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Executives

Frank Hopkins – VP, IR

Scott Sheffield – Chairman and CEO

Rich Dealy – EVP, CFO and Treasurer

Analysts

Kevin Smith – Raymond James

Richard Roy – Citi

Michael Blum – Wells Fargo

Pioneer Southwest Energy Partners L.P. (PSE) Q1 2010 Earnings Call Transcript May 5, 2010 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, Chief Financial Officer and Frank Hopkins, Vice President of Investor Relations.

Pioneer Southwest has prepared PowerPoint slides to supplement in their comments today. These slides can be accessed over the Internet at www.pioneersouthwest.com. Again, the Internet site to access these slides related to today's call is www.pioneersouthwest.com. At the website select investors, then select investor presentation.

The partnership 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 business prospects of Pioneer Southwest are subject to a number of risks and uncertainties that may cause actual results and 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 public filings made with the Securities and Exchange Commission.

At this time for opening remarks and introductions, I would like to turn the call over to pay Pioneer Southwest 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 is going to be the first speaker. He will review the financial and operating highlights for the first quarter and then he'll give you a brief update on what's been happening with PSE's very successful drilling program so far this year Spraberry Field. Rich will cover first quarter financials in more detail, he will provide earnings guidance. And after that we'll open up the call for your questions.

Scott, I'll turn it over to you.

Scott Sheffield

Yes. Thanks, Frank, good morning. I appreciate everybody coming and listening to this call for PSE. Slide number 3 on our highlights; we had first quarter adjusted income of $23 million or $0.70 per unit. That excludes the non-cash market-to-market gain of $16 million for tax or $0.49 per unit.

First quarter production up significantly, over 6400 barrels of oil equivalent per day, almost all due to excellent drilling results, up 6% versus fourth quarter 2009. Cash flow from operations about 24 million. And with that we declared a distribution of $0.50 per outstanding unit for first quarter of 2010, payable on May 12th, record day May 4th.

We have a two-rig program, obviously it's on schedule. We put 12 wells on production during the first quarter of 2010. Flipping to our update on our drilling program, slide number 4, again as we have announced we expect to drill about 50 wells during 2010 with a two-rig drilling program.

Production rates for the new Wells have exceeded expectations. That's primarily due to the fact that we're opening up some new zones, both the shell zones in the Spraberry and the shells zones in the lower Wolfcamp, so obvious getting much higher rates, more production and more reserves than we expected.

Drill time and capital costs are on target. Our total inventory inside PSE, we have about 150 40-acre locations remaining and about 1200 20-acre locations. Obviously, strong rates of return at current NYMEX prices of 50% or greater, internal rate of return.

Let me turn it over to Rich to go over the financial highlights.

Rich Dealy

Thanks, Scott. Net income on slide 5 was 39 million at $1.19 per unit as Scott mentioned we did have the non-cash mark-to-market derivative gains during the quarter of $16 million primarily related to decline in forward commodity prices between December 31st and March 31 related to our derivative positions, so after mark-to-market $23 million or $0.70 per unit.

Looking at that the bottom of the page slide how we did relative to guidance you can see that production was, as Scott mentioned, well above our guidance due to the great performance of the wells that we put on production. All the other items there you can see was in the lower to midpoint of the guidance ranges and everything came out as expected.

Turning to slide 6, looking at second quarter guidance, production, we're expecting another good quarter of 6200 to 6600 BOE's per day of production. Production costs, DD&A, G&A, interest expense and our effective tax rate same guidance as we use for the first quarter and so no changes in those items as well.

Looking at slide 7, PSE remains a strong financial position. We did borrow $2 million during the quarter to fund the drilling programs. So we went from 67 million at the end of the year to 69 million. We still have $300 million credit facility out there of which we have access to 195 million incremental today and so we've get plenty of liquidity in the company.

If you look at our derivative positions in the appendix slide, you can see that we're 85% hedged for 2010, 75% for 2011 and 2012 and 60% for 2013 and then this is – provide a good stable base to sustain our distribution and potentially increase them in the future.

So with that, why don't I stop there and we'll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Kevin Smith with Raymond James.

Kevin Smith – Raymond James

Good morning, gentlemen. Nice quarter.

Scott Sheffield

Thank you.

Rich Dealy

Thanks, Kevin.

Kevin Smith – Raymond James

Can you talk a little bit about what you're seeing in the acquisition market in the Permian? I mean, I know this year is more focused on organic growth, but are you seeing some nice opportunities out there to maybe start consolidating assets?

Scott Sheffield

Yes. Kevin, I think what's happened is that the Permian Basin has 20% of the U.S. oil reserves, probably your most oily basin next to the North Slope in Alaska and so it's caused a rush of people to come in there, obviously I won't name companies, but people are paying some very high prices, there's been some deals announced in the 150 to 180,000 per flowing barrel metrics. And so people are really paying top dollars just to get inside the Permian Basin. So we haven't really seen many opportunities at all and just got really very competitive at this point in time.

Kevin Smith – Raymond James

Okay. Fair enough. And would you – I guess, just you still start to see the impact really of your drilling program, I mean, isn't it fair to expect to see kind of volumes sequentially ramping up throughout the year? What, kind of, if you put the midpoint of your guidance it really going to shows that production is supposed to be staying flat. I guess in the second quarter.

Scott Sheffield

Yes. We still expect production to grow. We set the range conservatively and then plan on over-performing.

Kevin Smith – Raymond James

All right. Well, I appreciate your time. Thanks.

Operator

And now we'll hear from Richard Roy with Citi.

Richard Roy – Citi

Thank you. Just to follow up a bit on Kevin's question, I mean, the wells are coming on better than expected on a percentage basis. What kind of magnitude are we talking about? And also, do you expect to repeat this throughout the entire drilling program?

Rich Dealy

Yes, Richard. I think we came out expected about a 15% growth in production initially. Obvious, we got 6% to 7% already the first quarter, so if we continue – if the wells continues to perform like that obviously we'll be upping that target and looking into 2011 about potentially increasing distributions, if we continue to see this strong performance.

Richard Roy – Citi

Got it. In terms of your comments on the acquisition market, it seems that you prefer to allocate your capital and your time to the drilling program, but at which point do you start looking at acquisitions more closely? I mean, is that a 2011 event or from a timing perspective, what would you – how would you characterize that?

Scott Sheffield

We have 1350 locations. As long as we're getting 50% returns inside the MLP by just drilling wells, we cannot duplicate that by making acquisitions. So PSE has a nice luxury not to be able to have to acquire like other MLPs have to do. They have to acquire. So they've got to pay top dollar. So right now drilling is the best way to good on these economics. We just can't duplicate on the acquisition side.

Richard Roy – Citi

Great. Thank you very much.

Operator

(Operator Instructions). And now we'll hear from Michael Blum with Wells Fargo.

Michael Blum – Wells Fargo

Hi, good morning guys.

Scott Sheffield

Good morning.

Michael Blum – Wells Fargo

Just two quick questions, kind of – I think you just touched on one. Just in terms of thinking about distribution growth, I think – did you say would you consider it in 2011, assuming the drilling program remains successful as it's been?

Scott Sheffield

Yes, that's what I said.

Michael Blum – Wells Fargo

Okay. And then just along the same lines, but instead of acquisitions, would you guys consider consolidation in the space is that something that would you look at or you think ear just going to kind of stick to your name?

Scott Sheffield

Yes. Right now, I think the best focus is get these wells drilled. So at this point in time we're not looking at any consolidation opportunities.

Michael Blum – Wells Fargo

Okay. Thank you very much.

Operator

And there appear to be no further questions at this point, gentlemen. I'll turn it back to you for any closing or additional remarks.

Frank Hopkins

Again, thanks we appreciate everyone taking the time listening to our call. And again, look forward to seeing you on the next quarter. To update you on the next quarter's drilling. Again, thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Again, we appreciate your participation.

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