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Executives

Kevin Nanke - Chief Financial Officer, Treasurer, Chief Financial Officer of DHS Drilling Company, Treasurer of DHS Drilling Company and Director of DHS Drilling Company

Carl Lakey - Chief Executive Officer, President and Director

Broc Richardson - Vice President of Corporate Development & Investor Relations

Daniel Taylor - Chairman, Member of Audit Committee and Member of Nominating & Corporate Governance Committee

Analysts

Gregg Brody - JP Morgan

Joseph Allman - JP Morgan Chase & Co

Andrew Shapiro - Lawndale

Delta Petroleum (DPTR) Q1 2011 Earnings Call May 11, 2011 12:00 PM ET

Operator

Good morning, and welcome to the Delta Petroleum First Quarter 2011 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Broc Richardson. Please go ahead, sir.

Broc Richardson

Thank you, everyone. And thank you for joining us for Delta's first quarter 2011 financial and operating results conference call. Before we begin, I would like to remind you that we are conducting this call under Safe Harbor and that this call will include projections and forward-looking statements within the meaning of the Federal Securities laws and are intended to be covered by the Safe Harbor protections. In that regard, you are referred to the cautionary statement displayed on Delta’s website, which is incorporated by reference with respect to the information provided for this call. Investors are urged to closely consider the oil and gas disclosures and the risk factors set forth in Delta’s Form 10-K for fiscal year ended December 31, 2010, as updated by subsequent periodic and current reports on Forms 10-Q and 8-K, respectively.

Today's speakers from Delta are Dan Taylor, Chairman of the Board; Carl Lakey, President and Chief Executive Officer; and Kevin Nanke, Treasurer and Chief Financial Officer.

I will now turn the conference call over to our Chairman, Dan Taylor.

Daniel Taylor

Thanks, Broc. Good morning, everyone and thank you for joining us. As I'm sure many of you have noted, over the past few months, there has been a renewed and increasing interest in the Piceance Basin driven by increasing recognition of the revenue from natural gas liquids and drilling success occurring in the deeper shale formations.

In a recent report published last week, an analyst stated that the wells drilled by a nearby competitor rival Haynesville wells and provide indications that continued development of the Niobrara may dramatically change the economics of Piceance development. The analyst noted that the Niobrara is located at shallower depths in the Piceance than in the Haynesville and thus, the well cost is less, which combined with similar initial production rates equates to better economics.

As Carl will discuss, the indications of our wells to date support this preliminary conclusion. We have initial production from the 2B well and expect higher rates from the 2C well, which is all of the pay of the 2B well plus an additional 2,800 feet of gross interval to complete.

I believe our strategy to dedicate all our efforts in capital to the Vega Area was a correct one and is being validated with the results, not just from our wells, but from other operators as well. As mentioned in our press release, we have decided to market for sale our non-operated properties in Texas and the DJ Basin in order to raise capital to drill 2 additional wells in the Vega Area targeting the Mancos and Niobrara shales. These 2 additional wells to be drilled are wells that will hold leasehold so they will be accomplishing two objectives: First, to continue to quantify and confirm the reserves and economics of the shale formations; and second, to secure our acreage position in the Vega Area.

It is always easier to have these conference calls on the heels of what I believe are solid financial results from the quarter. While our production increased over the prior quarter, it was slightly lower than expected due to our decision to delay completion dates so that we could focus on the deep shale wells. We anticipated completing all 5 uncompleted wells on our inventory, but only completed 3 of them in the first quarter. However, while we missed our production guidance slightly, it was more than offset by lower-than-expected G&A. Kevin will discuss the first quarter's financial results in more detail.

As I mentioned in the last conference call, I'm expecting a very promising year for Delta and what I've seen to date only heightens my expectations.

With respect to our capital needs, our primary goal is to create value for our shareholders. We believe our assets are tremendously undervalued by the markets today. To be sure, part of the challenge is to provide clarity on how we will recapitalize our balance sheet. But in order to maximize our access to the capital markets, and to provide maximum value to our shareholders, we must also be able to present a clear picture of our resource potential in the deep shales of our acreage in the Piceance. We have much information today and have the time to gather and provide much more information before we will move forward with strategic alternatives for the company. As a result, we will not take questions on today's call regarding our capital raising alternatives. Now I'd like to turn the call over to Carl. Carl?

Carl Lakey

Thank you, Dan. Good morning, everyone. Thank you for participating. Delta did have another strong quarter. The focus on our core assets is being validated in the numbers. The improvement is related to numerous items, which Kevin will share with other financial metrics shortly.

As proud as I am of these financial results, I really want to share why we are so excited about our shale wells. As we've announced previously, the information we have gathered to date continues to raise our expectations on the resource that exists in the shales of the Williams Fork.

In fact, we believe the resource will exceed that of the Williams Fork and our field, and based on our findings and other published information, perhaps across much of the Piceance Basin. The 2B wells drilled through a portion of the Mancos formation have reached a total depth of 10,700 feet. We've completed roughly 1,200 feet of gross pay in the upper Mancos and Corcoran formations only. This represents only 33% of the shale play identified in the 2C well.

Gas production began in April 24, and the well was flowing 3.3 million cubic feet a day by April 29. Through May 9, sales of average 1.8 million cubic feet per day. It is early in the clean-up process as well recovery from the frac stimulation is only 27%. The well has had the opportunity to produce up to be for only the last 4 days.

The Williams Fork section in this well will not be completed until more production information is gathered from the Mancos and Corcoran formations. While still very early in the life of this well, it seems clear that Delta has a discovery in the upper shales. With respect to the rest of the shales, the well drilled on path 2C has resumed normal completion activity with 6 additional frac stages scheduled for later this week targeting the Niobrara and lower Mancos formations.

The well has already flowed at a rate of 2 million cubic feet a day and produced 30 barrels of condensate over merely a few hours with 6,700 PSI wellhead flowing pressure from 2 stages in the Frontier and the lowest 20 feet of the Niobrara.

This pay represents less than 10% of the 4,000 feet of gross hydrocarbon-bearing interval identified in the well. The static of bottom hole pressure is 10,900 PSI. As shown on our website presentation, the logs and the appendix show approximately 600 feet of Niobrara pay with a signatures adjusting condensate, of which only the 20 feet of the Niobrara that has already been opened has produced condensate. We are obviously very excited about the potential for meaningful liquids production from the shales. Kevin will speak directly to the economic importance of these liquids on our financial performance in his comments.

Well density per verticals wells in these intervals has been established to 10 acres by at least 2 other Piceance operators. We continue to think the resources in our field based on vertical gross pay thickness of 4,000 feet and bottom hole pressure of 10,900 PSI vastly exceed the potential of the substantive activity that we are aware of elsewhere in the basin. This potential best lends itself to vertical well development. Others in the basin have already proven horizontal potential, this technique is available to Delta if we think it necessary, we have permitted a number of contingency locations to test this potential if the vertical wells prove unable to deliver what we think they are capable of.

Our capital plans for the remainder of 2011 include the drilling of an additional well in Section 6 of 9 South, 92 West in the Frontier formation in the newly formed federal Sheep Creek Unit. This well will spread in the coming two weeks and is programmed to a measured depth of 13,500 feet. It is targeting the same intervals identified in the 2C well. This well will also hold the unit of 2,715 acres and raise our total secured acreage to 93% across our entire acreage position.

As Dan mentioned earlier, our results are validating our strategy of focusing on the profitability of future potential of our core assets in the Piceance Basin. Divestiture of our remaining non-operated assets will allow further investigation of the shales and additional portions of our acreage position to be secured. In anticipation of the successful sale transaction, we have initiated work on a fourth well to test the shales in the Vega Area. This well, as planned, will spread in Q3 in Section 17 of 9 South 93 West and will also test intervals from the shales below the Williams Fork. We expect the 4 wells collectively will demonstrate a productive cross-bearing section across our acreage position of roughly 5 miles from west to east. We believe, based on internal studies, that a similar cross-section of productive shales can be demonstrated in the north-south orientation also. I will now ask Kevin to expound on the financial metrics that would validate another successful quarter for Delta's business.

Kevin Nanke

Thank you, Carl. Good morning. EBITDAX from continuing operations increased to $8.8 million, an increase of 19% from Q4 2010. After adjusting for the one-time benefits of $1.2 million in Q4 related to a production tax true-up and transition fees earned on the sale of properties.

The EBITDAX increase is primarily a result of higher commodity prices, increased production and a continued focus on maintaining cost control on our core asset. For the first quarter, we reported production from continuing operations to of 3.5 Bcfe, an increase of 4% to Q4, but slightly under what we expected. During the quarter, we completed 3 of our 5 remaining Williams Fork inventoried wells. We anticipated completing all 5 however, with limited frac crews and a focus on the shales, we decided to leave the 2 completions for a later date.

Our natural gas liquids currently represent approximately 1/3 of our revenue from the Vega Area. To put this number in context, the extraction of the NGLs from our gas stream only reduced our MMBTu content by approximately 15% and the current prices of the NGLs are far in excess of what the revenue would be if capital is in the gas production.

This is evidenced by our realized price per Mcfe. In the first quarter, our total realized revenue before hedges for the Vega Area was $5.55 per Mcfe whereas the average Henry Hub spot gas price for the quarter was only $4.18. Moreover, our realized price was reduced by the differential of the Henry Hub to Colorado Interstate Gas or CIG of a negative $0.17 for the quarter. In essence, our liquids and condensate combined to provide us an equivalent price for a production that is roughly 38% over the CIG benchmark for the quarter.

Our lease operating expenses per Mcfe from continuing operations were $1.33 per Mcfe. This is an increase from the $1.09 per Mcfe for the fourth quarter of 2010, and is primarily a result of higher operational and expense work over cost in our non-operated assets in Texas and offshore California. Piceance operations continue to remain in line at sub-dollar per Mcfe. We maintain G&A at $6.6 million for the first quarter, of which $2.3 million was non-cash equity compensation. This equates to a Delta stand-alone cash G&A for the first quarter of approximately $4.3 million, which was slightly lower than cash G&A guidance of $4.5 million per quarter given.

The marketing effort of DHS continues to move forward. DHS is working with a potential buyer who has provided a full company and multi-rigged bid. Either outcome if completed will be beneficial to the shareholders of DHS and its management. DHS continues to work with its lender during this due diligence process. With DHS assets classified as held for sale, Delta's financial statements more clearly show Delta stand-alone results.

As Dan mentioned, we're beginning the marketing process of our non-core Gulf Coast assets. The proceeds of these assets will allow the company to expand the validation of our shale potential, further validation will strengthen the overall value of the company and allow us to address our long-term liquidity profile. In conclusion, we are pleased with the first quarter and look forward to updating you with our progress going forward.

With that, we will open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Joe Allman of JPMorgan.

Joseph Allman - JP Morgan Chase & Co

In terms of the deeper wells, the B and the C, could you give us the cost of those wells and what's your expected costs going forward?

Kevin Nanke

On the 2C well, we're expecting still around $10.5 million. The 2B well is -- A or B, they're just under $5 million. We believe in subsequent attempts, including this well, we're about to spread in the Sheep Creek Unit that will go all the way to the depths experienced in the 2C well that we can see that A and B come in around $8 million is what we're targeting.

Joseph Allman - JP Morgan Chase & Co

Okay, that's helpful. And then In terms of the feet of pay you're seeing, I know you gave gross feet. I think could you give us a net on the 2B and then on the 2C? I know you only drilled some of that, but of what you drilled, what's the net to gross there?

Daniel Taylor

Really, when you look at these shales on the logs, the entire section is hydrocarbon-bearing and really, the net to gross is just almost 1:1. I mean we're not high grading the shales to any material degree based on log signature. All of it seems to have hydrocarbon in it, all of it seems to be attractive. Some of it has better rock mechanics properties and others. But all of it seems to be hydrocarbon-bearing So when we go to stimulate, we're intending to basically stimulate the entire section.

Joseph Allman - JP Morgan Chase & Co

Okay, that's helpful. And then In terms of EUR per well, what your expectations there with what you drilled already and going forward?

Daniel Taylor

Still too early to say. Obviously, once we've established the decline curve off these wells, we'll have a much better indication of what that looks like. But it's a little premature to say. There is some public data out there on other wells that competitors have drilled on the basin where EURs can be established from that. And I'm not prepared to talk about their wells here. But suffice to say, we think they're encouraging.

Joseph Allman - JP Morgan Chase & Co

And then just what would you consider the main differences between sort of the geology where you are versus nearby industry activity?

Daniel Taylor

Well, to be fair, as we look at our intervals, we just have not been able to see any place else in the basin where the section is overpressured and hydrocarbon-saturated from the top of the Mancos all the way to the bottom of the Niobrara. And so we think we just have more pay than any place else we've been able to identify. We have seen some logs in other areas and other portions of the basin that suggest a little lower pressures or hydrocarbons that are more productive or more suggestive of production in the deeper parts of the Niobrara, but not across the entire section like we have.

Joseph Allman - JP Morgan Chase & Co

Okay, all right. Very helpful.

Operator

The next question is from Gregg Brody of JPMorgan.

Gregg Brody - JP Morgan

You may mentioned that the borrowing base would potentially decrease if the asset sale is completed, can you give us a sense of how much of the borrowing base those assets represent?

Kevin Nanke

Gregg, we don't have that information yet. We're still working with Macquarie and we'll identify that here once we move down the path with the transaction.

Carl Lakey

The one thing we'll point out is obviously we believe we will improve our liquidity as a result of the transaction based on our estimates of borrowing base impact.

Gregg Brody - JP Morgan

Okay, that's helpful. Do you happen to have a production or reserves for those assets?

Daniel Taylor

No. Year end, roughly around 11 Bcf, and current production, we had about 0.5 Bcf produced for the quarter.

Gregg Brody - JP Morgan

Okay. Is that mostly gas?

Daniel Taylor

No, that's mostly oil in the Gulf Coast. Probably on the order of 70%, maybe a little higher than that. That's oil.

Gregg Brody - JP Morgan

That's very helpful. And then just one follow-up question, I guess the acreage that you've identified, that's perspective for the deeper zones, how much acreage do you think kind of fits that potential?

Daniel Taylor

Well, our Vega acreage position in its aggregate is about 22,000 net acres and we believe all of it is perspective for the deeper shales. In fact, those 4 wells that I mentioned earlier in the call will basically stitch across section demonstrating productive shales east to west across our entire acreage position. We feel confident that we could do the same thing north to south it just so happens that acreage holding dictates that we'll drill on an east west orientation first to secure our acreage position.

Operator

The next question is from Andrew Shapiro of Lawndale Capital Management.

Andrew Shapiro - Lawndale

A few follow-up questions off your script and just prior question there. First off, should we expect further reductions in stand-alone test G&A from Q1's levels or are we at a stabilized phase or should we expect increases?

Kevin Nanke

Andrew, I believe the second half of 2011, you can see some decreases in our G&A. I think for second quarter, we'll still come in at below $4.5 million for the quarter. But hopefully, we can make some improvements on the latter half of the year.

Andrew Shapiro - Lawndale

Okay. And then regarding the newly announced sale of properties in Texas and you call it the DJ Basin, where is this asset by the way? Would these assets be sold together with the Texas assets?

Daniel Taylor

Okay, there's actually three distinct properties that are part of the package, two of them are in Texas, one called Midway Loop in Polk County. The second is the Newton Field in Newton County, that's a Wilcox oilfield. And then finally, a smaller property we call Golden Prairie in the DJ Basin in southeastern Wyoming.

Andrew Shapiro - Lawndale

Okay. So that's far enough away that may not go in the same sale.

Carl Lakey

We expect it probably will, but certainly we'll let the bidding process and offers dictate how that goes.

Andrew Shapiro - Lawndale

How long of a process do you envision for this asset sale? I mean, are these complex thus requiring a lot of time to sell?

Carl Lakey

Yes, just before the end of June is what we're targeting.

Andrew Shapiro - Lawndale

Okay. And then regarding the DHS sale, as a 49% shareholder, to what extent are you involved in the acceptance of the price that they choose to monetize it in? And based on last quarter's call, the process started March 1 or earlier, where does that process stand and what are the bidding milestones left and expected timing of determining the winning bidder is on the DHS sale?

Daniel Taylor

Andrew, this is Dan. I'm going to address your global question first and then Kevin can talk about the specifics of DHS. It was only recently that we actively moved forward on this process and there have been a number of different structures that we have considered. As Kevin mentioned during his comments, it was a multi-rig bid as well as a full company asset profile bid. Those have evolved and we've got people looking at these assets. And we also have to deal with our lender in connection with these assets as well because as you know, we have a forbearance agreement in place on our loan. So the goal here is to now finish the process in a rather efficient manner. We think we've seen all the opportunities and our lender is working with us on this.

Kevin Nanke

Yes, Andrew, the process, the due diligence process is underway. We have spent some time out in the field looking at all the rigs. We're going through that process right now. I think they'll come back to us over the next couple of weeks and give us their final assessment. If they move down a smaller rig package, we do have other groups that are interested in the remaining rigs. And like Dan said, we are working with our lenders during this process.

Andrew Shapiro - Lawndale

Okay. And a final question, you've talked about a little bit of this last quarter as well, but you can maybe give us an update and also if these new deeper wells have any implication. What's the status of your water disposal permitting activity and your water disposal capacity as you were starting to, I guess, put the water in used-up wells and such?

Carl Lakey

Sure, Andrew this is Carl. We've got 2 wells taking water right now at about 3,500 barrels a day, that's against our total water production of about 4,200. So we're essentially at breakeven right now. We expect 2 additional wells for conversion to be permitted by the end of the second quarter and we'll bring those online, which is over the top to be able to handle all of our produced water to injection of our inventory wells.

Andrew Shapiro - Lawndale

And does your demand for this activity increase with the new deeper well drilling you're doing?

Carl Lakey

No, it does not. In fact it goes down. What we're seeing on the shales, is that the shales relative to Williams Fork are very dry in terms of produced water from the formations. So we'll expect to see less water production going forward as our Williams Fork wells that were completed in the fourth quarter and the first quarter produce some of their load back. They're still having residual load and that water production will decrease as we go forward.

Andrew Shapiro - Lawndale

Great.

Operator

Next is another question from Joe Allman of JPMorgan.

Joseph Allman - JP Morgan Chase & Co

Just in the Vega Area, your lease expiration, can you just describe the acreage that you got held already. And how much is not held and what's the timetable of the expiration for that?

Daniel Taylor

Clearly, we've got out of the 22,000 acres, we've got 2 blocks that we're considering holding together this year that are material. The first is we formed the federal unit called the Sheep Creek Unit late last year on the northeastern flank of the acreage, that's about 3,700 acres. And the BLM has agreed with us that if we spread a well in May, that will hold that acreage together. So that's first and foremost, we'll begin spreading that well next week. So that's well in progress. The second piece of acreage that we have that's at risk of expiry this year is in that Section 17 area kind of in the West Central portion of the field and it's not nearly as much I want to say it's about 480 acres, something in that neighborhood. So it's not nearly as substantive an acreage position and its expiration would be in September of this year. And so we're targeting potentially spreading that fourth shale well in August.

Joseph Allman - JP Morgan Chase & Co

And then what's the status with the expiration of the other acreage?

Daniel Taylor

Most of the other acreage is really not too bad. We're going to be in good shape. By the time we get done with the Sheep Creek unit, 93% of that acreage position will be held by production or held by unit. And it strings out over the next several years for the remaining bits and pieces.

Joseph Allman - JP Morgan Chase & Co

Okay, that's helpful. And then in terms of infrastructure, so if you do produce oil or condensate here, do you have the infrastructure in place to handle that? And if not, what do you need to do to provide that?

Carl Lakey

No, we're well positioned. In fact, one of the nice things about the shale play is the infrastructure was already laid in place for the Williams Fork, and by using that infrastructure to move the gas, we're well positioned to handle it. So from an infrastructure standpoint, it's almost the build up.

Joseph Allman - JP Morgan Chase & Co

And including the higher pressures that you might be seeing from the deeper?

Carl Lakey

The higher pressures are handled well-head equipment and separators and chokes, very near the well head. That's not the largest part of the infrastructure piece. In fact, it's a relatively modest piece.

Andrew Shapiro - Lawndale

That's helpful. And then just on the prior question, what's the timetable on those two new water disposal wells?

Carl Lakey

We'll certainly have one of them going in the second quarter and then the next one is kind of we expect to have a permit back whether the well will be injecting in the second quarter remains to be seen, but certainly on or about the end of the quarter, we'll have the second one on line.

Joseph Allman - JP Morgan Chase & Co

Okay. All right. Very helpful.

Operator

[Audio Gap]

This concludes our question-and-answer session. I would like to turn the conference back over to Broc Richardson for any closing remarks.

Broc Richardson

I'll turn the conference over to Carl for closing remarks please.

Carl Lakey

Thank you so much for attending our first quarter conference call. You can see why we're excited and we're very pleased with our performance and we look forward to sharing more with you in the future. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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