Executives
Frank Hopkins – Vice President Investor Relations
Scott Sheffield – Chairman, Chief Executive Officer
Rich Dealy – Executive Vice President, Chief Financial Officer
Analysts
[Leo Mariani – RBC]
Kevin Smith – Raymond James
Michael Blum – Wachovia
[Steve Taft – Tocqueville Asset Management]
Pioneer Southwest Energy Partners (PSE) Q1 2009 Earnings Call May 6, 2009 12:00 PM ET
Operator
Welcome to Pioneer Southwest Energy's first quarter conference call. Joining us today will be Scott Sheffield, Chairman and Chief Executive Officer, Rich Dealy, Executive Vice President and Chief Financial Officer and Frank Hopkins, Vice President of Investor Relations.
Pioneer Southwest has prepared power point 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.poineersouthwest.com. At the website, select investors, then select investor presentations.
The partnerships comments today will include forward-looking statements made pursuant to the Safe Harbor provision 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's Vice President of Investor Relations, Frank Hopkins.
Frank Hopkins
Good day everyone and thank you for joining us. Let me briefly review the agenda for today's call. Scott's going to be the first speaker. He'll review the financial highlights for the first quarter and discuss some growth opportunities that are currently being evaluated. Rich will then cover the partnership's strong financial position and provide earnings guidance for the second quarter. Then after that, we'll open up the call for your questions.
So with that, I'll let Scott get started.
Scott Sheffield
Good morning. On Slide 3, our highlights, PSE had another great quarter, reported first quarter net income of $12 million, $0.03 per unit. Production was up significantly close to 5,300 of oil equivalent per day. Obviously about 320 barrels of that were from NGL's. They were not sold in the fourth quarter but we're still above target even with that.
We did have derivative settlements comprised of 55% of the oil and gas revenues, obviously the benefit of some great hedges that were put in place about a year ago. Cash flow from operations about $14 million. Again, had another distribution, I believe this is our fourth declared distribution of $0.50 per outstanding unit payable on May 14, record date as of May 7.
What's more important obviously with a balance sheet of zero debt, obviously we're looking at opportunities both from third party opportunities, drop downs from the parent and also we're looking seriously with crude moving up into the $65 to $70 range over the next two years, to go ahead and begin initiation of development drilling.
With costs coming down, obviously about 25% to 30% we expect another 5% to 15% drop by this summer, so obviously something we're seriously looking at to initiate development drilling. We'll be making these decisions over the next several weeks and be announcing those.
Slide 4, our strong liquidity position. We do have a cash balance of $29 million as of March 31, the quarter end. We're retaining 25% of the cash flow for maintenance capital and that's for either development drilling or acquisitions.
We have no borrowings on the $300 million credit facility. It doesn't expire until 2013. Next comment obviously a very, very strong fact that we are seeing progress in hedged with production in 2009, 70% in 2010 and 45% in 2011. We are looking at when is the right time to start putting on new hedges in 2011 and 2012 with the current strip well above $70 a barrel. Our position on our hedges is about $106 million as of March 31.
Obviously our distributions are supported by the partnerships strong financial position and our strong hedge position. Let me turn it over to Rich Dealy to go over the highlights of the quarter.
Rich Dealy
As Scott mentioned we had $12 million of net income for the quarter. That did include a non cash $8 million mark to market charge on derivatives, really a reflections of the NLP's, our year comp from year end mark to market accounting from hedge accounting. Oil prices rose during the quarter. That just meant our derivative value went down a little bit, but that was the cause of the charge.
If you look at production, we ended up with 5,300 BOE's per day relative to our guidance and obviously included 300 barrels of NGL's that were in storage at the end of the year and then were sold during the first quarter. We also did benefit from production from the work of a program that was done in 2008 where we had some incremental production in the quarter.
Production costs, one of the big highlights where you see a significant drop in production costs relative to third and fourth quarter last year. It's primarily due to Permian Basin asset team really doing a great effort in terms of seeking savings on all our LOE items, electricity, disposal and general field costs, and in addition we had a lot less work over activity in the first quarter. So total production costs for the quarter were $19.26, a big decrease from where we were in the fourth quarter.
DD&A, $5.77 relative to our guidance at the low end. We benefited in the first quarter as oil prices did rise towards the end of the quarter. That did increase our reserves slightly and therefore our DD&A rate was slightly lower than where we predicted at the beginning of the quarter.
G&A came in a $1.2 million at the middle of the range and effective tax rate was where we expected it to be at 1%.
If you look at Slide 6 and talk about our second quarter guidance, we are projecting production to be 4,700 to 4,900 BOE's per day for the second quarter. Productions, $19.00 to $22.00. We're still very much focused on reducing costs and hoping to do better than that but that's where we're forecasting guidance at this point.
DD&A $5.50 to $6.50 on strengthening oil prices. We still expect to see a little bit higher reserves as we get to the end of the second quarter and so we brought the range down a little bit there.
G&A, $1 million to $2 million consistent with where we were in the first quarter and effective tax rate just being the Texas margin tax still at 1%.
So why don't I stop there and we'll open up the call for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from [Leo Mariani – RBC]
[Leo Mariani – RBC]
Question for you in terms of work over activity, you mentioned it was pretty low in the first quarter. Any expectations for what that spending could look like in 2009? I know it's something that's hard to forecast.
Richard Dealy
We monitor and its predicated on what's happened with the wells themselves so it is hard to forecast, but I think it would be today where it's at less than last year and probably a little bit higher than the first quarter run rate, but probably in that ball park.
[Leo Mariani – RBC]
Obviously the partnership's got great liquidity, nothing drawn on their debt facility. I'm curious if you could give us a little more insight in terms of how you think about asset draw down, some PXD into PSC and what the criteria are you looking at that?
Scott Sheffield
We emphasize development drilling is probably the most important item. We're continuing to get drop down. It's basically a balance as to pricing and working out everything with the Board. But I think the thing that's obvious right now is a strong return in terms of development drilling that we're seeing with crude prices moving up substantially and cost reduction.
So you're probably going to see us emphasize even though we are still seriously looking at a drop down, we're going to be emphasizing a lot of the balance sheet and the capital going into development drilling.
Operator
Your next question comes from Kevin Smith – Raymond James.
Kevin Smith – Raymond James
I noticed you had a pretty large what looks like accounts payable transaction on this quarter, $6.5 million. Can you explain that?
Richard Dealy
It's basically what happened, we had our December JIB that did not get paid prior to year end and so it got paid in January, but then our March joint interest billing was paid in March as well. So you basically have an extra month of operating costs being paid and that's what your payable change is.
Kevin Smith – Raymond James
It's roughly $2 million more or something close to that?
Richard Dealy
Yes. And the other thing is, you would have had taxes which are paid annually in January and so that would have been an impact as well.
Kevin Smith – Raymond James
Your operating cash flow on a normalized basis should have been another $2 million higher?
Richard Dealy
Yes. $2 million to $3 million.
Kevin Smith – Raymond James
That still leaves you fairly tight though on for how much cash you want to reserve for acquisition, on a total cash basis?
Richard Dealy
Yes, we've been running our coverage is right around 1 to 1.1 and I would expect it to stay there until we start using that maintenance cap ex to replace production.
Kevin Smith – Raymond James
What do you think the driving factors for lowering you LOE is going to be? Where do you see the most softness?
Scott Sheffield
I think the operating assets teams are continually focused on the things I mentioned, electricity, salt water disposal, general field costs, so they'll be compression to the extent that there is, but there's not a lot in the Spraberry area but generally speaking, those are going to be the key focus areas that we're going to be looking at.
Kevin Smith – Raymond James
What do you think your maintenance CapEx on a per flowing barrel should be? Do you have a target rate you think you can acquire assets for? Originally it was close to $70,000 per BOE?
Scott Sheffield
The market's changing all the time so it's hard to predict on a flowing barrel basis. I can tell you that what we're targeting, leading for maintenance CapEx is 25% of operating cash flow.
Operator
Your next question comes from Michael Blum – Wachovia.
Michael Blum – Wachovia
In terms of the production cost in your guidance for Q2, is that just conservatism, because you did say you expect to see another 5% to 15% drop in OpEx by the summer. So the Q2 guidance just reflects almost flat production costs. I'm just trying to reconcile those two.
Scott Sheffield
We're talking about drilling costs on that decrease, another 5% to 10% on drilling costs but we do expect Op costs to continue to come down as we initiate our cost reduction activities. And so I think it's probably on the conservative side, the $19 to $22 per BOE.
Michael Blum – Wachovia
Can you talk a little bit more about how you're thinking about the various options you have in terms of deploying capital and specifically the economics of the returns of drilling versus acquiring from third parties. We're starting to see some acquisitions particularly in your back yard that seem pretty attractive from a buyer's perspective.
Scott Sheffield
If you go into our PXD charts we show some return slides for Spraberry and the returns are getting up into $65 to $70 are getting up into the 30% plus rate of returns. So it's hard to make acquisitions to get a 30% return so obviously why the focus is really to initiate development drilling.
So the returns right now look much better even though you can buy. There's been some deals that have been announced recently in the $75,000 to $80,000 per flowing barrel but right now it's hard to get at 35% to 40% return on what we see may be coming for drilling in the Spraberry area.
Michael Blum – Wachovia
So in terms of the plan if you went ahead with development drilling, is that to say you would initiate that program latter, 2010 to 2011 event?
Scott Sheffield
It could be late 2009.
Operator
Your next question comes from [Steve Taft – Tocqueville Asset Management]
[Steve Taft – Tocqueville Asset Management]
You say at $60 to $65 it pays to do development drilling. That's really a question and based on the present course or the costs that you foresee in a few months of additional reductions, I would presume that if you entered into this development drilling, at that point you would be or very soon after hedging future positions to cover it and it would show the 30% return you're talking about. I'm just trying to put all these factors together.
Scott Sheffield
Yes, you definitely have it right.
[Steve Taft – Tocqueville Asset Management]
We noticed there was a big drop in the inter-company account from $5 million or so. Is there any interest charge on the inter-company account and do you expect to pay off the other $5 million soon or will we see that cash disbursement in the following quarter?
Richard Dealy
There is no interest on the inter-company and the inter-company should stay relatively low at this point. It should be just minimal activity going forward.
[Steve Taft – Tocqueville Asset Management]
I don't understand, PSE has a very large cash balance. Why is there an interest expense item on the income statement?
Richard Dealy
Interest expense item relates to our credit facility. We pay unused commitment fees and that's what that interest charge relates to, just having the access to that facility out there and it's pretty minimal.
[Steve Taft – Tocqueville Asset Management]
I noticed that the depreciation and depletion expense went up considerably, about 40% or something. Why did it go up so much?
Richard Dealy
It really went up in the fourth quarter of last year and what happened is when we did our year end reserve report, commodity prices, oil prices dropped significantly from third quarter to fourth quarter and that cause us to take a negative reserve provision as those tail reserves became uneconomical out there at low prices.
So even though we believe it's temporary and as prices improve, we'll get all those reserves back with the lower reserve balance at year end and still into the first quarter. Our depletion rate was higher because we had to use those crude reserves to calculate our depletion rate.
[Steve Taft – Tocqueville Asset Management]
I don't really follow it. Could you explain it in a little more detail?
Richard Dealy
I'll try one more time. Otherwise we can take it offline and do it if you'd like and I'd be happy to walk you through it. Basically our reserves are determined based on the commodity prices that exist at the end of each quarter, crude reserves for depletion.
And as prices change, as they go down, our reserves therefore go down too because it's not profitable to recover those tail end reserves at a low price environment. However, as prices come back, those reserves will come back on the books and our depletion rate will go lower.
So it's really just a function of what's happening with oil prices being the primary driver affecting our depletion rate. Low oil prices, we're going to have a higher depletion rate, high oil prices, we'll have a lower depletion rate.
[Steve Taft – Tocqueville Asset Management]
As a partner in this business, we're an investment advisor, and personally and for our clients, they had to pay taxes on more income than the dividends received and this was contrary to what was in the prospectus. Could you explain why that happened and will it happen in the future?
Scott Sheffield
It happened as part of the start up of the entity and just timing of how the entity was put together that over time, we will get that tax shield in place, but initially for the first year, it ended up we got to the end of the year and what happened with prices we did not have that tax shield and the h edge position and how we had to do it for tax purposes on the dropping the hedges into the MLP.
So the combination of those events led to the case of the year one we had a negative tax shield. But we don't expect that to continue going forward.
[Steve Taft – Tocqueville Asset Management]
In other words, in 2009 you don't expect that to happen.
Scott Sheffield
Depending on whether we start, if we start drilling obviously we'll improve it quite a bit. If we don't drill, it should be closer to neutral in 2009 and then better in 2010.
[Steve Taft – Tocqueville Asset Management]
As a stockholder, I'm looking, you have to make these decisions of whether you're going to drill or whether you're going to have a drop down of additional wells and so forth, are there independent directors of PSE that evaluate this? I'm not suggesting that you're doing anything wrong. I'm not unhappy with what's happening, but I would feel more comfortable to hear that there are independent directors representing just the partners, outside partners in PSE that are looking after our interests.
Scott Sheffield
Yes. That's why we're unique among the MLP's out there. We set ours up to have three independent directors and only two directors from PXD. So we have three independent directors and two directors from PXD.
[Steve Taft – Tocqueville Asset Management]
And the independent directors are not also directors of PXD?
Scott Sheffield
No. And they can't hold stock in PXD so they're totally separate from PXD.
Operator
There are no further questions. At this time I'd like to turn the call back over to our presenters.
Scott Sheffield
We appreciate everybody joining us today and look forward to talking to you over the coming months and next quarter for sure. Thank you.
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