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Encore Acquisition Company (NASDAQ:EAC)

Q2 2008 Earnings Call Transcript

August 7, 2008 10:30 am ET

Executives

Jonny Brumley – President & CEO

Ben Nivens – SVP & COO

Bob Reeves – SVP, CFO & Treasurer

Analysts

David Kistler – Simmons & Company

Brian Singer – Goldman Sachs

Joe Allman – JPMorgan

Noel Parks – Ladenburg Thalmann

Pavel Molchanov – Raymond James

Stephen Berman – Pritchard Capital Partners

Barry Haynes [ph] – Sage Asset Management

Greg Brady [ph] – JP Morgan

Jeff Sutton [ph] – Maiden Capital [ph]

Operator

Good morning. Welcome to the Encore Acquisition Company and Encore Energy Partners LP Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (Operator instructions)

This presentation includes forward-looking statements. Forward-looking statements give Encore's current expectations or forecasts of future events based on assumptions and estimations that management believes are reasonable given currently available information. However, the assumptions by management and the future performance of Encore are both subject to a wide range of business risks and uncertainties and there is no assurance that these statements or projections will be met.

Actual results could differ materially from those presented in the forward-looking statements. Encore undertakes no obligation to publicly update or revise any forward-looking statements. Further information on risks and uncertainties is available in Encore's filings with the Securities and Exchange Commission.

I would now like to turn the call over to our host, Mr. Jonny Brumley. Thank you. Mr. Brumley, you may begin your conference.

Jonny Brumley

Okay, thank you. Thanks for being on this second quarter 2008 conference call. In the room with me today is Ben Nivens, our Chief Operating Officer; Greg Barnes, our Vice President of the Northern region; John Arms, who is our Senior VP of Acquisitions; Kevin Treadway, who is our Senior VP of Land, Bob Reeves, who is our Chief Financial Officer; and Jon Brumley, our Chairman.

We are pleased with the operating results for the second quarter of '08. Later on in the call we'll be discussing the strategic alternative process, but first let's go the real quick to highlights of the second quarter then we'll get straight to the strategic alternative process.

Some people have wondered why we put out the press release a day early. The reason is that it was big news and we did not want to sit on it for fear of a leak. After our Board meeting on Tuesday we decided to send it out that night. We already had the conference call scheduled Thursday, so we kept to the schedule.

The call will go as follows. I will go over the quarterly highlights and strategy alternative process, then Ben Nivens will go over an operational update, and finally Bob Reeves will go over Encore Energy Partners. Then we'll open the call up for questions.

First off, EBITDAX was huge; it was $263.2 million for the quarter. That's a big number and more than doubled our EBITDAX in 2007. We are also very proud of production numbers especially given the fact that we hit the mid-point of guidance even with a storm in the Cedar Creek Anticline, pipeline problems in West Texas on a third-party pipeline that moves NGLs from West Texas to the Gulf Coast, and third-party gas plant problems in New Mexico that just the resiliency of our people and properties and our ability to oil down the line during tough times.

I am also really proud of our marketing group, our differentials are tight. We have good, solid purchasers, and we avoided the problems that many producers face with a large purchaser filing for bankruptcy.

Back in 2006, we began refocusing on oil properties and that bet has paid off. You can really see it in our EBITDAX per BOE numbers. Our EBITDAX per BOE for the second quarter was $75.68. So that's a margin of $75.68. that equates to $12.61 per Mcf margin when you use a 6 to 1 ratio to convert the oil to gas. That's at a time when gas was only selling for $10.68 on the NYMEX. That just highlights the importance of oil properties. Our EBITDAX per BOE is higher than a gas company's revenue.

We have always believed that oil properties are more valuable than gas because the production takes less capital to stay flat, and the margins are higher. This was one great quarter for Encore.

Now, we'll discuss our strategic alternative process. As you are aware, we announced the process at the end of May to review strategic alternatives and possibly a sale of the Company. We started the process basically for two reasons. The first one is that oil markets were strong, and we felt that large companies would have a strong appetite for domestic production with a lot of growth potential. Secondly, we felt that when potential bidders came to the data room they would see our upside potential and value us at a large premium to the share price.

We signed 16 confidentiality agreements, and had indicative proposals due in mid-June. We called out the low bidders and invited the top five companies into the data room. We've set up a through data room with our technical and corporate information. During the process, a lot of things – a lot of positive things started happening at the Company. We hit a big Sanish well in North Dakota. We drilled a huge Montoya well in the Delaware Basin that came over 12 million cubic feet a day. And the Haynesville play was becoming more and more valuable by the day.

This was happening at a time when the three markets that buyers were concerned about began to deteriorate. Oil started falling, equities began to decline, and the credit markets worsen. Once that began to happen, you saw a huge contrast in sentiment. Encore is getting better and the stocks of potential purchasers were getting worse. They became discouraged. We were running a true strategic alternative process, and not just going down one path. We are prepared to roll out our plan, and this plan will be good for shareholders. The plan will improve the Company's balance sheet, enhance our focus on core areas, decrease our natural production decline, and allow us to commit our financial and human resources to successful drilling plays.

Encore has a large and meaningful upside potential in the Bakken, West Texas JV, the Ark-La-Tex, which has the Haynesville and Lower Cotton Valley plays, our huge CO2 potential at Cedar Creek and Bell Creek, and the Tuscaloosa Marine Shale play. When you add up all of this potential you get a 3P number of 700 million barrels.

Our plan is three-fold. The first part of the plan is to divest of our Overton Field in Smith County in East Texas and also to the West of our New Mexico properties. The Overton Field is a good gas field, but the Company has grown to a size that the field has become non-core and with our other opportunities at Encore, we do not have the manpower to exploit it. We believe the winning bidder will pay us for the opportunity to drill the prospects.

In New Mexico we have upside potential in the morrow or Toca play that's been successful, but like Overton, our New Mexico properties have been – become non-core and – for Encore as well. We'll hire – we'll take an investment bank to help us package these properties and will get a good price for the properties from a company that will focus on these properties.

The second part of the plan will be drop down properties into the MLP to help us deleverage as well. We are currently reviewing our menu of properties that can be put into the MLP and use the drop down to grow the MLP's distribution and also to delver. The property drop down being arranged is about $50 million to $150 million.

The divestiture and drop down should pay off our bank debt and free up the human resource to allow us to invest more money into our core areas like the Ark-La-Tex region and the Bakken, and the West Texas JV.

The third part of the plan is to purchase 8500 barrels a day of put that is struck at $110 for calendar 2009. This will ensure that we have good revenues in 2009 to fund our drilling program.

So, what this leaves you with is a very strong Company that's well positioned for '09. We'll be able to fund a large capital budget plus if the opportunity presents itself, make a large acquisition in one of our core areas. The Company will have a $1.1 billion borrowing base with nothing drawn on it at a time when credit markets are tight. This gives us a competitive advantage in one of the things that we do best – buy oil properties.

The Bakken/Sanish play is improving, and we have grown the play from 37,000 acres in 2007 to 240,000 acres today. We have more leverage to this play than any of our peers, and this is the best and largest oil and gas play in the entire U.S. In fact, we have drilled our largest well in the play in late July, which IP-ed over 1100 barrels a day with the introduction of this Sanish play – with the Sanish the play is getting better and better. We figured the Sanish out early. We started picking up acreage, and we believe that at least 150,000 of our 240,000 acres is prospective for both the Sanish and the Bakken. Having two zones to go after really improves the play.

Another recent improvement in the play are refracs. We think this has increased the rate of return in the play significantly. We have done five refracs in our Murphy Creek area, and have seen an increase of about 100 barrels per day per refract and have seen reserves increase about 50,000 barrels to 80,000 barrels. That is for a project that only cost $500,000. Encore believes that these refracs will be very significant to the play and increase it across the board.

The West Texas JV is improving as well. We have discovered that the Devonian is productive at Brown Bassett and just brought on a huge well in Block 16 in the Delaware Basin, that's the 12 million a day well that I mentioned earlier. This was Encore's first completion in the Delaware Basin. In the Midland Basin area, the JV grew 20% quarter-over-quarter at a time when we had production curtailed because of the pipeline problem that moves NGLs from West Texas to the Gulf Coast. The commitment wells are now behind us, and now we are exploiting the low-risk good stuff.

As you are aware, our East Texas and North Louisiana region is becoming more and more valuable and will be a large focus for our development team in 2009. We have some of the best acreage in the Haynesville and Lower Cotton Valley plays. We plan on having a rig running in the Haynesville play in the fourth quarter of 2008.

During the quarter we exercised a pref right in our Greenwood Waskom area to purchase 3200 acres of Haynesville potential. This is first class acreage with a log and a core to the Haynesville. We feel fortunate to have acquired this acreage, but one thing I don't want you to overlook is the Lower Cotton Valley and the Bassett potential in our Ark-La-Tex region.

Another operator drilled a 16 million cubic feet per day Lower Cotton Valley well (inaudible) on a section where we own a small interest, but more importantly we have recently been AFE fore two wells in the adjoining section where we have authority percentages.

In the Stockman area in East Texas there is significant Bossier potential. There are two wells producing from the Bossier, one with an IP at 10 million cubic feet per day, and another with an IP of 7.5 million cubic feet per day, producing right in between our 2400 acre block and our 1000 acre block to the south. These are huge wells that are Bossier, but they have Haynesville type potential.

With everything working well, 2009 will be even better than 2008. We are currently working on our 2009 budget. The budget is going to be larger than 2008, and the growth range for 2009 will be higher than 2008. We have taken a lot of risk out of the budget this year, and now it's time for us to get busy and exploit the development wells.

We are planning on three additional Bakken rigs and move from three rigs in the third quarter of 2008 to six rigs in the first or second quarter of 2009. We are also planning on adding more Bakken rigs in the second half of '09. If we can get these rigs sooner that will really help our year-over-year growth. We also have a Haynesville rig that will spud in November, December, and may even have an additional Haynesville in '09. We will finalize the budget in September, present it to the Board in September or October and then present it to you after that.

Since we are talking about budget, I'd like to reconfirm the 2008 growth rate of 6% to 8%. We are expecting a big fourth quarter and the third quarter would be even better but we are striving to get two wells on in Pegasus once those wells will come on in late August or early September. And so those wells will really help the fourth quarter.

We are getting geared up for '09. You can see that in the increase in our growth rate, the strength of our balance sheet, the protection of our cash flow, with our (inaudible) program, the improvement in our drilling program, and our ability to continue to expand through developing our large potential.

We will be ready to make an acquisition if the opportunity for an acquisition arises. With this plan, Encore will add long-term value in 2009.

Now, I will turn it over to Ben Nivens. Ben's our Chief Operating Officer. He will go over the operational update and then Ben will turn it over to Bob Reeves to go over the MLP.

Ben Nivens

Thanks Jonny, and welcome everyone this morning. I will start with our Bakken/Sanish drilling. We had two rigs running in the second quarter and as we previously discussed, we had – we completed a well in the Charlson Field. It's the 11-16H. The well had an IP of over 1100 barrels a day and stayed strong with an average of 840 barrels a day for the first seven days of production. We are currently drilling our second well in the field and plan to drill another four by year-end.

We will be active in this field throughout '09 and beyond that with 10,400 acres in the Charlson area now with 28 locations. This field contains the most prolific Sanish well drilled in North Dakota and we think it is some of the most prolific Sanish in the entire play.

We will be expanding our Bakken/Sanish drilling by adding a third rig in September. This rig will be dedicated to our Cherry Creek Prospect where we own over 70,000 acres. We are currently drilling one well in the prospect now and we hope to have results on that well within a month. The area has potential for both Sanish and middle Bakken. We will be testing the middle Bakken with the well we are currently drilling and we will be testing the Sanish with the second well.

With our continued success in over 240,000 acres in the play, we are focusing on increasing our acreage position and our drilling program. We intend to have six rigs running in the Bakken by the middle of next year and we intend to continue to pick up leases in the Bakken.

Our refract program is going well, as Jonny highlighted earlier. Since December 2007 we have refracd four wells in Murphy Creek and one in Amculi [ph] with very positive results. (inaudible) projects for 50,000 barrels of recovery but we have averaged about 80,000 barrels per well with a cost of about $0.5 million per well. One well, the Toolish [ph] 24-2, is actually producing 140 barrels a day higher than its prefrac rate, 70 days after the refrac. So we are very excited about his project. Obviously, the economics are great. We plan three or four more refracs in the – before year-end. And we see a large potential for refracs across this entire play.

Moving onto our Bell Creek area, in the third and fourth quarter of this year we intend to invest $7.5 million to return 13 wells to production and convert nine wells to injection and we hope to see results from this work in early '09.

Moving to our Southern region and our West Texas JV, we had five rigs running in the quarter. And Jonny described our big Montoya well that we are very excited about. That well is the Pyote Gas Unit 3-3H. It's a very strong well. We cut it into sales on August 5th, and it's currently making 12 million a day with over 200 barrels of condensate and is producing at a 3800 pounds tubing pressure. So, we are very excited about that.

And we are excited about the potential in Montoya. This well was a commitment well that was drilled on the edge of the existing production and drilled in a different direction than the current producing Montoya wells. This really opens up Block 16 to further Montoya development. We have over 20 locations in Block 16, and then we have several more possible location in Waha and Coyanosa that sit just south of Block 16.

We will spud our next Montoya well in the fourth quarter of this year and will have at least one well drilling Montoya wells throughout '09.

Moving to our Brown Bassett Field, where we have some exciting news on the Devonian play that we previously announced. Two wells that came on in June and July testing at 4.5 million a day and 3.4 million a day, which were well above our expectations of 2.5 million a day. These two Devonian wells are holding strong and still producing at a combined rate of about 6 million a day. This is huge when you consider the fact that there was no Devonian production in the Brown Bassett Field when the JV was signed.

So we've already identified with these two locations, 25 additional locations to be drilled and we will spud our next Devonian well in the fourth quarter and we will have one or two wells drilling throughout '09 in Brown Bassett for (inaudible) and that will be Devonian, but we will also be – continue to drill our Strawn and Ellenberger as well.

Moving to our Tuscaloosa Marine Shale, we ran pipe this morning on our third horizontal well in the Tuscaloosa Marine Shale and that's the Warehouser 1-H [ph], and is located in St Helena Parish, Louisiana. This well reached a lateral distance of 4200 feet making it our longest lateral in the play today. We continue to show improvements on our drilling efficiencies. This well we reached TD 45 days faster than our second well while drilling 1100 feet more lateral section. So, things are improving on the drilling side in the TMS.

We did have a bit of a disappointment with our (inaudible) plantation well, our second well in the TMS. We achieved a lateral distance of 3100 feet, which we were real excited about. We simulated the well with three separate fracs and as we went into clean up the well one last time to put it on production, we encountered a tasing [ph] part about 10% – so now what that amounts to is only about 10% of the lateral is open. We put the well on pump and is producing at a stable rate of about 50 barrels a day. And although this is a big disappointment that we only had 10% of the lateral open, we think it bodes well for the fact that it is making 50 barrels a day with only a small portion of the lateral open.

So we look forward to bringing on this third well in this play and we will be drilling our fourth well following up this third well.

Moving on to our Haynesville, I will go over that rather quickly as Jonny detailed a lot of that. We did exercise our option on the Greenwood Waskom acreage. We will have a 92% working interest in that area and an additional 3200 acres in the heart of the Haynesville play, giving us a total of about 16,000 net acres. We will be drilling on that Haynesville – in the Haynesville in our agreement with Waskom area in the fourth quarter of the year, and as Jonny outlined, we'll have one or two rigs going in 2009.

In East Texas, our Stockman field continues to deliver with a successful drilling and recompletion program. We have increased the production from 1.7 million Mcf a day to 9.6 million Mcf a day currently. That was with three drilled wells on line at about five well program. We are still drilling in the play right now. Also, we completed two wells in the Petit [ph] (inaudible) and those wells average 1.5 million a day. We see a lot of upside potential and further recompletions in the Petit. Those wells will eventually be co-mingled with the existing (inaudible) preparations in those wells. So, we have some running room in the Petit as well as in the Travis Peak and the Stockman area.

I will finish up by just saying that on our enhanced recovery efforts we have a team that is dedicated to finding a field (inaudible) source and bringing those 200 barrels of potential reserves that we see in our Rocky Mountain properties to a reality. And that will certainly help us grow in the long term at Encore.

With that, I will turn it over to Bob Reeves to talk about our MLP.

Bob Reeves

Thanks Ben. I would like to start by stating our second quarter 2008 distribution rate (inaudible) will be about $0.688 or $2.75 annualized. This is as 20% increase over our first quarter distribution and a 97% over our stated IPO distribution of $1.43 on an annualized basis. At yesterday's unit closed price of $24.65 this equals 11.2% annual yield.

In a low interest rate environment, it's really hard to beat 11.2% annual return with a significant tax shield associated with it. I'd like to walk through the components that reconcile to our distributable cash flow and talk a little bit about each component. For the quarter, NYMEX oil averaged $124.30. Our differential for the quarter was $12.77 or 10%. This beat our expected guidance of 13%, so we netted a wellhead amount of $111.53.

For the third quarter of 2008 we are expecting 11% negative differential. So roughly in line with what the second quarter results were. So in total our oil revenues were $47.1 million in the second quarter of 2008.

On the gas side, NYMEX gas was $10.94 on average. Our differential was plus $0.12 or 1% positive. This beat our guidance of negative 11% for dry gas. We guide on a dry gas basis for the second quarter and differential being positive included the liquids associated with it. So this netted to $11.06 on a wellhead basis.

For the third quarter, we are trying to guide more towards expected gas price. So we have an 8% positive differential for the third quarter of 2008. The positive differential as you probably know is primarily attributable to the Crockett County production of very rich gas, so that's why the positive differential.

Gas revenues total were $11.8 million for the quarter. Marketing revenues were roughly $1 million for the quarter with an offsetting marketing expense of $1.6 million. So, total revenues were $59.8 million for the quarter. On the volume side, we averaged 6600 barrels of oil equivalent per day for the second quarter, which was a the high end of our guidance.

We have the same production guidance for the third quarter as we did the second quarter, which is 6000 BOE per day to 6600 BOE per day. Remember, our stated goal is to keep production relatively flat through our organic projects over a 12-month period. Some quarters of production will be a the high end of the range like this quarter and some quarters will be toward the middle or lower range, but over a 12-month period we just expect to keep our volumes relatively flat. We plan to grow the volumes in the Partnership through acquisitions and drop downs.

On the expense side, total operating expenses were $17.3 million for the quarter, excluding the non-cash items such as DD&A, hedging, mark-to-market for future periods, equity compensation. So, revenues of $59.8 million less operating expenses of $17.3 million equated to EBITDA for the quarter of $42.5 million.

On the LOE side, LOE averaged $11.53 per barrel, which fell inside our guidance range of $10.75 to $11.75 per barrel. Our production tax percentage of revenues came in at 9.8% versus our guidance of 11.2%. This is due primarily to the higher volumes we experienced in our Crockett County properties in Texas that have a lower production tax rate than up in Wyoming.

On the G&A side, excluding our non-cash compensation G&A came in at $3.12 per BOE, which was below our range of $3.40 to $3.85 per BOE.

We did have a large derivative fair value loss of $76.4 million for the quarter. We do not use hedge accounting for our commodity hedges. Our actual hedging related cash settlements for the quarter were roughly $1 million comprised of $650,000 loss of oil settlements and $325,000 for gas settlements. The majority of that loss was marked-to-market of future contracts of $73.2 million, and premium amortization of $2.2 million.

In a volatile commodity environment that we saw oil prices averaged 27% higher in the second quarter versus the first quarter it's really nice to have our hedging strategy that allows unitholders upside commodity exposure but protection from big drops in commodity prices. As you know, this strategy resulted in a 20% increase in our quarter-over-quarter distribution to unitholders.

On the capital side, for the second quarter of 2008, we incurred capital cost of $5.7 million. This was higher than our prior guidance of $2.5 million to $3.5 million for the quarter but it was money well worth investing. Because of a rig availability, we moved some of our Crockett County wells forward to the second quarter from the planned second half of the year. This resulted in the largest well drilled in Crockett County by Encore in the eight years we have owned this property.

We do plan to reduce our capital expenditures in the second half of the year down to around $2 million per quarter. With higher service cost, we also increased our estimated annual maintenance CapEx to $15.7 million per year versus our previous guidance of $13.7 million per year.

Typically, we reduce our cash available for distribution by the quarterly amount of our estimated maintenance CapEx regardless of the capital expenditures for the quarter. This keeps everything level and predictable for the year. However, in this quarter, with the robust commodity prices we experienced we reduced our cash available for distribution by the full amount of our actual expenditures of $5.7 million for the quarter.

Our interest and income taxes equaled $1.6 million for the quarter. So, deducting revenue less expenses less our interest and our capital this equated to $35.3 million of cash available for distribution for the quarter. Under our new variable distribution methodology, our total distributions are calculated as follows. The $35.3 million is cash available for distribution less our minimum coverage ratio of 1.1 times, that's a deduction of $3.2 million, our minimum distribution of $1.73 per unit, which is $14.1 million. That leaves us remaining cash available for distribution of $17.9 million. We are distributing 50% of that excess, which is $9 million. So, our total distributions to unitholders for the quarter will be $23.1 million.

Our coverage ratio under the second quarter is a very robust 1.53 times for the quarter. On the debt side, we paid down $14 million of debt this quarter. And our current outstanding balance as of June 30th is $151 million. We now have about $90 million available under our $240 revolving credit facility for drop downs of future acquisitions as of June 30th, 2008.

With that, I will turn it back over to Jonny.

Jonny Brumley

Okay, now we can just open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of David Kistler with Simmons and Company.

David Kistler – Simmons & Company

Good morning, guys.

Jonny Brumley

Good morning, Dave.

David Kistler – Simmons & Company

Hey, I wanted to dig into some more details in the Bakken and specifically kind of want to break it into two parts. If I think about what you are planning on budgeting for the Bakken, how does that get split between the refract program and just basic drilling?

Ben Nivens

Basic drilling is obviously going to be the biggest part of that. We will go from three to six rigs in 2009 and we'll carry on a program of refracing wells probably three to four a quarter. So, the bulk of the money will be spent on development drilling.

David Kistler – Simmons & Company

Okay, and then on the development drilling component of it, can you walk us through days to drill, what you expect each well cost to be, maybe EURs at this point or are we a little ahead of ourself?

Ben Nivens

On the EUR standpoint, that's going to vary from area to area and that might be a little ahead, but as far as the drilling goes, we are going to be drilling primarily 12-80s next year and those cost are going to vary from about $5 million without a liner to about $5.5 million with a liner and a multi-stage frac. So that's where your – most of the drilling is – the range of the drilling program there as far as cost goes. And what was your other – your – the third part of your question?

David Kistler – Simmons & Company

Well, just days to drill.

Ben Nivens

Days to drill –

David Kistler – Simmons & Company

How should we think about how to model it out a little bit.

Ben Nivens

It's about 45 days to drill and about three weeks to complete and bring home to sales.

David Kistler – Simmons & Company

Okay, great. And then kind of a broader question. Jonny, at the beginning you had mentioned and has historically been the case that you guys favor oil over gas. Obviously stepping into Haynesville is definitely a very gas levered play. Can you give us a little bit of color on why you are doing that kind of just general thoughts from that standpoint.

Jonny Brumley

Okay. First off, with these type of results that we are witnessing in the Haynesville whether it's oil or gas it's a huge rate of return. And that's more important than anything. Secondly, that oil plays are hard to come by, and so if you are going to drill, you are probably going to be drilling for gas. That's why we feel so lucky to have 240,000 acres in the Bakken and have 65% of our production coming from shallow declining waterfloods. And so that's really the benefit of being oil. I think if – so, that's really the answer to the question is that we will drill for whatever has a high rate of return but being oil focused does make a lot of sense because you just make so much more money.

David Kistler – Simmons & Company

Sure. I appreciate that additional color on that. And then last question, I will let somebody else hop on. You mentioned once you complete kind of your three-pronged strategy here, balance sheet will be in order that you would be looking at potentially buying oil assets. As we look at the marketplace right now, how do you compare that to just buying shares back?

Jonny Brumley

We will look at all of that. I think that we always look at buying shares back as you are aware and having a share repurchase program going on in '08. But also look at acquisitions too. I think we might have a good advantage with credit markets being most tight it is really tough for people to get bank financing that don't already have it set up.

David Kistler – Simmons & Company

Sure, well I appreciate the additional color and I might hop back on in the queue in a bit.

Jonny Brumley

Okay. And I think we'd like to talk a little bit about EURs in the Bakken. They are averaging at least 260,000 barrels and our better areas are higher than that.

David Kistler – Simmons & Company

Great.

Operator

Your next question comes from the line of Brian Singer with Goldman Sachs.

Brian Singer – Goldman Sachs

Thank you. Good morning.

Jonny Brumley

Good morning, Brian, how are you.

Brian Singer – Goldman Sachs

I am well, thank you. Appreciate the color with regards to the strategic review process and it certainly (inaudible) from you comments that it was a lot of the market volatility that played a role in how things transpired. So I wonder if to the extent that there is some greater level of calm or if there is some greater confidence in oil markets and oil prices and oil equities, if you would commence the process either publicly or privately again or if this is more of a final decision?

Jonny Brumley

It's really a pretty final decision. Everything we do at Encore we do a 100%. And so when we went through this process we announced it and hit it full bore and really tried to do – to run a good process and the markets just turned against us for getting that done. Now – and so now we are really moving forward with our drilling program. I mean we have a ton of value at this Company. We have a great drilling program and really positioned well for 2009. So we are getting excited about '09, ready to move forward.

Brian Singer – Goldman Sachs

Great. And then on the West Texas JV, does the recent success open up any additional opportunities either for gas JVs or oil JVs?

Jonny Brumley

I think it could, I think that we are happy with what we have. The JVs that we have is very successful but it does take a lot of people to run all those rigs. So if we were to another one it would either be smaller or we'd have to have a bigger interest.

Brian Singer – Goldman Sachs

Okay. Great. Thank you.

Operator

Your next question comes from the line of Joe Allman with JPMorgan.

Joe Allman – JPMorgan

Hey, good morning, everybody.

Jonny Brumley

Good morning, Joe, how are you?

Joe Allman – JPMorgan

Hey, good, thanks everybody. Hey, Jonny, I think you mentioned, at least Bob had mentioned that you think that 150,000 net acres of return of 40,000 net acres in the Bakken play is prospective for both the Bakken and it's three course Sanish. Can you talk about what data you have that makes you comfortable with that kind of acreage position that's prospective for both?

Ben Nivens

Yeah, Joe, this is Ben. Our geological team has looked over thousands of wells that are available out there and have mapped the Bakken and the Sanish play out. And so that comes from them looking at this – the entire play and a kind of general idea of where the Sanish is thick and prospective.

Joe Allman – JPMorgan

Okay and (inaudible) but so how many data points do you have that kind of tells you that? Any rough idea?

Ben Nivens

I don't know. It is – it's several thousand wells.

Joe Allman – JPMorgan

Okay. Got it. Okay. And then I mean what tells you that – I mean do you think that you basically have over 150,000 acres, do you think there is separate reservoirs and kind of – because I think you know like the original analog field I think it produced from both I think that (inaudible) well that – the USA wells I think that real strong one was maybe the best well in the whole field. I think it's probably getting contribution from both the Three Forks and the Bakken and can you tell you me what you think about that and what makes you think that – do you think there is separate reservoirs?

Ben Nivens

Well, when you take separate reservoirs you mean Bakken and Sanish. You don't mean even within the Sanish and the Three Forks?

Joe Allman – JPMorgan

Sorry, I mean, yeah, a separate – basically where you can produce separately where from the middle Bakken and separately from the Three Forks/Sanish.

Ben Nivens

I think that hasn't been proven yet, but it's certainly seems to be evident in the Charlson area. That well is so strong and has remained so flat. You are up on the Anticline, there is a good chance you have additional fracturing going on and there is a good chance you may have communication between the two reservoirs. There is also areas where it doesn't look likely where the middle Bakken is thicker. And there is more separation between the middle Bakken and the Sanish with a lot – with the shale of the lower Bakken. So I think there is going to be areas in which you have a lot of communication, areas in which you have some communication, and maybe areas which you totally develop the Sanish and the Bakken. So, it's still unknown to a certain extent.

Joe Allman – JPMorgan

So, you think in your Charlson you think you are getting contribution from both the middle Bakken and from the Three Forks/Sanish?

Ben Nivens

I think the Petro-Hunt well is likely getting contribution. I don't know that we are. Our well is a big well, but it is still not as big as that well. If you look at just the oil in place in either the Sanish or the Bakken, you are talking about 8% to 10% of oil in place for these kind – for 300,000-400,000 barrel of oil. So you could certainly not – I mean certainly get that kind of recovery from just one of these reservoirs.

Joe Allman – JPMorgan

Okay, got you, got you. And then I think Jonny you mentioned that you are – did you say 250,000 barrels of oil, is that we assume?

Jonny Brumley

Well, there are at least 260,000. Some of the 12-80s will be higher than that. So – in the end if you look at the refract program you can add 50,000 barrels to 80,000 barrels on top of that for $0.5 million. So you look at the total package and you are looking at anywhere from 310,000 barrels to 350,000 barrels for $5.5 million.

Joe Allman – JPMorgan

Okay. And when you look at – when you look at your acreage spread you kind of divide up the acreage and say well you know you think this area is here, it's better, and it's probably higher EUR than this other area is less and maybe lower and you get up – you get to that average of you know 260 or get in the refract 310 to 350, how do you think about that?

Jonny Brumley

Yeah, I think so, but I think that what we are focusing on is developing 260 and above.

Joe Allman – JPMorgan

Okay.

Jonny Brumley

I think if we drilled a bunch of 180,000 barrel of oil, we go to a new area.

Joe Allman – JPMorgan

Yeah, but – okay you think that some of your acreage is probably better than some other areas, is that right or is it too early to tell at this point?

Jonny Brumley

Oh, no, you are exactly right. I mean Charlson, when the well comes on at 1100 barrels a day, that could be well into the 400,000 barrel rate.

Joe Allman – JPMorgan

Okay. Got it. Okay. Alright so okay. And then on the Tuscaloosa Marine Shale, so what are we thinking here? So are you not as encouraged about this play or you just as encouraged as you were before? Can you talk about that?

Jonny Brumley

No, we are very encouraged I think and we are very frustrated. I think that – once you – we got a good well drilled with a long lateral and it's only – it's producing 15 barrels from just 18 perforations. So, it's not – from 50 perforations.

Ben Nivens

50 barrels.

Jonny Brumley

Oh, I mean 50 barrels from 18 perforations. So that is – and it is staying relatively flat, so they are showing you there is a reservoir there. And then the fact that the first well we drilled we only got 1000 feet out on it is also staying pretty flat. So we just have been anticipating getting a long horizontal lateral frac and that's whey we are so excited about this third well is because it drilled better. We didn't have the same problems that we did – had on the other two going in coming out of the hole, drilled it 45 days quicker. And already have the casing in the hole, ran it – we ran it real slow, but ran it without any problems. That smooth. And we are currently (inaudible) and we are really looking forward to getting this on to see how it can be.

Joe Allman – JPMorgan

Okay, that's helpful. Just back to the Bakken just for one second. Like your efforts going forward you are going to be ramping up rig count and everything. What – is your focus mainly going to be on the Three Forks/Sanish or you are going to kind of divide it up equally middle Bakken and then Three Forks/Sanish or how are you going to do that?

Jonny Brumley

Ben will answer that.

Ben Nivens

It's going to be divided up. As you heard in Cherry where the first two wells one will be a Bakken, one will be a Sanish. And in Charlson we got a lot of emphasis on the Sanish but we see a good Bakken in the Charlson areas as well. The other areas, we will go after both Sanish and Bakken. Some will be primarily Bakken, some will be primarily Sanish.

Joe Allman – JPMorgan

Okay. Very helpful guys. Thank you.

Jonny Brumley

Thanks.

Operator

Your next question comes from the line of Noel Parks with Ladenburg Thalmann.

Noel Parks – Ladenburg Thalmann

Good morning.

Jonny Brumley

Good morning.

Noel Parks – Ladenburg Thalmann

I have a few questions. I wanted to start with the Montoya. That was a new target for me and I was just curious, and maybe Ben could answer this, you mentioned something about drilling in a different direction from existing Montoya production and I was just interested to hear about that. And also just confirm for me, that – the Montoya is below the Barnett and the Woodford in the Delaware Basin, isn't it?

Ben Nivens

Yes. Yeah, that's correct. Now, this is Ben. And as far as drilling in a different direction, most of the wells that were drilled by Exxon-Mobil in the late 90s were drilled in a north – northwest of southeast direction and we drilled it almost perpendicular to that, trying to see if we can encounter more fractures, and we got a strong well. Now I will say the other wells are very good too. So I think we are on to something going in this direction and we will do that wherever we can. However, some of the wells that we have is PUD locations which are literally in between these big well that were drilled by Exxon-Mobil, will have to be drilled in the same direction just because of the way the faults line up in the other wells, the other existing wells line up as well. So, it's very encouraging. This is an idea that our geologists had just going into this opposite direction and it looks like it's going to pay bid dividends.

Noel Parks – Ladenburg Thalmann

And actually are there other people trying similar techniques near you or do you think you are the only guys out there targeting the Montoya there?

Ben Nivens

There has been – and historically there has been a lot of focus on the Montoya. Right now, not so much focus and we hope it stays that way.

Noel Parks – Ladenburg Thalmann

Okay.

Jonny Brumley

But you know this is in the JV and so Exxon-Mobile may have the biggest and best fields out there. So –

Ben Nivens

(Inaudible)

Jonny Brumley

We have the acreage, so –

Ben Nivens

With all help of our production acreage.

Noel Parks – Ladenburg Thalmann

Okay. Great.

Jonny Brumley

That's the benefit of the West Texas JV.

Noel Parks – Ladenburg Thalmann

Okay. Great. And (inaudible) also to ask you a few things about the Bakken. You know on the last quarter call I remember you were saying that in the Almond [ph] area, which I think is the far northeast if I am right, that there were few wells being drilled there by other operators. And do you have any information on what the area is looking like now?

Jonny Brumley

No, we wish we did. They are holding that really tight.

Noel Parks – Ladenburg Thalmann

Okay. And do you have plans for drilling up there in the near term or–?

Jonny Brumley

Yes, we are going to be drilling up there in a month.

Noel Parks – Ladenburg Thalmann

Okay.

Jonny Brumley

And we do think the fact – I mean this has been held so tight I mean you go to think that's pretty good news.

Noel Parks – Ladenburg Thalmann

And how much acreage do you have in that area?

Jonny Brumley

70,000.

Noel Parks – Ladenburg Thalmann

Okay. So that's a big – a decent size percent of your overall holding?

Jonny Brumley

Yes.

Noel Parks – Ladenburg Thalmann

Okay. And just actually a similar question, I know you and several firms were involved in a consortium where I guess a lot of people had the small stakes in acreage and agreed to share data, and was there any outcome or anything that you learned from that that has been helpful and how you are approaching the play now?

Jonny Brumley

We are getting the data, we think it will be helpful. We sign confidentiality agreements not to discuss with consortium in the public and we are going to respect that, and we think that the other people will too as well probably more than they have in the past.

Noel Parks – Ladenburg Thalmann

How long does that process go on before you are able to be public about it and ask them what you have?

Jonny Brumley

I don't know. I don't see provided there is any sense to us being in a consortium, paying for a consortium and then going and telling in the public what we found out, I mean, that is the whole reason why you do something like this.

Noel Parks – Ladenburg Thalmann

Right, but it is still ongoing in other words.

Jonny Brumley

Yes.

Noel Parks – Ladenburg Thalmann

Also I was curious about the Bakken and the refracs, you talked about how for a modest cost sort of [ph] get the production back up, you have any sense as to how that acts on maybe the reserve like profile for the wells, if you are able to give them a successful refrac?

Jonny Brumley

Yes it stands at a loss.

Noel Parks – Ladenburg Thalmann

From roughly what to what would you say?

Jonny Brumley

I don't know. But I mean, it would extend it – these are long-life wells to start with. I just don't know to guess, but the real thing is that the biggest impact (inaudible) is the immediate production firms [ph] that you get for only $500,000. If you can raise the production by 100 barrels per $500, you can't beat that.

Noel Parks – Ladenburg Thalmann

Sure. And I guess, just the last thing on the Tuscaloosa Marine Shale, you were talking about – if I heard you right that you had 45-day improvement in the drill time on the second well. Is that entirely just learning curve or are the wells you said are going to uniform enough that you can get that sort of wealth, you can head down a lot of improvement in drill time from where you are now?

Ben Nivens

No, this is Ben. I think you are saying the same thing there, it is a learning curve and we do think that there is going to be continual improvements that we can take forward.

Jonny Brumley

Yes, there are things from this well that we'll probably improve from on the next well.

Noel Parks – Ladenburg Thalmann

Actually how long was the (inaudible) turns in to drill this one?

Jonny Brumley

70 days to (inaudible).

Noel Parks – Ladenburg Thalmann

Okay, great. That's all from me now.

Jonny Brumley

Thank you.

Operator

Your next question comes from the line of Pavel Molchanov with Raymond James.

Pavel Molchanov – Raymond James

Good morning guys.

Jonny Brumley

Good morning Pavel, how are you?

Pavel Molchanov – Raymond James

Alright. Couple of questions, first, when you were doing the IPO of the MLP last year, you mentioned that there were approximately 166 million barrels of potential drop down properties at the parent company level. Do you have any updated numbers on it?

Jonny Brumley

No, I think that would really be fairly close to the same just because we really haven't increased our water floods. That basically is the water floods and the company about 166 million barrels and they would all fit there. As the reserves grow along the water flood that would increase somewhat but we hadn't like acquired anything that would increase it.

Pavel Molchanov – Raymond James

Got it. And can you help quantify the pace of dropdowns that we should be thinking about, maybe on an annual basis?

Jonny Brumley

Yes, I think that $100 million dropdown or $50 million to $150 million dropdown will not be the only dropdown that you will see. I think that you could see another one in 2009. So, I am not sure, also we are currently revealing properties at the MLP to purchase and if we were to acquire property, then we would be less likely to drop down.

Pavel Molchanov – Raymond James

Then, last question about your hedging strategy, obviously you have picked up work very well given up the run up in crude. But going forward, do you think there is any value in perhaps looking at couple of quarters to reduce your hedging cost?

Jonny Brumley

Probably not because what I found that a costless collar is always increasing the hedging cost.

Pavel Molchanov – Raymond James

Okay, fair enough. Thanks very much.

Operator

Your next question comes from the line of Steve Berman with Pritchard Capital Partners.

Stephen Berman – Pritchard Capital Partners

Thanks and good morning.

Jonny Brumley

Hello Steve.

Stephen Berman – Pritchard Capital Partners

Question on the joint venture as you head into the post commitment stage now, how in any manner do you anticipate things changing, not inwardly [ph]. The image is for example is the month, the great months for your well, is that a well that you guys designed and just going forward with it what do you different if anything?

Jonny Brumley

That was the last commitment well we drilled and obviously it was a big success but I think what changes in the commitment phase is that it will be most pronounced in the Midland basin but we are having to drill these drill holes on our well which have just been tough to drill, tough to complete and they had not been coming on time. Now, we have those behind us and we can focus on drilling the (inaudible) which basically get 80% of the reserves of the dual horizontal for half the cost.

Stephen Berman – Pritchard Capital Partners

Good and Haynesville question, are you involved in any non-operated wells there, even now or in the future, anything on the horizon?

Jonny Brumley

Yes, we are involved with Haynesville well in close to Elm Grove that we – what we own in that?

Ben Nivens

45%.

Jonny Brumley

About 45% working interest.

Stephen Berman – Pritchard Capital Partners

Is that currently drilling?

Jonny Brumley

It will be soon.

Stephen Berman – Pritchard Capital Partners

Can you say which – both in Elm Grove, okay. Alight, thank you.

Operator

Your next question comes from the line of Barry Haynes [ph] with Sage Asset Management.

Barry Haynes – Sage Asset Management

Hi, good morning. I just had a follow-up question on the strategic process. You kind of walked us through that process up to the point we had five people going through (inaudible) room, I wonder if you could describe whether you actually got some bids presumably if you did, they weren't acceptable but if you give us some sense of when you did your own analysis on DCS [ph] of the company, what percent higher your own internal members were relative to any bits you may have received? Is there any color on those lines? Thank you so much.

Jonny Brumley

We are not going to get into real deep here of what happened towards the end of the process. I can tell you that our DCS analysis is much higher than whatever the share price is and whatever the share price has been. So, there is a kind of upside in this company and we are really excited about it and that's really all I am going to say about the process.

Barry Haynes – Sage Asset Management

Okay, great. That helps, thanks so much.

Operator

Your next question comes from the line of Greg Brady [ph] with JPMorgan.

Greg Brady – JPMorgan

Good morning, guys.

Jonny Brumley

Hello Greg.

Greg Brady – JPMorgan

Hi. Just want to jump back to the strategic review and focus on more on the financial risk management.

Jonny Brumley

What grade for you at the JPMorgan?

Greg Brady – JPMorgan

Title [ph] research, high yield.

Jonny Brumley

Okay.

Greg Brady – JPMorgan

I know you mentioned you are going to be hedging more and you are going to pay down debt in the interim. I was wondering if you just (inaudible) turn away as part of the strategic review, any sort of financial target long term in terms of leverage, post the pay down and then what everyone is doing (inaudible).

Jonny Brumley

No, not really. I think we have to be pretty nimble and also market sensitive. These higher prices are debt-to-EBITDA is relatively low and we still have room on the balance sheet to make an acquisition. I think that this company wears leverage really well because of its shallow declining base with 65% of our production being water flood. But I do think that cleaning up this balance sheet will do two things for us. One, it will allow us to invest more and more into the Bakken, the West Texas JV and the Haynesville. And I also think that it allows to be more opportunistic on acquisitions.

Greg Brady – JPMorgan

Okay, thank you.

Jonny Brumley

Thanks.

Operator

Your last question comes from the line of Jeff Sutton [ph] with Maiden Capital [ph].

Jeff Sutton – Maiden Capital

Good morning. My question is when you look at the Bakken acreage, I am curious what percentage of your current production can be classified as Bakken and acreage or is there something that is really going to be coming into the future?

Jonny Brumley

When you say our current production I understand when we have a lot of matters in production in North Dakota, are you talking about our current Bakken production, how much acreage comes from that, I guess I don't exactly understand your question.

Jeff Sutton – Maiden Capital

I guess you said that you guys was it 240,000 in the Bakken area and I am just sort of curious if you can break out how much of that is sort of currently producing or is most of that still undeveloped?

Jonny Brumley

The lion's share is our bit in percent (inaudible) is developed. Most of it is undeveloped.

Jeff Sutton – Maiden Capital

Great. That's it, thanks.

Jonny Brumley

Thank you.

Operator

At this time, there are no further questions. Gentlemen, do you have any closing remarks?

Jonny Brumley

Yes, I would like to wrap up the call just by saying that Encore is a strong Company, we went through this process, we realize we have a lot of upside potential, we are going to have a great budget for '09. The growth rate is going to be higher than it was in '08, excited about that. We are excited to clean up our property portfolio and put some of that money into the drill in progress and think that we have finally have a low-risk enough budget that is large enough for us to do things like that but the (inaudible) with where the Company is positioned. We like having a lot of our production floored but also have like about 80% of the upside for prices to increase so investors will get to enjoy price increases if the prices go up but (inaudible) that if the price is dropped to protect that cash flow in '09 and allow us to implement our plans. So, we are really looking forward to '09. We are working on the project now, I am excited about getting to present that to you at the end of September or in October and we are geared up and ready to go. That's it.

Operator

This concludes today's conference call. You many now disconnect.

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Source: Encore Acquisition Company Q2 2008 Earnings Call Transcript
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