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Executives

Scott Sheffield - Chairman & CEO

Rich Dealy - EVP & CFO

Frank Hopkins - SVP, IR

Analysts

Kevin Smith - Raymond James

Ipsit Mohanty - Bank of America Merrill Lynch

John Razzano - RBC Capital Markets

Bernard Dolman - Private Investor

Pioneer Southwest Energy Partners L.P. (PSE) Q3 2012 Earnings Call November 1, 2012 12:00 PM ET

Operator

Welcome to Pioneer Southwest Energy's Third Quarter Conference Call. Joining us today will be Scott Sheffield, Chairman and Chief Executive Officer; Rich Dealy, Executive Vice President and Chief Financial Officer; and Frank Hopkins, Senior Vice President of Investor Relations.

Pioneer Southwest has prepared PowerPoint slides to supplement their comments today. These slides can be accessed over the Internet at www.pioneersouthwest.com. Again, the Internet site to access the slides related to today's call is www.pioneersouthwest.com. At the website select Investors then select Investors Presentations. This call is being reported. A replay of the call will be archived on the Internet site through November 26th.

The partnership's comments today will include forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements and the business prospects of Pioneer Southwest are subject to a number of risks and uncertainties that may cause actual results in future periods to differ materially from the forward-looking statements. These risks and uncertainties are described in Pioneer Southwest's news release on Page 2 of the slide presentation and in Pioneer Southwest's public filings made with the Securities and Exchange Commission.

At this time, for opening remarks, I would like to turn the call over to Pioneer Southwest's, Senior Vice President of Investor Relations, Frank Hopkins. Please go ahead sir.

Frank Hopkins

Good day everyone, and thank you for joining us. I want to first give a shout out to all of our friends on the East Coast and especially those in the New York City area, please continue to be safe and we hope you're all able to recover quickly from the devastating storm that impacted your area earlier this week.

Now let me briefly review the agenda for today's call. Scott will be the first speaker. He will review the financial and operating highlights for the third quarter of 2012. He will then update you on PSE's drilling program in the Spraberry field and our recent acquisition made by the partnership. Rich will then cover the third quarter financials in more detail and provide earnings guidance for the fourth quarter. After that, we'll open up the call for your questions.

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

Scott Sheffield

Thanks Frank. Highlights on slide number 3. PSE had third quarter adjusted income of $17 million or $0.47 per unit. This does exclude unrealized mark-to-market derivative losses of $11 million after tax or $0.32 per common unit.

We reported third production averaged about almost 7700 barrels oil equivalent per day, up 8% versus second quarter. We benefited from 215 barrels a day from partial NGL, natural gas liquid inventory drawdown at Mont Belvieu, offset by a production loss of 450 barrels a day equivalent due to our continuing third-party fractionations capacity constraints at Mont Belvieu. We do have remaining NGL inventory about 8400 barrels expected to be drawdown in the fourth quarter, but that could be offset by line fill requirements for a new Loan Star natural gas line, liquids line in fourth quarter.

We do have Ethane rejection going on at Midkiff/Benedum related to third-party NGL fractionation capacity constraints at Mont Belvieu resolved in early fourth quarter, and also Spraberry gas processing facilities are nearing capacity in the fourth quarter due to greater than anticipated industry production growth both from us and other third-party.

To solve that they just have a major expansion that will be on late March/early April of a $100 million a day, a second $100 million a day will come on about the summer time, and then we are in the process of building another $200 million a day to come on in 2014.

Going to Slide number 4. We did complete, we have six new wells, four wells recompleted were placed on production in the third quarter, total of 29 wells and four recompletions year-to-date. Six additional wells are waiting completion at the end of third quarter. We continue to see tremendous results in benefit from going deeper to Wolfcamp, Strawn and Atoka intervals.

We expect to generate full year production growth about 8% compared to '11. Cash flow from operations at $25 million, and distribution of $0.52 per unit for the third quarter payable on November 9th to unitholders of record on November 2nd, equates to $2.08 per common unit on annualized basis.

We did have a important acquisition and we purchased 94% working interest in 3,000 gross acres in Midland County for $6.3 million, includes all deep rights, Spraberry, Dean, Wolfcamp, Strawn, and Atoka. The sector is up for 75 40-acre vertical locations, 75 20-acre vertical locations. We do have horizontal Wolfcamp Shale potential, where PHD is drawing fairly close to this existing acreage and a couple of wells that will announce sometime in the month of February in 2013 for our results. That could setup obviously several horizontal Wolfcamp Shale locations inside PSE. We expect to move two PSE rigs to this acreage during the fourth quarter.

In Slide number 5, on 2012 drilling program. We expect to drill, recomplete 50 wells with 3-rig programs. We spent about a $110 million to $120 million at capital including facilities, 85% of the acreage position has Strawn potential, and since, the older wells drilling in 2012, will be drilled to the Strawn, and we're adding 30,000 barrels of oil equivalent to the EUR estimated ultimate recovery. 35% of the 2012 wells are expected to be drilled to the deeper Atoka interval, where we're adding 50,000 to 70,000 barrels of oil equivalent, and 70% of the acreage has Atoka potential in PSE. We have four 20-acre down spaced wells on production. Results to-date are very similar to our type curve for a Lower Wolfcamp well, EUR of 140,000 barrels of oil equivalent. We have current inventory of 155 on remaining 40 acres and almost 1300, 20-acre locations.

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

Rich Dealy

Thanks Scott. See on Slide 6. Net income for the quarter was $6 million or $0.15 per common unit as Scott mentioned. It includes unrealized mark-to-market derivative losses of $11 million or $0.32. So adjusting for that adjusted income was then $17 million or $0.47 per unit.

Looking at the box in middle of Slide 6 there, we compare our guidance relative to results, and Scott talked about production. So I'll move past that. On production cost couple of reasons why we're higher than the guidance range. One, we had a saltwater disposal that was hit by lightening during the quarter that caused us to increase our water hauling out there and pay for third-party disposal, that has since been fixed. We've also added a new disposal facility out there to help with the water constrains just given the activity level in the area. So that should help us in moving to the fourth quarter deadline to first quarter next year reduce the hauling cost. In addition, during the quarter gas prices, which are used in the electricity generation out there were up 30%, so we had higher power cost related to that, had some increased repair and maintenance during the quarter. And then, also as Scott mentioned, we lost the production about 450 BoEs per day. And so, on a per BOE basis that had the impact of raising that cost level.

The other items are consistent with our guidance ranges. So I'm not going to spend any time on those here.

As you turn to Slide 7, looking at fourth quarter guidance production, because of the slower ethane recoveries, as we filled the plants in West Texas our guidance range is 7,400 to 7,900 for the quarter. Production cost do reflect some of those costs carrying into the fourth quarter, as we fixed for the lightning strikes and energy costs of $22.50 to $26.50. And then, the other items are consistent with actual results in prior guidance for the most part.

If you turn to slide eight. Plenty of capacity into our credit facility is about $212 million of unused capacity there. On the derivative side, we have added some 2014 gas hedges since the last time we talked. You can see our 80% covered for the fourth quarter, 65% for 2013, 70% for '14 and then, a little bit in 2015. Continue look to add to more gas position in 2013 and oil positions for 2015.

So, at that line I stop there and we will open up follow-up questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Our first question is from Kevin Smith with Raymond James.

Kevin Smith - Raymond James

On the operating cost I appreciate the color there, but it seems like that that should be trending lower, right, both on a real basis and a BoE basis? Is that some, we should see kind of normalize maybe in the second and third quarters in next year, or how should I think about that?

Rich Dealy

Yeah, I think that is right. And I think minor items that hit this quarter in as capacity constraints go way that -- those will come back down to normalized levels.

Kevin Smith - Raymond James

And do you have any sort of clue or any sort of number you are comfortable with on what normalize level is you would expect to --

Rich Dealy

Yeah. Our previous guidance, I think it was 2050 and 2350 I think, it is going to be back in that range.

Kevin Smith - Raymond James

And then, I have got one question on your production outlook. As I think about it you said the 450 BoE a day came back online in early October, correct, from I guess to process in capacity?

Scott Sheffield

It did. Now that these capacity constrains have been fixed, so that back on as we mentioned that we will because the processing facilities in West Texas are getting full or nearing capacity. As we continue to see growth in the basin, we can probably put more gas to those facilities but our recoveries of ethane is going to go down and so, we would expect to be in back at 100 to 200 BoEs per day in the fourth day because of that.

Kevin Smith - Raymond James

Okay. So, that helps clarify why you wouldn't be seeing the incremental 450 on top of third quarters.

Scott Sheffield

Exactly.

Kevin Smith - Raymond James

And then lastly, on your acquisition, I was kind of surprised by how quickly you are moving rigs there. Is there any read through on that, as far as moving? Sorry, go ahead.

Scott Sheffield

Yeah, the answer is we have been working on it for a while this took longer to get closed than we thought, so we have been getting prepped to be in a position to do that, so we will probably have one rig there late November, early December and the second one the second half of December.

Kevin Smith - Raymond James

Okay. And then what's your redrill for next few months or next few quarters, I mean, you plan on keeping two rigs there for a good while?

Scott Sheffield

You know we're going to access 2013 capital budget as see what commodity prices are in December, early next year, so and it will come out with a capital budget after the first year as we get a better feel where commodity prices are going to be.

Operator

Our next question comes from Ipsit Mohanty with Bank of America Merrill Lynch.

Ipsit Mohanty - Bank of America Merrill Lynch

Quick question just overall following up on the PXD call, as we go more into oil and to drilling and there is a potential for drop-down on some other vertical asset, matured assets into, how does the readthrough look like for 2013 and beyond?

Rich Dealy

I think right now we're focused on the inventory growing locations that we have, as we've added to that. Now have 155, 40-acre locations, and, as Scott mentioned, about 1300, 20-acre locations. So that's really going to be our focus in terms of drilling what inventory we have versus drop-downs from PXD.

Ipsit Mohanty - Bank of America Merrill Lynch

So there would the outlook be sort of if at all there is an appetite for acquisition, you would probably go out into the market and compete rather than getting the drop-downs, I mean how does that sort of fit into your strategy?

Rich Dealy

Yeah, I think longer-term that the drop-down is still a potential. But I think in the short-term either acquisitions like we did here this quarter or focusing our drilling inventory is going to have better economics in the acquisition market today.

Ipsit Mohanty - Bank of America Merrill Lynch

And just an overall question on where you're at in Permian, with the play tremendous amount of drilling activity happening there. Are you seeing any kind of so this cost inflation again going into the end of the year and beyond do you see that increasing your overall cost?

Rich Dealy

Yeah, we've seen some this year, may be has not been tremendous because we've a lot of those services; PXD provides to PSE that are internal because we're vertically integrated. But there has been some we're just now going out for bids to look at the 2013 cost. So we'll see where those come in as we move into next year.

Operator

(Operator Instructions) And our next question comes from John Razzano with RBC Capital Markets.

John Razzano - RBC Capital Markets

Is there anything to be read into in terms of the size of the acquisition and you kind of what's draw the base for any, seems to have planned additional inventory remaining in the certainly now '13. Just wondering if there is anything that drove you to need to pickup just another 3,000 acres there?

Scott Sheffield

No, it was just opportunistic that it was a near some existing acres that we already have and it was a nice bolt-on at a reasonable price and probably good drilling locations on both 40s and 20s and with some horizontal potential and all depth right. So, it's just strategic in that nature and that's why we pursued it.

John Razzano - RBC Capital Markets

You mentioned that the saltwater disposal well is uncompleted and I think that the guidance for the fourth quarter ROE still seems to be inflated, is there anything else that's being baked into the operating cost there that we should know about?

Scott Sheffield

No, not really. I'm adding to the run rate like we said was a little bit higher in the third quarter and the facilities weren't back up and running exactly at the beginning of the quarter. So, it's just some of those costs that carry into the quarter that as we talked earlier will trend down into the fourth quarter and into next year.

John Razzano - RBC Capital Markets

And then in addition to some of the ethane rejection issues and constraints on the processing facilities, is there anything that you're seeing in terms of heightened gathering line pressure that that are may be causing some production cannibalization as you bring new wells or anything of that nature?

Scott Sheffield

Those are small part but not anything substantial but there is obviously would be a little bit of that but not anything significant.

John Razzano - RBC Capital Markets

Can you give us a quick feel for bigger picture an outline for investment on the midstream sites for processing primarily capacity as we look into '13 and '14 and kind of what the outlook is on the big picture basically?

Rich Dealy

I think Scott mentioned that we've got the driver plant, which is a plant out there that's being added that comes on March or early April 2013 for 100 million a day. In the summer there's another 100 million that comes on in addition to that to expand it. And then later next year into 2014 there is an 200 million a day plant that's coming on this area. So, they're definitely being built out and infrastructure there that should relieve these capacity issues.

Operator

Our next question comes from private investor, Bernard Dolman.

Bernard Dolman - Private Investor

Would you please tell me where the 8% increase in the outstanding shares, how did that come about?

Rich Dealy

Not following you. We haven't since the last --

Bernard Dolman - Private Investor

I see 33,000, I now see an extra several thousand shares, 2,000 shares in addition to the capitalization. I mean, is that something that was assigned to various people that worked there as phantom stock or whatever something like that?

Rich Dealy

There is some -- yeah, I have to -- I'll double check and I can -- I'm happy to call you back. I'm not familiar with most of the step that we issue internally whether to directors or employees who purchased on the open market; so I'm not understanding that.

Bernard Dolman - Private Investor

Well, that it was purchased on the open market it wouldn't change the capitalization?

Rich Dealy

Exactly.

Bernard Dolman - Private Investor

Let me quickly turn into something else, if I may. What is your relationship with the UBS Company? They wrote a rather scathing report rather their own complimentary a month or so ago. You used them at one-time in order to sell shares or borrow money, etc. Do you still have a good relationship with this company?

Rich Dealy

Yeah, we don't deal with --

Bernard Dolman - Private Investor

Did you read that report?

Rich Dealy

Yes, I did read that report. So, I'm really --

Bernard Dolman - Private Investor

Okay, I see. Well, I didn't mean to ask these questions that will embarrass anybody. I was trying to contact the various individuals by phone but I was unable to, but I'm going to thank you for being day and doing everything you can. And I appreciate the fact that you're continuing the dividend.

Frank Hopkins

Bernard, this is Frank Hopkins.

Bernard Dolman - Private Investor

Yes, Mr. Hopkins. Yes I've spoken to you.

Frank Hopkins

So that we can follow-up on first question, either -- why don't you call me at 972-969-4065 and give me your contact information. You can call that number a little later after the call and then we'll get back to you particularly on your first question. And then we can talk on your second question.

Operator

As we have no further questions at this time, I'd like to turn the call back over to Mr. Hopkins for any closing comments.

Frank Hopkins

Thanks everyone for listening this quarter. We will be out on the road some during the fourth quarter. If we don’t see well we'll look forward to talking to you in February on our next call. Thanks a lot.

Operator

That does conclude today's call. We appreciate your participation.

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