidered it. We have some limitations, both in our high yield bond and our bank line arrangements. Not to say that we couldn't consider going back to the banks and try to work through those issues, but presently we will be restricted at the amount of the buyback program that we could do, but we are definitely considering that.

James Ackerman - Sloan Securities Corporation.

It certainly would be a strong showing of what Management believes, which it appears to be an awful lot of value at a $16.84 price.

Rick McCullough

We agree this. I mean, as I said from the outset, we have shown in one of those charts, there has been quite a change in the stock price over the last two quarters, but the basic fundamentals, operationally and financially continue to get better and better.

James Ackerman - Sloan Securities Corporation.

Well, it certainly would be a positive shot to Wall Street if you were to talk to your lenders and see if they would agree to a buyback program, with the capitalization where it is at this point, it seems an awfully good investment at $16.84. Are you restricted also on paying a cash dividend with your agreements?

Rick McCullough

We have similar limitations in the agreement. We have permitted payments, but they are again restricted as you would typically see in these types of agreements with lenders.

James Ackerman - Sloan Securities Corporation.

And so that prohibits paying cash dividend to common stock holders.

Rick McCullough

We are not prohibited, but I think, we're again restricted as to total amount.

James Ackerman - Sloan Securities Corporation.

Okay. Thank you very much.

Operator

Our next question comes from the line of Philip Mcpherson from Global Hunter Securities. Please proceed with your question.

Philip Mcpherson - Global Hunter Securities

Hey, good afternoon guys. Great job in the quarter, I wonder if you could tell us little bit about the dry holes, the exploration charge in the quarter and where they're at?

Bart Brookman

Yeah. One was the Prairie du Chien project it was a joint-venture in Michigan, one was the well that was a deeper horizon project, where we picked up, what I refer to as the New York Marcellus acreage. And I believe the balance of them were in NECO project, where we had a series of dry holes. Then there is incremental cost, I believe, on a deep [cache] in the Piceance Basin where we were looking for a water disposal zone. And the incremental cost related to taking that well below our Williams Fork members where written off this expiration expense. So those were the four primary projects that I know that hit the quarter.

Philip Mcpherson - Global Hunter Securities

Okay, great. And Rick can you just review, I caught it late, but on the credit facility what's your current draw on that credit facility? Is it $75 million?

Rick McCullough

We're at $127 million, but we got our cash balance of almost $50 million.

Philip Mcpherson - Global Hunter Securities

Okay. Great and I know you sort address the Bakken JV, but can you tell us like what your working interest funds would be in the wells or is this too early and we just have to wait?

Bart Brookman

A lot of that is still been determined, so again, I can't really go into the terms of the agreement. It is executed. We are going to drill these wells and again all I can tell everyone is that on the front end here depending on the results we're at minimal capital exposure.

Philip Mcpherson - Global Hunter Securities

Okay. Great, guys keep up the good work. Thank you.

Rick McCullough

Thank you, Phil.

Operator

There are no further questions at this time. I would like to turn the floor back over to Management for any closing comments you may have.

Rick McCullough

Thank you, Chris. And thanks everyone for joining us again today. We appreciate your support in these difficult times and look forward to sharing more information with you in the future. Thank you.

Operator

Ladies and gentlemen this does conclude today's conference. You may disconnect your lines at this time and thank you for your participations. May you all have a wonderful evening.

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