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Executives

Frank Hopkins - VP, IR

Scott Sheffield - Chairman and CEO

Rich Dealy - EVP and CFO

Analysts

Richard Roy - Citi

Rhett Bruno - Bank of America

Kevin Smith - Raymond James

Chad Potter - RBC Capital Markets

Steve Tabb - Tocqueville Asset Management

Pioneer Southwest Energy Partners L.P. (PSE) Q3 2010 Earnings Call October 27, 2010 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 Investor 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 call 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 review the agenda for today's call. Scott will be the first speaker. He will review the financial and operating highlights for the third quarter and update you on PSE's successful drilling program in the Spraberry field. Rich will then cover the third quarter financials in more detail and provide earnings guidance for the fourth quarter. And after that, we'll open up the call for any questions that you might have.

With that, I'll turn the call over to Scott.

Scott Sheffield

Thank you, Frank and good morning. Slide number three on the highlights. We reported third quarter adjusted income of $23 million or $0.71 per unit. This does exclude our mark-to-market derivative loss of $17 million after tax; that's primarily due to the recent run up in crude which our $100 hedges obviously are worth less because of that mark-to-market accounting standpoint.

Our third quarter 2010 production averaged 6,600 barrels a day; that's up 3% from second quarter 2010. And it reflects our continued two well drilling program and the positive results we're seeing from the lower Wolfcamp, and opening up the organic rich shale zones and the Spraberry zones itself also.

We'll eventually take a few wells to the strong as we have reported recent success at the PHD level. So we will do that late this year, and going into 2011.

Cash flow from operations of $25 million declared another distribution of $0.50 per outstanding unit for third quarter 2010, that's payable on November 12 to unit holders as of November 4. That reflects an annual distribution rate of $2.00 per common unit.

On Slide number 4, again in regard to our two well drilling program, we have put on 21 wells to date on production through September 30. We're seeing our well cost still stay fairly consistent about $1.1 million to $1.2 million per well. Locked in almost all the calls obviously for 2010, and production rates are exceeding expectations. If you want to get more color, you can refer to our successful results from our PHD drilling presentation by going to that website in regard to successful, Wolfcamp and some strong drilling.

We have 140 remaining 40 acre locations and over 1,200 20 acre locations. We'll be starting to drill some 20s going into 2011 and 2012 mixing with our 40s.

Let me turn it over to Rich Dealy to talk to our earnings for the course.

Rich Dealy

Thanks, Scott. On Slide 5, Scott talked about net income reported $6 million or $0.20 per common unit. That did include the unrealized mark-to-market derivative loss that Scott discussed as $17 million or $0.51. So adjusting for that, we're at $23 million or $0.71 per unit. Looking at the bottom part of the slide where we talk about our guidance relative to our results coming into the third quarter. if you look at production, Scott talked about drilling results continued to look good. And we're at the upper end of production guidance for the quarter.

Each of the other items are basically at the lower end or the midpoint of guidance and where we would have expected very consistent with prior quarters. So all in all, a great quarter for PSE.

Turning to Slide 6, and a little bit about the fourth quarter. very similar with the drilling program continuing to go on. We are upping our production guidance to 6,400 to 6,800 BOE's per day. And all the other guidance items are consistent with what they've been all year long that we've been riding a middle out of the lower part of those guidance ranges.

On Slide 7, financial position; PSE still has a great financial position. $180 million availability under it's credit facility, strong hedge position in place at over 70% for 2011, 80% for 2012 and 60% for 2013. And so another good quarter for PSE.

So why don't I stop there. And we'll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Richard Roy with Citi.

Richard Roy - Citi

Early in the year your focus has been on the organic growth program to internal development opportunities. As you look in to 2011, how would you characterize your strategies that you have continued to focus on, on organic growth or do you see acquisitions becoming a part of your CapEx spend next year?

Scott Sheffield

Yes, that's a very good question. Obviously, the returns that we're seeing in from our drilling activity are much better than we can make acquisitions. I think that the reason is there's only three areas that are considered oily in the U.S., the Bakken, Sprayberry and the Eagle Ford. And in those areas people are significantly overpaying for assets, and that market I don't see changing for next several months.

We would like to be able to buy some PDP properties. We're looking in the marketplace in west Texas for anybody willing to sell PDP only. It's when you have to look at it in a data room for the PUDs and the probables that people are way overpaying. There is very few PDP deals available is the issue. We'll continue to look at whether or not we should do a dropdown from PXD. So the long term focus is a mixture of both acquiring properties and drilling, but right now we don't see changing that going into 2011.

Richard Roy - Citi

And just another question, I guess this is for Rich. Looking at your EBITDA or your DCF schedule, you had mentioned that you had 6.143 million maintained production cash, looking on the cash flow statement it's to 10.83. And suggest the difference between and so that would be what you would characterize as growth CapEx.

Rich Dealy

That is correct Richard.

Operator

Our next question comes from Rhett Bruno with Bank of America.

Rhett Bruno - Bank of America

Well, if I look at NGL volume growth during the quarter, it looked like it pretty significantly outpaced gas and oil, is that your infrastructure considerations driving that or what's that coming from?

Scott Sheffield

Yes, mainly the timing is part of it, just the way you had your (listings overall) (4-0:03), but two we did a plan modification out there. The Midkiff-Benedum plan, where our most of our gas is processed and it has a higher yield component, so that's why you're seeing some NGL pick up.

Rhett Bruno - Bank of America

And another one if I could. When I look at the quarterly release between this quarter and last quarter, if I'm reading it right (inaudible 4-0:25) it looks like you only connected one additional well to sales during the quarter.

Rich Dealy

Actually it was three wells for the quarter. Last quarter was through the date of the release and this quarter it's going to work as through that September 30. So there was actually three wells put on during the quarter.

Rhett Bruno - Bank of America

And then just one final question. Talking about the vertical integration at the PXD level, how does those savings or do those savings anyway sold just through the PSE or they just more or less assigned it, the capital cost based on third party market prices.

Rich Dealy

A lot of the tubular goods that PXE has locked in through 2011, 2012 go straight to PSE, just as those come through as cost, where some of the other services are more market related cost, that's a combination.

Rhett Bruno - Bank of America

So the frac services specifically, does it try to be more of a market related?

Rich Dealy

That's correct.

Operator

Next we'll go to Kevin Smith with Raymond James.

Kevin Smith - Raymond James

You mentioned you're going to start drilling the 20 acre spacing, I'm sorry, did you say you're going to do that in 2011 or 2012?

Scott Sheffield

We'll do some in 2011.

Kevin Smith - Raymond James

And what's your result are so far, has PXD done it?

Scott Sheffield

PXD did a series of them back in 2008. We've done seven wells already in 2010, we're going to do another eight this quarter, so we're down about 15. At PXD level we're going to do another 15 next year. So PXD is continue to do it on 20s, that's very successful. We are adding all of the other (results) (4-2:15). The organic shales, the Wolfcamp and areas where needed to we'll go to the strong.

Kevin Smith - Raymond James

And so far what's the production difference there?

Scott Sheffield

We just started the 20s at PXD level. So the first seven have not been put on pump yet, have not been completed. On the 40s, I mean go to our slides at the PXD level and the wells that are going to the lower Wolfcamp are outperforming the (inaudible 4-2:54) by about 30%.

Kevin Smith - Raymond James

What's your outlook for hedging, I know your hedged pretty strongly for the next two years, at what point do you start to look at (inaudible 05-0:08) and hedges? And how far I guess is the mandate you want to be hedged off?

Rich Dealy

I think '13 and '14 is the next two years to finish. '13 were 60%. So we need to finish up '13 a little bit more and then do work on '14. Even though crude has bumped up significantly over the last several weeks up in the low 80s, the odd years hasn't moved up enough. There are a lot of producers. They are taking their crew production and selling calls and are taking those proceeds and lifting their gas price. And so it'g put pressure on the odd years in 2012, and 2013, 2014.

And so, normally those crude months would go up pretty significantly may be up to $95 to $100 a barrel. We need a way to this pressure. And I think that will lift sometime by the end of this year. And so going into next year, we see crude up between $80 and $90. I think we'll get a chance to lock in something $95 to $100 a barrels in those odd years like 2014.

Kevin Smith - Raymond James

Internally, do you have targeted kind of distribution growth rate? I know you've kept the distribution flat since going public, but do you have any sort of long term over three to five year period you'd hope to grow by x%?

Scott Sheffield

We clearly want to grow it and know that's something we need to be doing but we have not come out with a defined number of what that percentage is per year.

Operator

And moving next, we will go to Chad Potter with RBC Capital Markets.

Chad Potter - RBC Capital Markets

Couple of questions on the well tie ends, what's your inventory of wells that are drilled but not tied into sales at this point? And how do you see that changing over the next quarter and the next year as the PXD adds completion (inaudible 5-2:16)?

Scott Sheffield

September 30 we are in that 10 to 15 wells waiting on completion. And we expect to see what the additional frac price that we talked about at PXD level; those completion will accelerate and we'll do more than we did in the third quarter. Obviously, the third quarter was a light quarter that will probably due anywhere between six and 10 during the fourth quarter of completion and then stay on schedule after that.

Chad Potter - RBC Capital Markets

And then moving to the Strawn, how much additional well cost does it add when you do drill deeper to the Strawn?

Scott Sheffield

We're taking all the wells of the Lower Wolfcamp, so we're only going another 200 feet. So it's pretty minimal. It's $25,000 to $50,000. And then we run a log and we take a look at whether or not we have porosity in the Strawn. And then if we decide we have porosity, we put another frac stage in it. And so if it's successful, it could cost $75,000 to $100,000. If it's unsuccessful, by going that 200 feet deeper, it only cost about $25,000 to $30,000.

Chad Potter - RBC Capital Markets

You said, you're going to start doing that late in the fourth quarter, is that going to be pretty much with every well drilled, or is it just a slight fear?

Scott Sheffield

I don't know. Rich, do you know what the percentage of our acreage is?

Rich Dealy

Most of our acreage is in the Strawn. And so, we'll take a look at a lot of the wells that we do. I mean it won't be a 100%, but a big chunk and we'll look at the porosity there, then we'll complete it.

Chad Potter - RBC Capital Markets

As far as the production characteristics of the Strawn, does that really change as far the gas, crude NGL mix?

Scott Sheffield

I think it's a little bit higher gravity. I recall that Spraberry is about 38 to 40, Strawn is a little bit higher gravity. And it's a solution gas drive just like the Sprayberry, but we're allowed to commingle as we've stated before. We got approval from the commission. And our first few wells we did at PXD level. We did about three wells and they tested somewhere between 30 and 80 barrels a day.

Operator

(Operator Instructions) Our next question comes from Steve Tabb with Tocqueville Asset Management.

Steve Tabb - Tocqueville Asset Management

I am looking at the page six, and your average daily production that you expect in the last quarter of the year was from 6,400 barrels per day to 6,800 barrels a day. But in the last quarter, you did 6,600 barrels a day. So when do you expect to have a go from 6,600 to 7,000 or something because you got more wells being completed and added?

Scott Sheffield

We're obviously trying to be conservative on our guidance range, so I'd leave it at that.

Steve Tabb - Tocqueville Asset Management

The income tax that you expect so far on the quarterly distributions or annual distributions of $2 a share, what do you think that the individuals are going to have to pay on that? What rate of tax? How much of it is going to be taxable?

Scott Sheffield

It's too hard to predict. Everybody has got different tax base depending on when they came into the unit price. So I can't give you an estimate. It is very specific to the individual and when they bought into the units.

Steve Tabb - Tocqueville Asset Management

Well, suppose they held it, but you are right, you can't do it with each individual. But suppose that you have it for the full year, what does the range that it looks like?

Richard Dealy

Well, I think, if somebody was a holder from the IPO standpoint, it's probably in that 30% to 50% range, I don't have an exact number because I haven't looked at it in a little while, but it is probably in that 30% to 50% range if they were bought in at the IPO.

Operator

(Operator Instructions) And with no one else queuing, I would like to turn the call back over to Scott Sheffield for any final and closing remarks.

Scott Sheffield

Again, thanks for listening to our call. I had another successful quarter and look forward to talking to you all in February. Everybody have a Merry Christmas and Happy New Year. So we'll see you in February. Thank you.

Operator

And once again ladies and gentlemen, this does conclude today's call. Thank you for your participation, and have a great day.

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