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Swift Energy Company (NYSE:SFY)

2012 Barclays CEO Energy/Power Conference Call

September 5, 2012 3:45 pm ET

Executives

Bruce H. Vincent – President

Unidentified Analyst

Good afternoon everybody. It’s my pleasure to introduce Bruce Vincent, President of the Swift Energy Company. Without ado, here is Bruce Vincent.

Bruce H. Vincent

Thanks and good afternoon everyone. It’s great to have an opportunity to talk about our company. Appreciate all listening. Before I start, let me remind everyone that some of my comments will include forward-looking statements based on our current assumptions are need to be taken in that line. What I’m going to do is talk to you first kind of give you a strategic overview of the company, focus most of my time really on our core operations and then kind of wrap it up with a quick financial review.

First off, when we talk about our company, it’s important that to see us as a company that’s very balanced, diversified, yet a very focused asset base. Three core areas in South Texas, South Louisiana and Central Louisiana, and we developed a diversified portfolio of lot of low risk project, particularly with regard to the resource plays of the Eagle Ford shale in South Texas and the Olmos low-permeability sandstone. While at the same point in time we have some significant exploration upside.

When it comes to our corporate strategy, we’ve been around for about 33 years and operated with the same strategy for a long time. We’ve always employed to use both drilling activity and acquisition activity to find the lowest cost reserve. We’ve always done that by leading with technology and want to be the best with that in our particular area. And while everyone can say they use horizontal drilling or 3D seismic or hydraulic fracturing, understanding how to use it better and being on the leading edge of those is particularly important, whether its on 3D where we are actually taking multiple data suites together and merging that data together and reprocess it in ways where we are seeing things people haven’t seen before or whether horizontal drilling and hydraulic fracturing we’ve been doing it for 20 plus years very much on the leading edge of doing that.

You will find that we like to look for operations where we can repeat what we are doing when we are successful. And often entails large acreage positions both to protect your flanks but also to continue in a repetitive fraction doing what you are successful at. Also, we love areas with multiple horizons. No matter we always try to drill a well in our business where you got two shops at one, whether it’s Lake Washington with 70 plus different producing horizons or even in South Texas where the Eagle Ford Shale is so prominent. We are also developing the Olmos low permeability sandstone which sits above Eagle Ford and that efficiency from having two horizons develop really the same way add some additional efficiencies and increases in productivity and lower cost.

You also find a part of our strategy is to mitigate operating risk and mitigate financial risk. On the operating side, we think you need to do that particularly through maintaining a good reserve to production ratio, ours is about 15 to 1. We think that kind of 10 to 20 is a right place to be. If its much shorter than 10, how you get another ground quickly but you are on a very, very fast decline curve and pretty much on a spending wheel. It’s tough to keep up with, but its too long and you got long life reserves and that’s great but you are not maximizing present value of the asset.

We also think it’s important to maintain operating control. We’ve seen I’m sure as you – where people are non-operate, they can’t control the timing, they cannot control the technology and often times things don’t work out as they had hope they would. We also think its important just as in your business to balance and diversify your assets. So you’ll see us balance diversified but at the same point in time we think its real important as in most things in life to remain focused.

The financial side is pretty simple, keep your debt down and keep your cash healthy, low leverage, high liquidity and that really helps from a financial strategy standpoint. We also think in today’s world, it’s important to have a price management strategy or hedging strategy. Ours this is generally implied to use the floors or participating callers, but with our improving production base on shore particularly in the Eagle Ford shale, with the volatility and prices particularly in the gas market, we think its going to be important to implement the use of long term slot as well as in that priceless management strategy.

Moving to the operating side of the business, I mentioned that we have three core areas, South Texas being both the oldest and the largest one. It’s where the bulk of our activity is. We are spending 70% and 80% of our capital budget down there. Central Louisiana and East Texas principally focused on the Austin Chalk, principally through a joint venture with Anadarko. And then South Louisiana, where we have a couple of very old fields discover in the 30s and the 40s, but they are incredibly prolific, continue to be big producers and predominantly crude oil selling into the HLS market down there.

Today, I’m going to focus principally on South Texas. We are spending 70% to 80% of our capital there, principally on the Eagle Ford Shale but also developing the Olmos low permeability sandstone in the area. I look at whether it’s an Olmos well or an Eagle Ford well pretty much the same thing. The Eagle Ford Shale, as many of you know, has multiple hydrocarbon windows. You will find that our acreage actually is in all of those areas whether it’s a very oily area or a rich condensate area or a dry gas area, we’ve actually put out models on all those different areas. The Olmos tends to be too different distinct areas, one with a significant oil component, lot of free flowing oil and condensate with it, much better economics and then there is an area that has very little condensate but it’s a very liquid rich gas running 1250, 1300 btu. So generally good NGL recovery. The economics align themselves very similarly to those of the Eagle Ford and the liquid rich plays.

South East Louisiana, Lake Washington is our big field in the area. It’s a 99% oil producer roughly producing about 6,300 net barrels a day. I will give you an update when I get to that point on the hurricane activity and what’s happening there and also Bater Sain which is more of a gas field, lower level of production, but two wonderful oil fields that have been around long time, continue to have a lot of upside potential.

And then of course Central Louisiana and East Texas, which is principally focused on the Austin Chalk whereas Swift has a significant both mineral interest and also two joint ventures with Anadarko. We drilled two wells in there earlier this year that we’ve announced most successful. We have two other wells that have just recently been drilled and are soon to be tested and then we’re going to drill at least one of the well and then another one going into the next year.

Let me really start with South Texas. We have kind of three distinct areas in South Texas in McMullen County, around our AWP Olmos Field. Swift has been there since 1988, we’ve been there for about 25 years principally developing the Olmos sand. It’s a low permeability sandstone in the northern part of the field and a very good permeability. Its probably up to 60% recoveries of gas in place, very economic with vertical drilling, all those wells have been hydraulically fracture stimulated over time.

As we move to the South and the Olmos sand note became a lower permeability. The sands got readier, the economics became margin less but what we found with horizontal development and multistage fracking that it dramatically improved economics in recovery, so that’s why we are now developing in it. And in the Eagle Ford shale which incorporates both the very oily wind into the north all the way to a dry gas window to the South.

Then what we call La Salle county area where we call our teaser wells. This is a development area principally in the oil and high liquids rich area, proving to be very, very robust in terms of its economics. That’s where probably much of our activity is focused this year as developing the teaser wells there. And then in Webb county, which is a dry gas area and people don’t like to talk about too much, but its perhaps some of the most prolific Eagle Ford rock we see in the cross sell in Texas. The wells we said will produce at least 10 BcF and we think they could easily, could be well above that. So it’s been very, very prolific and it’s a great dry gas area.

We’ve earned all that acreage. We’ve earned it on 640 acre spacing unit. So for each level that we drill and produce, you probably got at least seven undrilled locations that are available. So it’s very much like an annuity but it is very depended upon the gas mark in the future, but it’s probably economic down to 350.

Little more detail on all of that breaking our acreage into almost an Eagle Ford. We are about 78,000 in the Eagle Ford, about 37,000 in the Olmos. On the Eagle Ford, the numbers here on the slide really talk about it in terms of 80 acre spacing unit. We have generally talked to people about 80 acre spacing unit. We believe that it’s likely that will end up spacing, further down the net.

We are in the process now of testing 40s and 60s. Fairly confident, probably will end up spacing it down to at least 60s, may be a little bit below that. So what we are doing in a number of places like our teaser wells, we are actually setting up a development grid on 120 acre spacing so that we can take it to 60s or we can take into 40s depending upon what the size tells. Getting good recoveries out of the Eagle Ford, very, very good economics. It’s driving our perhaps number one goal for this year as to drive liquid production up without focusing so much on dry gas production.

On the Olmos, as I mentioned, it’s distinguished too much between an Olmos well and an Eagle Ford well. Olmos is a little bit cheaper because it is a little bit shallower, but you drill in the same way, same drilling plan, you complete in the high way, they are both liquids rich, some are little more early than others but a really good position and basically have very common surface infrastructure. So a lot of economics of scale, by having both an Olmos development and Eagle Fort Shale development there.

One of the things we like to point out, if you – the Eagle Fort and the Bakken probably the two hardest plays in the U.S. today, both very prolific one in liquids basin. If you look at exposure to the Eagle Ford and the relationship to your size and your stock price, Swift is actually the most leveraged to the Eagle Ford of the other operators down there.

What are we trying to accomplish in South Texas? Same thing we are trying to accomplish corporately and that’s drive liquids production, particularly on the oil side that’s where your better economics are. Our objectives for this year with our budget in South Texas is to drive liquids production from the Eagle Ford and the Olmos by 38%. Our gas production is growing not nearly so much, that’s growing really from the associated gas. Our capital budget how that’s drilling dry gas well in the first quarter of the year and that’s 99% of our capital budget this year is all focused on liquids opportunities. Our capital budget in 2013 and 2014 will be entirely focused on liquid rich opportunities as well. Unfortunately, we have the inventory to be able to do that.

In summary, obviously stronger liquid focus. We are achieving those results, you can see the production mix changed just in the first half of the year growing liquids production as a percentage. The big thing that’s happening, you hear a lot of people talk about manufacturing operation, well it truly is. We like to think of it as a resource factory. And when you are at a stage we are at now both in the Eagle Ford and the Olmos, you truly move that into a manufacturing optimization, where you are trying to optimize the efficiency of the development, you are trying to drive productivity, you are trying to lower cost and do all those things for your drilling production and that’s really the stage we are at in South Texas both in the Eagle Ford and the Olmos.

The other thing that becomes important in this business really is midstream. So you got to ask those questions about marketing infrastructure. One of the advantages that we felt we had with the Eagle Ford in South Texas because this had been the basin developer decades, it had a lot of existing infrastructure in place, a lot of additional capacity. So our sales in other operators were actually able to get in there and develop the Eagle Ford as you got history really of Eagle Ford development and production history and get it on production. So we could watch those production characteristics before we had to make other longer term commitments.

But what you also found, we’ll had existing excess capacity, that excess capacity got taken up very, very quickly. It’s been a boom for midstream players and they have been great to work with. They have come in and added significant capacity both in the transportation and the processing front. But in the old days when you could just get in a spare capacity whether it will be processing your transportation, you didn’t have to make long term commitments. Totally different story today, you have to make long term commitments and Swift is positioned itself in all three of those areas I mentioned earlier both McMullen County, La Salle County and Webb County with midstream commitments both for the transportation and/or processing of the liquids.

Move to Central Louisiana and East Texas, principally this is an Austin Chalk area. Swift has been involved in this area for over 15 years and we’ve been developing the Austin Chalk horizontally for over 20 years, very prolific area for the Austin Chalk. In the Louisiana section, it does get deeper so you tend to do it higher pressures and higher temperatures. Much of the development where we are fitting capital into joint venture with Anadarko, actually two joint ventures, one 50/50, one 55 Anadarko, 45 Swift. We plan for six wells this year. We will get at least five of those in probably start the sixth.

As I mentioned earlier, two of those have been drilled, tested and announced and are performing absolutely along expectations, maybe a little bit above. Two more have been drilled or soon to be tested. So we hope we will have announcements on those test in the coming weeks and are to be on production hopefully by the end of October. And then one rig is going to be released and another rig will start drilling the fifth well. The one rig that was released will comeback after drilling the well for someone else and drill another well. So we expect that activity to continue in the next year, same thing this year probably intermittently probably drill four or five wells in that area.

But in addition to that, we also have a Wilcox field, The South Bearhead Creek. We’ve owned that for sometime, we developed it vertically, it’s a tight sandstone oil production principally with some gas, does need to be hydraulic or fracture stimulated. We’ve developed it vertically which you might have heard about some other operators that are looking to developing the Wilcox horizontally. We believe that has potential as well. We are actually pretty excited about that, so we are looking to testing that, but we wouldn’t drill our first horizontal well into the Wilcox till next year.

And one thing about the Wilcox there most of members, most of our development at South Bearhead Creek was developed both in the upper and the lower, but there are some other members. And so what we need to do is determine which one we want to try first, but we think there is some potential there. We don’t talk about it too much because we are not spending any money on it yet, but next year it ought to be a part of the equation.

What’s happening in Central Louisiana East Texas, same thing that’s happened in Louisiana just on a slightly different scale, driving liquids production and that’s happening. Gas production is going up too, but not nearly as much as liquids production and the liquids production is obviously a lot more valuable.

Southeast Louisiana, this is another area Swift has been involved in for quite sometime, couple of old legacy fields Lake Washington, Bay de Chene. Lake Washington discovered in the 30s, Bay de Chene in the 40s. Lake Washington by Exxon, Bay de Chene by Texaco. Both are around salt features, people commonly refer to them as salt dome for the longest time, the pretty seismic tells you its not only a deeper dome its actually a pillow or piece of salt where there is potentially subsalt potential. Both have been very good to Swift, will continue to be.

Lake Washington actually amazes me. That field is over 80 years old. We’ve owned it for what over 12 years, drilled couple of hundred wells, we are still able to drill wells for fairly shallow depth 7,000, 8,000 feet and find 200 plus feet of true vertical pay in three, four, or five different [horizon] pretty remarkable. We decided we have kind of laid off some activity there in the last couple of years because we were diverting capital to other places.

And so you saw the field decline, but we put a rig back in the field, you pretty much need a rig to be in the field to maintain those decline rates. So we kept the field in there, our rig in there pretty much all year and it will continue to stay in there the rest of the year, we would hope to keep that same rig in the field all of next year as well. We think when the year is done, you will find it did mitigate the decline; it might even uptick a little bit. But all of that oil production, it all sells into the [HCLS] market, which is today selling at about $16 premium to WTI. We’ve had some really good success in that field today and we would expect that to continue, great inventory of projects.

Bay de Chene, we haven’t had much activity in largely because it’s more of a gas field than an oil field, but we do have some really attractive potential there as well. We just need to put a rig back in the field at some point. Now, we think that’s more depend on the gas market than anything else.

Just to give you some appreciation for the inventory we have at Lake Washington, I know its always hard for people to kind of get their hands around this because this is more geologically complex. Its not resource play that can put in a spreadsheet and kind of do the math, but the inventory is just as prolific as it might be in some resource play.

And we spent a lot of time mapping that dome, a lot of wells drilled, a lot of subsurface data as well as a 3D and have put together a very, very attractive inventory of projects to be able to keep that activity going. And what’s happened in Lake Washington is the same thing. Again, just a different scale but driving liquids in this case fewer oil production of growth and gas production is actually declining because we are not focusing on that.

On the financial side, lets look at the balance sheet real quick. If you look at June 30, no bank borrowings at the time. We subsequently gone into the bank a little bit. All of the debt is really long term debt, well layered, 2017, 2020, 2022, so it’s spread out very, very well. You will find that Swift been around 33 years, we look carefully after the balance sheet. And we’ve always believed in kind of a low leverage high liquidity strategy, so we like to have a lot of untapped capacity in our bank line. Our bank borrowing base is $375 million, the commitment amounts only 3.25 but a lot of liquidity there. I think we are in pretty good shape, debt to cap is about 40% net debt, that sounds probably a little higher than we like it but very, very comfortable with it and the coverage ratios on the debt is pretty good shape as well.

Look at our capital budget this year, we’ve got in between $675 million $700 million in capital spending. The vast majority of that is on the development and the vast majority of that is in the South Texas in the Eagle Ford and Olmos, probably 70% to 80% of the capital is being spent down there driving that liquid production there as I shown you. Obviously doing a little bit prospect development, little bit of acreage but most of it is development.

I got to summarize a little bit, go back over those three areas. South Texas, Eagle Ford, almost over 1 billion barrels of potential between the two, good acreage position, its fairly well contiguous, fairly well defined, its now scattered all over (inaudible), marketing infrastructure in place both transportation and processing. We’ve got several years of activity. I think we’ve disclosed multiple models whether it be the oil window that high condensate liquids window, the low condensate liquid window, the dry gas window whether it be Webb County dry gas, whether it will be South (inaudible) dry gas and we have enough activity to have confidence in those models we keep it and those things are very, very well. And so the performance is driving that production growth that we keep talking about.

Central Louisiana and East Texas, Austin Chalk development with Anadarko, two successful wells earlier this year. We are testing two more wells and we expect the test probably along the lines of the others, drill at least another well and start another before the end of the year. Wilcox potential also in the South Bearhead Creek that we will be looking at next year. Southeast Louisiana driving oil production. Lake Washington is wonderful oilfield that continues to have wealth of opportunity. It tends to be the cash cow generating a lot more cash and we are ploughing back into it. Again capturing [HLS] pricing. Even the crude oil at the Austin Chalk is essentially to capture (inaudible) pricing. So we are getting a really good premium for the oil barrels that we produce principally on Louisiana both Central and South.

What’s that doing overall? It’s driving liquid production. Oil production and liquid production is expected to be up 34% quarterly from the beginning of the year to the end of the year and gas production basically relatively flat for the year. Lets (inaudible) we think corporate production will actually grow about 20% this year and its happening from that combination of factors in each of those areas and principal part of that growth is obviously coming from the liquid side.

What’s happened? We are all set and done on when we talk of wardrooms we say a lot of things, we know you can’t walkway remembering everything about our company. So what are the few things that we want you to remember about our company? One, the company has been around a long time, significant amount of operating experience, the company that supports that with world class leading technology. It’s a company that’s very balanced, very diversified yet at the same point in time it remains very focused in its three core areas. The company has built a significant resource base in its legacy assets both in Lake Washington and the Austin Chalk. At the same point in time, its build these world class resource potential in both Eagle Ford and the Olmos with a multi-year inventory that is much more reliable, much more dependable and much more line of sight than we’ve ever seen before. And we’ve done all that while we maintain a strong balance sheet keeping our leverage down and keeping our liquidity high so that we can have flexibility in this ever changing external environment we live in.

So with that, I’ll open it up for question and answers.

Question-and-Answer Session

Unidentified Analyst

Yeah. I’m just curious, have you guys looked at potentially selling any of the gas you are accessed to plough capital into some of the more liquids with the Eagle Ford, there was a window were potentially?

Bruce H. Vincent

Well, what I would tell you, let me expand on that question and answer it but to give you a little more of an answer. One of our challenges – what we’ve seen because we are in this manufacturing operation, whether you are running cars in the single line or making widgets, you want to try to optimize manufacturing process, that both adds productivity efficiencies and drive cost down, we will do the same thing. The biggest key to that right now at least is the dedicated frac crew and spread. And if you have that busy all the time, you’re really driving efficiencies there. You are getting more frac stages done for a month.

We’ve seen that tremendous improvement in that over the last couple of years. That then backs into number of rigs that it takes to support that. It used to take may be three rigs to support a dedicated frac crew. Today, we think that that number is more like five, that’s significant. The other thing that’s happening is you are doing the same thing on the drilling side. Instead of drilling a well in 40 days or 45 days, you are drilling 20 days. You are getting a lot more wells drilled for rig days. So you have one rig all year instead of drilling next well as you can drill x plus 50% well. That’s a good thing but both of thanks me and that you are spending a lot more money if you are running at that optimal level to feed that frac spread continuously and having that frac spread fit continuously keeps it at an optimal level.

We did that this year finding that optimal level, we also drove all those efficiencies and as a consequence we have spent cash flow which we knew going in, we knew we are go to help in cash flow, we prefunded it in the fall of last year with the debt deal that we started the year with a lot of cash, prices pulled back a little bit so that spread between the cash flow and capital spending has been little bit larger than we anticipated.

But we also knew that we needed to realign ourselves with cash flow spending and so we went into the years in South Texas we go from a six rig program to a five rig program to four to three. So that is where we are at. We are a three rig program in South Texas and that’s where we would expect to be next year in order to maintain our capital spending near the levels of cash flow. And that’s where we would like to be borrowing something else.

However you would also like to optimize your levels of activity. In order to do that, you have to bridge the funding gap. I think there are multiple ways to bridge that funding gap. The easiest one, the preferred one is to have higher prices. And if you get higher prices protect some of that with longer data swaps and that is possible, we certainly are seeing the crude oil market improve, we’re seeing some strength in the gas market, I wouldn’t go gangbusters over 330 strip but it certainly better than we thought it was going to be a few months ago, I think we have to kind of watch how that plays out.

So that’s one way to do it. Another way to do it is to asset sale and not trying to talk about gas assets, oil assets this one or that one but that certainly one you could have non-strategic assets that you’re going to dispose out to maybe help bridge part of that funding gap but another one are different financing tools available to it, obviously raising equity, $20 equity price off the table, we don’t want to even look at that. There is also debt financing and I think you want to be careful about having a lot of new debt and you need to have new debt not just replaced debt, refinanced debt to get new capital.

So other financing tools available to you would be various types of joint ventures. And joint ventures can be with financial players, joint ventures can be with international non-operating oil companies who have strategic reasons for getting involved in your assets or they can be within (inaudible). Joint ventures could be in some of 100% chalk acres for instance so they could be in Lake Washington or they could be in South Texas.

I think all those things are options and at this point in time we are just looking strategically at 2013 and 2014, so we don’t have to make any decisions. But I think you have a decision to pull back capital spending, little bit in cash flow, weather through this or to pick it up through employing one of those options to help bridge the gap and I just think that what I’m trying to tell you is what we think about strategically without having made any decisions that what we might do.

Right now, we are preparing to live within cash flow and spend at those levels. That’s the action we are taking so, yeah.

Unidentified Analyst

Okay.

Bruce H. Vincent

Pardon me?

Unidentified Analyst

Is it your plan to live within cash flow next year?

Bruce H. Vincent

Correct. Correct. Yeah I mean our commitments already made through the end of this year, but we have also said in motion the decisions to reduce rig count, so that your capital spending will come down unless you do something else. And then what we’ve said is basically expect us to have three rigs employed in South Texas that is what we have now, we will have for rest of the year, probably one barge rig through most of next year in Lake Washington and in intermittent activity in Central Louisiana lot is dependent upon our Anadarko or partners we certainly operate in.

Unidentified Analyst

Okay. We have no further questions. We are going to be hosting a breakout session in Room Liberty 5 after this. Thank you all.

Bruce H. Vincent

Thank you.

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