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SM Energy (NYSE:SM)

Barclays CEO Energy-Power Conference

September 6, 2012, 1:05 p.m. ET

Executives

Anthony J. Best – CEO, President, Director and Member of Executive Committee

Analysts

Unidentified Analyst

Operator

Ladies and gentlemen, thank you for standing by and welcome to the **** First Quarter Fiscal 2008 results conference call. (Operator Instructions)

Unidentified Representative

We'd like to get started with our next presentation. I'm pleased to welcome SM Energy to our conference this year. With us for the presentation for SM is Tony Best, the company's president and CEO, and I'll turn it over to Tony.

Anthony J. Best

Thank you, Jeff. It is again a pleasure to be here at Barclay's conference this year. And it's a pleasure to provide you with an SM Energy update.

This is again another strong year performance for our company, exciting time to be with SM Energy. And with that, let's get started.

In my presentation today, there may be a couple of forward-looking statements. So let me provide the appropriate cautionary language, which is also in the slides that we provided for you.

For those of you that are not all that familiar with our company, let me give you just a brief profile of SM Energy. First of all, we're traded on the New York Stock Exchange under ticker symbol SM. We're going to be back in New York in a couple weeks. It's going to be kind of an exciting time. We've got our board meetings. But we're also going to ringing the closing bell at the New York Stock Exchange to celebrate our tenth anniversary on the exchange, so looking forward to coming back in a few weeks.

In terms of share price at the end of August, we were somewhere around $47. I think as you had seen our press release that came out yesterday, we've had a nice uptick. So today, I'm pleased to say that share price is up about $5 more at ground $52. Market Cap is also gone up nicely as a result of that. And we're now about $3.4 billion Market Cap again as a result of that uptick.

On the financial side, presently we've got almost $1 billion of liquidity. So plenty of drive powder to fund our program going forward.

Debt to Book Cap is around 43%, so rather modest compared to the peer group. And debt to trailing EBITDA is about 1.2 turns. So again, strong balance sheet.

Operationally, second quarter, we produced almost 8.5 million barrels of oil equivalent. And our production mix is around 44%. Liquids today for the year, we expect to see that going to 45% liquids, 55% dry gas. And then within the next couple of years, we expect to be pretty evenly balanced at 50/50 between liquids and dry gas.

In terms of crude reserves, we have about 210 million barrels of oil equivalent as of the end of last year. And from a proved development standpoint, that stands at 67%. For those of you not intimately familiar with SM, there's a couple of metrics to provide a little profile for you.

Let's talk about our fundamental strategy. At SM Energy, we are focused on resource play opportunities in North America. And as we pursue that strategy, our focus is on organic growth. We focus on early resource capture, which means you have to get out early. You have to do a lot of technical work. You have to establish a position before many of our competitors jump into some of these plays. We've had some excellent success over the last four or five years building the portfolio that we're now leveraging to grow this company.

At the present time with this year's program, we operate 90% of what is funded by our CapEx program this year. And we like to control the pace and spend with the development of these new plays. For us it's not about growth for growth's sake. First thing, we focus on our returns with our projects. And as the quality of our inventory has continued to improve, those returns, those high returns on our projects is what is steeling the growth that we're now enjoying.

And then as I mentioned earlier, one of our legacy traits is to maintain a very strong balance sheet. And certainly that is the case today. I'll share some additional information on our balance sheet here shortly. In addition to leverage on our balance sheet, to fund our program, we've also been very active in terms of selling some of our non-strategic assets over the last four or five years. And in fact until last year, we had sold over $600 million of non-strategic assets. And last year alone, we announced over $1 billion in transactions including our joint venture with Mitsui.

We'll get right into it. If you take a look at the centerpiece of our program this year, it's not a surprise. It's the Eagle Ford. Let me start with our operated Eagle Ford position. Here you can see this shown in yellow with our acreage block in south Texas. At the present time, we operate almost about 150,000 net acres in the play. And as you can see from the map, we're positioned very nicely in the rich gas window. So there's very few dry gas wells that we have to drill in our current position.

This was news yesterday as we put out our press release, in July, we announced that we had averaged 230 million cubic feet a day equivalent. And that's up from 207 million cubic feet per day, which was the average for the second quarter. And we had received a lot of inquiries especially at the end of the second quarter during our call and press release regarding our operating production in Eagle Ford. We felt it was timely especially prior to this conference to be able to put out an update. We typically wouldn’t do that. But we're very pleased with the uptick that we've seen in production.

For those of you who have kept tract, at the end of the second quarter, we indicated that we had some delay in receipt of some of our tank batteries and some of the equipment to build out some of our mid-stream infrastructure. Since that time, we have continued to add tank batteries in our operating position. We're not through with that yet. We've still got some additional tank batteries to add. But clearly, we're seeing the benefit now of that continued infrastructure build down.

I should point out too tonight in the materials that we provide for you, but I will talk about it. So for July, we averaged 230 million cubic feet a day equivalent. If you're wondering where the next constraint is in terms of our build out, I will say that's with our wet gas takeaway capacity. And so that's the big pipe that takes away our production. And we expect to reach that constraint by year end, which will basically take us from about 230 million cubic feet per day in July up to about 289 million cubic feet per day when we reach that pipeline constraint. And we expect that to occur before year end. So we'll still see a nice ramp on production between now and the end of the year.

As we've mentioned earlier, we're currently running a six rig program. And sometimes between now and the end of the year, we expect to drop back to a five rig program. And for the year, we'll average about five and a half rigs in our operating position. But very pleased with the continued build out and the ramp up that we're seeing on the operating production.

Let's talk about our non-operated position. Again, this is the blue acreage shown here on the map. It is directly north of our operated position. And this joint venture that we have with Anadarko was operator as well as Mitsui and others. We currently have about 46,000 net acres in our non-operated Eagle Ford. According to Anadarko, we expect them to continue to run with a ten rig program. That would be nine full size drilling rigs as well as one sputter rig that they use for their program.

As a result of our Mitsui transaction that we closed last December, we will essentially be carried 100% on all the drilling in the joint venture for the next three to four years. So that's certainly beneficial in terms of our CapEx management.

One of the things that we've seen this year that is a little bit of a change from where we expected when we started the year was they have increased the size of some of their midstream facilities as well as accelerated the pace of some of that build out. As a result, we've seen an uptick in our proportional share of that for this year. I'll also mention though that while our CapEx may be up a touch somewhere around $50 million from where we started the year, to date we've sold about $50 million worth of non-strategic properties. So it's been a nice offset to the slight increase we saw in our CapEx program for this year.

Moving to the Bakken/Three Forks, this is an area that continues to perform very well, been very pleased with the results. If you take a look at the middle map, it kind of shows our total acreage in the Bakken/Three Forks. It's close to 200,000 acres. Our area of focus however is in three prospect areas shown with the map on the right hand side. That represents about 87,000 acres, relatively new acres for us. The prospect areas include Gooseneck, which is up near the Canadian border. And the focus there is on Three Forks at 35,000 acres there. And then the other two prospect areas include our Raven and Bear Den prospects. And again, that represents the 87,000 acres of primary focus right now.

We've also added a fourth rig in the program at the end of the second quarter. So again, we're very pleased with the results we're seeing there. And as a result, we've ramped up that program a bit.

For this year in the second quarter, we began to move to pretty much full development drilling. And in fact, we're now focused on pad drilling to improve our efficiencies, try to lower our cost. And that's what we're about right now. We're expecting to be utilizing two to three well pads going forward as we continue the development in these prospect areas. But we've been very pleased with the results to date.

This is a bit of a new headline for you for those of you who have been following us. We've been a little bit quiet in affirming over the last couple of years. There's a reason for that. We've been quietly building a larger position. And now we're beginning to talk more about that growth in the Permian. In the first half of this year, we added almost 28,000 acres of new acreage in the Permian Basin. And that now takes our total acreage exposure in the Permian to about 115,000 net acres.

In terms of rigs, we have ramped up our drilling program in the Permian Basin. We have now two rigs drilling in our Tredway prospect, which is basically focused on horizontal Mississippi and Limestone testing and development. We have one rig running in southeast New Mexico focused on horizontal Bone Spring development. And then finally, some of our new acreage, we're now testing horizontal wells in the Leonard Shale.

If you take a look at the slide here, it basically just says the area for this Leonard Shale testing is the Midland Basin. We have been intentionally vague in terms of where this acreage is because quite frankly, we're still leasing where we can. And we want to try to grow this position. But we're currently drilling and testing this new play concept in the Permian.

So we're very pleased with the expansion of our program. It's all oil focused. In Tredway for example, we've provided now the results of our latest three horizontal wells. You can see these on the slide. The seven day average for these three wells has now exceeded 600 barrels of oil equivalent per day. And the 30 day rate is a very strong 540 barrels of oil equivalent per day.

So we've been very pleased with the results. We continue to drill and hope to have further understanding and hope to see additional positive results between now and year end. Let me mention this is one of the areas where we want to see some additional drilling results. And that will determine kind of the pace and size of our Permian program as we think about our plans for 2013.

One way to think about this is we expect to sell well cost here about $6.5 million, so this looks to be a very robust project for us with continued success. And we're very pleased with the results to date. And for that reason, we've added now the second rig in the Tredway program.

In terms of other activity areas of focus, the Granite Wash continues to be active for us. We're currently running three rigs here. And our focus here is on the Marmathon washes. And as we have I believe mentioned previously, we expect to drop one of our operated rigs here before the end of the year. This allows us to manage our CapEx and allows us to allocate more capital into the Permian oil program. The Granite Wash for us is pretty much all HBP. So it allows us a lot of flexibility in terms of how we allocate our capital and drilling program.

And then finally, we've got one other rig running in southern Rockies. At the present time, we've got about 90,000 acres in Wyoming. We've got about 30,000 of that in the northern DJ Basin as well as another 60,000 acres in the Powder River Basin. And several intervals of focus here including the Niobrara, the Codale, Frontier, Essex just to name a few. So we're in the midst of drilling and evaluating our wells on this acreage.

From a production growth standpoint, I think we have guided 25% production growth for this year. And again, that's on top of 54% production growth that we saw in 2011. As you kind of look at that over a two year period, that represents very strong production growth of 39% compounded annual growth over that two year period. So I think what you're seeing here is the resource plays of focus for us are truly driving the growth of our company. And we continue to see success with those plays.

In terms of our capital budget, again, we're targeting somewhere around $1.5 billion for our capital program for this year. You can kind of see the range around that, $1.45, $1.55 billion. The vast majority of that capital is focused back over almost 95% of our drilling CapEx. It's focused on forward plays, Eagle Ford, Bakken/Three Forks, Granite Wash, and Permian oil. And that has taken the bulk of our capital and appropriately so.

As I talked about earlier, we did experience some tank battery delays after, in the first half of the year. We think we've gotten beyond that. Depending on our ability to ramp through the rest of this year, which we think we'll be able to hit that pipeline constraint by year end of 289 million cubic feet net production. However, we may end up deferring some completions of some of our new wells. But we'll see how that pace continues through the rest of the year. And if we have capacity, we'll certainly complete those wells. That has allowed us to think about allocating additional capital to the Permian oil project as I talked about earlier either from the Granite Wash or from some of these Eagle Ford completion deferrals.

And then a couple of things that I mentioned earlier that we're seeing a little bit of increase on the capital side, again, coming from some acceleration of mid-strength facilities and our non-op Eagle Ford position as well as a little bit of higher capital for our new ventures program, we're having good success leasing as well as drilling some test wells in some of our new prospect areas that we don’t talk about at this point. But at the right time with success, we may talk about that more going forward.

I should also point out that our capital budget this year includes an expiration program of about $100 million, which is up from $80 million last year. But we're going to remain inquisitive in terms of looking at new resource play opportunities. And then fundamentally where we want to get to is to be able to continue to high grade our portfolio like we've done over the last five or six years. And we view all of these new resource plays as currency. You may have heard me say before, we'll look at self-develop. We'll look at sell-down, joint ventures, outright sale if that provides the most value increase and the most value for our shareholders. And we've got examples of doing all of that over the last few years.

Talk about our credit facility, this is something else that was included in our press release yesterday morning. And that's the fact that our borrowing base has increased from $1.4 billion to $1.55, which we certainly saw as a positive sign in spite of the weak pricing environment especially with NGL's and natural gas. Having said that, we intend to maintain our commitment level in our credit facility at $1 billion. And again, provides us with plenty of dry powder to execute on our development plans.

In terms of our balance sheet financials, if you take a look at the left hand side, you can see that our debt to total book cap is around 43%, which I think is pretty healthy compared to our peer group. We've only had, at the end of the second quarter; we only had $61 million drawn against our credit facility again with that $1 billion commitment level. And then we've got three tranches of senior notes totaling $1.1 billion. We don’t have any debt maturities coming to us anytime soon. You can see on the right hand side, our credit facility comes due in 2016. And then we've got our senior notes spread out nicely. The first one doesn’t mature until 2019. So in very good shape there from a balance sheet standpoint.

Two key takeaways, first of all, we are very well positioned in our four key plays that are driving the growth of the company. I talked about that a few minutes ago. So it's four plays. It's the Eagle Ford, Bakken/Three Fork, Granite Wash, and now Permian oil. And we're very pleased with the progress we've made and our performance so far this year. And that's going to be driving our growth going forward. And again, we expect to see that growth somewhere around 25% for this year. We've got a strong balance sheet, which is a legacy trade of SM Energy. And that's going to provide plenty of dry powder for our program going forward.

And then let me leave you with a little bit of a note. If you take a look at a lot of the metrics associated with our company, one of the ones that is a little bit puzzling is if you look at our multiple especially on an EV or EBITDAX standpoint, we're well below a lot of our peer group. Do you know what that means? I think this is a great time and a great entry point to consider an investment in SM Energy. I could not be more pleased with the progress we've made. I'm excited about where we are. I'm even more excited about some of the new venture areas that we're now testing.

With that, I'd like to thank you for your time and your interest in SM Energy. Thank you very much.

Question-and-Answer Session

Operator

(Operator instructions).

Unidentified Analyst

Tony, thank you. We do have some time for a few questions before moving to the breakout room. I’d like to start. You referenced maintaining roughly 289 million a day in the Eagleford, once you hit that capacity, with the carryover of [inaudible] that you would have going into next year, how much capital could you reallocate from the kind of numbers you’ll spend this year in the Eagleford to other areas like the Permian or the Bakken?

Anthony J. Best

Yeah, and Jeff, I appreciate the question because it allows me a chance to kind of clarify where we see our takeaway capacity going. So let me start with that and I’ll address the question about [inaudible] that you might allocate elsewhere. So for the end of the year, pipeline capacity would be, like I said, 289 million. Through the first half of next year we’ll get another tranche of capacity, that will take us up to about 325 takeaway capacity, million per day takeaway capacity. And then in the second half of next year, that will go up even higher to around 400 million cubic feet per day equivalent takeaway capacity. So we’ll continue to build out the wet gas system over the next couple of years and in fact, it goes up again in 2014. If we were to drill and be able to satisfy our take or pay commitments and produce into that capacity, takeaway capacity, potentially there might be a rig that we might lay down assuming, and we’re still going through the numbers right now to see exactly how many rigs will it take for us to meet those take or pay obligations. But if we were able to allocate a rigs worth of capital somewhere else out of the Eagleford, it’s probably in the 120 to 130 million kind of range. But again, we’re working through those numbers right now and as we work up or plans for 2013 we’ll have a better idea of exactly what our rig requirements will be to meet those take or pay obligations.

Unidentified Analyst

Tony, on exploration, do you – are you – will you be far enough along in some of these plays in terms of acreage and testing that you’ll be able to start talking about them sometimes either later this year or first half next?

Anthony J. Best

Yeah, I would say for the most part we don’t give a timeframe for disclosing a lot of information on our exploration program for obvious reasons. One thing is if we see positive results, we’re going to be out there leasing and increasing our position in a lot of these plays. Let me give you a couple of examples. I just talked about the Permian oil growth that we’re seeing. That was a play that we began almost three years ago, put together a nice acreage position, almost 100,000 acres and it takes a little bit of time to go and drill your wells, you have to do an awful lot of technical work before you can fully delineate that play. So that’s an area where we start out close to 100,000 acres. Today, we’ve been able to kind of core that up, delinieate that so we’ve turned some acreage back and that’s sized now around 70,000 acres. But I’d kind of like to focus on, you know, some of these new prospects that potentially could be at least 100,000 acres as kind of a target because that will provide you with scope and scale to grow this company if you have success. So we go in, start out with smaller amounts of acreage, we’ll drill some test wells, if we like what we see, then go out quietly and continue to expand the position.

But we don’t typically give a time table just because we know it’s going to take some time to work through technical work to get the well results and then most importantly, to keep it quiet while you go out and continue to lease in some of these new prospect areas.

I’d say, today, we’ve probably got 10 or 12 prospective areas we’re now either leasing or drilling test wells.

Unidentified Analyst

Any other questions for Tony? Tony, I’d like to thank you for being here.

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