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Forest Oil Corp. (FST)

Q2 2007 Earnings Call

August 8, 2007, 1:00 PM ET

Executives

Patrick J. Redmond - Director of IR

David H. Keyte - EVP and CFO

H. Craig Clark - President and CEO

Analysts

Subash Chandra - Jefferies

Brian Singer - Goldman Sachs & Co.

Gil Yang - Citigroup

Larry Busnardo - Tri Stone Capital

Raymond J. Deacon - BMO Capital Markets

Tom Gardener - Simmons & Company International

David R. Tameron - Wachovia Securities

John P. Herrlin - Merrill Lynch

Jeffrey W. Robertson - Lehman Brothers

Presentation

Operator

Good afternoon. My name Bradley and I'll be your conference operator today. At this time, I would like to welcome everyone to the Forest Oil Second Quarter 2007 Earnings Conference Call. All lines have been placed on mute to present any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.

Mr. Patrick Redmond, you may begin your conference.

Patrick J. Redmond - Director of Investor Relations

Good morning. I want to thank you for participating in our second quarter 2007 earnings conference call. We have joining us today, Craig Clark, President and CEO; and Dave Keyte, Executive Vice President and CFO.

Before we get started, I would like to take a moment to advise you about our forward-looking statement within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of Securities Act of 1934. All statements other than statements of historical fact that address activities that Forest assumes, plans, expects, believes, projects, estimates or anticipates, will, should or may occur in the future are forward-looking statements. The forward-looking statements provided in this press release are based on the current belief of the management of Forest, based on current available information as to the outcome and timing of future events.

Forest cautions that the respective future natural gas and liquids production, revenues and expenses and other forward-looking statements are subject to all the risks and uncertainties normally incident to the exploration for and development and production and sale of oil and gas. These risks include, but are not limited to price volatility, inflation or lack of available goods resources, environment risk, drilling and other operating risks, regulatory changes, the uncertainty inherent in estimated future oil and gas production or reserves and other risks as described in reports that Forest files with the SEC including its 2006 annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

Also the financial results of Forest foreign operations are subject to currency exchange rate risks. Any of these factors could cause Forest's actual results and plans to differ materially from those in the forward-looking statements.

I will now turn the call over to David Keyte. Thanks.

David H. Keyte - Executive Vice President and Chief Financial Officer

Thanks Pat, thanks for joining. Wow, what a quarter. The following four transactions were announced during the quarter and in combination we will focus our operations more sharply on the development of North American Natural Gas, significantly reduce the cost structure of the company and provide liquidity and low cost term capital to allow us to execute our plan.

First and most notably, we closed the previously announced THX merger. This added five key areas, producing over 200 million a day of natural gas. The assets are highly concentrated and have almost 3,000 drilling locations not including the more speculative Uinta play and have very low operating costs. With this transaction, since Craig was named CEO in late 2003, we've spend about $3 billion to purchase oil and gas assets in our key areas. The average cost for the crude reserves will be about $2 per Mcfe and 6700 for flowing Mcfe per day. These are very good metrics, however, it's more important to do what you do with the assets after you buy them and I think as Craig reviews the initial progress after earning these assets for one month, you'll agree that this transaction will be as good or better than previous purchases.

We also agreed to sell our Alaska assets. This divests our last offshore property, our only non-growth business unit, our largest non-operated property and our highest operating cost property. The announced sales price metrics are in excess of where all of Forest trades today. Even though this asset was a significant free cash flow generator, it was not in sync with our long-term strategy of onshore North American Gas.

Third, we announced an amendment to our credit facility which now has a borrowing base of $1.4 billion and a present commitment of $1 billion and at June 30, a drawn amount of about $430 million. We announced also a closing in the $750 million senior note offerings, which not only was a) the fourth largest E&P high yield offering ever, b) at 235 basis points the tightest treasury spread for any high yield issuer this year, but also it was for a non-conforming term of 12 years with only a five-year no-call provision. This note was fortunately issued just prior to the credit markets deteriorate.

The combination of these four transactions leaves us with more assets with a greater weight toward onshore natural gas production, significantly more drilling locations to ensure predictable returns and low risk production profiles and an excellent capital structure with substantial liquidity to grow further. There is lot of deal execution in last couple of months that has left us, bigger, better, stronger and more importantly, with the significantly more robust drilling inventory than we had in March.

Now I would like to turn to the quarter results. First, these results include the operations of the TXH assets since June 6th, 2007. The headline for the quarter is that the results were about as anticipated with cost remaining in line against the backdrop of improving differentials and higher derivative realizations from our improved hedge portfolio. Overall, I characterize the second quarter as right down the middle, as our investors have become accustomed to.

Overall adjusted earnings were $0.67 per basic share, an increase of 26% from last year, due to the increased production, higher commodity realizations and higher derivative realization. EBITDA at $188 million was up 36% from last year for the same reasons. Discretionary cash flow was up 34% from last year, the top line growth was offset somewhat by increased interest expense.

Sale volumes were up 18% from 2006, reflecting the acquisition for a partial month and the big three assets at Buffalo Wallow, Wild River in East Texas are now producing 124 million cubic feet a day, about 25% of the company's production. This compares to a combined rate a year ago of 84 million cubic feet a day or increase of 48% in the big three assets.

On a revenue side, gas realizations improved as NYMEX prices were higher and differentials lower in the quarter. Lower gas differentials reflect the impact of the greater exposure to Houston ship channel in our gas portfolio. Liquids differentials increased slightly as natural gas, liquids represented a greater percentage of our liquids sales stream.

Productions and expenses were also up slightly to about 1.80 for Mcfe due to higher operating expenses in Alaska, offset by the introduction of lower cost production in those assets acquired from THX.

G&A expense was as planned, as it increased due to the regular salary increases and headcount added to manage THX assets. Interest expense increased substantially, reflecting higher cost term loans in Alaska and average debt balances which were higher to finance the THX acquisition.

During the quarter we spent $158 million in capital expenditures, received about $32 million in asset sales proceeds for a net spend in the quarter of $126 million or about 80% of discretionary cash flow.

Net debt at the end of the quarter stood at about $2.1 billion, including $265 million of senior notes during 2008, which are now classified as a current liability. As of June 30, we had about $570 million available under our credit facility.

On the Alaska transaction, since we announced our intention to sell Alaska, we worked with several parties, all of which were in some way financed by private equity or hedge fund money. We announced the sale to one of these parties, Pacific Energy Resources. It became apparent about the time that credit markets began to collapse the financial backers would not be able to provide the same amount of cash as initially envisioned. We work with Pacific Energy to restructure the transaction which resulted in added risk to the currency Forest would accept for the asset. It keeps us neutral we believe from a value perspective.

At this time, we had a deposit of $5.2 million of cash and $15 million of Pacific Energy common stock. The transaction is expected to close by August 24 and a deposit may only be refunded basically if both side agree on action of the course. Based on discussions with Pacific Energy and the financial backers, we remain optimistic we will be closing this transaction in August.

I would now like to review our guidance with you. The issued guidance specifically does not reflect any operations of Alaska and is only for the last six months of 2007. It is based on a capital budget for those 6 months, $450 million to $500 million and does not take into account any post June property sales.

Production is expected to be 500 to 510 million equivalents per day. In this forecast we take into account a reversionary interest in the Rincon field in South Texas, which will reduce our production at 7 to 10 million cubic feet a day when that property pays out. The short and sweet explanation is that at payout we own 50% of Rincon's net profits to Rice University. We will account for those as a decrease in both production volumes and in revenues. When we initially thought the combined property could produce 502 million equivalents a day in 2007 without Alaska. We did not anticipate loosing those volumes. The pay out has been accelerated due to excellent results in that property.

In summary, we view the 500 to 510 million a day guidance to be an increase of about 3% to our previous guidance. However, due to the accounting of Rincon and the expected performance has been offset by loss of Bcf of production due to the early payout. We also believe using the same math that this guidance implies an 8% to 9% organic growth rate over the same asset base in 2006, all spending less than cash flow.

Production expenses are expected to be $130 million to $140 million, $1.40 or $1.50 per unit down 20% in the second quarter rate of $1.80 per unit due to the THX acquisition and the elimination of the Alaska assets.

G&A expenses should be about $30 million and stock-based comp will be about $7 million. DD&A is expected to increase to 2.50 to 2.70 per unit, reflecting a purchase price in order the purchase accounting gross-up for the THX asset acquisition. Income taxes will be about 36% on a total rate current portion being about 5% of total tax expense and finally we believe shares outstanding will remain it about 88 million shares. This concludes my remarks and I'll now turn over to Craig, who just celebrated his fourth anniversary as CEO of Forest. For the record, the stock has appreciated 270% since he started. Craig?

H. Craig Clark - President and Chief Executive Officer

Thanks for the plug, Dave. We had a lot of highlights this quarter, both financially and operationally. It was a very critical quarter for our company. Many important steps were taken which shape the company's future. I am the most pleased that all the steps we are taking in the regimented order and timing we had planned. Our timing in all steps was excellent particularly on the debt offering.

The hallmark of the new Forest may be our ability to get things done in any market. Although, we had a recent history of being transactional in our company, I think we approach each transaction or acquisition from an operations point of view and not solely on the deal trades standpoint. In addition to the financial transaction highlights Dave covered, we've had many more on the operations side, including the newly acquired properties. I'll talk more in detail and try and tie this to the guidance as we go through each area, but a few additional highlights are as follows.

Not only did we close on Houston Exploration in the second quarter, but we are now integrated in terms of the organization, offices and more importantly, the tracking systems. We've only owned this thing for two months, particularly, the systems and automation which are the keys to measuring success and cost control and investment efficiency. Personnel are in place from both companies, I want to welcome the new employees as well to mange the new company and the new business unit set up. We recently hired Ronnie Nutt to run our southern business unit office in Houston and J.C. Ridens is to be committed for the excellent job in assisting in the transition, many of you, our shareholders have met JC.

Consistent with past acquisitions, we hit the ground running on the recent acquisition with production gains already in East Texas, Arkoma and the Rockies. There has been some great work already by our people from both companies with the drill bit and surface for some of these in particular. There was also a trade, I need to note earlier this year, which Houston exploration did and we approved for our small position in Eastern Oklahoma for working interest in East Texas around the Willow Springs area that covered approximately 5000 acres of additional acreage in East Texas. This was an even up trade.

We also sold year-to-date as of the end of the second quarter $40 million of marginal properties. Our goal was $500 million to $600 million by year end 2007. I guess, with Alaska and other sales in progress, we may accomplish this goal by the end of the third quarter instead of the end of the year.

Turning to the quarter results, we spent $158 million in capital in the second quarter including the CapEx for Houston Exploration assets in June. The Forest spin rate was lowered due to spring road conditions in Canada as expected and as a note, Forest was minimally affected in the second quarter by weather specifically, the heavy rains in Texas and Oklahoma. Our only issues were the seismic crews that were shed down in the Barnett Shale and moving rigs around in the mud in places like East Texas.

We have made progress in reducing capital on the Houston Exploration assets already, particularly in the Rocky Mountains from 3 rigs to 1. Our new capital guidance reflect aiding a couple of rigs in East Texas in Arkoma basin and Italy delineation well. These should be no surprise as we've been talking about that.

We're seeing well cost reductions continue in Canada, but they are flattening out somewhat in the U.S. although I think year-to-date we'd estimate a 10% decrease overall with more discounting hopefully to come in Canada. We now have redeployed some company owned rigs to the Texas Panhandle and the Arkoma basin in addition to East and West Texas, and they kind of spread out. Through the second quarter of 2007, we drilled total of approximately 150 wells gross, that's mostly Forest at 98% success rate. Again the development of phase kicks in.

Our well account activity will pick up considerably in the last half of the year with an estimated 250 gross wells to be drilled. We noted these 2007 wells remaining to be drilled in the major areas in each area the operations release. On the other side of cost, although we said about flat for the same period last year and last quarter higher workovers in Alaska and overlay production taxes offset the gains elsewhere. The effect of our synergies on the combination of Forest and Houston Ex properties should begin in the third quarter as we combine field operations already in three areas following the transaction close. 0

We did not assume any cost savings on their properties, they were low but we have already had some synergies in combining these offices. Our project focused cost control program will move from taxes after finishing in Canada later this year that are up there now. You can see that how we improved cost structure of company today and revised guidance which reflects about a 20% decrease on our current LOE per unit cost.

On the production side, our production was up 27% since last quarter due to several factors, mainly the partial month of Houston Exploration properties, but organic growth on both property sets, Alaska crude oil lifting's, almost got cut up and the plant down towntime that we stated in the first quarter was remedied. We set record production levels again in this quarter and Buffalo Wallow East Texas, Wild River and for our Waller at Katy.

We also saw sequential production gains in Arkoma and in Rocky Mountain properties. I revised the guidance which is up slightly from the beginning of the year as Dave detailed reflects this performance with Houston Exploration being included since June 6 and Alaska removed for the rest of the year. I should note the property sales to-date made approximately 3 million a day equivalents of production and those closed at the end of the second quarter.

Dave commented on product differentials, but we should note that WTI crude pricing have been complaining about it, has come back somewhat in line with Brent finally. We also continue to get a premium for light crude in Canada and Gulf Coast. Liquids differentials which we've guided reflect the increase NGL recovery. Our decision over a year ago to focus on extracting NGO was a good one, because we got a huge delta right now between the price of natural gas and liquids of value currently.

Gas price differentials improved as Dave stated that I should note that the decision to ship from Texas to Texas in Canada away from the western areas proved prudent as our differentials near to that. The average Canadian well head prices actually were higher in this quarter and some of the places certainly Rockies and the Mid Continent.

In the press release we have listed the major projects in order to newly reorganize business unit. It was quite an effort to add these properties and then same properties back and forth to make these units conform geographically. Our folks in places like Denver and Houston, field officers have done a good job here. From this point forward, I will speak only of the combined asset basis just to simplify the things.

You should now take notice of the diversified but highly focused asset portfolio. More importantly, that each big growth asset wherever you call them throughout the company seems to be making around 40 million a day has about four or five rigs running on and has a net acreage particularly undeveloped acreage that running around for years to come. This portfolio is by design and loads the boat with future growth opportunities. Furthermore, the big growth fields, I want to call them Buffalo Wallow, East Texas, Wild River, Arkoma, South Texas are about 60% of our production where our rigs are running. So you can basically see our company now by these five fields alone.

In the western business units, Buffalo Wallow is the biggest field and had another production record this quarter, 42 million a day equivalents. We've now doubled production since acquiring this field. We have yet to drill a dry hole even in the outlined undeveloped acreage. I should note that the pace of wells added has slowed only because two of the five rigs are driven in the offset deeper areas where the average depth is 15,000 feet versus 13,000 feet in the main Buffalo Wallow area. So far so good in the outlying areas is the last two test are noted in the operations release at 3 million to 4 million a day a piece. This drilling continues to confirm that offset areas are as good as the main field area.

Another positive in the outlying areas is that we went ahead and performed a separate test on the deep Atoka and it by in itself made over 2 million a day. This is noteworthy because our previous Atoka tail only tested about 400 Mcf a day. This certainly justifies drilling deeper more than ever and I said in the last quarter and the quarter before, the area continues to surprise us to the upside.

In Haley/ Vermejo we added three more re-entries at a combined rate of 9 million a day equivalence, we don't have much more drilling plan until we see the new 3D survey later this year. The reason Anadarko Chesapeake transaction comments about this area reflects positive on our acreage holdings which are right in the middle of our joint venture and may help to extend the play.

As we stated last quarter, the increased oil drilling we did more of in the Permian and the Rockies this includes further explanation on our North Anvil discovery in Montana and the horizontal play in North Dakota that we got from Houston Exploration in the third and fourth quarter this year. We included a short period wrap in the release on the Rocky mountain assets. Just to clarify what's going on up there. We recently acquired these and production increase over 50% since early 2007. Even tough we reduced capital spending here this quarter, we were able to see these productions gain primarily from the new wells drilled in the shallow Niobrara, did some catching up on Uinta completions and there were some downtime eliminated, which was their scourge last winter. There were quite a bit of surplus facility work in both areas, particularly in the Niobrara. There is currently one non-operated rig running in the Uinta.

The biggest encouragement we've seen in Uinta was that the last three Mesa Verde Wasatch wells had rates markedly better than previous one. I don't know if they are the best that we've had. But I tested at 2 million a day a piece, so we may have found our sweet spot. And there is also been some offset industry drilling, you've heard about, we are seeing some good results in the deeper zone below the Mesa Verde, specifically in the Mancos and the Dakota near our acreage. So as we previously announced this quarter, this area was included and our shareholders would have option value in the future. We may now see some of this value coming around.

Our acreage position is large in both Uinta and in particularly in the Niobrara, that's over 0.5 million acres. The installation of salt water disposal fields and both saltwater disposal facilities in both areas will reduce operating cost in the future. In the Eastern business unit, it's our own southern business unit renamed. It covers East Texas, Arkoma, and the Barnett Shale and the upper Texas Gulf Coast. They have already had gains on the newly acquired properties in East Texas and Arkoma, similar what they have previously done on the Forest East Texas assets.

In the East Texas Cotton Valley trend, where we doubled up on acreage and rig activity, the clear highlight is the record net production again on the property said in our first successful horizontal Cotton Valley test. Our first horizontal Cotton Valley well was studied for a while and our 2700 feet laterally and we did five fracs that came in and the oil came in over 4 million a day. This certainly met or exceeded our expectations, and I would like to personally get more frac stages off in subsequently wells to see if we can do a little better. We would like to get two more horizontals done in different areas from this by year end and we have stated are identified as 5 additional horizontal location as a follow up.

Our East Texas net production was 41 million a day equivalents in the second quarter and we recently going to 5 rigs based on the success we've had and also more activity on the newly required fields. We had production increases I should note on both property sales during the second quarter. Net production increased in the Arkoma basin as well in the second quarter, now it's around 40 million a day equivalents. That's that number again. The highlight well and we've been asked about this we've got 1 well which came on initially or flare test initially 11 million a day. We are down in need of additional compression and pipeline loops as these are subnormal pressure reservoir that's typical that produce into the sales line at lower rates than test until compression is installed.

We will increase activity from 2 rigs to eventually 4 rigs by year end including 2 of our company owned rigs they are already been retrofitted for air drilling. As we previously stated, this area was the most pleasant surprise on the recent acquisition, we've got about 70,000 gross acres here.

In the Barnett Shale, we increased our gross acreage position to 26,000 acres and began seismic in both Hill and Erath County, the second of well tested 1.9 million a day and the third well is being fraced this week. A fourth well is currently drilling. I would like to increase our acreage through partnership so this becomes a meaningful contributor to the portfolio that announced 26,000 gross acres.

In the Southern business unit, in Houston it's up and running. The inherited the Forest Katy field from Eastern in pretty good shape. Our team in Katy has doubled production in almost a year going from 13 million to 26 million a day gross. We pretty much had a continuous workover with restoration program going on and we drilled I think about half a dozen wells. The Middle Wilcox program, though, is the prize here with wells that are coming around 2 mean a day or around 10,000 feet deep. We've got three Wilcox AFEs currently approved.

We also drilled a 4 million a day Wilcox well in the El Campo area, and it's probably closer to our Wharton acreage, but it is southwest of Katy. So this area should continue to be appraised, the growth area for the new southern region.

South Texas Wilcox problem which includes the largest field in South Texas, Charco as net production of 104 million a day, just from the Wilcox. This program is focused on the Perdido and Lobo sands. The average initial rate for the 12th completions that we have done year-to-date is 5 million a day. One well in Charco in the second quarter had initial sales of over 10 million a day. These are not large targets however, but can we identified effectively with 3D seismic and have attractive flow rates. We added to our 3D position in June in South Texas in the Wilcox program.

There has also been some recent horizontal drilling success in the Perdido section we are evaluating. Our four rig program in South Texas should drill about 27 wells the last half of the year. Further south in our Vicksburg program right on the Rio Grande border, it does include the Forest McAllen Ranch field from eastern. It produced about 35 million a day net. The major field here is Rincon field which makes over half the net production and had a production record set in the second quarter. Dave referred to this field's MPI earlier. We added 3D seismic in the Vicksburg program in South Texas as well. There are currently no rigs running in the Vicksburg program, but we will restart this program later this year.

In Canada, Canada went from being the second biggest to the smallest business unit after Houston Exploration acquisition, even tough they have grown quite a bit organically the past few years. I know this sounds kind of boring, but they are yet to drill a dry hole this year and set another net production record again at Wild River. Wild River net production was 41 million a day equivalents after new processing facilities have broadened the service in April. Now a lot of wells were brought on line in the second quarter because of the road ban. We are continuing to utilize a two-rig program at Wild River and recently drilled I think our 100 well and productions are up almost 5 fold during our three-year ownership. I should probably refer now refer to Wild River, Ansell and Hinton as the big basin, since they are in close proximity and that's what's commonly called up there.

We had two more Ansell exploratory wells coming at 1.3 to 2.0 million a day and three more planned there. We also have three more planned at Hinton for the remainder of the year. The last Hinton well came on at 3.6 million a day and it was note worthy that we and our partners added seven sections of leasehold in the Hinton area bringing our acreage to around 15,000 acres gross. So we have a lot of run room in Hinton and Ansell as well.

In the Southern Foothills, it's not in the release, our second Waterton well was completed at 14 million a day to follow up last year's well at approximately the same producing rate. A third well is completing and should be tied into Shell's sour plant by year-end. Now we have 12.5% in this unit. The deep basin, foothills and shallow oil in Canada would dominate the program throughout '07 and '08.

I always mention the international business unit last, nothing intended but in this case not least. Our first discovery well in the Monte Pallano area in central onshore Italy tested around 7 million a day after perforating from the lowest gas pricing. Test rates were limited by the production test equipment on the rig. Additional gas play does exist uphold, so well not eventually produce on a commingled basis 10 to 15 million a day from both zones. As noted in the release, no asset or frac stimulation has been done to this point on these zones.

The second offset was immediately spud shortly thereafter and is now drilling and should reach total depth by the end of August. It will probably take us a year to hook up these wells to sale even old pipeline's not very far away. The gas market in Italy remains robust, current indications I'm told are $7 to $10 premium BTU U.S. dollar. Congratulations to our international guys for doing leasing and trades which basically over the last two years have traded out of our old mountain front thrust plays in the current 300,000 acre position mostly around the Poe Valley.

The sale of Alaska later this month, we have now essentially sold most or all of the assets of the company we inherited 4 years ago this month and replaced then with the assets we discussed at length today. You can currently know Forest by the five main fields that make about 60% of our production with backup fields in the up and comer category for future growth and running around. In these five main fields we got about 300 million a day production, 300,000 net acres and I think about 20 rigs running at this time.

It's nice also to have something flying, what we call the flyer category and add value like Italy and the Uinta. So the program is working and this plan was by design. I do not believe in any industry however, particularly our industry that we as managers should not become complacent with our current hand and must force change every few years, because complacency breeds inefficiency and we are caught by surprise and changing market conditions and as everybody knows the market condition is changed daily in our industry. Certainly we are not hesitant to change your Forest and have not stood still this period of time.

So we are off to a good start on the new asset base so far in 2007. My only hope is that the Aggie's get up to a good start in football the same way we did. Thanks for listening and being patient with all the changes. As always, thanks to our cash shareholders for their support and we welcome the new shareholders who choose Forest shares in the recent transactions. Operator, we will be happy to take any questions ahead.

Question And Answer

Operator

[Operates Instructions]. Our first question comes from Subash Chandra of Jefferies.

Subash Chandra - Jefferies

Thank you. Was there in the South Texas assets that Houston Ex had, was there sequential decline this quarter or do... am I looking at the wrong thing?

H. Craig Clark - President and Chief Executive Officer

Gosh, I don't think there was a decline at all. I think it was pretty flat I don't know the exact number, but all the difference is probably because we shift some properties in north and south, but I don't think there was a sequential decline.

Subash Chandra - Jefferies

Okay. And McAllen, your McAllen properties how much of the 35 is your net production?

H. Craig Clark - President and Chief Executive Officer

Its only a couple of million a day.

Subash Chandra - Jefferies

Okay got it. In the Norbrara is that the rig you are using a call tubing in it?

H. Craig Clark - President and Chief Executive Officer

Its rig.

Subash Chandra - Jefferies

do you think moving to CTU, any plans to do that or to add one to accelerate development?

H. Craig Clark - President and Chief Executive Officer

Actually they... our processor used one to drill 20 wells on turnkey and I can't comment whether they are quicker, I can just say that the current rig turnkey is as cheap when I look at cost per foot. I guess the jury is still out. They used one for 20 wells and it looked about the same but our rig is just a conventional single drilling rig.

Subash Chandra - Jefferies

Okay, great. And Uinta when do you think you might be able to legitimize sort of the three P potential Houston Ex was looking it. Do you think that you might make any headway this year or is that going to be a longer program?

H. Craig Clark - President and Chief Executive Officer

Well, we are certainly trying to make headway. We did not honor that potential because it was so large and we wanted to study the results of the well. And I guess, it's safe to say we brought in based on the current proven, what you see is what you get and we are evaluating the entire area using our folks.

Subash Chandra - Jefferies

And the deeper Mancos, any way to qualify that?

H. Craig Clark - President and Chief Executive Officer

No way to qualify except that a lot of that activity particularly on the north side is near our acreage.

Subash Chandra - Jefferies

Okay and the final one and I'll hop. The working capital number the debt that showed up, did any of that have to do with sort of depending on Alaskan sale or was it just a recategorizing debt for long to short?

H. Craig Clark - President and Chief Executive Officer

It's recategorizing the debt from long to short.

Subash Chandra - Jefferies

Okay, thanks very much.

Operator

Your next question comes from Brian Singer of Goldman Sachs.

Brian Singer - Goldman Sachs & Co.

Thank you, good morning.

H. Craig Clark - President and Chief Executive Officer

Good morning, Brian.

Brian Singer - Goldman Sachs & Co.

Based on the success you had over the last couple of quarters in the extension of Buffalo Wallow, can you draw any larger conclusions in terms of seismic scope and what it is really in the timing there for becoming more aggressive development with respect to what you did see?

H. Craig Clark - President and Chief Executive Officer

Not much, we said some time ago there is really not much wild card in the main field area. It's just a matter how fast you want to go in that business unit with rigs. I think we've added one. That's the only limiting factor as we hold the business units to their free cash flow. The other area was going deep and going out in the outlying areas and you have to step to see with these 2 rigs, but obviously we are not being disappointed in that. In the main field there is the only question is how fast you want to drill.

Brian Singer - Goldman Sachs & Co.

And in terms of the extension, the extension areas did you have some sort of conclusion now in terms of size or at least has that changed?

H. Craig Clark - President and Chief Executive Officer

We... if you Brian, if you looked at our when we did the Houston Ex for locations, we used to run the main field is allowed to down space to 20s, so many offset outlying areas, its it's statewide rules of 40s and 80s and we have never made a projection that down spacing would be more or less, in this case less, but it could be this many I believe we took our location kind of up to over 600 locations and that came, the additional locations came primarily from the outlying areas, but that does not assume 20 acre spacing yet. So the location change from last year to this year is primarily outlying areas which we added a couple of 100 locations. If you use 20 acers, I am going to have to get my calculator out because there will be a whole bunch of them because the main field is on about a third of the acreage, its 45,000. The main field is not the biggest acreage plot it's the outlying area. So you have a lot more locations and we haven't been disappointed yet.

Brian Singer - Goldman Sachs & Co.

Great. And then secondly, you've historically got it towards 6% or mid single-digit type of growth looking out into next year. Is that still your thought process that you have to attract some of your profit sharing for a month and what are your thinking in terms of capital spending next year, is that consistent with what you are projecting here for the second half?

David H. Keyte - Executive Vice President and Chief Financial Officer

I think our business model consistently is under spend cash flow into shoot for a mid single-digit type growth rate, but beyond that we don't have a comment.

H. Craig Clark - President and Chief Executive Officer

We gave them flat simply because we want to reduce the capital which is you see is we made tremendous progress and but stopping the capital allocation or overspending was our first priority and then we'll go from there in '08.

Brian Singer - Goldman Sachs & Co.

Great thanks.

Operator

Your next question comes from Gil Yang of Citi.

Gil Yang - Citigroup

Good morning. Could you talk a little bit about Italy in terms of what your plans are, what the cost of wells is and what the economics?

H. Craig Clark - President and Chief Executive Officer

The plans are to build the second well. We are not required to test it since we tested the lesser zone, I'm sure those zones are pretty good. We will finish drilling the well, we don't... we are not required to do any additional testing or completing. We will proceed with just contracting pipelining work. The economics are pretty good because the wells are I believe drilling complete over there, is $3 million to $4 million they are around 7000, 8000 feet deep and we have not made a decision on whether to do any stimulation. In years past someone did some acid jobs that worked out really well. We were so happy to have a well that exceeded our expectations and to drilling this accumulation I think you will probably need to do two or three wells depending on the rates. And will be doing that reserve analysis by the end of this year, based on the second well and then proceeding to hook it up or monetize this asset.

Gil Yang - Citigroup

Its already cost 30B's or so, is that about right or?

H. Craig Clark - President and Chief Executive Officer

That's about... big current, I think that's the gross after you take out the nitrogen, there is some nitrogen in the gas, that's the gross reserve number and you got to net that down. We have 90% working interest in it I think.

Gil Yang - Citigroup

Okay.

H. Craig Clark - President and Chief Executive Officer

Yes.

Gil Yang - Citigroup

The CapEx number of $900 million or so with your last divestiture is that a defacto increase in the CapEx based on your previous guidance that maybe included Alaska?

David H. Keyte - Executive Vice President and Chief Financial Officer

Not really, I think Alaska spent about $1 million in the first six months of this year, so its not an active CapEx program in Alaska.

Gil Yang - Citigroup

okay alright. And then the $500 million to $510 million, does that include other divestitures?

David H. Keyte - Executive Vice President and Chief Financial Officer

It does not.

Gil Yang - Citigroup

Okay, so that will go down if you do other divestitures that help you to get that $600 million target, right?

H. Craig Clark - President and Chief Executive Officer

that is correct

Gil Yang - Citigroup

Alright great, thanks.

Operator

Your next question comes from Larry Busnardo of Tri Stone Capital.

Larry Busnardo - Tri Stone Capital

Hey good morning Craig.

H. Craig Clark - President and Chief Executive Officer

Hey Larry.

Larry Busnardo - Tri Stone Capital

Hey. In Buffalo Wallow, one of the two extension wells that were drilled, were those primarily on the southern extension acreage?

H. Craig Clark - President and Chief Executive Officer

Yes. And as you've seen on our map most of the extension acreage is to the south.

Larry Busnardo - Tri Stone Capital

Were both of those wells drilled at the Atoka?

H. Craig Clark - President and Chief Executive Officer

Yes, as a standard most almost all, I think I may be... I think almost every well, I say almost I think every well goes through the Atoka now no matter how deep it is. It's about a 300 to 400 foot extension.

Larry Busnardo - Tri Stone Capital

Okay. And what is that add-in cost, is it much?

H. Craig Clark - President and Chief Executive Officer

Not much, because initially we were doing it to just to wear out the bits, but it's the cost, the real cost of the additional frac job.

Larry Busnardo - Tri Stone Capital

Right.

H. Craig Clark - President and Chief Executive Officer

And we may have to evaluate it for doing a bigger job based on that right. We tested it separately in the south because it was so big relative to the north. But it started out just as an adder zone and we are still treating it as such, but we may need to oscillate it more in certain areas. That was a... that was better than we expected.

Larry Busnardo - Tri Stone Capital

Okay. Just shifting on to East Texas, the success that you had with the horizontal well. Is there a reason why you wouldn't drill more, are you restricted in any way from drilling more horizontals or you just waiting to see what the result are from that first one and how that holds up?

H. Craig Clark - President and Chief Executive Officer

We were... you know we were very selective in our first one. Unlike the craze going on over there currently, it's still active. And I think we did... we selected Canada in different areas. There's no restriction on it except that we have to put the land together to provide for the horizontal extension and some places provide for you to pull them together, some don't and also we were pretty selective on our candidate and we are also selecting locations on the Huston Exploration properties well. But there is no restrictions, so we are going to take, we are not going to have one rig exclusively for horizontal. But we are going to use our same rig coincidently it's the one we own to continue to do and that will get us two more by the end of the year, but right now we have got 7 that we are looking at.

Larry Busnardo - Tri Stone Capital

Okay what's the timing of the next one?

H. Craig Clark - President and Chief Executive Officer

I think what we are going... I think we take like a break to get everything together just because the next couple of wells are nearby, probably a third quarter well.

Larry Busnardo - Tri Stone Capital

Okay. Just lastly, how many total rigs do you have running right now operative?

H. Craig Clark - President and Chief Executive Officer

The total I just looked at this, it is 33 and think all but 3 or 4 of those are operative.

Larry Busnardo - Tri Stone Capital

Okay, alright. And what's the plan on those going forward. I know is the level going to remain the same, I know you are talking about shifting some rigs around, but I guess where could that level go here during the second half of the year?

H. Craig Clark - President and Chief Executive Officer

Be pretty flat, expect we dropped 2 in the Rockies and are picking up 2 or 3 in Arkoma and East Texas, so flat.

Larry Busnardo - Tri Stone Capital

Alright, thanks.

Operator

: Your next question comes from Ray Deacon of BMO.

Raymond J. Deacon - BMO Capital Markets

Yes, hey Craig. I was wondering how was Ansell looking as a potential replacement for a Wild River a couple of years from now after you are gone through the inventory there?

H. Craig Clark - President and Chief Executive Officer

So far so good, I don't think its going to draw hole. I think we are up 15 to 20 wells. They still are using 3D to pick them, so I wouldn't call them the development program and they are only completing one zone versus Wild River where you get as many 4 zones. I don't know if it will be better than Wild River, although the initial rates are better, but it certainly looks like it's a substitute and it's about the same

Raymond J. Deacon - BMO Capital Markets

About 14,000 acres.

H. Craig Clark - President and Chief Executive Officer

Yes, and actually its net 14,000, I think gross is 28,000. Its almost exactly the same size in area as Wild River and it's the same zone, the main zone as it can, looking pretty good though.

Raymond J. Deacon - BMO Capital Markets

It's good. And is your acreage in Hills still around 7,000 or have you even added many acreage there?

H. Craig Clark - President and Chief Executive Officer

The acreage where, Ray?

H. Craig Clark - President and Chief Executive Officer

I am sorry in Hill County and in the Barnett.

H. Craig Clark - President and Chief Executive Officer

oh I don't know the breakout; we added some leases in both areas. So I think we are up a couple of that, but I think that was about evenly split between Erath and Hill.

Raymond J. Deacon - BMO Capital Markets

Got it, got it, great. Okay, thanks very much.

H. Craig Clark - President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Tom Gardner of Simmons Company.

Tom Gardener - Simmons & Company International

Good afternoon Craig, Dave, Pat. Hey, first housekeeping question; what were the Houston Ex properties producing at the close of the transaction and how much of your 2Q production was from those properties?

H. Craig Clark - President and Chief Executive Officer

We don't have those numbers available because we just mixed them all together. We had some properties that went in some you can see because they stand alone but others just kind of split around.

Tom Gardener - Simmons & Company International

Okay.

H. Craig Clark - President and Chief Executive Officer

So can't have that number.

Tom Gardener - Simmons & Company International

Okay. Well, skipping over to the Barnett, you know you are drilling your fourth well now, can you give us an idea where you are in the cost learning curve and where do you think this cost may end up?

H. Craig Clark - President and Chief Executive Officer

Well the first cost... the first two wells were high and they changed that to drilling rigs. The third one was high, didn't change that to drilling rigs. We got to give the costs down, the dry hole cost area. They are a little deeper, a little more faulted down there, but I think the drilling cost was supposed to be in the $2 millionish range, completed cost will be $2.5 million, $3 million something like that. They are deeper than the Johnson County stuff, but we ran them for about that cost and come in about $2 million a day. We have not gotten out 3000 feet yet, I think the longest lateral we drilled is 2200 foot. And we are getting that extra lateral, if the hole cooperates is not really a big issue. In fact we changed out the mud system on the next well to see if we can do something better with the cost and the drilling time. We've even tried the air drilling out there. So it's safe to say, it's still kind of an experiment. There are wells surrounding us there's been a mix of mud and air drilling going on and so it's safe to say we are not their only cost.

Tom Gardener - Simmons & Company International

Okay. And then skipping over to Katy, regarding the Wilcox wells, can you talk about our success to-date, the economics of the wells, how many potential locations you see going forward?

H. Craig Clark - President and Chief Executive Officer

There is couple of plays going on in the shallow wells, cost a couple of $100,000 a piece. If someone else to do the shallow ones first, you fill them with the workover rig, they come in 0.5 million a day type wells, no frac. Economics are good because they are so cheap and the price of gas is the Houston ship channel. So the real focus of the middle Wilcox is probably where you are headed. If we can use an existing well bore, because if you remember there is a 130 of math there and only about half of more producing when we took over. We permitted that problem a little bit. But if we are inside a well deepening or recompletion you are talking about $0.5 million job that gives you know B to 2Bs, pretty good economics. We are still aggressive with each well, you have to set pipe in it to deplete NOL you are talking about a couple of million dollar well, $2 million to $3 million to find about 2Bs and the economics are pretty good on those as well.

Location wise, the field is not... its 33,000 contiguous acres, we are not even close to down spacing. We would envision some day maybe the Wilcox being on 80s. But that assumes that there are no other Shale, and deeper inner wells and that would be a bold assumption because there production shallow. But if you drill them on 80s I think the total count at the analysts conference was somewhere around 50 wells, something like that, we have only drilled a couple, Exxon gives us 180 at a time.

Tom Gardener - Simmons & Company International

Alright. That's very helpful. One last question, I'll hop off. Any thoughts on spinning any assets or selling any assets into the MLP market?

H. Craig Clark - President and Chief Executive Officer

We knew you are going to ask that today. The... we have to take a look at that just like we said last time. Our initial focus right now is getting Alaska out. But we have some type of those assets particularly in the Permian basin, San Juan and we have to take a look at it just like every body else says. Not going to use it to justify a transaction. We looked at Eastern Texas purely operational and what we could do with it different, but we need to get Alaska out of the door first that's our top priority.

Tom Gardener - Simmons & Company International

Thank you guys.

David H. Keyte - Executive Vice President and Chief Financial Officer

Thanks.

Operator

Your next question comes from David R. Tameron of Wachovia.

David R. Tameron - Wachovia Securities

Hi congrats on the good and getting the acquisition done.

H. Craig Clark - President and Chief Executive Officer

Thank you, Dave.

David R. Tameron - Wachovia Securities

Couple of questions, I guess for Dave first, the hedge is the hedges that you provided, is the last that backed out of those or is there any impact once that closes for the acquisition?

David H. Keyte - Executive Vice President and Chief Financial Officer

No we will probably all those hedges that you see on that schedule.

David R. Tameron - Wachovia Securities

: Alright. And then Craig, what if somebody ask you today what Italy is worth, what do you think?

H. Craig Clark - President and Chief Executive Officer

I don't know, the number one effect to that test so, we had a data room and didn't keep only one but that before spud and I don't... the answer is I don't know because after we drill the second well and book reserves a lot of value is highly driven of the gas market which last winter I think was in the teens and its still pretty robust over there. It depends on that but I mean it certainly worth more than people give us credit for. But some more than zero, but at the... I don't know, I think we probably found 30 Bs if the second well is successful and they were penetrations out here years ago and helps you with the geology but this is 2D seismic and monetization versus hooking it up could be an option, although we got more prospects behind it in the Poe Valley, I am just happy that these guys make something out of nothing and brings some value for it.

David R. Tameron - Wachovia Securities

Okay. I guess along the same line, divestitures, you guys kind of said 600 million for the year or target 500 million to 600 million. Ex Alaska, you are talking another 100, 150 or more, what gives you the idea what you consider non-core for at this point?

David H. Keyte - Executive Vice President and Chief Financial Officer

I think we honestly, David, we just haven't focused in on it yet. We have been too busy buying THX and getting ready to sell Alaska. So my guess is that it's going to be in Texas, but that's about 85% of our property, so beyond that I don't know.

H. Craig Clark - President and Chief Executive Officer

And I am kind of partial to that state as you know. I'll tell you the process we went through already and here we identified. We identified the Alaska assets and then we identified certainly marginal properties that were either geographically or high cost properties that made up the additional 100 to 130 million, non-op to be specific. Particularly we look at what I call the non-performing, non-performing means non-booked or something international or rigs or something like that that would add to and then you will have to look at selling stuff, possibly to an MLP that might change the property mix, but it was strictly driven with marginal properties primarily onshore U.S.

David H. Keyte - Executive Vice President and Chief Financial Officer

And with any of this activity we look to upgrade the portfolio, upgrade the assets.

David R. Tameron - Wachovia Securities

Okay. And final question; Craig you talked a lot about when you joined, you had to change the culture, change the mindset. Now that you kind I would assume that your asset base fairly in place. What's your next big challenge?

H. Craig Clark - President and Chief Executive Officer

Clearly, it's the newly acquired properties. I think I said our biggest challenge this year other than the integration piece, which we've made a lot of inroads in was how the company or the industry behaves in a lower commodity price environment. Certainly for gas we are probably still need to be careful of that. So we are tying watch our margins as you know, that challenge is still there. I think the near term challenge post integration of Huston Ex, now that we have made some progress in the capital allocation is how these properties behave. Because we've dramatically changed the capital allocation for those assets. And that would be my biggest challenge other than usual integration and culture issues that occupies day-to-day.

David R. Tameron - Wachovia Securities

Alright. Thanks.

Operator

Your next question comes from John Herrlin of Merrill Lynch.

John P. Herrlin - Merrill Lynch

Yes. Good sign, you're still optimistic about the Aggie's, Craig?

H. Craig Clark - President and Chief Executive Officer

Thank you, John.

John P. Herrlin - Merrill Lynch

Got some quick ones for you, With Cotton Valley, was that a sand versus lime?

H. Craig Clark - President and Chief Executive Officer

It was actually the Taylor sand, John.

John P. Herrlin - Merrill Lynch

Okay. Regarding well costs, you said that count is still going down, but you are flatting the U.S. are you seeing any efficiencies in terms of different equipment or completion of purchase or any thing?

H. Craig Clark - President and Chief Executive Officer

Yes. We are as rigs slow down we are seeing some of the efficiencies or I would call trouble time remedy, but that situation is not back to where it was two years ago. And I think we said last quarter that we were getting 5, 10% in the U.S. and probably maybe 10 to 15 in Canada. We are probably slightly higher than that for both of them. Clearly, Canada has done more discounting in terms of services than the U.S. year-to-date.

John P. Herrlin - Merrill Lynch

Okay. You mentioned the 60% of your outputs now basically five fields. Do you think you need another core area or do you like your current mix?

H. Craig Clark - President and Chief Executive Officer

Like the current mix probably would love to have a little more oil, just simply from the balance of Alaska's divestiture creates. There are plenty acreage running room particularly in areas like Canada around these five fields. So basically the story would be all in beefing up in the same areas.

John P. Herrlin - Merrill Lynch

Okay. And last for me. You are not that heavily hedged for 2008, you are going to be 70% gas leverage or thereabouts going forward. The prices get weaker when you slow down your activity and were there any lease issues you have to worry about?

H. Craig Clark - President and Chief Executive Officer

The answer, just in reverse order we added to the hedges for '08 as should be updated. Those were particularly hedges related to the Houston Exploration properties. Our goal was to get about half of their production hedged in '08. We'll be adding and as we've described as spike capture. But we were particularly aggressive in adding '08 hedges around closing of this introduction we were already hedged in '08 and they were partial. Second in terms of the activities since we live within our cash flow, yes, I would adjust it. As I have said, I wish I would adjust it everyday. But you can't do that, but we should change and allocate capital to a bit of areas; for example, drilling for oil right now is more than gas in our company. And we would allocate those areas. Lease exploration not meaning for two reasons, we've done a pretty good job of managing that, hadn't gone crazy, adding acreage and also we own them drilling rigs. We are not going to lose any lease when you are not drilling there.

John P. Herrlin - Merrill Lynch

Okay. I guess the very last one for me is, did you get a look at Haley that, the JV that Anadarko Chesapeake did?

H. Craig Clark - President and Chief Executive Officer

Yes. It did, it surrounds us. It's both to east and to the west of us. Most of the big acreage blob is in the Chevron farmout is west, but we are kind of the middle of it and it's all being shot, or most of it with this 3D survey that we are initial underwriting participating and we could see that here in the third quarter.

John P. Herrlin - Merrill Lynch

Okay thanks.

H. Craig Clark - President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Jeff Robertson of Lehman Brothers.

Jeffrey W. Robertson - Lehman Brothers

Good morning. Craig can you talk a little bit about the work you all are going to do in the Arkoma Basin on the gathering system, and is that a result of the drilling you have done, think you will do or do you think that their production up their has their has just been constrained from lack of capacity?

H. Craig Clark - President and Chief Executive Officer

Little of both, and thanks for asking. I got to give our marketing group a compliment, headed by Blaine Wafford. Blaine has got actually engineering personnel and now. He is a... Blaine is a plain guy as well. And so we've got a marketing group that's going to de-bottleneck, and up in that area, there were two things needed. We thought one was just simple compression to pull those wells down to the ultimate abandonment pressure. That was not adequate, it was provided primarily by the pipeline. And the pipeline has matched out, they have put 4-inch gathering lines to hook up some of these bigger wells and that's a bottleneck. The pipeline company is doing a line loop for us as we speak, which would increase the trunk and we will have to work on the gathering. The puzzle, I guess, is when these wells come in like 5 million a day they are going to the pipeline making about half of that, because you have to book 1000 pounds. However, they not other wells off, so you don't ever see the incremental production gain from a new well and that in our opinion is a compression problem that existed. So lien looping done by the pipeline company and compression primarily sponsored by Forest Oil.

Jeffrey W. Robertson - Lehman Brothers

So you can add production their without drilling new wells by completing that work.

H. Craig Clark - President and Chief Executive Officer

I think East Texas and Arkoma we already have.

Jeffrey W. Robertson - Lehman Brothers

Do you see any of those opportunities in South Texas, Craig?

H. Craig Clark - President and Chief Executive Officer

We see them everywhere on those property sets.

Jeffrey W. Robertson - Lehman Brothers

Okay. Will any of that add reserves to how you have... how those assets have been booked?

H. Craig Clark - President and Chief Executive Officer

If it lowers the abandonment price, it should. The big thing for us is it gives... wells get knocked off and bottlenecked. It gives them back on, but we see compression facilities processing being a huge operation, and that's why I am so public about Blaine's name.

Jeffrey W. Robertson - Lehman Brothers

Okay. Thank you.

Operator

[Operator Instructions]. There are no further questions at this time. Mr. Patrick Redmond, do you have any closing remarks?

Patrick J. Redmond - Director of Investor Relations

This concludes our conference call. I want to thank everyone for their interest and participation in the call. If you should have any further questions, please feel free to contact us. Thank you.

Operator

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.

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Source: Forest Oil Q2 2007 Earnings Call Transcript
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