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Executives

W. King Grant – Executive Vice President and Chief Financial Officer

Mark A. Erickson – President and Chief Executive Officer

Michael K. Decker – Executive Vice President and Chief Operating Officer

Analysts

David Tameron – Wachovia Capital Markets, Llc

Joseph Murbak – Private Investor

Gasco Energy, Inc. (GSX) Q4 2008 Earnings Call Transcript March 5, 2009 11:00 PM ET

Operator

Good morning. My name is Chastity, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gasco Energy fourth quarter and year-end 2008 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session (Operator Instructions). Thank you, I will now turn the conference over to Mr. King Grant, Chief Financial Officer. Please go ahead sir.

W. King Grant

Thanks and good morning everyone. Please be advised that our remarks that follow including answers to your questions include statements that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated. Those risks include among others matters that we have described in our earnings release issued yesterday and in our filings with Securities and Exchange Commission.

We disclaim any obligation to update these forward-looking statements. While the Company believes these forward-looking statements are reasonable, they are subject to factors such as commodity prices, competition, technology and environmental and regulatory compliance, our drilling schedules, capital plans and other factors may cause our results to differ materially.

Now, I will turn the call over to Mark Erickson, President and Chief Executive Officer of Gasco Energy.

Mark Erickson

Good morning, thanks for joining us for today's call. There are a few points I want to emphasize before we get into the details of the quarter. Looking back at 2008, we have many achievements, despite the adversity facing the global economy and more specifically the energy industry. Strong cash flow, net income for the year and continued advances in optimizing the completion designs for the Mancos Shale were some of our accomplishments. Due to lower prices on December 31, 2008, we posted lower reserves of 53 Bcfe versus 110 Bcfe in 2007.

The majority of the revisions were attributed to the fact that we booked no proved undeveloped reserves in 2008. In 2008, we added proved developed reserves for $3.72 per Mcfe. Finding cost for 2008, excluding the capital expenditures for the Gate Canyon 23-16, which have no reserves assigned at year-end, is $3.44 per Mcfe. All-in, our fully produced cost for 2008 development including production taxes, excluding G&A was $5.10 per Mcfe versus an average realized price of $7.37 per Mcfe.

One important recent development for Gasco is the successful completion of the Gate Canyon State 23-16, which is demonstrating the highest flowing rates and pressures of any well we have drilled to date and further extends the productive potential of our leasehold to the relatively undrilled Western part of Riverbend Project.

Mike will discuss what we have learned from this well later in the call. Given the Street's concern with liquidity for companies of every size, we're going to focus today on outlining our plans for 2009 with respect to CapEx and liquidity.

King will cover the liquidity discussion and Mike will outline our 2009 program. We recently announced a revised initial 2009 capital budget of $10 million, which is inline with what we anticipate for internally generated cash flow from operations during 2009. In order to ensure that our capital expenditures are within our means, we opted to lay down our contracted drilling rig to focus on up-hole recompletions. While a maintenance CapEx is not what investors want to look for in a growth company, it is a necessary and prudent measure that will help us to persevere through a particularly difficult year that 2009 is setting up to be.

We are fortunate to have options to weather the storm during a down commodity price environment. We are seeing service costs soften as our vendors are becoming more competitive to keep their equipment and people busy in the field. Our major capital items, including drilling, pressure pumping and steel are 30% to 40% lower than their peaks in 2008.

We believe this trend will continue given the aggressive reduction and development activity by industry. Lower service costs obviously are an important input in calculating per-well economics. The lower cost should allow us to stretch our $10 million budget in the program for 2009 while improving rates of return.

As managers of projects and people, we are keeping a very close eye of costs and expenses we can control. We have set an internal goal for reducing general and administrative expense by 15% to 20% in 2009 exclusive of non-cash compensation expense.

Most contract services have been brought in house. We are on target with this goal, and most of the changes have already been implemented. In the field, we are targeting a reduction to operating costs as well with implemented a wage freeze, eliminated overtime and reduced vehicle expense. Such belt-tightening is part of the oil and gas industry.

The majority of our staff have endured multiple cycles in this industry and understands what it takes to survive a downturn. It is by no means enjoyable but oil and gas professionals are a resilient group. Gasco remains focused on being able to capitalize on a revitalized natural gas market when it returns, as it always does.

We can now move to additional prepared remarks joining me on the call today are Mike Decker, Chief Operating Officer; King; Peggy Herald, our Vice President of Accounting and Administration. Once King covers the financial results, Mike will discuss detailed operations and Riverbend progress. After the prepared remarks we will welcome questions from the conference call participants.

I would now like to turn the call over to King Grant to recap our financial results and to further discuss liquidity.

W. King Grant

Thanks Mark. Despite the global economic turmoil and precipitous drop in commodity prices 2008 was the best year in our history. All of the income statement items within our control were effectively managed on a per unit basis. Natural gas prices in the Rockies were incredibly volatile and quite low for the latter third of 2008.

Through all of the noise we were able to post record cash flow of $18.2 million, oil and gas sales grew by 86%, and record net income of $0.14 per share or $0.08 per share net of hedging gains and impairment charges, which is a non-GAAP measure. The average realized price for gas for 2008 was $7.05 per Mcf versus $4.19 per Mcf during 2007. For liquids the average price received during 2008 was $77.71 per barrel as compared to $56.38 per barrel for 2007.

For the full year 2008 Gasco reported net income attributable to common shareholders of $14.5 million or $0.14 per basic share as compared to a net loss for the same period in '07 of $104.4 million or $1.12 per basic and diluted share. Included in the full year 2007 operating expenses is a non-cash charge of $97.1 million related to impairments to the carrying value of oil and gas property that we're incurred during 2007.

Impairment charges for 2008 totaled $3.5 million and related to a decrease in the carrying value of the Gasco owned drilling rigs. Included in the 2008 results unrealized derivative gains of $9.2 million attributed to hedge effect. Excluding the effect of derivative gains, a non–GAAP measure, and the $3.5 million impairment charge, Gasco would have posted net income of $8.8 million or $0.08 per share. The Company did not hedge its volumes in the comparable period in '07.

Lease operating expenses for 2008 were $1.07 per Mcfe compared to $0.72 per Mcfe during 2007. We attribute this rise in LOE to increased water disposal cost, higher equipment repair and maintenance cost along with greater chemical treatment cost related to the transition from contract pumpers to Company pumpers, as older wells were repaired and returned to production.

We also had an increase in the number of producing wells in 2008 reporting period. DD&A expense for 2008 was $1.96 per Mcfe as compared to $2.29 per Mcfe in the 2007 full year reporting period.

General and administrative expense for 2008 was $1.90 per Mcfe, as compared to $2.12 per Mcfe in 2007. For 2008, non-cash stock-based compensation comprised $0.64 per Mcfe of the G&A expense. This compares to $0.72 per Mcfe in 2007.

We invested approximately $37.8 million in developing the Riverbend Project during the full year 2008. Their capital expenditures include $2.4 million for pipeline and infrastructure and $34.6 for our Riverbend Project drilling and completion activity.

In the third quarter 2008, we divested a certain non-operative properties to working interest partner for proceeds of approximately $7.5 million. As previously announced Gasco's estimated pretax future net cash flows discounted at 10% commonly known as the SEC PV-10 figure for proved reserve at year-end is $69.4 million, the 2008 PV-10 calculation used year-end commodity prices of $4.63 per Mcf of natural gas and $15.33 per barrel of crude oil net to the Wellhead.

The gas and oil prices used to estimate 2008 reserve quantities were 29% and 79% lower respectively compared to 2007. Prices at year-end 2007 were $6.53 per Mcf, and $73.95 per barrels resulting in 2007 SEC PV-10 value $160.5 million. In order to mitigate some of the natural gas price volatility, we entered into derivative contract that allow us to ensure predictable cash flows at prices above the Riverbend Project economic threshold approximately 55% of Gasco’s current net production volumes are hedged at prices greater than $6.75 for 2009.

Balance of our production will generally be sold at spot prices. An active risk management program is essential to our success here in the Rockies, where volatility is a part of doing business giving pipeline infrastructure constrains in the growing production base from all operators in the Mountain West. For your reference, the hedge positions are outlined in tables in both the 10-K and in the earnings news release from last evening.

Late last month, we laid down our last drilling rigs, since the contract was not up until March 2010, we incurred a shortfall provision under the contract equal to $12,000 per day for each day the rig was released prior to the contract expiration. We estimate the liability at $4.6 million. This liability was secured by $6.6 million letter of credit issued in favor of the rig company. When the rig company invoices us for the shortfall provision, which we except any day we'll pay the invoice amount and cancel the letter of credit.

At that point in time, we estimate that our total loans outstanding under our credit facility to be just shy of $36 million. The two biggest issues facing Gasco and our small cap peers in 2009 are low commodity prices and capital formation. These issues intersect for most of us in the borrowing base redetermination of our reserve base credit facility.

Our borrowing base is scheduled for redetermination in April and we're preparing the materials for the bank engineers now. We maintain an active dialogue with our lenders at multiple levels within their firms. It's our belief that making sure that they are aware of our current operations and our future plans is a key ingredient to managing the redetermination process successfully.

We know that the price deck that will be used by the banks is lower than the price deck was used at the last redetermination in October. We also know that our borrowing base will be lower than the $45 million that we have currently. We do not know what the borrowing base will be, the price deck is not the sole factor in setting the borrowing base, it's an important ingredient, but ultimately the banks extension of credit is a negotiation and in today's environment the negotiating leverage, no pun intended, is tilted heavily in their favor.

I can tell you that based on the information that we have today we believe that we will be able to manage our liquidity needs through this borrowing base process. Additionally, we believe that we will be able to remain in compliance with our loan covenants. The world in which we operate is changing rapidly, we'll keep you informed as we work our way through it.

I will now turn the call over to Mike.

Michael Decker

Thank you King. Current budget of $10 million for 2009 includes money for completing the Gate Canyon 23-16, the drilling and completion of two gross wells are 0.84 net and re-completing 12 gross wells four net. To date notwithstanding the Dakota Morrison tests, the Gate Canyon 23-16 has been fully completed in the Mancos and partly completed in the Blackhawk.

The two gross wells that have both been drilled and are waiting on completion, in total we have four wells that are drilled, cased and waiting on completion. And finally, year-to-date two gross wells or 0.67 net have been recompleted into upper pay zones. Gasco currently has an inventory of 32 wells with up-hole pay.

I would now like to discuss the Gate Canyon 23-16 well. I think it is important to reiterate from yesterday’s press release, that over the past 20 days this well flowed 5.5-inch casing without tubing at an average flow rate of 3.42 million cubic feet per day with an average flowing casing pressure of 4,150 pounds per square inch.

The well was still cleaning up and flowing back frac fluid. This well confirms what we have always thought. Not only is there Mancos production on the West side of our acreage, but that there is commercial Mancos production on the West side of our acreage as well as the Eastern side.

Important to note that the amount of shale pay encountered in this well was similar to that seen on the Eastern side, an early internal reserve estimate on the Gate Canyon well indicates that the currently open interval has 3.5 billion cubic feet of gas. There also is remaining up-hole pay yet to be completed of approximately 1 to 1.5 Bcf. So the sum of the parts yields total reserves of 4.5 to 5 Bcf, and with reduced service cost, the current AFE for well drilled fully to the Mancos shale to top of the Dakota formation and with 10 frac stages is somewhere in the range of $5.7 million.

These numbers yield a competitive F&D cost of $1.50 per Mcfe. The Gate Canyon well also has the benefit of our latest completion techniques, which have been successfully applied elsewhere in our Riverbend Project. This well is our 18 Mancos well and we've made nice improvements in our Mancos completions and of course in our drilling techniques as well.

Operator, I would now like to the turn call over for question.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of David Tameron

David Tameron – Wachovia Capital Markets, Llc

Hi couple of questions. Mike on the Mancos can you talk more about what this means for the acreage on that side of play. Do you expect it has been present everywhere can you just go into some details and how think was the formation I don’t know if you mentioned that or not?

Michael Decker

No we didn't David, in general on the west side of our acreage the Mancos we're seeing probably in the range of 4,000 feet think on the western side and do we expect to encounter the same reservoir quality and the number is still sequences and so on, yes we do. We have seen for example on East side that the Mancos Shale soils are fairly correlative across the large area. And I was fully anticipate that on our side as well especially things we have been able to exchange logs with a few of our competitors and have been able to correlate at large area across the Gate Canyon just a single well. So we feel comfortable that what we're seeing in the Gate Canyon 23-16 is repetitive.

David Tameron – Wachovia Capital Markets, Llc

Okay. And you have now drilled, I think, the number 18 wells in the Mancos into the Mancos.

Michael Decker

Yes sir.

David Tameron – Wachovia Capital Markets, Llc

I guess this seems to be one of the better wells that you have drilled into the Mancos. Did you do something different? Is it just a better you've just mentioned you expected going forward with this. How do you, what gives you the confidence that there will well be concisely going forward I guess.

Michael Decker

Well, I guess, two things. Is one, as you point out, on this side of the acreage we did have a thicker Mancos section here to complete. And then the thing that we have done, we have been modifying our fracs. For example one thing that we have been doing as of late, David, is that we have been actually pumping more sand, larger jobs, into each stage. And with that we think that has also helped improve our results of what we are seeing.

David Tameron – Wachovia Capital Markets

Okay. I don’t know if you have mentioned the cost or not.

Michael Decker

What we see with the lower cost now, the current AFE that were seeing right now David for a Mancos well drilled to the top of the Dakota with 10 frac stages is approximately $5.7 million.

Mark Erickson

The cost of this well David was about $12 million and counting. We went through, we saw some of the mishaps that we have on this well and there was a lot of science put into this well.

David Tameron – Wachovia Capital Markets

Okay

Michael Decker

Remember the old well and the current, the 23-16 went all the way into Morrison and we actually had frac stages in the Morrison as wells so, you are comparing a little bit apples to oranges on the costs, and that why we want to give you more current AFE and be more specific about the number of frac stages and depth and so on.

David Tameron – Wachovia Capital Markets

Okay. And $5.7 million, this was four fracs is that right? I'm sorry was this is six stage at Gate Canyon?

Michael Decker

The Gate Canyon well has six stages in the Mancos.

David Tameron – Wachovia Capital Markets

Okay. And go forward when you say 10 stage frac are you talking a handful on the Mancos then a couple of color or what are the 10 stages?

Michael Decker

Well I would say that again we probably see approximately six stages in the Mancos.

David Tameron – Wachovia Capital Markets

Okay.

Michael Decker

And then four stages start moving up into the Black Hawk and lower Mesaverde, and of course this is always depended on how much pay we have. So, it could be nine, it could be 10,11, 12 stages, it just depend, but right now 10 is just a good ballpark number David.

David Tameron – Wachovia Capital Markets

Okay and this is the XTO wells did they have any more plans to drilling more wells with you guys?

Michael Decker

We're in discussions with them on a go forward basis for 2009.

David Tameron – Wachovia Capital Markets

Okay. One more question then I will, I have few for King but if you look at the recompletes you are doing? What price do you need, what NYMEX price or how you want to characterize? What price do you need to make those economic?

W. King Grant

At $3 natural gas David, those will yield by 50% plus rate or return.

David Tameron – Wachovia Capital Markets

Okay $3…

W. King Grant

Rocky Mountain gas.

David Tameron – Wachovia Capital Markets

$3 well ahead. okay.

W. King Grant

Yes

David Tameron – Wachovia Capital Markets

All right. And then King a couple of questions, it sounds like you expect your borrowing base to be lowered I'm not sure what the right number is? Can you give us a different scenarios if they go into where your currently revolver is. Does that change in your thinking, what you build on your $10 million, 2009 CapEx budget, what assumption from that or and/or if they were to go below. Can you just talk to a couple of scenarios, if you are allowed to?

W. King Grant

If you could rephrase the question.

David Tameron – Wachovia Capital Markets

Yeah no, if I look at your current, when your revolver gets redetermined in April?

W. King Grant

Yeah.

David Tameron – Wachovia Capital Markets

If they come down to 35.6 or if they come down to your current outstanding, does that change in your plans and how do you think about 2009?

W. King Grant

I don’t think that by itself it changes any of our plans. Currently we shutdown the recompletions by the winter, and we haven’t started them backup yet. We are just holding onto cash, right now going into the shoulder season because we would rather stack these up and what we hope might be a better second half market rather than produce into the shoulder season. But I think based on your estimates and as well as our estimates for cash flow, we should be able to continue investing in the program even if we had very little to no availability under the revolving credit.

David Tameron - Wachovia Capital Markets, Llc

Okay. I guess you cross that bridge when you come to it, but do you think there is a likelihood that they would go below your current borrowing limit?

W. King Grant

I can't handicap that.

David Tameron - Wachovia Capital Markets, Llc

Okay.

W. King Grant

Some level of they can go below that we would just cash flow out in the 90-days because the way the foreign base credit facilities work, once the banks come to agreement on what's the borrowing base is in that 90-days from that date to, if there is any outstanding in excess of the new borrowing base to repay those outstanding. But obviously we have cash flowing right now and we would repay what we could in the 90-days or seek other alternative

David Tameron - Wachovia Capital Markets, Llc

Okay, but absent action any reduction below your current borrowing, am I correct in modeling that you guys could ride this out for 2009, not have any rigs running just do the recompletes and financially you would be fine.

W. King Grant

Yeah.

David Tameron - Wachovia Capital Markets, Llc

Assuming prices stay relatively where they are at, even at this deck?

W. King Grant

Right, there is a lot of assumption to get to fine.

David Tameron - Wachovia Capital Markets, Llc.

But are relative to, all right I will let somebody else jump on. Thanks.

W. King Grant

Thank you, David.

Operator

Thank you (Operator Instructions).Your first question comes from Joseph Murbak –Private Investor.

Joseph Murbak –Private Investor

Hi, guys.

W. King Grant

Good morning, Joe.

Michael Decker

Good morning, Joe.

Joseph Murbak –Private Investor

Very nice job Mike, you are doing a fantastic job. The market seems to be just constantly worried about bankruptcy. And I guess I just have to address that with King. That it seems that nobody believes our cash flow is good enough to get us true this 2009 period, could you address that King please.

W. King Grant

I think that I did with David

Joseph Murbak –Private Investor

I'm sorry I missed that.

W. King Grant

Okay.

Joseph Murbak –Private Investor

I had to get off for a second.

Joseph Murbak –Private Investor

We believe that based on the information we have today that we have adequate liquidity for 2009.

Joseph Murbak –Private Investor

I'm sorry. I missed that I've get a dog problem here. It rained like hell in Malibu, guys. And my dogs I have got four of them and they are all muddy and one just run across my feet.What did you say King?

King Grant

We believe that we have adequate liquidity for 2009.

Joseph Murbak –Private Investor

Okay great. That sums up the major question that the market seems to have here, and they have taken our stock down to a point where they are telling us that they don’t think we are going to survive basically.

King Grant

Your management team believes that it had adequate liquidity. Our auditors gave us a clean opinion. We don’t have there is no going concern opinion, General Motors or some of other all cap peers that reported already. And that's all based on the best information we had today.

Joseph Murbak –Private Investor

Okay and how toxic is this convertible situation, what all are alternatives if we do come in below the $35 million number?

King Grant

The convertible has no financial covenants, it only a cross default to the other indebtedness, which of course is the bank facility. In normal times you take some comfort that if we were to have a problem with one of the financial covenants in the bank facility for example the current ratio, the bank has to make a decision to take all of the fault for a technical violation like that, if they still believe in management and the asset, do they want to invite the noteholders to the table at that time. So that somewhat provides us some leverage with negotiating with our lenders, changes the whole dynamic to have another large creditor at the table.

Joseph Murbak –Private Investor

Okey-doke. Thanks guys.

Operator

Thank you, you now have a follow up question from David Tameron.

David Tameron – Wachovia Capital Markets, Llc

Hi I will take advantage if nobody else will. A couple of question one, can you talk I have got a lot of questions about hedging and your hedge position financial versus physical if you don't, if you stop production and your volume start to drop. Can you talk about what would happen to those hedges, do you have to deliver the physical can you talk about those?

King Grant

We sell our gas to large midstream company at the Questar tap. And we sell a gas on a part on the first of the month price and part on the daily price. And that obviously floats based on the Northwest Rockies. Our hedges are with a financial counterparty, JP Morgan and are entirely separate from the physical. So they are financial hedges, so our delivery on the gases doesn't or non-delivery does not affect the hedge position.

David Tameron – Wachovia Capital Markets, Llc

Okay.

King Grant

In fact, we do not use hedge accounting, we just mark-to-market for financial reporting purposes.

David Tameron – Wachovia Capital Markets, Llc

All right and who exactly is in your bank group?

King Grant

It is JP Morgan and Guarantee Banc of Colorado.

David Tameron – Wachovia Capital Markets, Llc

Okay. All right, and then one question for Mark. Can you talk about or whomever wants to take it. Can you talk about your outlook for differentials, the Rockies, basis this summer with the Piceance activity coming off? Can you just talk about how you see the world over the next six months in the Rockies as far as pricing?

Michael Decker

Well one thing has been really clear is people are able to move their gas. So we're obviously doesn't appear that we're really pushing the limit of the takeaway capacity very hard. The differentials are, they are always the function of the local demand combined with the export demand for our gas in the Rockies, it's an area we've seen tremendous volatility due to the very, very tight take away capacity out of the Rocky Mountains. Some of the things that that we are seeing is there are some projects coming online that are going to increase the takeaway capacity out of the Rocky Mountain, pretty small increments in the near term, but our best read is that Ruby project is going forward. That is going to increase takeaway capacity out of the Rockies in 2011. So with the decline in activity, we are in a good position. And with the expanding capacity out of the region, I think medium-term we are in a good position. Rockies have typically experienced their highest differentials when it has been gas-on-gas competition. So I think we're in good shape. To see what I would say is more normal types of discounts to NYMEX, which are pretty typically in the range of about 20% off of NYMEX to a Rocky Mountain price.

David Tameron – Wachovia Capital Markets

All right. Thanks I appreciate it.

Michael Decker

Yeah.

Operator

Thank you. There are no further questions at this time. Do you guys have any closing remarks.

W. King Grant

Thank you very much for participating this morning. Talk to you next quarter.

Operator

Thank you for joining today's conference call. You may now disconnect.

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Source: Gasco Energy, Inc. Q4 2008 Earnings Call Transcript

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