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Executives

Tony Best – President and Chief Executive Officer

Analysts

Gil Yang – Bank of America/Merrill Lynch

SM Energy Company (SM) Bank of America/Merrill Lynch Global Energy Conference Call November 16, 2011 9:45 AM ET

Gil Yang – Bank of America/Merrill Lynch

SM Energy, Tony Best is the President and CEO and he will give the presentation. Tony?

Tony Best – President and Chief Executive Officer

Thanks, Gil. Good morning. It’s good to see everyone here. Its good be back at the Bank of America/Merrill Lynch Conference. We are pleased that we are invited back again this year. SM Energy is having a very strong performing year. We are excited about where we are today. Look at the company and the organization and I believe we are hitting on all cylinders right now. So, to me, it’s great timing to present an update of our company with you this morning.

In my remarks this morning, there maybe a forward-looking statement or two, so of course, the cautionary language. Couple of key messages. If you don’t remember anything else, couple of takeaways for you today. First of all, I do believe that we are generating significant value for the benefit of our shareholders and much of that is coming from our production growth this year and next year. In fact, that growth – the centerpiece of that growth is coming from our Eagle Ford program as well as our Bakken/Three Forks in the Northern Rockies.

And then finally as you’ve come to learn from us, we maintain a very strong balance sheet to help us fund our programs going forward. Speaking to growth, this is one of my favorite slides that you can see the significant production growth from 2010 to 2011. We have guided somewhere around 50% production growth. That growth continues into next year and we have shared – we expect our production growth from 2011 to 2012 to be 35% to 40%. So, again, that upward trajectory will continue into 2012.

We have also recently provided information and guidance regarding our capital program for next year. We expect that the total somewhere between $1.4 billion and $1.5 billion. Here we can see the breakout for the drilling program. And I’ll point out that 70% of the capital spend is going to be in two plays, the Eagle Ford and the Bakken/Three Forks and rightfully so given the higher returns and the strength of those programs.

I’ll also point out that 90% of this program is SM operated. And as you may recall, this has been a very deliberate strategy for our company over the last four, five years to gain greater control over the pace and spend of our capital investments. At the bottom of the pie chart, there is a note there that says non-operated Eagle Ford zero dollars and again our expectation is that when we close with the Mitsui deal, they will basically be carrying our drilling program for the next three to four years. So, that’s why there is not any non-operated Eagle Ford capital shown there.

Now, in terms of how we are going to fund this program for next year, first of all, let me remind you for 2011, we basically forecasted capital program of $1.55 billion. Our expectation for cash flow is somewhere around $800 million this year leaving us with a gap of about $750 million. In terms of filling that gap with our announced transactions, you can see those total about $478 million leaving us with what we believe to be a very manageable gap of about $277 million for this year. And as you will see in a minute with our balance sheet and cash on hand, we think that is a very manageable number.

For 2012, basically, we have forecasted as I just showed you capital program, $1.4 billion to $1.5 billion. We expect to see cash flow somewhere around $1.75 billion to $1.175 billion, again leaving what we think is a very manageable gap $325 million in 2012. The operating cash flow projections for ‘11 and ‘12 have decreased slightly from our second quarter ‘11 earnings call and that’s primarily due to lower commodity prices.

And again, we believe the projected gaps to be very manageable. And then I think also important to point out is that our off-stated goal has been to provide double-digit growth within cash flow. And we now see that inside, we expect that to occur in 2013. Let me give you an update on a couple of our key plays, and obviously, front end centers are Eagle Ford program. The yellow acreage shown on the map represents SM-operated acreage in the play. At the present time, 150,000 net acres in the operated area, basically at a 100% working interest.

So, again, we control the pace and spend of our operated program. Present time, we have four drilling rigs operated in our Eagle Ford program. We have seen significant production uptick. As you can see in the lower right hand corner, back 32% sequential production increase in the operated Eagle Ford program. We have a number of down-spacing and simul-frac pilots in progress right now, and I’ll talk more about that here in just a few minutes. For this year, we expect to drill somewhere around 65 wells for this four well or four rig program. Current well costs continued to trend upward, right now, $6.7 million to $7.7 million and again much of that is determined based on depth in the play. We expect to exit this year with five operated rigs and expect to take delivery of our fifth rig shortly from O’Ryan Drilling and this will be another walking rig new-build for our program.

Our job is to continue to monitor the results of our various pilots as well as to ensure that our pad drilling efficiencies come through for us. And we expect that just from the pad drilling alone, we could see savings of a $1 million or three wells on each pad as well as our intent is to go from first, but to last production within 80 days with the three wells and we are successful doing that again $1 million savings for those three wells.

Speaking of the down-spacing test, this map shows again our operated area and shows the present time we have five pilots operating on a down-spacing test basis with three more that will begin before the end of this year. Five of those will be on the Galvan Ranch, that’s the eastern flank of our position and then three in the Briscoe Ranch, which is the western flank of our position.

We are currently testing these pilots on average down to about 625 feet between horizontal wellbores. At the present time, all of our assumptions in the program have been with the spacing of 1,250 feet. So, this would cut that spacing in half it’s successful. I will point out that at the present time it looks to us that the eastern flank on Galvan Ranch, the productivity of those wells seems to be little bit higher than the Briscoe side. And what that means is the permeability is probably better in terms of that rock. So, the spacing may be a bit above 625, because basically we can drawdown with more productive rock. On the Briscoe side, the spacing may be a little bit less than 625, because the rock appears to be tighter over there. But again, these are early indications and what we expect to do is to be able to provide some meaningful data for you by year end or very early next year. But again, these are very important down-spacing pilots for us and it’s critical for us to optimize a full field development as we continue to build out infrastructure.

In the non-operated Eagle Ford, the blue acreage here shows the joint venture that we have with Anadarko, which is north of our operated position. We will retain 46,000 net acres in this play after we close on our transaction with Mitsui. And basically, we will be taking our overall working interest here from 27%, down to 14.5% in the joint venture. We’ve recently announced that we have extended the outside termination date of our close with Mitsui to December 23 as we continue to work in obtaining the final consents to close on this transaction.

At the present time, we fully expect to close on that by year end. Also at our last call, we indicated that we had a forecasting plus if you will as far as some of the NGL production from the joint venture. And we pointed that out in our call. I think that’s a one-time event. I think we have corrected our forecasting process, but at the same time, we wanted to share we pointed that out. For 2011, we anticipate and have seen that Anadarko has been running 10 to 12 rigs and we expect that to pretty much continue into next year.

The Bakken/Three Forks, the map here shows our three key areas in the play including starting from the north Gooseneck and Divide County is primarily focused on Three Forks development, shallower, but has about the same returns as what we are seeing in our Bakken positions shown in our Raven and Bear Den areas. Today, the Bear Den area, it is HBP already. So, our drilling focus has been in the Raven area this year.

All total, we have over 200,000 acres in the Northern Rockies with 87,000 acres of that in the primary areas that I discovered including Raven, Bear Den, and Gooseneck. Production is pretty much all back on line after the severe winter of last year and the very significant flooding that we saw for good part of the summer. SM as well as many of the other operators, where lot of those production facilities were shut in. Some of them were under water. We actually had some of our operators using their own boats to be able to get out and check on our well locations. So, it’s been a very challenging summer, but I am glad to report we have got pretty much all of that production back on line. Also, as a result of the flooding and the heavy rains, it was very difficult getting into lot of our drilling locations.

So, if you look at the first half of the year, we only were able to drill and complete 6 operated and 16 non-operated wells in the first half. And now we have come on strong in just the third quarter alone. We have been able to complete 8 operated and 21 non-operated wells. Lot of road restrictions and we have now gotten through that fortunately. Again another area, very strong production increase, 35% quarter-over-quarter in our Bakken and Three Forks program.

For the rest of this year, we expect to run three rigs and we just recently committed to a fourth rig, which will be coming on early next year taking that program to four rigs. Well costs continued to increase this is an area where we keep a very close eye on the margins. We are seeing well costs now $8.5 million to $9 million in our Bakken program and $6 million to $6.5 million in our Three Folks Gooseneck drilling program.

I should point out one of the things that it is unique about SM Energy. We are seeing our Bakken wells coming in $1 million to $1.5 million, some cases $2 million less than some of the offset operators. Primary reason for that is we are still drilling 10,000 foot laterals, but as you may know we don’t complete with this many stages. So, we have moved our stage count up to somewhere around mid 20s, 25 or so. We believe that and what we have seen in the results of these wells is that its volume of fluid pump, it is key to the productivity of these wells.

We also do not use ceramics, high string propanes we’ve been using regular sand. And the combination of those two differences accounts for significant savings and the well results. Something else that we have done is we have compared the productivity of our wells with those of the offset operators. In a lot of cases, we have working interest in their wells. So, we are getting the data and again the productivity is very comparable. So, in an area, where we are seeing some margin squeeze because of higher cost, we think this lower completed well cost it is very important to retaining the returns on our project.

The Niobrara, this is an area, where we have quietly been adding acreage. We announced that at the end of the second quarter that we had now amassed about 90,000 acres total in the Niobrara. Good way to think about this. A third of that acreage is in the northern DJ Basin. The other two-thirds is in the Powder River Basin. As you know we have been busy in the DJ Basin. We just provided well data for our five well test program and we had wells coming on with initial IPs over 1,000 barrels a day. The rates shown here are 30-day IPs ranging from about 200 barrels per day to about 600 barrels per day.

So, some mixed results, some wells that look very strong to us, but some others that we are going to have to watch a little bit and that’s exactly what we are doing. We are going to allow these wells to produce and then continue to observe their performance. In the meantime, we have moved our rig to the Powder River Basin. We just completed drilling our first well. We’ll be completing that shortly and now we just bought our second well in the deep powder, up in the Powder River Basin. Again, the focus here is going to be on horizontal Niobrara test. There are other zones of interest and certainly we will observe results in those other zones as well.

In terms of our capital structure, we are in very good shape. As you may have heard, we have recently announced that we issued $350 million worth of high yield bonds coming in with 6.5 coupon and our bankers tell us that was the fifth lowest yielding upstream high yield issuance since the recession back in 2008. So, we feel pretty good about that, I believe that we time that very well into what is a very volatile market.

I didn’t quite understand just how volatile and Wade Pursell, our CFO, we got to get ready and literally forks were watching the market, I thought is just on a daily basis, but it was almost on an hourly basis. And we had a strong day and boom the way we went and put that to the market and the results, I think were very, very favorable for us. At any rate, if you take a look at the graph here, you can see we have got three pieces of debt now. We’ve got $283 million, which is our convertible notes, $350 million of (6.58) notes that were issued earlier this year and then of course the $350 million that we are able to upsize with our recent bond offering.

And speaking of that, we will use the proceeds from that, that bond issuance to repay any outstanding borrowings for general purposes, but really it provides enhanced liquidity as we think about the possible redemption of our convertible notes, which can be called in April of next year. So, really puts us in a strong position in terms of our capital structure. Prior to the recent bond offering, our debt to book cap was 28%. Pro forma, it’s 38% although I will say that, that’s a gross percentage, lot of that is cash on the balance sheet. So, take that into account, we are really still at that 28%, but anyway went extremely well and now we are well-positioned with liquidity going into next year. And again, very solid leverage statistics, post transaction.

In terms of our long-term bank facility, current borrowing base is little over $1.3 billion and again we took a little bit of a haircut as part of the covenants from the bond offering. We have to lower our borrowing base $1 for every $4 that was issued. Recent re-determination had us at $1.4 billion. That was an increase over $1.3 billion and even excluding the announced transactions that we have made and the lower commodity price environment, we feel pretty good about seeing that borrowing base increase $1.3 billion to $1.4 billion. And I should point out again no borrowings from our bank facility as of the end of September. So, again, lot of dry powder, very strong balance sheet, and I think we are well-positioned to fund our programs going forward.

Finally, couple of key takeaways, again, significant production growth is what you can expect to see from us. A lot of the programs in place that we have entered over the last few years are now in the execution phase doing very well, expect to see 50% production growth this year and 35% to 40% production growth next year.

Again, the centerpiece of that growth is in the Eagle Ford and Bakken programs that are going very well and then as I just shared with you a balance sheet that is in great shape to fund our programs going forward. With that, I am going to ask Wade Pursell, our CFO to come up and we’ll be glad to address any questions that you might have.

Before we taking the questions, little story about our dinner last night. It was at Prime 112. We haven’t been there, great restaurant. All the beautiful people are hanging out and then all the (oilies) showed up, but had a great dinner last night and got the answers from great questions. Also we were told that Will Smith was in attendance there, we didn’t get to see Will, but he wasn’t exactly seeking out the oily, so a great evening and great conference so far.

Question-and-Answer Session

Gil Yang – Bank of America/Merrill Lynch

Tony, a couple of quarters ago, you changed your type curve revising up pretty significantly, could you talk about what were the dynamics behind that and how conservative do you think or how realistic do you think the current curve is?

Tony Best

It’s a great question, Gill. I assume we are talking about the Eagle Ford and EURs. Literally, a year ago, outstanding year and we are talking about kind of our expected EURs at the time. EURs, we have said, were like 2.9 to 3.5 Bcfe equivalent. And while we are here that’s when another company, I believe the name starts with an R offsetting us announced that they were now showing EURs a 7, 7.5 Bcf and of course we spent the next couple of days at the conference here explaining why our EURs were half there. At our second quarter release, we did announce that we have seen very strong well results, especially in our Galvan Ranch area and we are now showing EURs 6.5 to 7.5 Bcf and when you know it couple of weeks ago that same company comes out, so now their EURs are 10 Bcf. That’s not our approach to business.

As you probably learn from us, we really make sure that we feel good and confident about the performance of our wells, the wells that we announced and increased EUR up to 6.5 Bcf to 7.5 Bcf. We are on production for over a year. We track those closely. We make sure that we feel confident about the results before we come out with an increase. I would say too that those numbers are (P&ID) numbers as we have a very high confidence level. We continue to see that level of performance.

Gil Yang – Bank of America/Merrill Lynch

Yeah.

Tony Best

We may increase those EURs, but we tend to let well performance talk and that’s how we approach EURs and those expectations.

Gil Yang – Bank of America/Merrill Lynch

Was that all driven by the like of infrastructure and where you are permitted to book higher EURs because of that?

Tony Best

Yeah, I would say that was part of it, because we are waiting for infrastructure to get build out and to bring some of these wells on. In some cases, we did have to throttle back these wells, just because we didn’t have the infrastructure capacity just yet and we want to be able to flow those at full rates to make sure that we are seeing that level of performance. So, that’s a good point.

Unidentified Analyst

It’s Mark (indiscernible).

Tony Best

Hi, Mark.

Unidentified Analyst

[Inaudible]

Tony Best

Yeah, we have been busy consolidating some of our technical staff into Tulsa. We got larger space, newer space, and it really is part kind of a companywide upgrade to make sure that we are able to attract and retain quality people in our organization. I want to be sure they have got a excellent work environment. Tulsa is a very good example same as Denver. We moved into new space in Denver during the downturn, perfect timing, but a significant upgrade. We just completed the same thing in Tulsa.

That group has been very busy. Their focus right now is on the Granite Wash. We have got two rigs running there. We will probably add a third rig there next year. So, we like the Granite Wash and that’s a good thing about that program is its HBP already. So, we’ve had the luxury of learning from a lot of the offset operators. And as they have been investing in their capital, in a lot of cases, we have working interest with them as well. So, we’re getting the well data with much lower working interest. So, our capital spend there has been relatively modest. But we like what we see.

Originally, we were focused on kind of the deeper washes. In some cases, there is as many as 17, 18 washes stack on top of one another. And it’s going to take a while to kind of test all those and that’s what we have been doing. I would say our focus was originally on the Marmaton and some of the deeper zones. Those turned out to be more dry gas and as we saw some of the offsetting results from other operators and the shallower washes, that’s what we are now focusing Hogshooter, Checkerboard (indiscernible) to name a few, but we really like it. The returns there are going to be as solid as many of our other programs. So, that’s why we are probably be going to three rigs.

The other area of interest there is the Woodford and the Woodford is again HBP. There are some areas of the play, the position that we have, that have a liquid contribution. So, they could actually some of those could compete for capital today, but it’s HBP, so it allows us to focus our capital elsewhere in the meantime, but great group, very strong position there in the Mid-Continent.

I should point out one of the thing the Haynesville is one program that will be managed now out of our Tulsa offices. We’ve kind of consolidated some of our technical staff. We get some questions about the Haynesville, actually showed it on the capital slide, I didn’t point out it, but I will now. We expect to invest about $85 million to $95 million in the Haynesville next year. We are keeping one rig running. We’ve got about 7 wells to drill next year to get that to HBP. You may recall our stated goal this year was to find a partner in the Haynesville to help us drill out the remaining wells to get that HBP status, $3.50 and $4 gas, we didn’t get any compelling offers. And I will tell you, it was not a garage sale and the reason that play is important to us in that position, it’s not just the Haynesville, it’s also the Bossier.

The combination of those two intervals in our position represents potentially a Tcf equivalent of resource at SM Energy. So, we think it’s a great gas option. We’ll get that to HBP, I think around September of next year with modest capital. And then we will quit drilling, but it will allow us to retain what I think will be a great gas option going forward. So, we will let the fighting of the day after the drilling.

Unidentified Analyst

Tony, can you talk a little bit about going back to the Granite Wash, what have you learned about the repeatability of the play, is it repeatable? Can you really how much of a program can you actually run in the play with the amount of inventory that you have or do you have to go slowly because not really a resource play?

Tony Best

I think in a true sense some folks could say it’s more conventional, and unconventional, but if you had such a broad area or extent, I really view this as kind of a 3D opportunity. You’ve got the aerial extent, but then you’ve got these multiple stacked washes. So, in a way, it’s a 3D challenge for the industry. I would say today our understanding is much improved in the play, but we still have quite a bit to learn. I think now with the technical work that we have done, it was actually great timing to be going slower with kind of a one rig program and learning as much as we could from the other operators.

And that’s why you are seeing us ramp up now, a level of confidence has improved to the point, where I think we now have mapped out at least on our acreage position, where we think the play will work in which zones and intervals we work. We are not finished testing. There are still other washes to test and learn from. But I think especially like in the Hogshooter and Checkerboard, those were starting to gain more confidence as is the industry. We have had some great wells over on the Texas side in Wheeler County, again, in those shallower washes and now we have extended that over into the Oklahoma side, where we have got our largest acreage position. So, I would say in the shallower washes, our competence is pretty good and we’ve been able to map those. I would say in the deeper washes we still have quite a bit to learn, but we have got several years of drilling here and then that’s why we are going to picking up our pace now going to the third rig.

Gil Yang – Bank of America/Merrill Lynch

All right, well there are no further questions. Tony, thank you very much.

Tony Best – President and Chief Executive Officer

Well, thank you all very much.

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