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Executives

Scott Sheffield - Chairman & CEO

Rich Dealy - EVP & CFO

Frank Hopkins - SVP, IR

Analysts

Kevin Smith - Raymond James

Bernhard Weimann - Private Investor

John Razzano - RBC Capital Markets

Steve Tabb - Tocqueville Asset Management

Pioneer Southwest Energy Partners L.P. (PSE) Q1 2012 Earnings Call May 3, 2012 12:00 PM ET

Operator

Welcome to Pioneer Southwest Energy's First 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 May 25th. 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, Frank Hopkins. Please go ahead, sir.

Frank Hopkins

Good day everyone, and thank you for joining us. Let me briefly review the agenda for today's call. Scott will be the first speaker. He will review the financial and operating highlights for the first quarter and update you on PSE's expanded drilling program in the Spraberry field. Rich will then cover the first quarter financials in more detail and provide earnings guidance for the second quarter. After that, we will open up the call for your questions.

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

Scott Sheffield

Thanks, Frank, and good morning, good afternoon to some. On our highlights slide number 3; we had a first quarter adjusted income of $22 million or $0.62 per unit.

First quarter production, we had a tremendous quarter, on average well over 7600 barrels of oil equivalent per day up 9% versus previous quarter. We increased our drilling program from two rigs to three rigs during the first quarter.

We have the 14 new wells placed on production, and five additional wells are waiting completion, and three wells were being drilled at the end of the first quarter.

We continue to great results from drilling deeper to the lower Wolfcamp, Strawn, and Atoka intervals. 2012 program is expected to generate full year production growth about 10% compared to 2011. We are continuing to add more hedges especially to year 2014. We are well protected 2012 to 2014.

Cash flow from operations of $29 million. Distribution of $0.52 that we just recently increased cent per unit, with our recent quarter distribution, payable on May 11th, to unitholders of record as of May 4. This equates to $2.08 per common unit on an annualized basis.

On slide number 4, an update on our drilling program. We expect to drill 55 to 60 wells 3-rig program. We will spend about $110 million to $120 million including facilities. We expect essentially most all the wells, at least go to the Strawn formation, roughly 60% of the acreage position at Strawn potential. We are finding out from both PSE and also the PSE results we are writing about 30,000 drilled of oil equivalent to the EURs of a typical Wolfcamp well on top of that. 35% of the 2012 wells are expected to be drilled to be deeper Atoka interval. Well we expect to add about 50 to 70,000 barrels of oil equivalent.

We are starting to drill 40-acre space well, I mean 20-acre wells, we drilled four of those, results just like we have seen at the PXD last three to four years. Very similar to a tight curve, from a lower, full acre lower Wolfcamp well, an EUR of 140,000 barrels of oil equivalent.

Our total inventory, we still have 90 remaining 40-acre locations and over 1,200 20-acre locations. Average well cost it pretty much stands flat at $1.8 million, with an average before tax IRR of 45% to 50%.

Let me turn over to Rich to go over our earnings summary.

Rich Dealy

Thanks, Scott. I'm going to start on slide 5. Net income for the quarter was $14 million or $0.38 per common unit that did include unrealized mark-to-market derivative losses primarily relate to oil as the port strip has moved up at $8 million or $0.24 per common unit. Adjusted for mark-to-market derivative losses, partnership would have been at $22 million or $0.62 per common unit.

At the bottom of slide 5, it shows our results relative to guidance, as Scott mentioned production was at the, slightly above the high end of our range. So good quarter on production. Other items came in within range DD&A at the higher end of the range primarily due to the flood location.

Turning to slide 6, and guidance, still we expect with the 3-rig programs the production tend to move up in the range of 7400 to 7900 BOEs per day for the second quarter. The other items are consistent with prior quarters other than DD&A where we moved that up reflecting that we are continuing to drill putt locations.

Turning to slide 7, capital gains and financial position we did redo our credit facility this quarter, so we did extend that out for another 5-year term, $300 million facility of which we have $50 million borrowed on it at the end of the quarter. In addition, as Scott previously mentioned, we did add our old derivative position of bringing our total coverage position to 75% for 2012, 65% for 2013, and 55% for 2014. On oil, we are for all three periods were hedged at 85%.

So with that I'll stop there and we'll go ahead and open up the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) We will go first to Kevin Smith with Raymond James.

Kevin Smith - Raymond James

How much of Q1 2012 production was due to kind of one-time issues, I know 4Q you had some backlog as a percentage, well completions, and some other storage issues, should we think of the Q1 average as a good run rate or were there some artificial bumps, I guess is my question?

Scott Sheffield

I know, you look at it as run rate.

Kevin Smith - Raymond James

Okay.

Scott Sheffield

There really wasn't anything, unlike a year ago we didn't have weather related issues. So it was kind of a normalized quarter. We did have a few wells as I mentioned in the fourth quarter that came on at the end of the fourth quarters for those contributed but they continue to be on and steady business as we go with the third rig up and running.

Kevin Smith - Raymond James

Gotcha. And then can you remind me what -- how many of the 55 to 60 Permian Basin wells you're targeting. There is going to be 40 versus 20 now that you got four 20 acre wells working?

Scott Sheffield

There will be just a handful of 20s, the rest are going to be 40s.

Kevin Smith - Raymond James

Okay. And are you guys actively looking at adding more well hedges in 2014 or what do you think about as far as learning on new hedges at this point based off the price?

Scott Sheffield

In 2014 we're basically at 85%. So really we'll layer on in 2015 and beyond. As you know the curve is backward days, so we're just waiting for the right time.

Kevin Smith - Raymond James

Okay. All right. Thanks.

Operator

And we will hear next from Bernhard Weimann, a Private Investor.

Bernhard Weimann - Private Investor

I apologize for not being at the beginning of the meeting but am I talking to Mr. Sheffield now?

Scott Sheffield

Yes, you are.

Bernhard Weimann - Private Investor

Okay, Mr. Sheffield I just have one question. I'm a relatively new investor just about two years old but there's something that I'm concerned about talking about these hedges, why is it that the Pioneer Natural Resource Company has got a profit in this and a Pioneer Southwest Energy has come up with a loss two years in a row, how do you explain that? You are running both companies, how is that possible?

Rich Dealy

This is Rich Dealy. But the simple answer is that for PSE our derivatives are oil. For PXD, we have a big substantial derivative position on natural gas. And because natural gas prices have fallen that's why you see a big profit on PXD where only 10%, 15% of the production of PSE to natural gas and so we do not have very much it's just a different way of.

Bernhard Weimann - Private Investor

I understand it now. And thank you for all the work you're doing. Thank you so much.

Rich Dealy

You're welcome.

Operator

And we will hear next from John Razzano with RBC Capital Markets.

John Razzano - RBC Capital Markets

Can you just comment a little bit about where are we in terms of the strategy going-forward given the strong quarter, the recent distribution increase, the increased activity levels, I'm specifically asking about just distribution growth on the coming quarters and then what do you thought there?

Rich Dealy

Well I think this we talked about before. We're watching the results of our 3-rig drilling program that's where our focus is, and that we will continue to grow production about 10% this year and into future periods. And as that cash flow picks up, we will be able to see our coverage ratio improve and increase distribution.

John Razzano - RBC Capital Markets

Okay. Can you give us an update on PXD's ownership stake and their desire to maintain a steady position?

Rich Dealy

Yeah it's at 52.4% where it was at year-end and our intent is to stay around that level.

John Razzano - RBC Capital Markets

Okay. Any update or thoughts on just the acquisition market potential per drop downs anything new there?

Scott Sheffield

Yes, the acquisition market is still overheated in regard to for us to be competitive and people are still paying very aggressive prices out there from a PSE standpoint. We are working on some smaller transactions, we hope to close at some point in time and that looks very, very positive for PSE.

And in regard to drop downs, we don't anticipating do any drop downs at this point in time. We think with the behavior of the deeper drilling we're seeing and the great results and then results of the 20-acre spacing that there is no way we can get a 45% return pre-tax going forward by buying properties. So it's better to grow the company by drilling. And maybe at some point in time next year or two we can add a fourth rig. But I guess it has got the inventory, oil prices are -- will continue to be very, very good. We are seeing great results.

Operator

And we will hear next from Steve Tabb from Tocqueville Asset Management.

Steve Tabb - Tocqueville Asset Management

Hi, I am wondering about these -- obviously the company has lost a lot of money in the swaps I mean in the derivatives that it is going-forward. I assume that a lot of the volume of the derivatives is setting a price around $79 million or something like that or what you -- and it counts for a large loss this year in this quarter. Two -- few questions. Why do you go out so far now, I mean you are 85% comfortable already in 2014 and that seems to be going out quite a bit with a big percentage? And secondly, what does it look like for the remaining quarters of the affecting a profitability on this year because of the quantity of hedges you have in these pricing?

Rich Dealy

Steve, there are a couple things. One is, as we mentioned, last year we had a collar that ran up last year that was way above the market, so from a derivative standpoint we did exceptionally well last year. This year, reflecting the $80 hedges as you mentioned, those were put on at the time we did the acquisitions back in 2009. And so, it was to predict the economic and the acquisition and the production associated with that. So those were strategic in that point in time to buy those properties.

As we look forward, we continue to add derivatives that really look in a three year time period as a way to two things, one, protect the distribution so we know we have the cash flow on sustainability distribution. And two, to protect the capital budget so we continue with a three-rig drilling program. So it gives us an assurance of having any base level of cash flow to support both those activities.

Steve Tabb - Tocqueville Asset Management

Well, it seems that you are only making like $0.32 what did you make this quarter on a EPS basis say $0.38 and you're distributing $0.52 you're not really like maintaining it, I mean unless you are taking it from your cash flow and your depletion which is really money that you borrowed that you got to payback in a way. So I do not and I also (inaudible) or effect the remaining quarters of this year so they are two questions in there.

Rich Dealy

Yeah. I think our cash flow for the year is going to continue to move up as we continue to add production volumes. So, earning ought to improve. They're also I think component of our earnings piece as you know that of the $0.62 or so adjusted for the derivatives that is DD&A non-cash so the cash flow ability to support the distribution is a lot higher. As we mentioned on the fourth quarter call, moving to the third rig, we do expect to borrow some money this year. So, we expect to exit the year end around $90 million of debt and that will fund the growth program that we get going with the third rig.

Steve Tabb - Tocqueville Asset Management

You are saying that you are still going to have -- how are the derivatives going to reflect some of them will be running off as the year progress and I assume that you ought to recognize the loss in the derivatives going through whole year in the remaining period is a prime right? The loss in derivatives you show on the balance sheet I think its over $50 million of the losses on all derivatives going forward, am I correct? They wouldn’t be recognized again in the subsequent period so prices remain the same.

Rich Dealy

Yeah, prices stay the same then we will collect basically just make the math easier, $100 for every barrel we sell and on the derivatives we will give $20 back to the derivative counterparty on those swaps. Now, we have hedged in outer periods where we have participated in oil prices up to about $125. So it was at the time we entered $80 swaps to protect the economics on acquisition. In retrospect, the (inaudible) commodity prices have moved up. I'd say it doesn’t look as well but cash flow will be consistent with their first quarter as we move through the rest of the year.

Steve Tabb - Tocqueville Asset Management

No, maybe I'm not making myself clear. As of March 31 you recognized the loss on all the outstanding derivatives, correct, for the next few years?

Rich Dealy

On the balance sheet it reflects though but it wasn’t in the first quarter. At December 31 we would have had on those $80 those would have been a liability at that point in time as well.

Steve Tabb - Tocqueville Asset Management

Well they would have been a liability so you don’t recognize that liability twice, do you? What I meant that by going forward now your derivatives for the rest of this year, for the last half of year will say in 2013 that you recognized as of March 31 or maybe you had recognized it earlier. So, why would if you affected the -- unless the prices changed quite a bit you wouldn’t recognize those same losses to the same degree at the end of June?

Rich Dealy

That’s correct.

Steve Tabb - Tocqueville Asset Management

So, you wouldn’t have such a big derivative loss for the quarter?

Rich Dealy

Correct.

Steve Tabb - Tocqueville Asset Management

Well, that’s what I'm getting at. So I asked how will these derivative losses flow out if (inaudible) prices remain the same for the next three quarters against income?

Rich Dealy

In the same there will be no derivative impact and so earnings will be higher.

Steve Tabb - Tocqueville Asset Management

Okay, that’s what I was getting at. All right thank you very much.

Operator

And with no further questions in the queue I would now like to turn the call over to Scott Sheffield for any additional or closing remarks.

Scott Sheffield

Again thanks for participating. We look forward to the next quarter's call. Again thanks very much.

Operator

And ladies and gentlemen, again that does conclude today's call. We thank you for participating.

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