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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 Capital Markets

Kevin Smith – Raymond James

James [Gamble – Hecht]

Pioneer Southwest Energy Partners LP (PSE) Q3 2009 Earnings Call November 4, 2009 12:00 PM ET

Operator

Welcome to the Pioneer Southwest Energy's third 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 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 two of the slide presentation and in Pioneer Southwest's public filings made with the Securities and Exchange Commission.

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

Frank Hopkins

Good day everyone and thank you for joining us. Let me briefly go over the agenda for today’s call. Scott's going to be up first. He will review the financial and operating highlights for the third quarter and then he will update you on the drilling program that has just been initiated in the Spraberry field by PSE. Rich will then cover the third quarter financials in more detail and provide earnings guidance for the fourth quarter. After that we are going to open up the call for any questions you might have.

Before turning the call over to Scott I would like to call your attention to slide number three. Pioneer Southwest acquired assets and liabilities from a subsidiary of Pioneer Natural Resources Company in August of this year. This represents a transaction between entities under common control under generally accepted accounting standards. Because of that the financial and operating results of the partnership on the slides in this presentation that we are about to go through for the third quarter and certain prior quarters include the results of the acquired assets as if the partnership had acquired the assets at the beginning of each respective quarter.

With that note, Scott please begin.

Scott Sheffield

Good morning and thanks for listening to our call. The third quarter on slide number four our highlights for the third quarter of 2009. We had adjusted net income for the partnership of about $22 million or $0.74 per unit. That does exclude income attributable to the acquired properties prior the acquisition date in non-cash mark to market gains.

We had non-cash mark to market derivative gains of $7 million after tax or $0.22 per unit. We had third quarter production average of 5,853 barrels of oil equivalent per day. That does include production from the acquired properties. Cash flow from operations was $25 million. We declared our distribution of $0.50 for the third quarter of 2009 payable on November 12th to unit holders of record as of November 5th. This reflects an annual distribution rate of about $2.00 per common unit.

As we announced before we acquired $171 million acquisition. PSE did of Spraberry properties from the parent on August 31. Roughly $19 million BOE. Proved reserves at a purchase price of about $9 per BOE. Also we have signed certain hedge positions bringing coverage to 85% for the remainder of 2009 and 2010, 75% for 2011 and 2012 and 65% for 2013. Some of those hedge positions were also what we call three-way hedges which allows us to have upside as prices continue to move up.

We commenced a two-rig drilling program already, in fact this week. We will talk more about that. Going to page number five, initiating our drilling program. We just began our two-rig program. Our well costs are down over 30% from the peak of last year in 2008. We expect to drill 50-60 wells at roughly $1 million per well through 2010. We have an inventory of about 170 40-acre locations which will be focused on the 40 acre locations along with 1,200 20-acre locations.

What is also more important is we will be going even deeper throughout the Wolfcamp formation. Over the last three years the general partner, Pioneer Natural Resources, has driven over 100 wells and tested the Wolfcamp and we are experiencing potential reserve upside to about 30,000 barrels or higher with our results there in regard to the Wolfcamp so for a cost of about $150,000 to $200,000 obviously it is a great return in going to the Wolfcamp formation.

Strong returns of 50% plus based on the November strip. Production will be growing greater than 15% versus 2009. Obviously our Spraberry properties are well suited for maintaining MLP distributions. Very, very low decline rate. 4-6% per year after initial 7-8 years of production. That is on the newly drilled wells.

As you can see if you go to our website at PHD obviously investors will be drilling in the largest on-shore U.S. field in the lower 48. We have some interesting slides in regard to that discussing the Spraberry field.

Slide number six, production growth forecast. You can see the ramp up from roughly 2009 to 2010 of about 15% between 5,800 barrels per day and 6,100 barrels per day equivalent. Roughly about 85% of the production will be liquid focused and about 15% on natural gas.

Let me turn it over to Rich Dealy to go over our strong financials.

Rich Dealy

Thanks Scott. On slide seven as Scott talked about the acquisition with the acquisition we coupled that with the drilling program that we have initiated we do expect our coverage ratio to continue to improve. We have historically been around one and we are targeting to be greater than 1.15 with the acquisition and the drilling as that drilling ramps up.

Operating cash flow is expected to increase about 35% in 2010 compared to 2009 assuming the acquisition happened on August 31 and not prior periods there, similar to what we talked about when we did the acquisition so a great ramp up in cash flow for the partnership as a result of the acquisition.

We are still retaining about 25% of the cash flow that the partnership throws off to be utilized for our drilling program. So that drilling program will allow us to increase production using the cash flow principally from maintenance CapEx to fund that.

Liquidity position, the partnership still remains in a great liquidity position. We had $135 million of debt outstanding at quarter end and still has $140 million of availability under its credit facility. We do borrow on the credit facility at about 1.25% so a cheap rate for the company. As Scott mentioned, derivative position extends out through 2013 with a great hedge position at 85% through 2010, 75% through 2011 and 2012 and greater than 60% in 2013.

Turning to slide eight, to give you a brief overview of our earnings summary. Net income for the partnership was $25 million for the quarter. That did include $4 million of a net loss attributable to the acquired properties prior to the acquisition date. So if you look at net income attributable to the partnership that is available for common unit holders that was $29 million or $0.96 per unit. That did include a mark to market gain to the partnership of about $7 million that is non-cash for the quarter or $0.22 so adjusted for the mark to market gains we are at $22 million of income or $0.74 per unit.

Looking at the bottom of slide eight, guidance for the quarter that we came out was pre-acquisition. When you look at the Q3 results that does include the acquisition for the full quarter. I can say we were within guidance without the acquisition. Well within guidance in all of these categories. During the quarter with the acquisition we were within guidance as well other than production obviously where we acquired the incremental barrels which we said was about 1300 BOEs per day of production coming from the acquired properties.

Turning to slide nine, fourth quarter guidance, average daily production is expected to range from 5,600 to 5,900 BOEs per day. Production costs are expected to be $20-23 per BOE, slightly higher than prior guidance due to higher oil prices so we will have higher severance taxes and some increased work over activity in the field that made good economic sense at this point.

DD&A is expected to be $5-6. This is up slightly from prior quarters. Really as we look at the enactment of the new SEC pricing methodology that is coming into play for the fourth quarter that will have the effect of us running our reserves at year-end using a 12-month average for the year versus quarter end prices as historically has been done. So based on where we see the first 11 months of pricing our estimate for December we expect our reserves to run about $62 per barrel and $4 per MCF on gas and so that will have the effect of losing some tail reserves at that price there and hence have the impact of losing those reserves and increasing our depletion rate slightly for the quarter.

G&A expense is expected to be $1-2 million. Interest expense will come with the borrowings from the acquisition where we had the $135 million at quarter end borrowed so we are anticipating interest expense of about $500,000 to $700,000 for the quarter and our effective tax rate at 1% still reflecting the Texas margin tax that we are subject to.

With that why don’t we open up the call for questions?

Question and Answer Session

Operator

(Operator instructions) The first question comes from the line of Leo Mariani – RBC Capital Markets.

Leo Mariani – RBC Capital Markets

Obviously it sounds like you have your program starting to roll over there. I am just curious how many wells you anticipate drilling between now and the end of the year for PSE and how many on a sustainable, full-year basis would you expect to drill with two rigs?

Scott Sheffield

A rule of thumb, a rig can drill two wells a month in the [trend area]. Starting here we can probably get close to 4 wells down per rig so we could get 6-8 wells down by the end of the year. We will just continue that through all of next year and get up to easily 60 wells for next year. We will just keep them going after that.

Leo Mariani – RBC Capital Markets

Are those rigs contracted for a couple of years to kind of keep that drilling program going?

Scott Sheffield

No, it is contracted for one year. It is basically back to regardless of any long-term contracts we would have to escalate so it is really a bet on natural gas prices. Drilling contractors are betting that natural gas prices are going to recover significantly and so they can move up their costs. At this point in time we have elected to lock in a longer rate than one year simply because we would have to escalate it and pay a lot more upside in 2011. One of the reasons we are doing some 3-ways also is to allow us if prices do go up it allows us to participate if we do see some inflation costs in regard to the rigs going into 2011.

Operator

The next question comes from the line of Kevin Smith – Raymond James.

Kevin Smith – Raymond James

I would like to congratulate you again on the latest acquisition. It was a wise move to have the ability to drill and stabilize your production. Just as importantly, now you have more CapEx on tax savings to your unit holders. Dwelling on that, do you have a feel for what you expect the change in your year-over-year tax shield will be from 2009 to 2010?

Scott Sheffield

We expect 2009 to be in that 20% range and 2010 to be in that 70-80% range.

Kevin Smith – Raymond James

The next question is now that you are drilling does your mindset of maintenance capital change? I know you are reserving 25% of EBITDA but it seems not to be more formulaic to kind of calculate what you would need to maintain your production based off your drilling. Or is that not fair?

Scott Sheffield

It is still about the same. We have done the math and 25% basically covers it. We will borrow slightly in 2010, $5-10 million, but then after that we will have excess cash flow to start reducing debt as we move into 2011 and beyond.

Kevin Smith – Raymond James

Where do we go from here? I know you have in the past talked about picking up some mid-stream assets. Are you focused really on the AP side and really that is where your main acquisitions are going to be?

Scott Sheffield

Yes, because the returns are so good on the drilling side and with the inventory that PSE has our focus is to build up growth and deliver cash flow and at some point in time in the future look at what our distribution level is.

Kevin Smith – Raymond James

Would you prefer PDP or PUD? What is your look there? Do you want to once again acquire producing assets or some mixture I guess?

Scott Sheffield

We have 150 to 170 locations on 40’s and 1,200 locations on 20’s so we have a huge inventory. With the addition of the Wolfcamp zone adding significant reserves we can probably drill for the next several years. We have the option of increasing the rig count over time also which is a strong possibility too.

Operator

The next question comes from the line of James [Gamble – Hecht].

James [Gamble – Hecht]

Can you talk about your financing plans going forward especially given your drilling program?

Rich Dealy

Like I said we have plenty of availability under our credit facility to do whatever opportunities come our way. As we talked about at the time of the drop down in September we were considering an equity offering of up to about $75 million depending on market conditions. That is still our intent if market conditions are right to do something in that realm. You may have seen that we have filed a shelf registration at the SEC Level but really beyond that I can’t comment.

Operator

We have no further questions in the queue. I will turn the conference back over for additional or closing remarks.

Scott Sheffield

I look forward to our drilling program taking off. We will have a good report on those results next quarter. We appreciate everybody calling in.

Operator

That does conclude today’s conference. We do appreciate your participation.

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Source: Pioneer Southwest Energy Partners LP Q3 2009 Earnings Call Transcript
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