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Executives

Frank Hopkins – SVP, IR

Scott Sheffield – Chairman and CEO

Rich Dealy – EVP, CFO and Treasurer

Analysts

Kevin Smith – Raymond James

Michael Blum – Wells Fargo

T. J. Schultz – RBC Capital Markets

Stephen Tabb – Tocqueville Asset Management

Pioneer Southwest Energy Partners L.P. (PSE) Q4 2011 Earnings Call February 7, 2012 12:00 PM ET

Operator

Ladies and gentlemen, please stand by. We are about to begin. Good day, everyone, and welcome to Pioneer Southwest Energy’s Fourth 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, Senior 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 Investors, then select Investor Presentations. This call is being recorded.

A replay of the call will be archived on the internet site through February 28. 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 2 of the slide presentation and in Pioneer Southwest’s public filings made with the Securities and Exchange Commission.

At this time, for opening remarks, I would like to turn the call over to Pioneer Southwest’s Senior Vice President of Investor Relations, Mr. Frank Hopkins. Please go ahead, sir.

Frank Hopkins

Thanks, Rufus. 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 fourth quarter and update you on PSE’s expanding drilling program in the Spraberry field. Rich will then cover the fourth-quarter financials in more detail and provide earnings guidance for the first quarter. And after that, we’ll open up the call for your questions.

So with that, I’ll turn the call over to Scott.

Scott Sheffield

Thanks, Frank. Good morning. Starting on a highlight, on slide number 3, we had fourth quarter adjusted income of $26 million or $0.77 per unit. But it does exclude some unrealized mark-to-market derivative losses of $33 million or $0.98 per unit. Fourth-quarter production averaged about 7,000 barrels of oil equivalent per day, down about 6% versus the third quarter, primarily due to the fact that most of our wells were placed on production towards the latter part of the fourth quarter. We also had some weather-related downtime, including a lighting strike at a large tank battery. If it weren’t for these items, production would have been similar to the third quarter without these items. Rich will talk about the guidance coming up in his presentation.

11 wells placed on production in the fourth quarter, most of that towards the end, as I mentioned. From the 2-rig program, 8 additional wells were awaiting completion at year-end. We continued to see excellent results from deepening to the Lower Wolfcamp and Strawn intervals.

We had cash flow from operations of $28 million. Again, we announced a distribution of $0.51 per outstanding unit for fourth quarter, payable on February 10 to unitholders as of record date February 3 – equates to $2.04 per common unit on an annualized basis.

Reported year-end proved reserves are 51 million barrels of oil equivalent.

On slide number 4, going into the 2012 drilling program, we expect to drill 55 to 60 wells with a 3-rig program. Capital expenditure is expected to be about $110 million to $120 million, including facilities. Essentially, almost all the wells in 2012 are expected to be drilled at the Strawn formation, with about a 30,000-barrel pickup in the reserve potential in the EUR. But then 35% of the 2012 are expected going down to the Atoka – deeper Atoka interval. We expect it to add somewhere around 50,000 to 70,000 per barrels on top of our typical Wolfcamp or Strawn well.

Forecasting production growth of 10% in 2012 compared to 2011. Again reminding you, on the inventory, we have 100 remaining 40-acre locations. We have close to about 2 years' inventory. And if you read the PXD transcript over the last several quarters, including this recent one, this morning we’re still continuing to see excellent performance on 20-acre drilling, essentially achieving the same results as a 40-acre type well. The current average well costs about $1.8 million, average before-tax IR is somewhere between 45% and 50%, assuming flat commodity prices of $100 oil and $4 gas.

Turning over to Rich for financial highlights.

Rich Dealy

Thanks, Scott. I will start on slide 5. As Scott mentioned, we had a net loss of $7 million or $0.21 per common unit; that did include derivative losses associated with the increase in futures oil prices. And so adjusted for that item, income was $26 million or $0.77 per common unit.

At the bottom of the page there, you can see our Q4 guidance we put out in November and our results as Scott talked about production. If you look at the other items, all within guidance range. DD&A is towards the upper end of guidance, mainly because we continue to drill proved and developed locations. So adding that basis, everything else is consistent with what we forecast.

Looking into the first quarter on the next slide 6, you can see average daily production we do expect to be back up in the first quarter, ranging from 7,100 BOE to 7,600 BOE per day and the other items are all in line with what we’ve typically put out. Interest expense is down from what we’ve had in prior quarters, mainly because of the equity offering we did in December lowering our debt balance on the credit facility down to $32 million at year-end.

Turning to slide 7, partnership is still – great balance sheet. Like I said, with $32 million on its credit facility today, availability of $268 million, so lots of capacity to fund our 3-rig drilling program and for potential acquisitions in the future. As you see on this slide, on the third bullet point there, we are short derivative position 70% for 2012, 55% for 2013 and 45% for 2014.

Those percentages, we added derivatives in January – in 2014, that’s reflected there. These percentages are lower than what we’ve showed the last couple of quarters, mainly because now it reflects the incremental growth we expect from adding the third rig to our drilling program.

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

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And for our first question, we go to Kevin Smith with Raymond James.

Kevin Smith – Raymond James

Hi. Good morning, gentlemen. Help me try and understand some, it looked like you put – or I think you said you put 11 wells placed on production, but the majority of those by the end of the quarter. If my memory serves me correctly, last quarter you had about 8 wells waiting on completion. Were there any completion delays or am I not looking at those numbers correctly?

Scott Sheffield

Not anything major, Kevin, it’s just timing of when we get the completion rigs out there to do and when it’s convenient in the area, so those happened latter part of November and December where the bulk of the wells got completed and put on production.

Kevin Smith – Raymond James

Okay. So those 8 wells that were kind of – that were waiting on completion at the end of last quarter had to sit there for, I guess, a month and a half to 2 months, is that fair?

Scott Sheffield

Yes. There was a few done in October but then they were weighted towards the second half of the quarter.

Kevin Smith – Raymond James

Okay, great. And then on your 20-acre spacing, how many of those 1,200 locations are booked as PUDs?

Rich Dealy

I think zero.

Scott Sheffield

Zero, yes.

Kevin Smith – Raymond James

Okay. So we should see a significant reserve increase or bookings off that as we start developing them?

Scott Sheffield

Over time, yes.

Kevin Smith – Raymond James

Okay. And how many of your wells this year are supposed to be on 20-acre versus 40-acre are you forecasting?

Scott Sheffield

That we’re drilling this year, I think, most of them – there’s probably a couple that are 20s but most of them are all 40s.

Kevin Smith – Raymond James

Okay. And then one last question, do you know the volumes of your storage tank that got hit?

Scott Sheffield

I don’t know off the top of my head, no, Kevin.

Kevin Smith – Raymond James

Perfect. All right. Thank you.

Operator

And we go next to Michael Blum with Wells Fargo.

Michael Blum – Wells Fargo

Hey, good morning guys. How are you?

Rich Dealy

Good, Michael.

Scott Sheffield

Good, Michael.

Michael Blum – Wells Fargo

Hey, a couple of questions, I guess. One, so in terms of hedging, is it fair to assume that you are going to – you will sort of leg back up to the levels you were at before, adjusting for the third rig?

Scott Sheffield

Yes, I think that’s correct.

Rich Dealy

Yes, that’s correct.

Michael Blum – Wells Fargo

Okay. And then, just looking at the CapEx budget from – on a drilling basis, should we just – should we think of that as kind of in lieu of dropdowns or third-party acquisitions? You are effectively spending a nice – a pretty sizeable chunk of capital to grow the business. Is that the right way to think about it?

Scott Sheffield

Yes, I think when you look at our portfolio, that’s the most efficient and economic way to grow the partnership’s production today, given where acquisition costs are.

Michael Blum – Wells Fargo

Okay. And then the last question is just what criteria – what are you looking at from a criteria perspective when you’re thinking about whether not to raise the distribution?

Scott Sheffield

Well it’s like we have talked about before. It’ll be what our coverage ratio looks like and what the growth opportunities look like in the future, and so it’s a combination of that and how strong our balance sheet is.

Michael Blum – Wells Fargo

Okay. Great. Thank you.

Scott Sheffield

Sure.

Operator

And we’ll go next to T. J. Schultz with RBC Capital Markets.

T. J. Schultz – RBC Capital Markets

Hey, guys. Good morning. Just on the – I understand 40% of the acreage shows Atoka potential. Is there any percentage of your acreage that may be prospective for the Mississippian and any plans to drill into this soon?

Scott Sheffield

There is a very tiny portion at the Mississippian, but it’s like less than 5% of the acreage. So no plans in the 2012 plan – capital program to do any Mississippian drilling.

T. J. Schultz – RBC Capital Markets

Okay. And then just one thing on a point of clarifications on the issues impacting production. I guess ex these items, are you saying production would have been at the 7,400 barrels a day in the third quarter or the 7,200 barrels a day that you indicated as kind of the run rate?

Scott Sheffield

The 7,200 run rate.

T. J. Schultz – RBC Capital Markets

Okay. Great. Thanks.

Operator

And we go next to Steve Tabb with Tocqueville Asset Management.

Stephen Tabb – Tocqueville Asset Management

Hi. I see that you sold shares towards the end of the quarter, but you have no notation in the written write-up that you had sold shares, and at what price they were sold, and when they were sold, at what date?

Scott Sheffield

Yes, we did a – see, we did a public announcement of that back in December. We sold – the partnership sold 2.6 million units at $29.20 per unit, and raised –

Stephen Tabb – Tocqueville Asset Management

Well, I know – I know now, but I mean, normally it would be in the write-up review. Do you plan to sell any shares this coming year?

Rich Dealy

No intensions today.

Stephen Tabb – Tocqueville Asset Management

Now you say that your average before tax return is 45% to 50%, is that over the life of the well or is that an annual return, or what?

Rich Dealy

That’s over the life of the well.

Stephen Tabb – Tocqueville Asset Management

Now, further down, you say in the fourth quarter, average reported price for oil was $113.87, is that right?

Rich Dealy

That’s correct.

Stephen Tabb – Tocqueville Asset Management

And that is above the market price so I assume that was the result of favorable hedging?

Rich Dealy

It’s the favorable hedging as a result. Well, it’s 2 things. One, the favorable hedging that we had during the quarter because we had some collars at $115, and then also had some legacy derivatives that came in back when we originally IPOed.

Stephen Tabb – Tocqueville Asset Management

Okay. So – but now, when I look forward to the current year, you’re not going to have those favorable hedges. Is it going to be a negative factor in your earnings for the 2012?

Rich Dealy

Yes, we have got derivatives for 2012, basically around swaps around $80 for 3,000 barrels a day and then some three-way collars with upside up to about $104.

Stephen Tabb – Tocqueville Asset Management

So with this negative outlook on the pricing, what is your projection for covering your distributions?

Rich Dealy

I think our coverage ratio will still be right around that 1.2 times level. How we – based on the calculations and cash flow, while down from – slightly from where we were in 2011 because of the different derivative position, the production growth offsets most of that.

Stephen Tabb – Tocqueville Asset Management

The production is supposed to be up about 10% next year. Is that what you are saying here?

Rich Dealy

That’s correct.

Stephen Tabb – Tocqueville Asset Management

So that – another thing, switching the area of questioning. On the balance sheet, you have partners’ equity that shows a substantial increase from the year before. A great deal of it was due to the raising of money through the sale of the stock, as you say the $2.6 million shares, was it that you said?

Scott Sheffield

That’s correct.

Stephen Tabb – Tocqueville Asset Management

And you don’t provide any reconciliation of partners’ equity in here, do you?

Scott Sheffield

Not in that. We will be filing our 10-K here later this month and it will have the details in there.

Stephen Tabb – Tocqueville Asset Management

So, but therefore – am I correct that your liability under your credit agreement will go up quite a bit in this current year because of the fact that you are not raising new capital?

Scott Sheffield

That’s correct. We expect that we’ll borrow somewhere in the $50 million range on the capital program.

Stephen Tabb – Tocqueville Asset Management

All right, I see. So right now, though, I think your derivative coverage is lower than it has been, it’s gone down this year as a percentage coverage for future production? Is that question clear?

Scott Sheffield

Yes. It’s only lower, Steve, because our forecasted production has moved up by adding a third rig. We have the same derivative position we had before. It’s just now our production forecast is higher because we are adding a third rig.

Stephen Tabb – Tocqueville Asset Management

So, I remember a year or two ago, I think you guys were pretty good in forecasting oil prices. It’s a tough thing to do, but what is your outlook now? Are you planning to increase your coverage percentages with derivatives for the coming 2012, ‘13 or ‘14?

Scott Sheffield

Yes, I would expect us to see those coverage percentage of derivatives go up over the next few months.

Stephen Tabb – Tocqueville Asset Management

All right. In other words you think today’s prices are still at a favorable level?

Scott Sheffield

We think particularly on oil that they are and that we can do similar derivatives that we’ve done in the past that are what we call the collar structure with a short put option, and so that’ll allow us to participate if they were to run up higher.

Stephen Tabb – Tocqueville Asset Management

But what is the percentage of your production of your income that comes from natural gas as compared to oil?

Scott Sheffield

It’s tiny. Given where gas prices are it’s probably – I can do the calculation, but it’s probably around 10% – 5% or 10%.

Stephen Tabb – Tocqueville Asset Management

I see. All right, well thank you very much.

Scott Sheffield

You’re welcome.

Operator

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Sheffield, I will turn the conference back over to you for any closing remarks.

Scott Sheffield

Again, thanks for participating. We’ll look forward to the next quarter’s call. Thank you.

Operator

And again ladies and gentlemen, this does conclude today’s conference. Thank you for your participation.

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