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Petrohawk Energy (NYSE:HK)

Q1 2010 Earnings Call

May 05, 2010 11:30 am ET

Executives

Floyd Wilson - Chairman and Chief Executive Officer

Richard Stoneburner - Founder, President and Chief Operating Officer

Stephen Herod - Executive Vice President of Corporate Development and Assistant Secretary

Mark Mize - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Michael Hall

Dan McSpirit - BMO Capital Markets Canada

Jason Gammel - Macquarie Research

Chris Pikul - Morgan Keegan & Company, Inc.

Subash Chandra - Jefferies & Company, Inc.

Ronald Mills - Johnson Rice & Company, L.L.C.

Gil Yang - BofA Merrill Lynch

Eric Hagen - Lazard Capital Markets LLC

Brian Corales - Coker & Palmer

Marshall Carver - Capital One Southcoast, Inc.

Leo Mariani - RBC Capital Markets Corporation

Operator

Good day, and welcome to the Petrohawk Energy Corporation's First Quarter Earnings Call. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Floyd Wilson. Please go ahead, sir.

Floyd Wilson

Good morning, everyone. Thanks for joining. This conference call may contain forward-looking statements intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For a detailed description of our disclaimer, see our press release issued yesterday and posted to our website, as well as our other public filings.

Again, good morning. We had a great first quarter here at Petrohawk. It was a very busy quarter and was a real kick start to 2010. Our production was on the high end of guidance, our costs were in line and our liquidity forecast is bolstered by the announcement of three major divestitures which is already closed. Our credit facility has been redetermined and divestitures were taken into account. We found a phenomenal business partner in Kinder Morgan on the midstream side of the Haynesville gathering business. And we increased our exposure to crude oil and liquids through a budget reallocation in Eagle Ford and two property additions in the Red Hawk and Black Hawk projects. And our third completion of Black Hawk is another high-rate oil and gas well.

Our reallocation of resources when the Eagle Ford will be accretive to cash flow, turns out you can do an awful lot of housekeeping at $4 gas. Another comment on our partnership with Kinder Morgan was their help in Petrohawk's production growth in the Haynesville. We expect to jointly turn that business into a real powerhouse with a focus on quality service to all producers. And our restricted rate program in the Haynesville is yielding some very exciting results. Moderating rates and moderating withdrawal during the time of low natural gas prices is an interesting capacity capability.

The theme for Petrohawk in 2010 is that we are exercising our options. We, like our shareholders, are here to make money. And while we can stay afloat on $4 gas, staying afloat isn't why we're here, so we're pushing hard. The optionality created within our strategy is bearing fruit today.

Sometimes I'm asked what is misunderstood about the company by the investment community. While I don't really know about that, I do want to focus attention on our awesome portfolio. Our entry into the Haynesville Shale was transformational for the company and landing the core position in that play was exceptional. Development drilling in the Haynesville will support strong growth in increasing cash flow for years, and the Eagle Ford is the perfect complement to the Haynesville in today's commodity environment.

The magnitude of this large oily component needs to be recognized. We currently have under lease roughly the same amount of acreage in the Eagle Ford as in the Haynesville, over 350,000 net acres in each play. And within the Eagle Ford, approximately 225,000 net acres are perspective for oil and natural gas liquids as well as natural gas.

Of all the risks future development locations within Eagle Ford Shale, about 2/3 of them or well over 2,000 drill sites should be crude oil and liquids rich. So while crude oil and natural gas liquids are a small part of our production today, we can grow it quickly without compromising our plan to secure and maintain leasehold at Hawkville, at the Haynesville Shale or anywhere else within our holdings.

Of course, we aren't alone. Several companies are playing the oil card where it exists within their portfolios. This makes sense today. We believe natural gas is an important part of the U.S. energy security and clean air picture, but while natural gas prices are low, we will continue to grow our crude oil components as quickly as possible. When the balance of supply and demand again tips in favor of natural gas, we will be there with an aggressive response. With that, I'll turn the call over to Mark Mize.

Mark Mize

Thank you. As Floyd have stated, the first quarter has proved to be another successful period for HK. We were able to exceed the $1 billion goal of divestitures, complete our borrowing base through determination, which did result in an increase to the credit facility, and production and LOE have continued on a strong positive trend. Regarding divestitures WEHLU did close on April 30, that yielded proceeds to the company of $152 million, and those were utilized to partially pay down the credit facility post close of the first quarter. Terryville is scheduled to close on or before the end of the month, as is the HFS transaction with Kinder Morgan. Cash taxes on all three transactions are expected to be approximately $100 million.

A final comment on KinderHawk. Once this transaction closes, we expect that it'll be accounted for at the HK level as an equity investment. This will result in a single investment line on the balance sheet and a single line on the income statement, which will appear below operating expense. The investment account on the balance sheet will be adjusted each quarter based on HK's ownership percentage in KinderHawk's income. Further, once the transaction's been executed, we'll incur -- we do expect that we will be incurring additional third-party gathering charges with KinderHawk. That will be reflected on the gathering line of the income statement.

Regarding the borrowing base redetermination which did occur at the end of April, the process resulted in the E&P borrowing base increasing from $1 billion to $1.2 billion, and including the revolver capacity on the midstream portion of the facility put us at about $1.4 billion. In the press release, you'll note that we do strip out the credit facility capacity related to assets that are being divested, and that does yield an estimated borrowing capacity of about $1.1 billion. The only other comment on the borrowing base, we do expect that KinderHawk will have its own credit facility and to the extent, we have capacity at that level that would further increase the overall liquidity of HK.

Now we'll turn to the first quarter results of operations. And for purposes of this call, I'll limit my comments on guided financial metrics to items that are not within the previously published guidance ranges. Natural gas price realizations, excluding the impact of hedges did come in at $5.15 or 97% of NYMEX; and including the impacts, came in at $5.61. We continue to maintain a hedged program with a target to hedge 70% of anticipated production over the next 18 to 24 months. We currently have locked in an average floor over the next few years on our anticipated gas production that ranges from just under $5 up to just over $8, and we collected $25 million in hedged proceeds on our natural gas position this quarter.

LOE, workover, gatherings, stock-based comp and our effective tax rate all came in within guidance, so there's not a lot to say there. I will comment briefly on LOE which came in at $0.31 per Mcfe, and that is significantly under where we were at the end of last year, with fourth quarter coming at a $0.44. This result was primarily driven by the divestiture of the Permian property. This is the first quarter that activity is completely out of the quarterly results, as well as increased production on lower cost area, such as Haynesville and Eagle Ford.

Taxes other than income came in at $0.23 per Mcfe, which is under the low end of guidance by about $0.10. The reduction is the result of Louisiana severance tax refunds at HK has either received or expects to receive. Going forward, we believe there'll be additional refunds in Louisiana as well as Texas.

G&A is $0.41 per Mcfe, excluding the impact of certain legal costs which were recorded in the current quarter and totaled $5 million. This charge resulted in an as-reported G&A per Mcfe of $0.50. Future legal costs become known and are probable of being incurred, that charge will be reflected in the results at the respective quarter.

This quarter, the unrealized non-cash derivative mark-to-market was fairly significant, coming in right at $190 million. However, this is a non-cash gain and has been removed from our results of operations in the selected items table that can be found in the press release.

Finally, regarding cash taxes. At the end of the year, we were holding about $214 million of restricted cash which represented proceeds remaining from the Permian divestiture, and those proceeds have now been redeployed into leasehold through a tax efficient like-kind of exchange. Second, we do not expect to have cash taxes in 2010, above and beyond those associated with the asset divestitures. With that, I'll turn the call back over to Floyd.

Floyd Wilson

Thanks, Mark. Our property base affords us a great degree of optionality and we are exercising our options as we speak. And this is timely. And all of our core properties are durable over the wide range of commodity pricing. At our upcoming Analyst Day, we will provide additional details on all of our core fields and projects. Jennifer, we're ready for questions, if there are any.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Jason Gammel with Macquarie.

Jason Gammel - Macquarie Research

Just a question on the eight rigs that are being deployed now across the greater Eagle Ford area. I think the split previously was four in Hawkville, three in Black Hawk and one in Red Hawk. Would you anticipate that, that number is going to change at all, or is that essentially the mix that you'll have moving forward?

Floyd Wilson

We're going to adjust that a little bit, Jason. By midyear, we should have five operating in Black Hawk and three operating in Hawkville. We do have one currently in Red Hawk, but after we finish this second well, we'll evaluate the results of that well and not be back there probably until the end of the year. So five in Black Hawk, three in Hawkville is the split.

Jason Gammel - Macquarie Research

And would you also be able to just share what the overall hydrocarbon mix is in each of these areas between nat gas, C3, C4 and then C5+ just on a percentage basis?

Floyd Wilson

Well, I don't have that. I have the condensate versus gas.

Jason Gammel - Macquarie Research

That's fine.

Floyd Wilson

Condensate gas is around 85% gas, 15% condensate in Hawkville; and around 2/3 condensate and 1/3 gas in Black Hawk; and 100% oil in Red Hawk.

Jason Gammel - Macquarie Research

The restricted cash, I understand that you pulled down the remainder of that so far during 2Q. That looks like that you maybe have roughly $150 million down that would be targeted for incremental leasehold expenditures this year. Would any of the cash and divestitures proceeds then have been directed into like-kind exchange restricted cash, or is that all just completely discretionary cash?

Mark Mize

The money -- are you referring to the press release that were brought in from WEHLU?

Jason Gammel - Macquarie Research

Yes.

Mark Mize

We took 100% of the proceeds that came in from WEHLU and pay down the credit facility.

Operator

We'll go next to Leo Mariani with RBC.

Leo Mariani - RBC Capital Markets Corporation

Just curious about your acreage that you've got out there in the Eagle Ford. Could you let us know what percentage or just give the individual acreage numbers in Hawkville, Red Hawk and Black Hawk?

Floyd Wilson

Yes, the total acreage position in Hawkville is around 235; in Black Hawk, the net position is around 53; and the net position in Red Hawk is about 87.

Leo Mariani - RBC Capital Markets Corporation

And clearly, you guys continue to add acreage. Are you trying to add mainly at Black Hawk and Red Hawk at this point in time?

Floyd Wilson

Leo, we've added in all of our core areas, including just a tiny bit in the Haynesville that really attracted prices. So all of these plays are quite tight right now, so there's not a lot of opportunity to add. But we are adding a little bit here and there. I think we added 4,000 acres at Hawkville, 32,000 acres at Red Hawk and the whole 56,000 acres at Black Hawk was added this year. 18,000 was added at Haynesville during the quarter, mostly deals that were struck last year and closed in the first quarter.

Leo Mariani - RBC Capital Markets Corporation

It sounds like you guys are going to more restricted rate, choke back wells in Haynesville. You guys feel pretty confident that you've sort of hit that, that crossover point on the production rate, and can you just give us some detail on kind of how much production history you've got and kind of roughly when do you get to that, that crossover point where it makes sense to choke the wells back?

Floyd Wilson

Leo, I think we've probably some curves on that prior to today. I think as a generalization in every case, we project that we catch up on cume [cumulative] within a year, sometimes less than that. And that's what our target is. And we've seen enough positive results from this that we're basically putting all new wells and most of our existing wells on a restricted rate program at varying choke size is depending on where they are within the field. Is that responsive?

Leo Mariani - RBC Capital Markets Corporation

Yes. Absolutely. I guess you guys are just getting ready to get after your first Bossier well. Do you have set plan to drill additional wells in the Bossier this year, or you're just going to evaluate that first well and decide from there?

Floyd Wilson

Well, the great news is that we don't have to do anything. On the south end of the play, we're quite interested in evaluating the Bossier potential. And the other piece of good news is, there's a lot of other companies have already evaluated down there with quite a few data points. So while we're not driven to drill specific Bossier wells, we'll probably drill another couple this year.

Mark Mize

The only thing I would add there to what Floyd said is that the way we have it mapped, we see some operated sections on the south end of our position that probably don't have Haynesville potential, but they have Bossier potential. So I think towards the end of the year, as we get a little further down the evaluation of the Bossier, we'll probably drill some of those sections that probably only require a well into the Bossier. We'll certainly drill a tail into the Haynesville and confirm our bias that the Haynesville is pinched out that far south. But I think there's a handful of wells that late this year, early next year, we could drill as Bossier stand-alone wells.

Leo Mariani - RBC Capital Markets Corporation

And do you guys have a rough estimate at this point in time as to how much your acreage you think is prospective for the Bossier?

Mark Mize

Yes, we've put about 122,000 acres that we've basically placed within what we think is a commercial limit based on subsurface mapping.

Operator

We'll go next to Michael Hall with Wells Fargo.

Michael Hall

Just curious on the Eagle Ford Shale, if there's any intention or thoughts along the lines of moving towards intentionally restricted rates in your program there? Or any thoughts as to why it would or wouldn't work similarly as to how it is in Haynesville?

Floyd Wilson

We are moving toward that. We're actually producing our first Joint Venture well with Swift at a restricted rate, albeit more based upon pipeline conditions than a conscious decision. But on our Hawkville operated position, we have a number of, what I call, experiments where we're testing whether it'd be restricted rate or hybrid frac, versus slick-water frac or various other comparisons we can make between either production practice or completion practice. And one of those is a restricted rate well offsetting a well that's non-restricted. To the question of whether we think it has the same makeup in terms of why it should work, it's really too early to tell. They are distinctly different reservoirs in terms of their overall mineralogy and things that might make you think that the Haynesville might be a more likely candidate. That's my own bias. But we're certainly not going to let that bias avoid the testing process. So we will test it, and we'll watch it and see what happens.

Michael Hall

And then, have there been any meaningful changes in completion design thoughts in the Eagle Ford, kind of what's the latest state-of-the-art that you're working there?

Floyd Wilson

Well, it goes back to what I just mentioned in terms of various changing specific set of parameters on wells that we're actually drilling from the same path and opposite directions. I'm intrigued with the hybrid frac. We are running hybrid fracs, meaning, primarily cross-linked gel fluid, transport to sand. We're doing that in the Black Hawk area exclusively and we're doing it in the Red Hawk, where both are very high liquid-producing areas. We're going to try it in Hawkville, see what happens there. The other change that we're testing is a premium profit versus a white sand profit. So those are some of the things that we're doing. We're clearly drilling longer laterals, that's an across-the-board operation at this point. We're building our units in a rectangle that is going to allow us to maximum about 7,000-foot vertical section, which would be probably in the order of 6,500-foot lateral length. That's more or less the limit the coil tubing can reach, so that's kind of how we're designing them today. So we're constantly changing parameters on the completion side. But as an evolutionary process, it takes quite a long time because you can really only change one parameter given time or we don't really know which one cause the change. So we're doing that in the Haynesville just as aggressively as we are in the Eagle Ford.

Michael Hall

Any chance on giving some initial thoughts on what rig counts will look like in 2011 in your respective plays, the Eagle Ford and the Haynesville in particular?

Floyd Wilson

Michael, in a general sense, we're planning on a relatively flat budget, keeping in mind that we've got quite a bit of optionality built into that. And whenever the lease capture issue in the Haynesville is behind us, we are in the midst of growing the very important business there, KinderHawk, so we intend to keep those pipes full. I think, at this stage, if you just look about a relatively flat budget and flat rig count in the various areas, you'd be fairly accurate.

Operator

We'll go next to Brian Corales with Howard Weil.

Brian Corales - Coker & Palmer

One, what is the ultimate goal with KinderHawk? I mean, is the plan down the road to sell the other half for capital, or just to maintain the partnership?

Floyd Wilson

Well, again, I would like to classify that as something we have in the way of options here. We intend first to make sure that this business that we created with this great operating partner is highly successful and one of the main operators of both Petrohawk and third party gases in the Haynesville fields. I'm hopeful that over time, the answer will come to us as to whether or not to sell down the rest of it or maintain it. They're very experienced and we're very comfortable with them as partners. So I would say that option is wide open. We do anticipate EBITDA growth within KinderHawk over the next couple of years, so the value should increase. And I just might add to that, that we're following the similar pattern down in the Eagle Ford. We don't have quite the intensity of rig count there, so the ramp up in EBITDA is more orderly and construction's a little more orderly. But we intend to follow some of our strategy down there to find a great operating partner and hopefully, it will be Rich Kinder, but that's in the future as well. Eagle Ford, as you know, is a year or two behind the Haynesville in terms of development.

Brian Corales - Coker & Palmer

Just in the press release, you commented that you're leasing in outside your core areas. I mean, can you provide any additional info there?

Floyd Wilson

No.

Brian Corales - Coker & Palmer

Nothing?

Floyd Wilson

No.

Brian Corales - Coker & Palmer

And lastly, just the service environment, both on the -- especially on the completion side, are you all seeing any major delays in the Haynesville or Eagle Ford?

Mark Mize

Major delays, no. Occasional delays of job in front of us might have gone a little longer and therefore, it gets pushed back about a few days. But as we mentioned before, we have built a very, very substantial relationship with Frac Tech by virtue of the agreement we signed at the end of last year to provide us two dedicated frac fleets. We have another one with another major service provider that's dedicating a frac fleet there in the Haynesville, so we have the dedicated fleets there. Schlumberger have been doing all of our stimulation in South Texas, did a three-rig program. We've added another frac fleet on top of that. So really, by virtue of our activity level, we get better service than most others and therefore, we're not seeing some of the delays that I think the industry is seeing, particularly those that don't operate 25 rigs in both plays.

Brian Corales - Coker & Palmer

And then finally, you mentioned that one other divestiture in the Mid Con, could you maybe give reserve or production?

Stephen Herod

Yes, we've mentioned this before. This is a group of miscellaneous properties in the Anadarko, Arkoma and also east Texas producing about 20 million a day equivalents right now.

Brian Corales - Coker & Palmer

And is that all gas or mostly gas?

Stephen Herod

It's about half gas, half oil.

Operator

We'll go next to Eric Hagen with Lazard Capital Markets.

Eric Hagen - Lazard Capital Markets LLC

What's your current thinking on Joint Ventures? Do you think they add value? Would you consider one?

Floyd Wilson

Well, our thinking has evolved a little bit there and that we certainly are open to the concept. However, since our financing is in such good shape and we project that we'll become cash flow positive soon, we don't have quite the drive to go down that path. I will say that we're clearly more -- we have considered it more recently than we have in the past, and that's not a signal. I'm just saying that the realities of a 30-year or 40-year drilling program are what they are. The other issue with that is and just being realistic, if you're not going to really accelerate drilling with a JV, that's one thought. And if you shouldn't maybe accelerate drilling when you have $4 gas, that's another thought. If you don't need the money so bad, that's another thought, so you throw all those things in the pot. There's some good reasons for us to think of these and there are some reasons that we're not really -- it's not a burning issue here by any means. Is that helpful?

Eric Hagen - Lazard Capital Markets LLC

Yes. Is it fair to say that if gas prices were to bounce back and that might be a better opportunity than versus sort of selling at the bottom, is that kind of your thinking?

Floyd Wilson

If we had some good reason to accelerate drilling beyond our already torrid pace, that would certainly be a consideration for sure. And there's some great JVs going on around the country. We've been able to watch those and see how the parties have been interacting. And it all seems pretty good to me.

Eric Hagen - Lazard Capital Markets LLC

In the Eagle Ford, what's the current processing capacity for the liquids there? And am I reading correctly, it's going about 12,500 barrels per day next year?

Mark Mize

Well, that's for the condensate stabilization facility which is different than like liquids processing.

Eric Hagen - Lazard Capital Markets LLC

Are there any bottlenecks now there in the basin in terms of processing, marketing your liquids? Is this going to be an issue for producers down there?

Floyd Wilson

Eric, we were fortunate early on that our group that manages that business secured some capacity in the processing plants well ahead of the drilling ramp up. And at this time, we don't really see any real bottlenecks for Petrohawk. I can't really speak to the basin in general. But you might assume that there's a lot of rigs running there that weren't running there a year ago. We have excess capacity now, contractually, and we're going to try to stay ahead of that. We don't exactly know where each component of the natural gas liquid stream gets priced. And each of those components bring their own opportunity or their own issue with them depending on what the markets are for them. Ethane, of course, being one of the components that is a bit under pressure at this time, price-wise.

Eric Hagen - Lazard Capital Markets LLC

One final one just for Dick, in terms of these horizontal oil plays, are you seeing the opportunity on any of your legacy acreage to replicate sort of the Black Hawk, Red Hawk concepts? And if so, when do you think you might be able to talk about them?

Floyd Wilson

I'd like Dick to answer that, but keep in mind that we've sold most all of our legacy acreage in the past two years.

Richard Stoneburner

The legacy has been outgrown [ph]. We've a very good opportunity underneath it. But that's kind of facetious, but no, I don't think there's much left that we can go looking for other opportunities underneath it. That's a good thing.

Operator

We'll go next to Dan McSpirit with BMO Capital Markets.

Dan McSpirit - BMO Capital Markets Canada

You spoke earlier about testing proppants, premium versus white sand. Can you speak about or speak to the cost difference, the savings involved?

Richard Stoneburner

It's significant. White sand is kind of on the order of a $0.05 a pound whereas premium sand is on the order of $0.35 or $0.40 a pound. And ceramic's even above that. So it's not an insignificant variable within your well cost. But then again, if you're going to have an appreciably higher EUR by virtue of a better well and that's the real question we're trying to answer. The availability, certainly, of ceramic is the biggest issue I think, in a perfect world, if ceramic was more available, probably run it particularly in the Haynesville. I think our really testing process on premium versus white in the Eagle Ford, in the deeper areas certainly, in the northeast part of Hawkville and Black Hawk, we're already gravitating toward the premium proppant. It's really what I'd call the core area of Hawkville where we've been drilling most of our wells in the 10,500, 11,000-foot range that we really need to determine whether it needs premium. But it is a significant cost component. We need to know the answer.

Floyd Wilson

Dan, I think we have enough tests going on throughout all of our areas to give us an answer as to how hard we need to push towards ceramic in given areas or totally premium in given areas. And we're fairly -- we've done a lot of drilling and really brought in a lot of new production. We've got by the end of this year, 200 or 300 wells drilled across all these plays out of thousands of locations. So we're testing this rather diligently to make sure that if a change is called for, we can secure supplies and have an orderly development program if we need to change to ceramic or whatever.

Dan McSpirit - BMO Capital Markets Canada

Then turning to the restricted rate program in the Haynesville, how should the first year decline rate compare to those wells drilled, say, with a 26/64" choke or put online with that choke size? And then by how much time, maybe I guess, measured in years do you postpone compression?

Floyd Wilson

The decline rate is about half, it's 40% to 50% in the general sense, at the worst. The postponement of compression is, we haven't quite run the full study on that. But I think on a intuitive basis, we've said it is four, five years probably. We have found out that in some of the earliest wells we drilled within the Haynesville, that we were considering compression on those. And we started restricting the producing rates on those and they're not going to need any compression anytime soon. So it's quite an economic jewel there to postpone compression. So four or five years is our best guess right now. But...

Richard Stoneburner

I can, too. I'd say it's more than that. And just as maybe an advertisement for the Analyst Day we have coming up in a couple of weeks, we're going to have a lot more specific information regarding all of our production practices that I think will be very, very interesting. It's hard to describe in a conversation in terms of what we're actually seeing. So I think we'll be able to show the public a lot more when we get in front of you and show you some of these data.

Floyd Wilson

The last comment on restricted rate, clearly, we're still evaluating these decline rates. I mean, we have the early data on a really good number of wells and the data is all similar. But it's too early to really generalize for the future. But we're still evaluating the decline rates for sure.

Dan McSpirit - BMO Capital Markets Canada

And then turning to KinderHawk, the question was asked earlier about what next, that is, how do you create a larger value creation event for your ownership position. How does the public route rank among those options?

Floyd Wilson

I would have to discuss that with Mr. Kinder. They already have an apparatus within their own company, I believe, to go that route with their own ownership. So I'm not so certain that this would be adaptable to that. I never really thought about it too much. Our focus right now is to finish the buildout of the main components of the field, to get the EBITDA up there where we think it can be. And then evaluate our options at that time. And if an MLP happens to be one of those options, I guess that's something tells me, though, with Kinder Morgan being in that business already, that's probably not the right answer.

Dan McSpirit - BMO Capital Markets Canada

At what point do you exit, really monetize your position in the Fayetteville or does that stay with the company until the company is ultimately sold?

Floyd Wilson

Well, I've got eight kids and I've only ever considered getting rid of one of them. So the Fayetteville, it's a great property, but it certainly is not our focus. And this is a clear signal that we are certainly considering our options there more than we have in the past. There's nothing ongoing at this time. But it's certainly a current consideration for us to think about that in the hierarchy of all of our opportunities.

Operator

We'll go next to Gil Yang with Bank of America Merrill Lynch.

Gil Yang - BofA Merrill Lynch

Your comment about your oil production ramping up to 15% to 20% of your volumes by the end of 2011, that's on a run rate basis, is that correct?

Floyd Wilson

Yes, that would be a run rate basis towards the end of the year, clearly. This year, we might get up to 5%, or 6% or 7% this year and then we'll just have to see where all this goes. It's not a black box, but it's certainly a projection.. I'm just going to say that it's a narrow growth of owning this great property at Red Hawk and Black Hawk, not so much something else. And of course, gas prices play a huge factor in what your appetite there is. If gas prices were different than $4, you might have a different development strategy in a lot of these areas.

Gil Yang - BofA Merrill Lynch

While in that context, I think you've commented that all your Haynesville acreage will be held by, I think, the middle of 2011, is that correct?

Floyd Wilson

Most of them. Substantially, all the material acreage by somewheres around the middle of the year. We have some 2012 expirations. They're not a huge number, but we're not under the gun on every single lease there. And as I pointed out, I think to you, in our last meeting, there are certainly some acreage around the fringe that we didn't intend to hold. It's not a huge component. But we don't feel the need to hold every single acre that we own there.

Gil Yang - BofA Merrill Lynch

Well, if the current gas environment versus oil environment persists into 2012, given that you'd have more flexibility to redirect capital, do you see that your oil component could significantly ramp up even from the 15% to 20% level in 2012 as you -- because presumably, you could derive a lot capital to oil drilling once you've held most of the acreage?

Floyd Wilson

That's a little far out there for us to make a projection on. We're certainly hopeful that natural gas prices firm up a little bit from $4. We have an awesome field there in the Haynesville and we intend to be as active there as the economy's gas prices versus cost will allow. We have a huge investment in gathering and treating there. So we fully intend that that's a focus. I think within Eagle Ford, the opportunity there is always going to be just to reallocate capital within the Eagle Ford. That's always going to be an opportunity for us. In terms of, listen, we're a 97% gas this quarter. We may get to 94%, 95% or something by the end of this year and maybe 80%, 85% next year. That's a big leap anyway because we are drilling in gas basins. Let's be practical.

Gil Yang - BofA Merrill Lynch

Floyd, did you mean that reallocating capital within the Eagle Ford into the oilier parts versus the gassier parts, is that what you're referring to?

Floyd Wilson

Yes. We have a much more modest lease capture program in the Eagle Ford that gets better every time we drill a well. So we would have the ongoing opportunity to drill in that part of Hawkville that's more liquids and condensate rich and, of course, up at Black Hawk and Red Hawk.

Gil Yang - BofA Merrill Lynch

I think, Dick, the last time we talked, you spoke about changing completion techniques in the Haynesville to reduce costs. Could you talk about what is driving the current decline in the completion costs that you're seeing today and whether or not you've implemented some of the new techniques that you were talking about in terms of frac-ing down the well casing rather than the production casing?

Richard Stoneburner

Well, probably a bit more technical than probably I want to get into on a call such as this, but we are trying to reduce our surface treating pressures by changing our well bore design. It's going to be a slow process to be comfortable with all of the changes that we're going to implement to make sure it's as safe as it needs to be. But that could -- if we can reduce our surface treating pressures to below 10,000 pounds which we think we can, we reduce our costs, number one. And we increase the number of frac fleets that can serve us at Haynesville well. Currently, 20 or some number of frac fleets in the whole field. But if we can reduce surface treating pressures in the number of frac fleets available to us, probably doubles. So it's a mid- to long-term program that we're going to test through the balance of the year. And if it works, maybe by 2011, we can implement it across-the-board and it could certainly have a significant overall reduction of our completion cost.

Gil Yang - BofA Merrill Lynch

Have you actually drilled the well or completed the wells using the new methods or not yet?

Richard Stoneburner

No, we have one that is designed and ready to drill. We're probably spudding it within the next couple of weeks. But again, we'll not only have to drill it and complete it, but we'll also have to watch production on it for a while. So it's going to be slow process to validate. But all the engineering evidence, if you will, supports that it's a solid design that should be just as safe and effective as any other design.

Gil Yang - BofA Merrill Lynch

And can you venture your expectation for the cost savings if everything works according to plan?

Richard Stoneburner

I'd just say significant. I think time will tell if those costs are going up, they're going down. But it's significant.

Operator

We'll go next to Ron Mills with Johnson Rice.

Ronald Mills - Johnson Rice & Company, L.L.C.

First question really probably for Mark, on the gathering fees, I know you all talked about in your 8-K, that gathering fee is about $0.30 or so for your production under that deal. Did you all already did an accounting for that in those realized price and so therefore you're kind of robbing Paul to pay Peter?

Mark Mize

Up until this point, all of Hawkville services was a wholly-owned sub of HK. So to the extent, there were revenues or expenses being generated internally, those were obviously eliminated in consolidation. And then going forward with KinderHawk, being a completely independent third-party, I mean, there will be a gathering fee paid and per the agreement, it's $0.34 and there's an additional amount that goes on top of that based on CO2. And we would expect under the equity method approach on the way it's going to roll up in HK, you're probably looking at a number probably around -- we're still working through this, but maybe call it $0.20 for the full year 2010 and probably a little more than that in third quarter and fourth quarter.

Ronald Mills - Johnson Rice & Company, L.L.C.

And then as it relates to the restricted rate program versus your production guidance, you left your production guidance unchanged for the full year despite bringing all your new wells on at restricted rates and just like even going back to quite a few of your currently producing wells. What's driving that implied increase production in other areas?

Floyd Wilson

Other areas other than the Haynesville, Ron, or what?

Ronald Mills - Johnson Rice & Company, L.L.C.

Just in general, if you were assuming $650 million to $660 million a day before, now you're going to bring your new wells on at restricted rates and even pull back on some of your current producing wells, yet your production guidance hadn't changed. That would imply if you hadn't done the restricted rate or expanded that that your production would've been higher. So I'm just trying to figure out where that delta is. Is it well performance or a ramp to the eight rigs in Eagle Ford? Or what was driving that?

Floyd Wilson

Yes, there's several things at play there, Ron. One, we did adjust guidance prior to today just to acknowledge the effect of divestitures. I think we dropped the full year guidance by about $20 million a day. And then secondly, as you can tell from our comments, we expect the Haynesville restricted rate wells to, generally speaking, catch up and exceed maybe the normal practice wells within a year. So we're counting on that and just the general sense that there's always a large backlog of wells to be completed that have already been drilled at any given moment. And so we're comfortable that we're on the right track with this restricted rate program. We're comfortable with our production projections as they, I think, they account to about 31% year-over-year organic production growth. And we have a fully wrought plan in each field, and we're not counting on any additional reallocation within, say, Hawkville and Black Hawk beyond what Dick described a minute ago for the balance of the year.

Richard Stoneburner

The only thing I would add, Ron, is that, and again, it's hard to describe these curves on a restricted rate wells without really looking at them. But we really get backloaded production in the third and mainly the fourth quarters as these wells remain flat as opposed to a highly declining well. So most of our growth that you'll see, as we announced today, our second quarter guidance is not significant growth over the first quarter on a pro forma basis. But when you look at third and particularly fourth quarter, you'll see that the production increases are significant as we get these restricted rate wells that are much flatter in the seventh, eighth, ninth, 10th month as compared to the other wells.

Ronald Mills - Johnson Rice & Company, L.L.C.

And then from a capital program, looks like your leasing budget is gone to about $500,000,000 from, I think your prior range $100 million to $300 million but it looks like you've already spent more than 60% of that. And then also on the KinderHawk program, the $280 million, is that your net portion of that CapEx? And if so, does that represent an increase in spending for the midstream versus prior expectations?

Floyd Wilson

Yes, first off, on the overall lease acquisition program, we did experience proceeds far in excess of expectations on divestitures. And since we've been making such great purchases within our core areas, we felt it was a pretty good move to increase our target there just a little bit. And then what was the last part of that, Ron?

Ronald Mills - Johnson Rice & Company, L.L.C.

On the midstream capital, it's $280 million now, up a little bit although you did sell half of the Haynesville gathering systems. So it seems like on the midstream side, there's quite a bit more expenditures, are most of those focused on the Eagle Ford?

Floyd Wilson

Generally speaking, they're all in Eagle Ford. We're having -- we've got the opportunity there to have and the need to lay dry gas lines and wet gas lines and provide storage and containment for these high-gravity condensates and so on. So we're spending more money there and, of course, that program's evolving. Keep in mind that when the Hawk Field Services budget was set and reported to the public last November, Black Hawk wasn't on the books. So yes, the growth is pretty much down there. But again, I think we're actually going to receive some of our first quarter and second quarter expenditures back on the Haynesville portion of the gathering system when we closed the deal. So net-net, it's all shaping up pretty well.

Operator

We'll go next to Chris Pikul with Morgan Keegan.

Chris Pikul - Morgan Keegan & Company, Inc.

We've heard from other operators that service companies have had to cut back or restrict some of their activity from kind of 24 hours to daylight only to better maintain their equipment. I guess specific to you guys, are you seeing anything incrementally out there that could, in any way, hamper your Haynesville program for the year?

Richard Stoneburner

No, we made that move probably nine months ago. I think the first probably three, four, five months we were going 24/7 and realized that not just the equipment but the people, it was too demanding. You really weren't being as efficient as you were with just running daylight. So we've been doing that for a long time. And as I said previously, with our current level of activity, I think we're a preferred customer, if you will, and we're getting pretty darn good service out there, both places.

Chris Pikul - Morgan Keegan & Company, Inc.

And then, we've kind of danced around this before, but just commenting strategically on the increase in your acreage budget and I guess, Floyd, your comment that we may see flat CapEx next year, I assume is that roughly, are we talking sort of $2 billion area all in?

Floyd Wilson

No, I was talking about drilling the completion CapEx. I have no expectations for lease purchases for 2011.

Chris Pikul - Morgan Keegan & Company, Inc.

So we'd still be looking at a number closer to $1.3 billion, $1.4 billion?

Floyd Wilson

Yes.

Operator

We'll go next to Marshall Carver with Capital One South Coast.

Marshall Carver - Capital One Southcoast, Inc.

In the past, you've given a breakdown of production by area. Do you have that for the Fayetteville, Eagle Ford, Haynesville and other for the first quarter?

Floyd Wilson

We certainly have it. I don't know that we've reported it. But we'll put it out there soon and it'd certainly be on the Analyst Day. If you'd like to call in, that information's readily available.

Richard Stoneburner

Yes, I could get it for you, Marshall. I could stab at it but it's probably not -- I'd probably miss it a little bit so why don't you shoot me an e-mail and I could forward it back to you.

Marshall Carver - Capital One Southcoast, Inc.

And one question on your modeling of Petrohawk going cash flow positive soon, when do you model Petrohawk going cash flow positive?

Floyd Wilson

This is an internal projection, of course, but it's 2012.

Operator

And we'll go next to Subash Chandra, Jefferies.

Subash Chandra - Jefferies & Company, Inc.

What are the practical implications of getting a tight gas designation in the Eagle Ford?

Floyd Wilson

What are the what, I didn't hear you, Subash?

Subash Chandra - Jefferies & Company, Inc.

What are the practical, I mean, what does it mean to get a tight gas designation in the Eagle Ford with the Railroad Commission?

Richard Stoneburner

I think it's a severance tax implication, but I'm not 100% on sure on that, Subash. I think tight gas allows for some -- Floyd, do you have any comment?

Floyd Wilson

We're going to have to look into that obviously, Subash. There's no tight gas designation right now for the Eagle Ford.

Subash Chandra - Jefferies & Company, Inc.

I thought I saw you guys on the docket asking for it. That's why I was curious.

Floyd Wilson

Those are field rules. We've been involved in field rules designations, but I don't believe anything on the tight gas side. I'll check into it, but I don't think so.

Subash Chandra - Jefferies & Company, Inc.

I guess I saw somewhere like almost 1 million acres of Haynesville acreage turning over coming due, I guess, in the next year and a half or so. I mean, does it make any sense to double down and to perhaps instead of looking for new areas, actually recommit to the Haynesville?

Floyd Wilson

Well, I don't know about doubling down. We've doubled down a few times in the past two years and it's worked out well so far. And I would hate to think that we wouldn't have gone out and found the Eagle Ford just because we were so enamored with the Haynesville. So I would have to say that there is a lot of acreage that may or may not turn over. We're very happy with our key position in the area. And we're always looking if we can find a low-entry place, but everyone else is looking, too. So it's not like a big free-for-all where it's growing on trees. So we're cognizant of all the plays in the country and we're pretty comfortable right where we are.

Richard Stoneburner

Subash, I'd just add that we're very particular about the Haynesville acreage that we would try and commit to. And based on our drilling plans and all the unitization filings that have been made within what we call the core, I'd be very surprised if very much quality acreage turned over in the Haynesville.

Floyd Wilson

Everyone, thanks a lot for calling in. If you think of something we didn't cover, give one of us a call and we'll be talking again, at least by Analyst Day if you're available. Thanks.

Operator

This does conclude today's conference. We thank you for your participation.

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Source: Petrohawk Energy Q1 2010 Earnings Call Transcript
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