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Executives

Frank Hopkins - Senior Vice President, Investor Relations

Richard Dealy - Executive Vice President and Chief Financial Officer and Treasurer

Analysts

Michael Peterson - MLV & Company

Praneeth Satish - Wells Fargo

Steve Tabb - Tocqueville Asset Management

John Ragozzino - RBC Capital Markets

Kevin Smith - Raymond James

Matt Niblack - HITE Hedge Funds

Chuck Goldblum - Hurley Capital

Pioneer Southwest Energy Partners L.P. (PSE) Q4 2012 Earnings Call February 14, 2013 12:00 PM ET

Operator

Welcome to Pioneer Southwest Energy's fourth quarter conference call. Joining us today will be Rich Dealy, Executive Vice President and Chief Financial Officer; and Frank Hopkins, Senior 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 are at www.pioneersouthwest.com. At the website select Investors then select Investor Presentations. This call is being recorded and a replay of this call will be archived on the Internet site through March 11th.

The partnership's comments today will include forward-looking statements made pursuant to the Safe Harbor Provisions of this 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 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 public filings made with the Securities and Exchange Commission.

At this time, for opening remarks, I'd like to turn things over to Pioneer Southwest's, Senior Vice President of Investor Relations, Frank Hopkins.

Frank Hopkins

Good day, everyone, and thank you for joining us. We're just going to go through the slide presentation on today's call. He'll review the financial and operating highlights for the fourth quarter, and then he'll update you on what's been going on with the drilling program for PSE in the Spraberry field. He will also take a quick look at the financials for the fourth quarter in more detail and provide you with the guidance operating and financials for the first quarter. After that, he and I will be available to take your questions.

So with that, Rich, why don't you go through the slides.

Richard Dealy

Thanks, Frank, and good morning. Starting on Slide 3 for those who have in front of them. For the fourth quarter, adjusted income of $18 million or $0.50 per unit did include unrealized mark-to-market gains of $5 million, after tax were $0.15 per common unit.

Production for the fourth quarter was essentially flat with the third quarter just under 7,700 BOEs per day. Indeed as we talked about in the third quarter call, it was impacted by 200 BOEs per day and reduced ethane recoveries associated with our gas processing facility in West Texas operating capacity. So that didn't lower our actual production for the quarter.

That is also expected to impact just in the first quarter of 2013 in the range of 200 to 300 BOEs per day. We have the new driver plant that will alleviate that problem, it comes on line in early April, and then that constraint will go away and we'll get those volumes back, but that is going to continue to reduce our ethane recoveries through the first quarter of 2013.

Turning to Slide 4, talk about operations a bit. We did complete 13 new wells and one recompleted well in the fourth quarter, brings our year-to-date to 42 wells and five recompletions. We do have nine wells waiting on completion at the end of the December, and the three rigs are running and will continue to benefit from drilling to the Wolfcamp, Strawn and Atoka intervals with good success. For 2012, we spent $126 million and generated 8% production growth compared to 2011.

Cash flow from operations for the quarter were $19 million or just under $100 million for the year. We did declare another distribution of $0.52 for the fourth quarter that was paid on February 11, to holders of record of February 4, and equates to $2.08 on an annualized basis.

For the year, we reported 49 million barrels of proved reserves, at the end of the year down 1 million barrel from yearend 2011, principally related to production of 3 million barrels, 1 million of negative price provisions, principally to gas prices dropping from $4 to high $2 range for the year-over-year. And then we had proved reserve additions of 3 million from our growing program and acquisitions that we've accomplished during the year.

Turning to Slide 5, looking at our 2013 drilling program. We are continuing with our three-rig drilling program, planned to drill about 50 wells for about $120 million, including facilities next year or this year. We expect that to generate about 9% production growth and the wells that we will be drilling similar we've talked about in past quarters.

We'll be virtually 100% going through the Strawn formation, but we expect that to add by going to the Strawn about 30,000 BOEs of incremental EUR. We've got about 65% of wells that will go to the Strawn and into the Atoka next year. And so that will be also add reserves going to the Atoka, adds about 50,000 to 70,000 BOEs per well for an EUR basis.

From an inventory standpoint, 160 40-acre locations left, still well over 1,200 20-acre locations are big drilling inventory. And for those of you who didn't follow the news in West Texas to have in a number of horizontal wells drilled recently in Midland County. PXD, having one of those, a third-party having another one that have had good success. And so it's encouraging for the partnerships 10,000 acres that it hold in the area. We're continuing to monitor that and to see more information over the next year as more wells are drilled, but it is encouraging for the partnerships acreage.

Turning to Slide 6, I've talked about earnings, just looking at guidance relative to our results. You can see that we were within the guidance range on all the items with the exception of depletion, which is a little bit higher, because of the negative price provisions and the fact that we're drilling primarily put locations.

Turning to Slide 7, and first quarter guidance. Because of the planned capacity limitations that we have for the first quarter, we are keeping our guidance range the same as 7,400 to 7,900 BOEs per day. I expect that to go up in the second quarter, once that bottleneck is relieved. Our production cost, DD&A and G&A, interest and effective tax rate are probably similar what they've been in past quarters.

And finally just to wrap up, partnerships still having a great financial position, has $135 million available under it's credit facility. Good derivative position for 2013 and 2014. On 2014, I will draw your attention in our appendix size. We did change our derivative position in '14 to tighten the collar range in our three-way collars that we have, so basically assuring the partnership a $100 oil in 2014.

So with that, I'm going stop there, and we'll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first to Michael Peterson with MLV & Company.

Michael Peterson - MLV & Company

I wonder if you could show your perspective on distribution growth with us, particularly in light of your guidance for 9% production growth and your expectations for a stable cost environment. What types of growth may we look for throughout 2013?

Richard Dealy

In 2013 because of our derivative position, we have $81 oil hedges that were put on back in 2009 in conjunction with an acquisition. So I don't see a lot of opportunity in 2013 because of those. I think there is more opportunity in '14 as we start to realize a higher oil price.

Operator

We'll hear now from Michael Blum with Wells Fargo.

Praneeth Satish - Wells Fargo

This is actually Praneeth Satish with Wells Fargo. Just one quick question from me. You mentioned that ethane recovery should increase in April when the new processing plants are up. But I'm just wondering with ethane prices at Belvieu being so low, whether you expect any voluntary ethane rejection to occur this year?

Richard Dealy

We're looking at that. I mean it could impact volumes if ethane prices are right now running at $0.20 range or mid-to-low 20s, and if it drops to another mid-to-high teens, it's something that we'd have to consider. As you are aware, increased cash flow would impact our production volumes. That's certainly something we're going to watch and make the right decision on.

Praneeth Satish - Wells Fargo

Is there anyway to quantify the impact to production on the NGL side, would it be in that kind of 200,000 or 300,000 barrel per day range?

Richard Dealy

It'd probably be in, I would say, 200 to 400 barrels a day type range.

Operator

Moving on to Steve Tabb with Tocqueville Asset Management.

Steve Tabb - Tocqueville Asset Management

I'm a little disappointed as a shareholder of a partner, whatever you want to call it, the unit. You spend about $100 million on oil properties and drilling, and you increased the company's debt on its credit lines by $94 million and yet your proven reserves are down 1%, and the average price of oil liquidity according to what you said two years, is maybe 2% or 3%. Why hasn't the proven reserves gone up?

Richard Dealy

Steve, couple of reasons, one as I mentioned we have the gas price declined, which in oil prices actually went down in terms of the SEC reserve compared to last year, and so that lost some tail end reserves. The second thing is as s we've talked about in prior quarters drilling predominantly proved undeveloped locations, though we're just developing what we have already booked, in those reserves.

And then we did add about 1 million barrels last year from small acquisitions that will actually because of being where it was from an SEC standpoint where not allowed to booked today, but as we drill wells and then coming months we'll start adding reserves associated that acquisition.

Steve Tabb - Tocqueville Asset Management

You want to review those first three steps?

Richard Dealy

First one on pricing, The SEC requires us to price our proved reserves using a trailing 12 month average. And so when you look at the price at which we price the reserves at yearend 2011, relative to what we price them at 2012, 2012 prices are down which limited the economic-wise of certain of those proved reserves.

Steve Tabb - Tocqueville Asset Management

Would you differentiate that how much, what proportion came from oil which was only down about 2% or 3% as above is to what the gas was down 25%?

Richard Dealy

In total, it was about 1 million barrels BOEs equivalent and predominantly the reason for it is probably both oil and gas but it's because that our gas prices were the big reasons to just shortened these lives of these wells from 30 years to 28 years.

Steve Tabb - Tocqueville Asset Management

Did it shortened life or the price that you expected to get from it? Actually it's based on the current price, right, when you establish what the oil is worth each year you use the average price of the oil for that year you're saying?

Richard Dealy

The trailing 12 months, that's correct.

Steve Tabb - Tocqueville Asset Management

So how much of your reserves are in gas in dollar amount weighted compared to how much are in oil?

Richard Dealy

I don't have those numbers exactly right in front of me, but I can tell you that the gas value is very, very low. Of our typical well 60% to 70% is oil, 15% NGLs, and 10% gas.

Steve Tabb - Tocqueville Asset Management

That's right, and that's my point. So the big differential in price was in the natural gas, so that would account for the fact that you spend so much money on your integrated proven reserves because most of it was in oil. Were the decrease in price was only about 2% or 3%? And if you spend all that money drilling, that would increase the amount of proven reserves that you would normally get. I mean you are going to lose what you produce. There is supposed to be a long life wells and so forth.

Richard Dealy

So the thing, I think you're missing is the wells that we're drilling, those reserves were already booked in the proved reserves. So you have producing wells in the proved reserves and you have undeveloped wells in your proved reserves. What we're drilling is predominantly the undeveloped wells that are already in our proved reserves.

So we're just not bringing that cash flow forward for those reserves that are already booked as proved. So in a perfect world you wouldn't have expected any change in your proved reserves. You just now have developed and put on cash flow. Those wells are you already had reflected in as proved reserves.

Steve Tabb - Tocqueville Asset Management

You are saying that you're going to spend $100 million a year approximately and you're not going to be increasing your proved reserves? That doesn't seem to make sense to me.

Richard Dealy

The NPV value that is built into your reserve value, and so you're PB value of reserves are going to go up because you spend that capital but your proved reserves as it relates to those undeveloped locations are already reflected. As I mentioned earlier, we do plan to add proved reserves associated with the acquisition we did last year that we'll add locations as we drill those additional locations this year.

Steve Tabb - Tocqueville Asset Management

But as a company, as a holder in the company, what should I expect in the next year, two or three years? You're going to be spending $100 million, will I be seeing the proved reserves go up each year or they not?

Richard Dealy

I think there will be commodity price to do this to a certain extent, but assuming they are relatively flat, they should increase modestly.

Steve Tabb - Tocqueville Asset Management

$100 million a year, a 20% increase in the amount, that you're carrying on the books and they'll only go up modestly?

Richard Dealy

Yes, we'll think about it. As I mentioned earlier, 148 locations that are booked as proved reserves and then if you're drilling 50 year that is basically is at 3 year inventory, the 1200 locations that are 20 acres, none of those are booked as proved reserves. And so in the future as those wells start being drilled we would add proved reserves associated with those.

Steve Tabb - Tocqueville Asset Management

Well, what I am getting at as are you eating up my capital by what you're giving me today because you're not proportionately increasing your proved reserves and you are only increasing your debt. That's what I am looking for. I think that all this money is being spent, the first question that somebody asked is what will expect in the way of distribution growth and you attributed to the fact that hedges placed a couple of years ago, because the price of oil has been for a year and year-and-a-half already, the buyer hedges that we're in at lower prices and now you're are saying further that the proven reserves are not going to go up very much either, but I can see the debt going up.

Richard Dealy

It's all right. I'd like to give you a call offline and we can kind of walk through all that. I'm happy to have it cover it with you.

Steve Tabb - Tocqueville Asset Management

Let me ask you about the drilling to these different formations. It seems to be right on the page on one of your report that your wells are being have turnout deeper. Does that mean that you have to go deeper to find the amount of oil that you expected or is that just mean that you are going to be able to get a lot more from each well.

Richard Dealy

It really that the latter, we're drilling deeper and so there is an incremental cost but the reserves that we're getting far outweigh the incremental cost, and so the Strawn and Atoka intervals and the production that we're achieving from those horizons is better than just drilling a Wolfcamp well, and so by going a few 100 feet deeper, we were picking up a quite a bit of reserved adds.

Operator

We'll go next to John Ragozzino with RBC Capital Markets.

John Ragozzino - RBC Capital Markets

Can you give me guesstimate on the total annual PDP decline rate currently?

Richard Dealy

It's probably on the older well, we've always said that in 4% to 5% range on the newer wells, it's going to be steeper on that and so on a blended average it's probably in that 6% to 8% range.

John Ragozzino - RBC Capital Markets

And if you were to possibly add fourth drilling rig in 2013. Can you ball park what type of additional organic growth you might believe we'll be able to see?

Richard Dealy

John, I don't have an estimate for you and I don't see we are capital program and cash flow mix and derivative position we have, I don't expect this to add a fourth rig.

John Ragozzino - RBC Capital Markets

Just going to the CapEx budget for 2013, slightly lower than last year, yet few additional wells. Can you kind of talk about what's driving that additional efficiencies more being spend on facilities last year or just a little query there.

Richard Dealy

It's really the similar capital programs, similar expected results as just last year our production was impacted because of the situations we had on NGLs in Mont Belvieu and take away capacity limitations. And so I think we will generate, the incremental generations, production growth this year is similarly we would have expected last year, if we've not had the other issues.

John Ragozzino - RBC Capital Markets

And then couple more. Do you have any idea what percentage of the '13 program is targeted on 20s instead of 40s?

Richard Dealy

Very little, most of it is all 40s. I'd say it maybe 5% or less.

John Ragozzino - RBC Capital Markets

And have you guys done any work either at the parent level or the other few levels to kind of fully assess what the potential for the holds on Wolfcamp base on you acreage?

Richard Dealy

We've down lot of work in the parent level in terms of the plan. In fact, I would point you to our PXE earnings presentation where we've got a map that's kind of highlights the Wolfcamp B horizon there. So PSE have 10,000 acres in the Midland County, so I think it's encouraging for that. I think what we'll do is watch because PXE plants have drill 30 or 40 wells in the Northern part of the field during the course of this year. We'll watch those results and see what if anything PSE had to do relative to Horizon drilling.

Operator

We'll hear next from Kevin Smith with Raymond James.

Kevin Smith - Raymond James

Can you talk a little bit I guess about we saw a pretty big step up in operating cost in 2012 in the Perm. What's your outlook on 2013? You think you'll be able to work some of those down?

Richard Dealy

I think we will. I think a couple things will work to help. One, saltwater disposal what was tight last year, both at the PXD level and PSE level were adding an incremental saltwater disposal handling. And so I think that will help bring down (inaudible) hauling that water we can just dispose of it via gathering line. And so that kind of cost cut a bit. The other thing with getting the volumes back, the driver plan, when that comes online and be able to recover a more of ethane will help on a per BOE basis. And both of those items will help improve our cost situation.

Kevin Smith - Raymond James

So should we think of that as, if we do see incremental reductions on a BOE basis, I guess it will be more second half weighted?

Richard Dealy

Hopefully we'll start seeing in the second quarter, when the plan comes on, that'll be the first thing that in the (SDW) kind of over throughout the year.

Kevin Smith - Raymond James

And could you talk about the kind of reduction on rather a amount of maintenance CapEx this quarter, I think this was probably one of your lowest quarter's you've had in the company's history for maintenance CapEx, how should we think about that?

Richard Dealy

I'm sorry, I'm not following your question.

Kevin Smith - Raymond James

The reduction in maintenance CapEx this quarter, I think it was down about $1.7 million sequentially?

Richard Dealy

Mainly we look at that as a figure of our cash flow and for the quarter. And so I think that it was just another reflection at lower commodity prices.

Kevin Smith - Raymond James

And then lastly, I have one question, I understand that you're probably limited on what you can talk about it. But then I think about the dropdowns to PSE and PXD's financing options. This is I guess the second time PXD's issued equity after you guys from PSE. A dropdowns at this point is really kind of off the table, you're just now having those discussions in organic and maybe third-party acreage deals are really only what you're looking at?

Richard Dealy

I think at this point PSE is focused the cheapest thing and the best return to drilling its acreage position. It's got a big inventory of locations. So acquisitions tend to be more costly, and because of purely what's happen in the Permian basin acquisition prices, it just makes more sense for PSE to drill than to acquire.

Operator

We'll go now to Matt Niblack with HITE Hedge Funds.

Matt Niblack - HITE Hedge Funds

Just a couple a questions to clarify here. So first on the horizontal drilling, maybe some more color on the timing of when that something you start to explore and the feasibility on how you would execute that, given the certain nature of your acreage and being a little less contiguous versus the pad?

Richard Dealy

I think it's early days, we're excited about the success we're seeing in the Midland County, where we have our acreage position. But we're going to need a little longer well results and little more time to evaluate more wells. For PSE purposes we'd want to commit any drilling program associated with horizontals. And I think it's definitely an option in the future, but it's probably something 2014 we'll be in a better position to evaluate and decide whether we want to switch some of our drilling capital to horizontal.

Matt Niblack - HITE Hedge Funds

And if you chose to do that, would you need to sign partners to make a sense or do you actually have enough contiguous acreage for that to be something you do internally.

Richard Dealy

Contiguous acreage, we have some places that we have and that's contiguous acreage. Otherwise, it'd probably be, because PXD is your next door to us in a lot of locations, then it would be in combination with PXD.

Matt Niblack - HITE Hedge Funds

And then as long as you are predominantly drilling the 40s, which sound like, if I interpret it your statement correct, that would be the next three years or so. Is this roughly 9% annual production growth, a good assumption for what you should be able to do over that time period?

Richard Dealy

I mean I did say to you with a flat rig count. It will be in that range and probably in the other year. It is harder to grow when you have these wells on decline. So it may not be as high as nine, but it will be in that mid-single digit range.

Matt Niblack - HITE Hedge Funds

And then in terms of financing the organic drilling program that you have, did you say you'll be able to do that entirely internally or will you need to come to the equity markets for equity yourselves in the course of the next year to finance that program?

Richard Dealy

Based on where we are today and our situation, we have planned to do it internally at this point.

Operator

We'll go now to Chuck Goldblum with Hurley Capital.

Chuck Goldblum - Hurley Capital

So you have a capital plan this year of $135 million available on the credit line. Talk about turning out debt is that one of the possibility?

Richard Dealy

I guess it's always the possibility out there, but it's not something that we're contemplating today. We've got plenty of those that are in the credit facility. We've got cash flows that are going to be in the $120 million, $130 million range. So I think we can fund it internally and with our availability under our credit facility.

Chuck Goldblum - Hurley Capital

But then as you lookout towards, I imagine a fair amount of that cash flow would be distributed, correct?

Richard Dealy

I mean distributions are in that $80 million annually based on our current distribution rate. There will be some incremental borrowings planned for this year. As I mentioned earlier that cash flow is impacted quite a bit this year because of our derivative position on oil that improved substantially next year, as we move up closer to the $100 on our realized price on our oil. So I think that will help our cash flow significantly.

Chuck Goldblum - Hurley Capital

So then the idea is as you look into next year with the higher cash flow that you more likely want to higher coverage cash distribution in order to help finance to growth, is that correct?

Richard Dealy

Yes, it is correct.

Chuck Goldblum - Hurley Capital

Last question I'd ask, you had sort of indicated, you've answered that the growth would be at similar levels or perhaps a little bit lower in the maybe next year or year after with the higher realized oil price, would you care to opine on what sort of distribution growth you'd would be able to do next year rather than give guidance on it?

Richard Dealy

Probably refrain it, it's hard to say at this point. I want to see how commodity prices play out this year and where they are next year before make a decision on the distribution. First and foremost we want to protect the distribution and increase it when we can afford to do so. I think the plan right now that's to see how commodity prices work out this year and then make that decision.

Chuck Goldblum - Hurley Capital

I'm not sure I understand that. I mean to a certain extent you guys are hedged this year, you pointed out to us in your script that you'll hedged next year at a 25% higher price, so how the commodity prices fit into the discussion again?

Richard Dealy

Well, we're still are unhedged on our NGL's and lowering our gas prices. And we've got a 85% of our oil, but we still we have exposure on those commodities that aren't hedged. And as you know drilling in capital cost fluctuate with where commodity prices are and so even if the commodity prices do go up or they come down that's going to affect our capital program.

Chuck Goldblum - Hurley Capital

And then you look on the Slide 11, you sort of go into I think a little bit of a differentials you guys are receiving on your commodities. Maybe can you talk about where do you think differentials are this year for oil, NGLs, gas?

Richard Dealy

Are you talking to just where do think our prices will be.

Chuck Goldblum - Hurley Capital

I am talking about sort of geographic differential. I know you guys we've heard on that in the past, on oil and I think I spoke to you guys that it would be a whole lot better this year for various reasons.

Richard Dealy

I think on oil, what we've seen so far is this was basically sold into the Cushing marketing with the Midland Cushing differential that is subject to, it fluctuated a lot last year. Early this year, there was some fairly wide differentials. My understanding is that its under dollar today. So if it stays in that range, our realized price compared to NYMEX price, it would be $1.50 to $2 different all in based on that differential.

Chuck Goldblum - Hurley Capital

I was going to ask on oil. Have you guys hedged some of that, you sort of books in sort of books and pipelines space or something like that?

Richard Dealy

Not at the PSE level. We've got some wells that are tied to one of our contracts is that a $1.75 rate, so that does impact some of PSE's wells and then rest would be whatever the differential, so part of that $1.75, the rest at the market which is currently around $1.

Chuck Goldblum - Hurley Capital

And then I'm sorry, you're talking about NGLs as well?

Richard Dealy

NGLs, they've been running 35% to 40% of NYMEX oil prices. I don't see significant change right now. Hopefully they move up but right now the price is still going to be in that 35% to 40%.

Operator

And at this time, I'd like to turn things back to you Mr. Dealy for closing remarks.

Richard Dealy

Great. We appreciate your interest in our yearend. We look forward to catching up. If you may have question or follow-up comments, feel free to call Frank and myself and look forward to talking to you again next quarter.

Operator

That concludes today's conference. Thank you all for joining us.

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