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Executives

Elizabeth Wilkinson – VP of IR and Treasurer

Joe Mills – Chairman and CEO

Darin Holderness – SVP and CFO

Analysts

Darren Horowitz – Raymond James

Helen Roe [ph]

Ron Londe – Wachovia Capital Markets

David Micheler [ph]

Eagle Rock Energy Partners, L.P. (EROC) Q2 2008 Earnings Call Transcript August 6, 2008 10:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the second quarter Eagle Rock Energy Partners, L.P. earnings conference call. My name is Jasmine and I will be your operator for today. At this time all lines will be in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. If you wish to ask a question, please press star followed by one. If at any time during the call you require assistance, please press star followed by zero and the operator will be happy to assist you.

I would now like to turn the presentation over to your host for today’s call Ms. Elizabeth Wilkinson, Vice President of Investor Relations and Treasurer. You may proceed ma’am.

Elizabeth Wilkinson

Thank you, Jasmine. Good morning and thank you for joining us today for our conference call announcing Eagle Rock’s second quarter 2008 results. Joining me today are Joe Mills, our Chairman and Chief Executive Officer; Darin Holderness, Senior Vice President and Chief Financial Officer; Alfredo Garcia, Senior Vice President, Corporate Development; Chuck Boettcher, Senior Vice President, General Counsel and Secretary; Steve Hendrickson, Senior Vice President of Technical Evaluations; Joe Schimelpfening, Senior Vice President, E&P Operations and Development; and Bill Puckett, Senior Vice President, Midstream Commercial Operations.

Our remarks and answers to questions today may refer to or contain certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. In accordance to Safe Harbor provisions the Private Securities Reform Act of 1995, Eagle Rock Energy Partners has included in its SEC filings cautionary language identifying important factors but not necessarily all factors that could cause future outcomes to be materially different from those set forth in the forward-looking statements. A more complete discussion of these risks is included in our Securities filings which are publicly available on the EDGAR systems.

We issued our second quarter 2008 earnings release yesterday after market close. You may access that release through our Web site at www.eaglerockenergy.com. In addition, a replay of this call will be available today on our Web site shortly after the conclusion of this call. When we begin the Q&A, please limit your question to one follow-up and then rejoin the queue. And with that, I will turn the call over to Joe Mills for his remarks on the quarter.

Joe Mills

Thank you, Elizabeth. Good morning ladies and gentlemen, I appreciate you joining us this morning for a discussion of our second quarter 2008 results. We did publish our earnings release after the markets closed yesterday and we are continuing 2008 with another record quarter.

Adjusted EBITDA in the second quarter totaled $57.5 million which is 9% over our first quarter results and a 160% improvement as compared to our second quarter 2007 results. Distributable cash flow for the second quarter was $36.7 million after excluding some non-recurring items which represents 122% coverage of the second quarter 2008 distribution that we will pay on August 14, 2008 to all unit holders of record as of August 8. We announced last week that we will increase the distribution paid per unit to $0.41 which on an annualized basis is equivalent to a distribution rate of $1.64 per unit. This increase represents a 2.5% increase over our first quarter distribution. These results reflect the impact of the acquisitions we have made, the organic growth projects we have completed, and our commitment to improving our operational and financial effectiveness. We will now focus on some of the operational and financial highlights of our three lines of business for the quarter.

Our Midstream business contributed a solid $32.5 million to operating income for the quarter. This is up 42% as compared to the first quarter and was primarily driven by higher realized prices received for our condensate, NGLs, and equity gas as well as a 4.5% improvement in our daily gathering volumes. Our Midstream business averaged 414 MMcf of daily gathering volumes as compared to 396 MMcf/d in the first quarter. As we compare this to the second quarter of last year, we are up an impressive 229% in our operating income and daily gathering volumes are up 23%. These improvements are a reflection of the strides we have made in operational efficiencies executing on organic growth projects, the full impact of our laser acquisition that we completed in May of last year, improved commodity prices as well as improved drilling results by our key customers. Our daily gathering volumes are back in line with our first quarter 2007 averages and we are very optimistic we will see volumes grow for the second half of this year.

As we drill down to the three Midstream segment results, our East Texas/Louisiana segment enjoyed its best quarter ever. Daily gathering volumes averaged 180 MMcf/d up 10% as compared to our first quarter throughput and 37% higher as compared to last year. Operating income increased by 77% from first quarter to total $7.1 million in the second quarter. Specifically impacting these volumes and revenues are the continued drilling success of various operators in the expanding Austin Chalk play of Polk, Tyler, and Jasper counties Texas. The horizontal drilling of this expanding play is resulting in some very impressive initial production rates. We have seen wells average 20 MMcf/d to 25 MMcf/d in initial production rates and this is contributing to an average of seven to eight rigs running in this area and we are very well positioned to capture these volumes in our gathering systems and processing facility. Last year we completed the installation of our Tyler County pipeline project and we are very pleased with the results today. Last fall we did expand the capacity of this pipeline by de-bottlenecking the system to improve the throughput from 40 MMcf/d to 50 MMcf/d and we are now evaluating further expansion and de-bottlenecks to expand the capacity to approximately 65 MMcf/d. We are seeing drilling activity moving into Newton County, Texas and moving towards the Louisiana border and with the producers’ continued drilling success in this play; we will be evaluating further expansions to our capacity as well as to our Brookeland processing facility in last 2008 or early 2009. This will require organic growth capital expenditures for our East Texas/Louisiana segment.

Turning our attention now to our Texas Panhandle segment, operating income totaled $23.6 million for the quarter, up 33% as compared to first quarter. Improved commodity prices drove this increase in our revenues. The segment averaged about 150 MMcf/d of gathering volumes which is down 3% from the first quarter of 2008. This small reduction in gathered volumes is due to delays in the drilling and completion activity in the Granite Wash play and our natural decline of volumes in our West Panhandle system. We are continuing to see steady drilling results in the East Panhandle system however some of our key customers have been making acquisitions in this area and this has distracted them and delayed some of their drilling plans throughout the second quarter. We have renewed our commercial efforts in this area to attract new volumes and acreage dedications and we have seen some excellent results in July and early August. We are optimistic that we will grow our Texas Panhandle volumes before the end of 2008. We continue to focus on cost reductions and operational improvements in the Panhandle to improve our economics. We announced plans in the first quarter of this year to improve our overall cost structure in the West Panhandle system by consolidating our volumes at our Stinnett facilities located in Moore County, Texas and diverting these volumes to our underutilized Cargray facility which is located in Carson County, Texas. By doing this consolidation, we will achieve cost savings by closing the Stinnett plant as well as maximizing our capacity at Cargray. We have successfully diverted the Stinnett facility volumes in early July and we are now in the process of dismantling Stinnett and making improvements to the facility in anticipation of its move to replace our aging Arrington Plant in Hemphill County, Texas. This project will make Eagle Rock more competitive and provide us with the state-of-the-art cryogenic facility with improved recovery rates in the Granite Wash play. We are still anticipating start up of the Stinnett facility at Arrington by the end of the first quarter of 2009.

Our third Midstream segment is our South Texas segment where we did experience 8% increase in gathered volumes over the first quarter and operating income improved by 50% over the first quarter due to improved volumes and realized prices. We are starting to see increased drilling results from some of our customers and our efforts to secure new volumes is bearing fruit. We are renewing our commercial efforts here as well and we expect to see stronger results from this segment in the second half of this year. Eagle Rock is very well positioned to cash incremental gathering volumes in this area as we go into the second half of 2008 and early 2009. In summary, our Midstream business enjoyed a solid quarter but we remained focused on continuing to grow our gathered volumes organically and to reduce our overall cost structure to improve profitability.

Turning to our Upstream business, this segment produced a total of 2.7 Bcfe during the quarter and contributed $26.6 million to operating income which is up 16% as compared to the first quarter of 2008. This improvement to operating income was in spite of a reduction of produced volumes of about 4.3% as compared to the first quarter. The reduction in volumes is attributable to our previously announced scheduled turnaround of our Big Escambia Creek facility in April and a direct lightening strike that we sustained at the facility over the Memorial Day holiday weekend. The scheduled turnaround in April caused the facility to be shut down for a total of 20 days, which is what we had planned, while we made major repairs to the sulfur recovery unit as well as other needed repairs to facility to improve operational efficiencies. This turnaround cost Eagle Rock $3.5 million. The facility is running much better today and we expect to see improved run times going forward especially with our sulfur recovery unit. The facility did experience a direct lightening strike over the Memorial Day holiday and it affected some of our electronics but specifically affected the motor on one of our very large solar compressor units which are required to move gas through the plant. Due to this lightening strike, we were forced to curtail the gas, oil, NGLs and sulfur volumes for just over a two-week period while we had the motor repaired by an outside firm. The unit was repaired and put back in service on June 10 and the plant has been operating at a normalized level since that time. Absent these disruptions, we believe that the Upstream segment would have generated an additional $8 million to $9 million of adjusted EBITDA in the second quarter.

The Upstream operations continued to enjoy improved realized prices on oil, gas, NGLs and sulfur. Our sulfur revenues totaled $7.1 million for the quarter and the realized price per sulfur averaged $360 per long ton which is up 76% over the realized prices we received in the first quarter. Total sulfur produced equaled to 20,000 long tons which was down due to our BEC turnaround and curtailment in June. We are still anticipating to produce approximately 8000 to 10,000 long tons per month on a normalized basis. Today, we are receiving approximately $617 per long ton at the Tampa pricing point, that is before transportation and marketing deducts. Our sulfur product currently is not hedged and we have endeavored to identify and negotiate a long-term contract to lock-in some of the price upsides. To date we have been unable to find a suitable counterparty to hedge our commodity exposure but we continue to maintain active discussions with various parties with hopes of securing a long-term arrangement before year end. Offsetting some of the reduced volumes we experienced at Big Escambia has been the strong performance of our recently acquired Permian basin assets. We closed the Stanolind acquisition on April 30, 2008 and therefore only two months of production can be attributed to our second quarter earnings. The assets have been performing exceptionally well and we are very pleased with the addition of the Stanolind team to Eagle Rock. At the time we announced the acquisition, the average daily production from these assets equaled around 850 barrels equivalent per day and today we are averaging 880 barrels equivalent per day. During the second quarter, the Upstream segment drilled and completed six new wells; this included three successful completions in the Permian Basin assets. Production rates for the Upstream segment averaged 9.6 MMcf/d, 2028 barrels oil per day, and 1304 barrels of NGLs per day for a total of 29.6 MMcf/d. This is down by 4.4% as compared to first quarter on a daily basis but remember this is primarily attributable to the Big Escambia Creek turnaround. Currently volumes are rebounding and we are averaging approximately 35 MMcf/d from these same assets.

Finally, our Minerals business enjoyed another record quarter with total operating income for the quarter equaling $8.2 million. This compares to $3.9 million in the first quarter which is up 111%. This improvement has been driven by higher leasing activity in volumes as well as improved commodity prices during the quarter. We averaged over 3.8 MMcf/d of natural gas, 450 barrels of oil per day, and 68 barrels of NGLs per day for a total of 6.8 MMcf/d which is up 9.5% over the first quarter on a daily basis. We continue to see very strong leasing demand across our key minerals as producers ramp up exploration and drilling prospects. In particular, we are seeing a very strong leasing appetite for our minerals in many of the unconventional shale plays such as the Haynesville, Floyd and Fayetteville [ph]. This leasing activity will continue to lead the future drilling activity and hopefully drawing royalty volumes. I want to remind you that as a mineral owner, we bear no cost to drill or operate the oil and gas wells and our royalty income and lease bonuses are delivered to us cost free.

I am not going to turn the call over to Darin Holderness for further detailed comments on our financial results.

Darin Holderness

Thank you, Joe. I plan to cover various income statement line items as well as touch upon certain balance sheet line items related to our second quarter. The majority of my comparisons will be to the first quarter of 2008 which was also provided in our press release as a reference.

As Joe mentioned, we had a solid second quarter reporting another strong adjusted EBITDA results in an outlet that allowed us to increase our distribution to $0.41 per unit for the quarter or $1.64 per unit annualized. Before I begin to cover our income statement line items and various elements of our corporate segment, let me remind you of our accounting treatment for open or unsettled derivative instruments. We use derivatives to hedge or protect a significant portion of our expected commodity price or interest rate exposure for future periods which helps us ensure minimum distribution levels. To emphasize, we do not enter into derivatives for purposes of speculation on commodity prices or interest rates and we anticipate having based on our current forecast the physical volumes and debt outstanding to support our outstanding commodity and interest rate derivatives. For accounting purposes, we use mark-to-market accounting as opposed to hedge accounting. The open or unsettled derivatives are mark-to-market based on current value at the end of each reporting period. This process results in a non-cash unrealized gain or loss that impacts our reported net income in the revenues and the interest expense sections of our income statement. This value change has no cash impact as derivatives are still open or unsettled; accordingly the unrealized non-cash mark-to-market gain or loss reported each period is added back in our calculation of adjusted EBITDA.

For the quarter, our total revenues of $186.3 million includes an unrealized mark-to-market loss of $256.3 million for open commodity related derivates. In the interest expense section, we recorded a $13.7 million of unrealized mark-to-market gains related to our open interest rate swaps. Overall, our unrealized non-cash mark-to-market derivative position had a net $242.6 million unfavorable impact on our reported net loss of $227 million for the quarter. Excluding the net, unrealized non-cash mark-to-market loss, we would have generated net income of over $10 million for the quarter. As a reference point, at July 31 commodity prices and interest rates we would have an unrealized mark-to-market gain for the month of July of over $120 million. As Joe mentioned earlier, our adjusted EBITDA for the quarter of $57.5 million is slightly up from $52.8 million reported in the first quarter of 2008. And as Joe mentioned adjusted EBITDA for the second quarter would have been $8 million to $9 million higher if it were not for the scheduled turnaround and lightening strike at the Big Escambia Creek facility. The increase in our operating expenses for the quarter is primarily the result of the scheduled turnaround and repairs from the lightening strike at the Big Escambia Creek facility, increases in severance taxes, and increase in cost affected by increased commodity prices and the contribution of two months of operating cost from our Stanolind acquisition.

General and administrative expenses of $10 million for the second quarter of 2008 were down in comparison with the $11.2 million for the first quarter of 2008. The decrease primarily relates to what we estimate as non-recurring components of audit, Sarbanes-Oxley, tax preparation and unit registration expenses incurred in the first quarter of 2008. General and administrative expenses include a non-cash component of our Long Term Incentive Plan compensation expense, which for the second quarter of 2008 was $1.5 million and for the first quarter $1.2 million. Going forward, with the addition of the Stanolind acquisition and our current staffing plans, we estimate that our quarterly general and administrative expenses run rate excluding the non-cash effect of Long Term Incentive Plan to be approximately $10 million.

In the second quarter 2008, we recorded a $6.2 million bad debt reserve against our receivables associated with the bankruptcy of SemGroup and certain of its subsidiaries. We consider this bad debt charge to be a non-recurring item and accordingly we have excluded it from our adjusted EBITDA calculation. During July, we sold additional condensate to SemGroup in the range of $5 million to $6 million which we currently plan to take as a bad debt charge in the third quarter. We have stopped all sales of condensate to SemGroup as of August 1 and we are evaluating our plans to collect the amounts we are owed from SemGroup.

Depreciation, depletion and amortization expense for the second quarter of 2008 had a modest increase to that of the first quarter. The increase is primarily the result of the Stanolind acquisition. Interest expense excluding the unrealized non-cash mark-to-market activity on our future period interest rate swaps decreased as a result of lower LIBOR rates during the quarter which favorably impacted the unhedged portion of our outstanding debt which was offset by additional interest expense associated with the borrowings incurred to finance the Stanolind acquisition. Debt outstanding at the end of the quarter was $623 million up $66 million from the first quarter of 2008. During the second quarter of 2008, we borrowed $76 million to finance the Stanolind acquisition which closed on April 30. In July, we partially exercised the accordion feature under our revolving credit facility which increased our aggregate commitments by $100 million bringing our total commitments to $900 million. Also there were no changes in the pricing and terms of the revolving credit facility resulting from the partial exercise of the accordion. The exercise of the according is to provide additional financial resources as part of our growth strategy. Currently we have $277 million of remaining borrowing capacity under our revolving credit facility.

Capital expenditures for the quarter were approximately $21.1 million excluding the Stanolind acquisition cost. Of this amount, $9.9 million was for growth capital of which $8 million related to our Midstream business and $1.9 million related to our Upstream Stanolind assets, and $11.2 million for maintenance capital expenditures of which $8.3 million related to our Upstream business. Growth capital primarily included our previously announced Stinnett, Arrington consolidation project, the Jasper County pipeline in East Texas and other plant expansions and modifications. Maintenance capital was mostly incurred in our Upstream business with the scheduled turnaround at the Big Escambia Creek facility, an increase in our well recompletions and workovers including those on the Stanolind assets, capitalized maintenance related to our Midstream assets and an increase in routine well connections.

With this I now turn the call back to Joe for further comments and Q&A.

Joe Mills

Good, thank you Darin. Okay, I would like to spend a few more minutes now just discussing Eagle Rock’s organic growth and acquisition focus for the balance of 2008. First organic growth, we continued to emphasize adding value to our partnership in the distributions group by executing on immediately accretive, organic growth projects inside our Midstream and Upstream businesses. In our East Texas segment, I mentioned earlier our growth there we have recently completed the installation of a new 16.5 mile ten-inch pipeline from our Brookeland system to gather new and growing Austin Chalk volumes from a key customer in Jasper County, Texas. We recently hooked up several wells on acreage dedicated to us on a life of lease contract on very favorable commercial terms at initial rates of 15 MMcf/d to 25 MMcf/d and we expect to hook up several more of these wells in the second half of 2008 that could deliver similar volumes. These wells are very prolific and the producers have indicated to us they intend to keep several rigs running in this immediate area for the balance of 2008. Based on these results in the producers’ drilling plants, we are evaluating laying additional gathering lines to gather their gas as well as the possibility of expanding our Brookeland plant in late 2008, early 2009 if this play continues to extend to the East back towards Louisiana border. We would anticipate spending between $15 million to $25 million of organic growth capital to expand our gathering systems and potentially add 25 MMcf/d of incremental processing capacity at our Brookeland facility. The producer is planning to drill a key well in Newton County, Texas and if successful, the scope of this play will be very large and Eagle Rock is very well positioned to capture the growing volumes.

With regard to Louisiana, in the continued leasing and drilling activity in the Haynesville play in (inaudible) Louisiana Eagle Rock currently owns and operates 58 miles of gathering and compression facilities in the area and today we gather approximately 15 MMcf/d from Goodrich Petroleum company in the Belle Bower and (inaudible) fields. We are valuating laying a large gathering line to support the drilling effort of some of the producers to gather growing Haynesville volumes. We are in discussions with several of the large active leasehold owners in this exciting play and Eagle Rock intends to be a gatherer in the Haynesville play of Louisiana or East Texas. We will keep you advised of further progress and announcements in this regard.

Now turning to our Upstream business, we are very focused on growing our volumes organically by drilling low-risk, proved undeveloped locations on our recently acquired Permian Basis assets. We are very excited about this acquisition and early results have been very encouraging. We have drilled and completed three successful wells and are currently drilling or completing three additional low-risk, proved undeveloped locations. Production is up 3.5% since we closed on the acquisition on April 30. We have identified numerous recompletion and drilling opportunities and we have the flexibility to grow our volumes organically and we intend to continue to grow the volumes. Our current expectation is to spend $3 million in organic growth projects in the second half of this year and exit 2008 producing 900 to 950 barrels equivalent per day. With this acquisition we are now positioned to continue to grow by the drill bit or by acquisitions in the Permian Basin of Texas. Speaking of acquisitions, we remain committed to growing our asset base through accretive assets. Today we continue to see some quality acquisition opportunities. Our focus is to remain opportunistic in the acquisition arena and look for accretive Midstream, Upstream and Mineral targets. Our near term focus has been on the Midstream space as we continue to see some excellent opportunities. Eagle Rock remains aggressive in the acquisition arena and we still anticipate spending another $100 million to $250 million in acquisition capital in 2008 for acquisitions which we could finance from our existing revolver credit facility.

As Darin mentioned a few minutes ago, we recently announced that we exercised a portion of our coding feature under our credit facility and expanded our facility by $100 million bringing the total size of the facility from 800 to 900 million of commitments. This provides Eagle Rock today with $277 million of available capacity under our revolver to draw from in the event we are successful in finding a very accretive acquisition. We still have the ability to further upsize our facility by another $100 million when the need arises. We continue to actively evaluate all sources of capital including equity and debt to provide us further liquidity for both our organic growth as well as our acquisition opportunities.

In summary, the second quarter of 2008 marked another record financial quarter for Eagle Rock. I want to thank the many employees of Eagle Rock who worked very hard every day to position us for growth and success into the future. Eagle Rock is very well positioned today and we will continue to execute on our growth strategy and deliver growing distributions to our unit holders.

With that we are prepared to open it up for questions and answers.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Darren Horowitz. You may proceed.

Darren Horowitz – Raymond James

Good morning Joe.

Joe Mills

Hi there.

Darren Horowitz – Raymond James

I just wanted to ask a quick question on that point that you just got off when you were discussing inorganic growth opportunities and you said that your focus obviously is going to be opportunistic but you are really trying to key in on any Midstream opportunities, can you give us a little bit more insight as to acquisition multiples out there in the marketplace today and synergistically where you think further Midstream enhancement makes more sense for you?

Joe Miller

Absolutely. I guess, first off, everybody recalls last year we were very aggressive in the Upstream space because the opportunities were there. I want to make it clear to everybody it is not that we were not looking for Midstream acquisition last year, quite frankly we bid on a number of opportunities but we are very disciplined in our approach to acquisitions and I believe very strongly and not overpaying for any acquisition. Last year, we saw a lot of the Midstream assets traded, it is a pretty exorbitant multiples 12, 14, 16, 19 times current or forward EBITDA multiples. As I have said before, if you look at all the acquisitions Eagle Rock has made since May of last year, all in we have paid 5.2 times EBITDA for all the acquisitions that we have made. So, to our hybrid strategy, we are opportunistic, the opportunities were in the E&P space last year. This year we are seeing some really tremendous opportunities in the Midstream space. The sellers’ expectations and the buyers’ realities are finally starting to come back together mainly due to the credit squeeze. Clearly, sellers’ expectations were fairly high given the robust multiples that were paid last year; buyers’ reality is of course grounded in our cost of capital structures and in the capital markets’ squeeze. So, today though we are seeing some really quality opportunities in that $100 million, $200 million zip code that are highly accretive and we think we will see acquisition multiples in the eight to ten times EBITDA range which is much more in line with historical averages. Last year was obviously a feeding frenzy and we are starting to see a much more normalized return to normal M&A type multiples for the Midstream space. In so far as focus, we continue to stay focused in our core areas being the Panhandle, East Texas, and the Permian Basis. Those are the three areas we know, we currently have assets, we want these acquisitions to be accretive, but more importantly to be synergistic to our current asset base. So, we remain focused on those three areas for any acquisition growth.

Darren Horowitz – Raymond James

Thanks Joe, I appreciate the color. Switching gears over to a lot of the organic initiatives that you outlined, when you look at the East Texas/Louisiana segments and a couple of other segments and you talked about that de-bottlenecking initiatives in (inaudible) county in the hopes to expand that capacity to around 65,000 a day, can you just give us a sense for the type of internal rates return in a lot of those organic initiatives aside from just the EBITDA multiple but on a percentage basis, the internal rates return that you can facilitate those up?

Joe Miller

Absolutely. You know the good news for us, the de-bottlenecks are typically fairly inexpensive. We are probably going to be looking at spending anywhere between $1.5 million to $3 million to de-bottleneck our system, that does include laying some additional looping lines so that we can bypass some small lines to improve the capacity. Obviously the rates of return on that are 100% plus, very accretive type projects. We are focused on it right now; clearly we want to continue to see volume growth by our producers. The chalk play, we all remember the chalk of the early 90s, this is a different chalk, this is a deeper, higher pressure chalk, of course the cost of these wells is quite high, it is costing the producers anywhere – on a good day it is probably $10 million to $12 million, on a bad day it could be $14 million to $18 million. These are dual horizontal wells, they drill them down to 14,000 feet to 15,000 feet before they kick off and they are drilling dual laterals, so they are doing one up dip and one down dip, anywhere between 4000 and 8000 feet. So these are a lot of hole, they are expensive, clearly with today’s commodity price environment, the producers are very aggressive. If commodity prices were to turn, obviously we probably would see some slowdown here. So, we are being cautious in terms of our expansions because we want to make sure that we are not over running our producers but in terms of rate of return these are 100% rate of return type projects. I mentioned the $15 million to $25 million of capital that we could anticipate spending, a lot of that is significantly weighted towards the expansion of our Brookeland facility. We have several options there that we are looking at to enhance the range between $15 million and $25 million.

Darren Horowitz – Raymond James

I appreciate it Joe, thanks.

Joe Miller

You bet.

Operator

(Operator instructions) your next question comes from the line of Helen Roe [ph], you may proceed.

Helen Roe

I just had a question about your maintenance CapEx expectation for the year; I think for the quarter it was a little bit higher than expected but if you could just share your expectations for the year?

Joe Miller

Sure. Thank you Helen. Yes, the maintenance CapEx was a little higher in the second quarter and that was all, as Darin mentioned, attributable to our turnaround at the Big Escambia Creek facility. Our expectations though are still that our maintenance CapEx will be in line with what we have said before which is about $27 million for the year. The breakout is still $12 million to $13 million for our Midstream business and around $14 million to $15 million for our Upstream business. So, as you recall, when we bought Redman and EAC, we have projected at that time $11 million or $12 million of maintenance CapEx for those assets and then another $1.5 million to $2 million for our Stanolind assets. So we are pretty much in line there. Clearly we have seen some cost increases across the board from our suppliers as commodity prices have gone up, we are starting to see some of that obviously impacting some of our cost structure. We are doing everything we can to mitigate that. Clearly our size gives us some economy of scale but notwithstanding that it is hard to negotiate too hard with all these suppliers. They have needs too; they got to pass along some of their cost increases. So, in summary, our maintenance CapEx was higher in the second quarter you will see it would come back to normalized levels, if you go back to the first quarter we actually were under in the first quarter relative to what our expectations were. So, second quarter really was more of a catch up than anything else but also largely impacted by our BEC turnaround.

Helen Roe

Okay great, thank you. Also one more question on your Upstream data, I notice the realized price on your oil and condensate was down sequentially 114 for this quarter versus 118 previous quarter, I was just wondering given the commodity price run up in the second quarter what was driving the sequential decline on your realized price?

Joe Miller

Yes, I am hesitating to answer it, but there should not have been one, absent your call when we reported first quarter earnings, we incorrectly have been carrying our sulfur revenues in there. Then you may recall, we issued a subsequent release that then showed the normalized price after you take out sulfur and so if you are comparing and hopefully you comparing it to the – I don’t have it in front of me but I can certainly get you an answer on that, but it should be sequentially up rather than down. I will double-check that.

Helen Roe

Okay, I think that makes sense. Alright, thank you.

Joe Miller

Thank you Helen.

Operator

Your next question comes from the line of Ron Londe, you may proceed.

Ron Londe – Wachovia Capital Markets

Thanks. Just curious on the lightening strike, do you have any insurance that covers any of the disruption?

Joe Miller

Great question Ron, good morning. We do, we carry business interruption insurance but we have a 30-day deductible and in this particular case, it went on for just a little over two weeks, it was about a 18-day curtailment and so unfortunately it did not impact our business interruption. Now clearly we carry large property and casualty insurance policies for our facilities but in this particular case, the fact that it affected in particular that one motor, while the financial impact i.e. the cost was not – it didn’t reach our deductibles, the impact in terms of lost revenues certainly was meaningful but unfortunately our BI only comes into play after 30 days and in this case it did not meet that deductible trigger.

Ron Londe – Wachovia Capital Markets

You talked about drilling the Permian, could you go through and maybe talk about your different areas and what kind of price you need for drilling to remain economic for you to go out and develop some of these properties?

Joe Miller

Sure, let’s start with the Permian because that is clearly where our focus to drill is currently, that is our inventory is of low-risk opportunities, we have a very favorable cost structure in the Permian Basin. We are drilling and if you recall when we announced Stanolind acquisition, we have about 35 proved undeveloped locations plus numerous recompletion opportunities, this is a very prolific area primarily the (inaudible) field where you have multi pay potential, we are really targeting separately the shallow and the deep, the deep being the Pennsylvania and Wolf camp which is primarily gas versus the shallow which is the (inaudible) which is primarily oil. Our cost structure on a F&D basis, our finding and development cost is very attractive; it’s $10.50 per BOE to drill the deep zones. So, again, on a Mcfe basis about $1.75 as compared to the shallow which is running us about $4.50 per BOE so again about $0.75 per Mcfe to drill these wells. When you add in obviously our operating costs which ran a little high this quarter mainly because of the BEC LOEs and the reduced production, in the Permian, we need on a Mcfe basis, we need around $5 to $6 probably $5 per Mcfe to make the economics work after you include taxes, and G&A coverage and rate of return. So, at these prices we are extremely economical, we will continue to drill aggressively. As you look at our other assets, of course our biggest can be Creek field, we continue to work on our unitization efforts there and so we really have no other drilling plans until the unitization occurs. We do receive a premium there since that product goes right into the floor to market. It is deeper, more expensive these wells to drill, to the smack over, it is sour production. We also have a very, very high severance tax that we paid at the State of Alabama which clearly affects our economics. So, there I would say we probably need closer to $6 to $7 – $6 to continue to drill our production there. In our East Texas area of course which is high sulfur, it is about 50% H2S in our reserves we have done a lot of recompletions there. We are looking at doing some additional drilling because of the sulfur component. As long as sulfur prices stay where they are, we can economically justify additional drilling of these type of wells where you are recovering about 50% H2S out of the well stream, same answer, you are going to need around $6 to make those numbers work going forward. Does that help you Ron.

Ron Londe – Wachovia Capital Markets

Yes, that’s great, that’s good. Also you talk about sulfur, to go back, do you use sulfur as kind of a tail that is going to wag the dog here for a couple of quarters until you can plan a way of firming up some long-term contracts?

Joe Miller

I don’t know about the tail wagging the dog but I will say that it is a byproduct that we are happy to have. I can tell you that each of us around this room have become sulfur experts as we have studied sulfur markets around the world. Sulfur is of course a global commodity. We have spent a lot of time trying to identify counterparties to hedge. Sulfur of course has been in the press a lot lately thanks to fertilizer, the increases in fertilizer prices. In the near term, near term being the next 12 to 24 months, we believe that sulfur prices will continue to stay very robust, $400 to $500 plus per long ton. Now, there is excess sulfur around the world and of course as the Middle East in particular brings on more their high sulfur oil production, we will continue to see more and more sulfur supply generated over time. So, we think long term you will see sulfur prices return back to more historical levels. I don’t believe that you will ever see it return back to $40 per long ton which is where it was when we bought these assets exactly one year ago. $100, $200 a long ton, that is probably more in line with what the supply demand characteristics will look like. At that we can still make a very sizeable return on our sulfur production. Little Eagle Rock today generates about 2% of the nation’s supply of very high quality molten sulfur, very pure, 99.5% purity, so we are at a very favorable position and again we are looking at probably doing a long-term contract that will lock in some of these higher prices so that we can look to pass a few in our distributions, have comfort, it is there as a long-term source of revenues.

Ron Londe – Wachovia Capital Markets

Okay, thank you very much.

Operator

Your next question comes from the line of David Micheler [ph] you may proceed.

David Micheler

Hi Joe. In a difficult MLP marketplace, very difficult marketplace, you are uniquely unappreciated or under-appreciated and misunderstood I think as a hybrid company, a company that has high sensitivity, many think of you as a non-growth MLP and you and I and others know differently of course, but I guess the transition that I see taking place in your company, as the Mineral business grows, as you take your Midstream business from a non-growth Midstream business that it used to be to one that really does have some great growth prospects, I am wondering how you are going to express that to Wall Street, how are you going to let people know that you have a good internally generated growth prospects as anyone out there, as most out there and maybe more than most, take your 11% yield which arguably is much too high and get people to appreciate that you are a growth company, so I want to give you the opportunity to tell us a little bit more about what might come out of Haynesville? What sort of Midstream growth prospects you have? Can you grow that business at 10% a year? What are the probabilities of locking in some higher sulfur prices? Is that 50% or more probability a reasonable level such that you will have sustainable earnings there? Can you give us some guidance along those lines?

Joe Miller

Listen, I definitely appreciate your comments. Every day I wake up and wonder if I am loved or not, you are so correct though, the company is so well positioned, has some tremendous upside potential in it. Clearly we spend a lot of time here inside the company trying to communicate that message and obviously it has been lost a little bit in the shuffle. There is no doubt that with the melt down in the MLP space in the equity markets that we have been dragged down along with everybody else, and that message is probably been lost on a lot of people, it is all about the yield and we understand that. One of the things I have said to my team repeatedly is execute on the business plan. At the end of the day, if we continue to hit our numbers and continue to show you improving results, increasing distribution growth we believe that in time Wall Street and the market will take care of itself. Having said that, my frustration level is quite high, I assure you. I do spend a fair amount of time on the road talking to equity as well as institutions. We are going to step up those efforts. You will see us, in particular me, a lot more on the road, at conferences, telling our story and really preaching the message. In so far as your question about probabilities, I think I could say with certainty to you that those probabilities are very high that we will execute on a number of initiatives that we have just talked about. East Texas segment in particular I am very, very excited about. That is an area that I have talked about on many a calls, I know that area well, I have spent a bulk of my career in East Texas, North Louisiana, I know these assets, I know these people, I know the players, I know the producers, I know the geology, so it is an area that I intend to grow Eagle Rock as we go forward both through acquisitions as well as organically. That is not to say that we don’t like the others. I love the Permian, I lived in Midland, that is why we made the Stanolind acquisition, we very much like the Panhandle, very long-life assets. I intend to grow those assets organically or through acquisitions. So, we are going to say focused though in the areas that we are in and we are fortunate that we are in three of the biggest, longest life producing basins in the United States, East Texas, North Louisiana, the Texas Panhandle and the Permian Basin, it does not get much better than that. South Texas of course continues to be an area that I want to increase our footprint; you will not see us going to South Texas as an E&P operator because it just does not fit the profile for an E&P MLP. So we will stay away from that as an E&P company. But sulfur, that is something that my frustration has been high there. We thought we were close to a contract with somebody, I think we still have an opportunity to lock in a very high price, it won’t be $600 but something higher than what we received historically for at least 12 to 24-month period which will then give me comfort on distribution growth. That is a little bit of manna from heaven because as you know I have said before the sulfur is a byproduct of our E&P operations. We bear no additional LOE expense to generate that sulfur. So every dollar of revenue that we receive from the sulfur draws right down to the adjusted EBITDA line. So clearly we are focusing on maintaining our E&P production not only for oil and gas but the sulfur as well. We have some very good contracts today but again they are fairly short term and so we are endeavoring to try and secure a longer term agreement to lock in some of the price upside on sulfur and therefore deliver higher distributions to our unit holders. I think ultimately this company’s value proposition will be recognized in the market as we continue. This makes our fourth quarter now continued stable and growing distributions and I assure you my plan is to continue do that quarter after quarter going forward.

David Micheler

I heard you say ultimately and I agree there, I guess I would like it to be sooner than ultimately, I go back to your 122% coverage ratio that you pointed to excluding $8 million or $9 million hit which would have added a nice bit of coverage there and then as one plays with the higher sulfur prices and plays with some of the growth that you have identified separately, the numbers look pretty good going forward over the subsequent several quarters and I guess I am wondering why the distribution increase might not have been a little bit higher or you already have such a high yield you are going to say what is the point and we will just retain the cash?

Joe Miller

Let me say that lots of those discussions clearly were held with our board of directors. As you know, we only had two months of Stanolind performance in our second quarter. We debated a great length in terms of increasing the distribution further and that is why I said last night, as we get into the third quarter I feel very confident that notwithstanding an acquisition we still will be looking to increase our distribution growth in the third quarter and beyond. Our focus has really been to continue to show steady and improving and continued distribution growth quarter in and quarter out. I think that is more important for the market to see and understand that this company is not going to be start and stop that we have a very steady upward trajectory on our growth profile and we will continue to execute on our business plan. So, I hope that gives you comfort, not trying to be cautious but I assure you that, notwithstanding the non-recurring items and of course SemGroup’s implosion certainly has splattered all over everybody, we want to be methodical, we want to be deliberate in our distribution growth strategy. As you saw, we have delivered 13% distribution growth since the second quarter of last year, on an annualized basis 13%; I would say that measures up pretty well against any of our competitors.

David Micheler

Okay, thanks Joe.

Joe Miller

You bet.

Operator

(Operator instructions) There are no further questions at this time; I would like to turn the call back to Mr. Joe Mills for closing remarks.

Joe Miller

Great, thank you. Listen, I wanted to first thank everybody for taking time out. I know this is a busy day for many of you with earnings calls with our competitors. We are trying to get the up sooner, I know tomorrow is going to be a full day with a lot of other calls but I think it is important and for a lot of reasons I just talked about, the company is very strong today, we continue to be laser beam focused on our organic growth as well as our acquisition growth. We are a growth oriented master limited partnership and I assure you we will maintain that focus going forward. Our Midstream business has done very well, I am very pleased with it, our Upstream business is performing exceptionally well, I think with the BEC turnaround now behind us, you will start to see a much more normalized run rate in our Upstream business and I am very excited about it. Our Mineral business has just been, really quite frankly, our best performing business. I am honestly very proud of it since I brought that to Eagle Rock a year ago and it just continues to outperform our expectations. So, with that I want to thank each of you for your time and attention this morning and look forward to talking to you in the next quarter with more results. Thank you very much.

Operator

Thank you for attending today’s conference. This concludes the presentation. You may now disconnect.

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Source: Eagle Rock Energy Partners, L.P. Q2 2008 Earnings Call Transcript
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