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Executives

Frank Hopkins - Vice President, Investor Relations

Richard P. Dealy - Executive Vice President and Chief Financial Officer

Analysts

Kevin Smith - Raymond James

John Kang - RBC Capital Markets

Michael Blum - Wachovia Capital Markets, LLC

Barry Damson - Damson Natural Resources

Ian Sinnott - Kayne Anderson Capital

Donald Baker - Private Investor

William Adams - FAMCO

[Steve Taft] - Tocqueville Asset Management

Pioneer Southwest Energy Partners L.P. (PSE) Q4 2008 Earnings Call February 4, 2009 12:00 PM ET

Operator

Welcome to the Pioneer Southwest Energy fourth quarter conference call. Joining us today will be Rich Dealy, Executive Vice President and Chief Financial Officer, and Frank Hopkins, Vice President of Investor Relations.

Pioneer Southwest has prepared PowerPoint slides to supplement their comments today. These slides can be accessed over the Internet at www.PioneerSouthwest.com. Again, the Internet site to access the slides related to today's call is www.PioneerSouthwest.com. At the website, select Investors, then select Investor Presentations.

The Partnership's comments today will include forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements and the business prospects of Pioneer Southwest are subject to a number of risks and uncertainties that may cause actual results in future periods to differ materially from the forward-looking statements. These risks and uncertainties are described in Pioneer Southwest's news release on Page 2 of the slide presentation and in Pioneer Southwest's final prospectus from its initial public offering and other reports filed with the Securities and Exchange Commission.

As a reminder, today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Pioneer Southwest Vice President of Investor Relations, Frank Hopkins. Please go ahead, sir.

Frank Hopkins

Good day, everyone, and thank you for joining us.

Rich is going to give you a review here this morning of our financial and operating highlights for the fourth quarter. He's then going to cover the Partnership's strong financial position and talk a little bit about some growth opportunities that are being evaluated for the upcoming year, 2009.

He'll then give our guidance, what earnings and our production and some other metrics are going to look like for the first quarter of 2009, and after that we'll go to your questions.

With that, I'll turn the call over to Rich.

Richard P. Dealy

Thanks, Frank, good morning, everybody. I appreciate everybody joining the call this morning.

For those of you that have the slides there in front of you, I'm going to start on Slide 3, just going over the quarter.

For the fourth quarter we did report net income of $20 million or $0.68 per unit. Fourth quarter production averaged a little over 4,300 barrels per day. Production was negatively impacted by about 500 barrels per day or BOE per day as a result of hurricane impacts related to our Gulf Coast fractionation facilities being down in Mt. Belvieu. It was a little bit higher than we expected coming into the quarter. We had a few more wells curtailed during the quarter than we anticipated, and we had some NGL inventory at the end of the third quarter that we thought would get worked off in the fourth quarter, but very little of that got worked off and so much of that will get worked off in the first quarter.

It is important to note that in mid-November the facilities came back up and we are now back at full production levels as we ended the year and as we move into the first quarter of 2009.

Cash flow from operations was $21 million for the quarter, so obviously financially the MLP is doing as we expected other than the little shortfall in production for the fourth quarter.

Talking about proved reserves that we also announced MLP had just under 23 million barrels of proved reserves at the end of the quarter. This does reflect a negative price revision of about 9.6 million barrels at year end 2008 as compared to pro forma year end 2007 reserves. This primarily is impacted by the fact that we run year end reserves at year end pricing at $45 crude roughly relative to or compared to $96 per barrel that was a year end '07.

I think it's also important to note that the barrels that are lost here are those at the end of the life of the wells, they're tail reserves, so this is production that wouldn't have occurred for another 15 years out there. So when you look at prices recovering over that time, if you go back to $60 crude you'll get about 50% of those revisions back in future periods.

Also I think it's important to note that we had during the quarter 20acre downspacing approval from the Railroad Commission of Texas. That occurred during the quarter. PSE obviously has the rights to infill spacing on their 40-acre locations that they have today and none of that is booked as we sit here today. And so if commodity prices improve, capital costs come down further, we'll be able to book those in future periods.

We also declared a week and a half or so ago our fourth quarter distribution of $0.50 per unit. That is payable on February 12 to unit holders on February 6 and represents an annual distribution per unit of $2.00.

Lastly on this slide, Pioneer Natural Resources, the parent of the MLP, has announced that it has the intention to drop down assets to PSE. It's evaluating that right now and so that'll be something that will be ongoing over the next few months as we evaluate that at the C Corp. level and then look at it at the MLP level as well. In addition, we are looking at some third-party acquisitions that are being evaluated, albeit they're small at this point.

Turning to Slide 4, a look at the liquidity position of PSE, excellent liquidity position - as of year end, a cash balance of $30 million. We continue to retain about 25% of our cash flow for maintenance CapEx. That can be used for the drop down, to fund part of the drop down as we talked about from the parent if that comes to fruition, third-party acquisitions, and 20acre drilling opportunities. The 20-acre drilling opportunity really is subject today on margins improving and seeing capital costs continue to come down.

PSE also has no borrowings on a $300 million credit facility that doesn't expire until 2013, and we have a very strong derivative position with 75% of our production protected in 2009, 70% in 2010, and 45% in 2011. In addition, these derivative positions represent at December 31 a value of $117 million to the MLP at that point in time.

So as you look forward over the next three years, our distributions are supported by the strong financial position of the company and, when you couple that with our attractive hedge position, it looks very good for distributions at the same level over the next three years.

Also we've had a question here and there about shutting in wells and we do not plan to shut any wells in today's low commodity price environment.

Turning to Slide 5, really no change since last quarter. This is our existing hedge position that sits out there and so you can see that by product, what we're hedged and at what price level, so that's there for your review. Obviously very attractive commodity prices.

Turning to Slide 6, looking at first quarter guidance, with the resumption of full production we are projecting average daily presentation to be 4,600 to 4,800 BOEs per day. Production costs, we are forecasting to come down from our fourth quarter results that were just under $27 to be in the $23.50 to $26.50 per barrel range. Pioneer as operator is actively pursuing a number of cost reduction initiatives, including reducing our electricity costs in the field, reducing fuel surcharges, and really overall looking at ways to reduce overall controllable LOE in the field. So we do expect to see a reduction over time in our production costs relative to these assets.

D&A for the first quarter is expected to be 575 to 675, consistent with the fourth quarter and really higher than the third quarter as a result of the lower year end reserves that we lost as a result of pricing.

G&A expected to be $1 to $2 million.

And overall effective tax rate, we're only subject to the Texas margins tax that we've talked about before, that 1%.

Turning to Slide 7 and just wrapping up on our investment highlights, most of you know that PSE is backed by a strong parent at Pioneer Natural Resources Company that has 68% ownership, obviously strong sponsorship and substantial drop down potential in the future to benefit PSE.

We've had very predictable cash flow, with 100% proved developed producing reserves, long-lived low decline rate that we think are the right assets to be in an MLP, and then if you couple that with an effective hedging program it makes for a nice yield vehicle.

We still believe that we can grow distributions in the future via acquisitions, whether independently or jointly with Pioneer, so I think those are still on the table, potential drop downs both of oil and gas assets and potentially midstream assets, longer term, when we see margins improve and capital costs continue to compress, some 20-acre drilling, and so I think all those three options are viable to grow production and distribution into the MLP.

As I mentioned, we've got lots of firepower with no debt and a $300 million unsecured revolving credit facility. We think we've got the right structure for the long term, with no IDRs or MIUs, and we think we've got the right management team in terms of lots of expertise in the field and lots of history working in this Spraberry Trend area.

So we think all those bode well for a very attractive inventories in PSE.

And so, [Martin], at that point I'll stop there and open up the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Your first question comes from Kevin Smith - Raymond James.

Kevin Smith - Raymond James

I just had a question about - it looks like a prospect of doing around roughly $200 million acquisition from the parent. I know that was released in Pioneer's press release. I assume that would be producing assets?

Richard P. Dealy

Yes, it would be PDP assets, probably most likely still in the Spraberry Trend would be the ideal assets and similar to what PSE has today - and up to $200 million, so that's still under evaluation of the exact dollar amount, but up to $200 million.

Kevin Smith - Raymond James

How do you think about when locking in hedges? I mean, if you did a transaction, let's say, in the next quarter, would you automatically lock in hedges from that?

Richard P. Dealy

I think we would definitely evaluate it but as part of the acquisition you'd look to hedge at least probably three years and maybe more.

Kevin Smith - Raymond James

Do you have roughly percentage of PDPs that you'd want to hedge?

Richard P. Dealy

You'd look somewhere in the 60% to 80% range.

Kevin Smith - Raymond James

And let's say you were able to do a deal, is that where we'd kind of ballpark what you'd think you'd be able to buy producing assets from here on out or at least, you know, for the next several months? Would that be a good kind of marker to kind of extrapolate a maintenance number?

Richard P. Dealy

Yes. I mean, I think it'll be a transaction that is fair to both parties, so I think it would be reflective, potentially. Third-party deals have other things that may with it; they may not just be producing assets, they may have some undeveloped, so that may change your metric slightly, but in general, yes.

Kevin Smith - Raymond James

And at this point in time you're not really considering any midstream assets, right?

Richard P. Dealy

No.

Kevin Smith - Raymond James

If something comes up, you'd look at it at that point?

Richard P. Dealy

That's right.

Operator

Your next question comes from John Kang - RBC Capital Markets.

John Kang - RBC Capital Markets

I guess just a follow up on the drop downs. Is there an oil and gas price that may keep you from doing the drop down or can you do it in any environment do you think?

Richard P. Dealy

We're just in the early stages of it, John, evaluating it, so I think it's - I can't think of a price that we probably wouldn't do it, but I think we'll really focus on what the current strip is today and doing those evaluations, and so we'll continue to finish that work and then make that call.

John Kang - RBC Capital Markets

Well, at least we're still in [Contango].

Richard P. Dealy

Exactly.

John Kang - RBC Capital Markets

And I guess I was looking at maintenance CapEx that you guys are estimating for the fourth quarter. It looks like slightly lower for your assumption for acquisitions, which obviously makes sense. Just wondering, what's your - can you give us a sense what your new estimate for replacing reserves are then?

Richard P. Dealy

No, we really don't have a good feel yet because the market has been so dynamic at this point. The maintenance CapEx we've targeted at 25% of cash flow and so that's how we derived the number in there, but in terms of what the valuation, still work is being done and evaluated at this point.

John Kang - RBC Capital Markets

And then just a couple of other quick questions. Production taxes seemed a little high this quarter. Were there any special items in there or is that where we may end up going down the road?

Richard P. Dealy

No, I think probably not production taxes. I think those really have come down this quarter. Ad valorem taxes came in at the end of the year and they were slightly higher than we had estimated, and so I think that's probably what you're seeing instead of production taxes.

John Kang - RBC Capital Markets

And then just lastly on our downspacing, if you were able to book those reserves, do you have any estimate on how much you could potentially book at these levels or maybe at the $60 level?

Richard P. Dealy

I haven't done that work yet, John.

Operator

Your next question comes from Michael Blum - Wachovia Capital Markets, LLC.

Michael Blum - Wachovia Capital Markets, LLC

In terms of financing the drop down, should we just assume that'll be financed with 100% debt or would PXD consider taking units?

Richard P. Dealy

I think going into it we're looking at keeping both options available. I think there will definitely be some cash involved, but there could also be a portion in units, too. It's something that we're, both the parent and the MLP, still have to work through, but I think both would be flexible on either. But there'll definitely be a component of cash.

Michael Blum - Wachovia Capital Markets, LLC

And any sense of timing in terms of the - if you decide to do some 20-acre spacing at the Partnership, when that decision would be made and would that be done potentially in '09?

Richard P. Dealy

Where commodity prices are at, we need to see capital costs come down further and we need to see more sustained prices, you know, above $60 or that we can see longer term before we'd want to embark down that drilling pattern and get our capital costs down a bit further. So where I sit today, I mean, I think it's probably late '09, early 2010 probably at the earliest.

Michael Blum - Wachovia Capital Markets, LLC

And then if I go back to earlier in '08, kind of pre-hurricane, I thought the production run rate was more closer around 5,000 and I'm just wondering, based on the guidance for Q1, is there still some recovery going on in Q1 or is it just a natural decline or is there anything else going on there?

Richard P. Dealy

I think you're looking at the natural decline. I mean, the recovery, we're back in full production on all wells and so, if you - you know, we came into 2007 right around 5,000. We projected that we would lose about 240 - 250 barrels a day, and so that kind of puts you in that 4,700 - 4,800 range BOEs per day.

Operator

Your next question comes from Barry Damson - Damson Natural Resources.

Barry Damson - Damson Natural Resources

Most of my questions have been answered, but I just had a question as to the rights of the Partnership as to the deeper drilling that the parent is doing. I know that there's been some successful wells drilled in the field and whether or not the Partnership had any rights to those or is there a limitation as to the interest of the Partnership?

Richard P. Dealy

Yes, in the partnership agreement, the Partnership has the rights to the depth of the existing wells, and so for the deeper rights, they would work with Pioneer C Corp., the parent, to probably figure out how to work together to drill those wells deeper, but then share the production rights. But that's yet to be worked out under the joint operating agreements. But under the existing agreement, as I started out with, they only have rights to the existing producing horizons.

Barry Damson - Damson Natural Resources

And the 20-acre spacing wells that have been drilled have been drilled on acreage that the Partnership does not own?

Richard P. Dealy

That's correct. The 20-acre that Pioneer Natural Resources has done has been on its existing acreage, not surrounding the wells Pioneer Southwest owns.

Barry Damson - Damson Natural Resources

And unlike the parent, the derivative hedges are still in place and you intend to keep them in place?

Richard P. Dealy

That is correct.

Operator

(Operator Instructions) Your next question comes from Ian Sinnott - Kayne Anderson Capital.

Ian Sinnott - Kayne Anderson Capital

I was just wondering about the oil price in the quarter. It looks like you guys got about $110 a barrel. WTI was obviously much lower than that, and even with the hedges it seems like you should be lower than that. What was going on there?

Richard P. Dealy

Yes, it really just a function of the hedges in place that we had. And there are probably small accrual adjustments in there, but generally speaking our hedges are at $100 and that's where you'd normally expect.

I guess if you look on Slide 10, which I didn't cover, back in the back, from the GAAP accounting standpoint we had some novated hedges that came in and you'll see if you factor that novation in, it really was about $97, which would be where you'd normally expect it given our hedge profile.

Operator

Your next question comes from Donald Baker - Private Investor.

Donald Baker - Private Investor

I would like to know approximately what level of production, both oil and gas, barrels equivalent, you might get from this if you did spend $200 million or whatever it ends up at?

Richard P. Dealy

We're early days on that, so it's hard for me to predict until we kind of work through the evaluation, so I'd hate to speculate at this point until we get further along.

Donald Baker - Private Investor

It would be well over 1,000 barrels a day, would it not?

Richard P. Dealy

Yes. It would probably be over 1,000 barrels a day, that's correct.

Donald Baker - Private Investor

And would a dividend increase be likely to follow within a few months?

Richard P. Dealy

It's too early to tell at this point until we get through the evaluation. I just don't want to speculate on that.

Operator

(Operator Instructions) Your next question comes from William Adams - FAMCO.

William Adams - FAMCO

I just had a question regarding your comments on the production costs. Are you suggesting that potentially those could come down further from the first quarter levels?

Richard P. Dealy

Yes. We have a number of initiatives under way to work on improving our cost structure out there and so we would hope that we could see those come down further as we progress through the year.

William Adams - FAMCO

Potentially how much, to $20 or how much?

Richard P. Dealy

We're targeting somewhere in the 10% to 20% decrease, so we're working hard to achieve that, but it'll take some time.

William Adams - FAMCO

And then as a follow up to Michael's question about the production, should we then just use that as kind of a run rate for first quarter and then just put some kind of 4% decline rate off of that for the remainder of the year?

Richard P. Dealy

Yes, I think that's fair.

Operator

Your next question comes from [Steve Taft] - Tocqueville Asset Management.

Steve Taft - Tocqueville Asset Management

I see that effective February 1st the Partnership is discontinued hedge accounting. Won't that have repercussions as to what income you show from here on in and why are you doing it?

Richard P. Dealy

It won't change the - it'll change income, it won't change taxable income in terms of it's still going to be hedged effective for tax purposes, so it won't change K-1 reporting. The reason we're doing it is really because the accounting rules have made it more difficult to get hedge accounting. The world is heading towards marked-to-market accounting. The vast majority of our peers are doing it. While that's not the reason we're doing it, we just think it will simplify our accounting, make it easier to track going forward. So that's the reason we've elected to do that effectively February 1. It won't change how we manage the risk or hedge the production other than there'll be marked-to-market versus hedge accounting. And it doesn't change any cash.

Steve Taft - Tocqueville Asset Management

Could you please go over some of the reasons why the parent company would not keep these wells but would choose to drop them down? What are the economics in favor of dropping them down from the parent company, and what is the advantage to PSE if they're dropped down and what are the risks?

Richard P. Dealy

We're still preliminary, like I said before, but I think the key for the parent is to really highlight the arbitrage difference between where these barrels trade with inside PXD versus where similar barrels trade within PSE. Obviously, we would do it only if it's accretive to PSE and makes sense for PSE, and so it's got to have the right returns and metrics. And we're just no far enough along today to say what those are, but those are the type of things that we'll evaluate when we're looking at the offering that Pioneer Natural Resources will present to PSE and decide whether that makes sense for PSE unit holders.

Steve Taft - Tocqueville Asset Management

So you're saying in essence that the price of a barrel of oil is valued higher in the PSE?

Richard P. Dealy

If you look where the two entities trade, that is true today.

Steve Taft - Tocqueville Asset Management

And has been true for the last year?

Richard P. Dealy

Yes.

Steve Taft - Tocqueville Asset Management

And you have no idea, if you go through with $200 million of drop down, what percentage of it would be paid in cash? I mean, is there a range? I mean, would you be digging into the $300 million credit line substantially or just in a minor way or what?

Richard P. Dealy

I think it would be, assuming it was $200 million just for example purposes or $100 to $200 million, probably 75% would probably be in cash, up to 100%.

Operator

And gentlemen, there are no other questions in the queue at this time. I would like to turn the call back over to you for any additional remarks.

Richard P. Dealy

Okay. Well, once again, I appreciate everybody's questions and enjoyed the call today and we'll be happy to take any other questions if you have any follow on afterwards. So I appreciate your time today and thank you very much.

Operator

And this does conclude today's conference call. At this time you may now disconnect.

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Source: Pioneer Southwest Energy Partners L.P. Q4 2008 Earnings Call Transcript
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