• Good chance they beat on 3Q volumes. They traditionally have either come in anywhere from center of guidance range to extremely high to guidance. Haynesville wells have exaggerated this habit. Either way they will be able to say they topped 0.5 Bcfepd for the first time, up huge (like 60%) from 3Q08 levels.
  
  • Mission accomplished. 0.512 Bcfepd largely due to better Haynesville well production.

• Probably a reiteration of the 30 to 40% growth in 2010 they announced last quarter.
  
  • Wrong: They Boosted 2009 numbers and then boosted 2010 to 43% above that bigger base.

• The Street is expecting bigger wells from them in the Eagle Ford. It would seem likely they deliver a modestly higher rate set of wells (just north of 10 MMcfepd, with a focus on more liquids rich wells) as they announced that JV with SFY which begs the question, why do that if the returns don’t justify it? Answer is that the returns due justify it and that the E.F.S. is every good a shale play as the Haynesville from a rock and organic content standpoint.
  
  • Nope, IP's contracted relative to their prior wells - hot topic for the call. They did announce additional acreage in the core and in the oilier Dimitt County area.

• Probably some Haynesville wells, look for drilling time to have fallen again and well costs to be down again. CHK saying some at $6mm now, last HK said was $8.5 mm.
  
  • $9.5 mm year to date average, trending to $8 to 9 mm.

• Budget talk to remain constrained to $1.3 billion next year.
  
  • Close but they upped it to $1.45 billion. But See Next Bullet.
    

• NO DEAL. No debt, no equity, no deal.
  
  • And I quote:
    

The plans outlined today aim to balance 2010 cash flow and expenditures and accelerate drilling in these core shale plays, eliminating the need for future capital raises to fund their development.

Pre Call Note Key Points:

• 3Q09 Production above the upper end of guidance
  
• Production guidance raised
  
• Biggest IP for a Bakken well in company history (> 4,700 BOEpd)

The 3Q Numbers:

A few key takeaways from the quarterly release and NFX update before we delve into the quarter:

• Total production for the first time since May 2006 is down on a year over year basis without the aid of hurricane related shut ins.
• U.S. Lower 48 natural gas production was 58.9 Bcfgpd
  • Down 0.2 Bcfgpd from year ago levels
  • Down 0.6 Bcfgpd from June
  • Since the Spring 2009 peak, Lower 48 produciton is off 0.9 Bcfgpd (1.4%)
• Texas, the largest piece of the U.S. production pie (32% of production), continues to show noticeable declines.
  • Texas production is down 1.5 Bcfgpd from its November 2008 peak (down 7%).
  • Production is down 1.0 Bcfgpd since March 2009.
  • Rigs have recently stabilized but I don't expect a meaningful bounce until gas prices are firmly above $6 / MMBtu.
  • Caveat: There are lots of drilled but not completed wells in Texas (100s) so expect to see a slower decline as prices creep higher and these wells are quickly turned to sales.
• Louisiana: Hockey stick action - Haynesville Shale completions continue to impress.
  • At 7% U.S. production, this is one of the few growth drives at current prices.
  • Company after company plans to hike their well count by the beginning of 2010, regardless (or nearly so) of prices (from HK's mouth today) but CHK and others are looking to add rigs despite low prices to get acreage into HBP status.
• Other States production is plateauing.
• Wyoming - production took a dive, numbers are probably in part related to crude shut ins that occured over the summer as the Bakken play bumped up against capacity and weak gas prices in late Spring. This probably bounces back a bit later this year.
• New Mexico - trending lower.
• Oklahoma - Blame NFX and FST and host of others for following their Woodford Shale success with a non shale horizontal play in the Granite Wash.

Nutshell: The long awaited production declines are beginning to become more noticeable. As basis differentials shrink in various regions, it becomes clear that curtailments are not the only limiting factor in the recent smaller than expected.weekly storage data.

• Production: 189 Bcfe, down 2% sequentially, up 8% vs the year ago quarter
  
  • Guidance for the second quarter was 181 to 194 Bcfe so volues were above the mid point.
• • The sequential decline in U.S. gas volumes was a little bigger than guidance and this may pressure the stock but it should have been baked into analyst thinking since the last conference call. The decline was foreshadowed by management on the last call but there may have been some curtailments in play here.
  • "Our North American gas production profile is such that our production nadir will occur at the beginning of the fourth quarter and begin inflecting upward at the end of the year in anticipation of stronger 2010 gas prices. Because of the current low gas prices, we are projecting our North American natural gas production to follow by 1% this year."
    • Additionally, we knew that they were delaying completions in the Bakken until July due to high transportation costs and low oil prices.
    • Importantly, they kept the 5.5% organic 2009 production forecast (raised from 3% last quarter) intact.

• Cash Costs: (includes LOE, transportation, gathering, production taxes and G&A):
  
  • Cash costs came in at a low $1.57 / Mcfe vs $1.75 last quarter and $2.05 a year ago. Much of the drop was attributable to to lower production taxes which is in turn due to lower commodity prices but they did manage to modestly improve lease operating expenses.
  • Every item was either at the low of the guidance range or below it.

Bottom Line Was Much Stronger Than Expected:

Nutshell: Much better than expected 2Q results for Southwestern Energy (SWN), minor disappointment due to the pipeline constrained guidance reduction but this is one of those "out of their control things" that institutional shareholders will often give managements (and stocks) a "get out of jail free pass" for. Maybe today, maybe it'll take a little longer. The key points are:

1. the reserves are still in the ground (not a problem to sell them later when prices are presumably higher),
2. drilling results continue to get better quarter after quarter after quarter,
3. the 2nd well in the Haynesville is encouraging and this could certainly emerge as a second core area for them.
   
4. at the end of the day, even with reduced guidance, they will have one of the highest growth profiles in the domestic E&P universe, this year and next.
5. CFPS estimates likely to come down slightly, not substantially.
   
6. In my book, reducing the growth rate from 49% to 45% is not worthy of analyst downgrades, especially since the cause has no impact on net asset value.

The 2Q09 Numbers:

NFX Reports Big Beat In Q2; Operations Highlights Very Strong

A few key takeaways from the quarterly release and a NFX update before we delve into the quarter:

Volumes:

• 2Q Production of 434 MMcfepd, beats guidance of 420 to 425 MMcfepd; cites better than expected drilling results Barnett and Marcellus.
  
• Sees double digit volume growth in 2009; prior guidance was 10% growth so without getting specific they are bumping that up a bit.

Operations Update

This is not exploration but exploitation and those long-lived assets mean that they are not on a production treadmill so they can afford to "hunker down" and await higher prices, keeping spending at a minimum to maintain production levels. Like many of its oily brethren, its stock price has suffered enormously, much more than oil itself did. My sense is it will "make it" and that as oil rises so too will its equity valuation, either via a rising stock price or via by acquisition by a larger entity who finds it cheaper to "drill on Wall Street" than with the drillbit. I own the common at $1.80 and some November calls a little higher than here.

The main things I think about when looking at the model vs the company's plans:

Talk about a story that has gotten simpler. Think 25 Haynesville wells in 2009 consuming 98% of the budget and leading to a back end loaded year with 2009 growing 86% over 2008 levels.

• The 4Q Numbers:
  • Production: 57.6 Bcfe (626 MMcfepd)
    • 44.1 Bcfe (479 MMcfepd) from the Fayetteville Shale
  • Revenues reported of $500 mm vs $540 mm expected
    • Fayetteville shale price realizations averaged $1.80 per Mcf below NYMEX prior to the completion of the Boardwalk pipeline in late December. This was expected.
  • EPS reported of $0.30 vs $0.31 expected
  • CFPS reported of $0.82 vs $0.82 expected
• 2008 Reserves:
  • F&D of $1.53 per Mcfe (very good)
  • F&D of $1.21 per Mcfe in the Fayetteville alone (even better)
  • Reserve growth of 51% to 2.185 Tcfe.
• Operations:
  • Fayetteville Shale:
    • YE 08 Production: 720 MMcfepd gross
    • As of Feb 15, 2009:750 MMcfepd gross
• Hedges: 48% of expected production with an average floor price of $8.48.
• Balance Sheet:
  • 23% debt to total cap
  • $1B revolver, untapped at present
  • "nearly $200 mm cash on hand
• Fayetteville Shale Well Update
  • Fayetteville wells now seen at average of 1.9 Bcfe estimated ultimiate recovery, up from prior 1.5 Bcfe previous estimate at YE07.
  • 2H08 wells cost $3 mm apiece, have gross reserves of 2.2 Bcfe each, for a straight up F&D cost of $1.36
  • Including improved well performance they scored F&D in the Fayetteville of $1.21 per Mcfe last year.
  • IPs are trending up with long lateral lengths.
    • 1Q08: Lateral length of 3,301′ with initial production of 2.3 MMcfepd
    • 4Q08: Lateral length of 3,850′ with an IP of 3.347 MMcfepd
  • 4Q08 wells cost $3.1 mm a pop with that 3,850′ lateral and took 13 days to drill (this was 17 days a year ago)
  • Closer Perforation Cluster Spacing test resulted in 20 to 25% better IPs. Will use on all wells going forward
  • They see completed well costs falling to an average of $2.9 mm in 2009 due to lower service costs and efficiencies (sounds a bit conservative given their past and the speed of the fall).
  • 875,000 net acres so lots and lots and lots of potential locations.
  • 26% HBP, average remaining leases have 5 years remaining and a 15% royalty burden.
  • 22 rigs running (1 more than last I’d heard).
• East Texas Update
  • Their first Horizontal Haynesville well has been drilled, completed and is currently testing so hopefully we get a little flavor on the call.
  • Second well is drilling and will be completed in 2Q09
  • "the company may invest more capital in the Haynesville/Bossier Shale than previously planned"
  • They also had good results from their horizontal James Lime program,
• Guidance:
  • 2009 Production: 280 to 284 Bcfe (767 to 778 MMcfepd) or up 45% (on the mid) over 2008 volumes of 194.6 Bcfe. This is the same as the prior guidance from the December operations updated reviewed here.
    • Fayetteville forecast to be
  • 2009 Capital Budget: $1.9 B
    • This is less than the prior budget by $100 mm as they plan to release 4 additional rigs over the course of the year.
    • $1.6 B goes to E&P vs 1.78 B in the old budget
    • $1.3 B goes to the Fayetteville vs $1.5 B in the old budget
• Conference Call: 10 am EST.

• The 4Q Numbers: In Line
  • Revenues reported of $525.7 million vs $522 mm expected
  • EPS of $0.93 vs $0.93 expected
    • EPS includes a $0.10 charge to write down the value of an investment in an oil tanker that may be converted for use by the company’s MOPS (mobile offshore production system division).
      
• Guidance: Below Street
  
  • 1Q09: Guiding to $0.60 to $0.70 vs Street Consensus of $0.76
    
  • 2009: EPS of $3.00 to 3.60 vs.
    
    • the Street’s $3.48 (range of $2.70 to $4.12 from 15 analysts)
      
    • and 2008 of $3.58.
      
• Balance Sheet: Strong, low debt
  
  • $229 million long term debt as of 12/31/08, for a net debt to total cap of 18%
    
  • They have debt maturing of $105 mm this year and talk of repaying it out of free cash flow (cash flow above maintenance capex generated from operations this year)
    
• Favorite Quote:
  

We do not pretend to have a "bulletproof" business strategy. It would, therefore, be presumptuous to claim we know the exact impact our customers’ spending cuts will have on demand for our services and products. However, we believe the deepwater market will be among the least vulnerable to these cuts. This belief is based on the inherent size and long-term nature of deepwater projects and our expectation that oil prices will inevitably rebound to a level that will make these projects more economical. While work on most authorized deepwater projects is likely to continue, the urgency to start new projects is in question.

• The 4Q Numbers: In Line
  • Revenues reported of $525.7 million vs $522 mm expected
  • EPS of $0.93 vs $0.93 expected
    • EPS includes a $0.10 charge to write down the value of an investment in an oil tanker that may be converted for use by the company’s MOPS (mobile offshore production system divsion).
      
• Guidance: Below Street
  
  • 1Q09: Guiding to $0.60 to $0.70 vs Street Consensus of $0.76
    
  • 2009: EPS of $3.00 to 3.60 vs.
    
    • the Street’s $3.48 (range of $2.70 to $4.12 from 15 analysts)
      
    • and 2008 of $3.58.
      
• Balance Sheet: Strong, low debt
  
  • $229 million long term debt as of 12/31/08, for a net debt to total cap of 18%
    
  • They have debt maturing of $105 mm this year and talk of repaying it out of free cash flow (cash flow above maintenance capex generated from operations this year)
    
• Favorite Quote:
  

We do not pretend to have a "bulletproof" business strategy. It would, therefore, be presumptuous to claim we know the exact impact our customers’ spending cuts will have on demand for our services and products. However, we believe the deepwater market will be among the least vulnerable to these cuts. This belief is based on the inherent size and long-term nature of deepwater projects and our expectation that oil prices will inevitably rebound to a level that will make these projects more economical. While work on most authorized deepwater projects is likely to continue, the urgency to start new projects is in question.

• The 4Q Numbers:
  • Production: 2.316 Bcfepd, 92% natural gas. This was already announced with reserves and was above the high end of the range despite some shut ins. On the surface this is flat sequentially.
    
    • Adjusted for asset sales and VPPs this represents 2% sequential and 14% YoY growth
    • 4Q08 volumes also omit 65 MMcfepd in voluntary curtailments due to low prices
    • Current production is 2.355 Bcfepd
  • Revenues of $2.981 vs $2.575 B expected
    • hedges improved gas price realization
  • Operating Costs
    • LOE: $1.09 a bit better than expected
      
  • EPS of $0.73 (ex items) vs $0.74 expected
  • CFPS of $1.76 vs $1.69 expected

CRK Reports Ho-Hum 4Q08 Results; Chops Budget; Increases Focus On Haynesville.

• 4Q Production: 4Q inches up from a ranged of 97 to 102 MMcfepd to 102 to 103. The company notes December production was 40% higher than January 2008 production.
• 2009 Production Guidance: 90 to 100 MMcfepd. The mid point of this range would yield growth of 2.5% over 2008’s 92.5 MMcfepd. With reduced spending this is not surprising. The resource plays are not economic in the Woodford and probably not in the Fayetteville as of today, but they are high decline rate with long production tails. So drill less and you notice the production fall off quite rapidly.
• Reserves:
  • 185 Bcfe, up 18% (would have been 34% were it not for price; 93% gas. Reserve replacement of ~ 83% (or 156% were it not for the write down). This is a little light to reserve growth guidance but I think it will be forgiven as the holdup was only due to low year end commodities.
  • See ceiling test writedown of $94 to $100 mm (not out of the ordinary or bad this year).
• Operations Highlights:
  • Woodford Shale:
    • Current net production: 40 MMcfepd.
    • 3 PQ operated rigs running.
    • 3 latest wells showing rates of about 4 MMcfepd - ok, not a big rate there nowadays and lower than the last couple of wells they completed here.
    • Completing an 18 frac stage, extended (7,000) foot lateral horizontal well, first two stages flowed at 3.7 MMcfepd which might grab some analyst’s attention as they have 16 more stages to go. A little hinky to report the well in pieces and those flow rates are max production (no choke size given, no period for the text so they are likely 1 day flow rates for all the press release tells you). Still, interesting.
  • Fayetteville Shale:
    • Current net production: > 9 MMcfepd.
    • 5 non-operated rigs running (bet they’d like to see that number fall a bit now given prices).
  • East Texas:
    • Current net production: 15 MMcfepd.
    • Palmer Prospect (Cotton Valley lime): 6th well producing 3 MMcfepd, very low operating costs here.
  • Gulf Coast: (exploration)
    • Bluff’s Prospect began production in November, currently flowing 16 MMcfepd gross, or 6 MMcfepd net to their interest.
    • No other prospects mentioned in the PR as their first big prospect (the 93 Bcfe Whistling Straits (24% working interest) doesn’t spud until May 2009.
• Hedge Update: 55% hedged at $7.87 per Mcf.
• Capex: $80 to $100 mm. That’s a drastic reduction (good idea guys) from the $250 to $260 mm spent in 2008. For them to be able to keep production essentially flat on that budget may be a bit of a stretch and will be highly dependent on their ability to get better rates out of wells in the Woodford.
• Valuation: Very cheap, probably going to stay that way for awhile with net debt to total cap around 40%. Not sure the flat 2009 vs 4Q rate won’t cause some further estimate reductions. I like these guys and the story bears watch but they need higher gas prices to get out of the cellar. Right now, they are in survival mode and I think they will make it but it depends on how long commodities prices stay low.

• 4Q08 Production:
  • 2.315 Bcfepd (92% natural gas). Up 2% sequentially and 14% year over year once you get everything on an apples to apples basis (adjusted for VPPs and asset sales )
  • This is just above the high end of the 4Q guidance of 2.23 to 2.27 Bcfepd.
• Reserves (preliminary)
  • Reserves grew 11% to 12.1 Tcfe (which is where they were at the end of 3Q and no doubt stalled from reaching 12.5 by a ceiling test writedown).
  • Reserve Replacement (new reserves added vs production and asset sales of 239%, this will be seen "as expected for them" and upper quartile among the large caps for 2008.
  • Writedown of $1.8 billion due to low year end oil and gas prices. This is non-cash and does not affect the reserves, simply an accounting rule they and all E&Ps are required to follow. The charge would have been smaller had this been 2009 when the new 12 month pricing rules go into effect. Not a big deal.
  • Finding & Development Costs:
    • Not given in the press release nor was final capital spending
    • but I’d bet the all in number is close to $3.50 per Mcfe (so-so)
    • and the drilling bit only F&D will be close to $1.50 per Mcfe (after impact of the reserve writedown)
    • F&D drillbit costs should fall substantially next year.
      
• Haynesvillle Shale Update: Bigger wells.
  • The average IP for the last seven wells is 16 MMcfepd, rising from the previous set of wells that were closer to 10 MMcfepd.
  • The last two wells which have been completed but not yet hooked to sales were 22 MMcfepd (its not clear if these two are included in the previous bullet).
  • Rig count in the play is now 20 with an average of 25 rigs expected for 2009 which is up a couple of rigs from their last update.
  • Potential well count implies net reserve adds of just under 600 Bcfe. That’s 25 rigs on average with a spud to spud time of 60 days (I think they can beat that), an 80% working interest (paying the equivalent of only 50%), a 25% royalty, and their middle of the road EUR estimate of 6.5 Bcfe 8/8ths.
    
  • Note: CHK entered JV with ETP to build the 178 mile, 42 inch, 1.25 Bcfgpd capacity Tiger Pipeline stretching to Carthage, Texas with an in service date of 2011.
• Hedges: Increasing Coverage
  • 2009:
    • 42% of expected production covered with swaps priced at $7.87,
    • 40% covered with collars with floors at $7.32,
    • minimal hedges subject to knockout swaps
  • 2010:
    • 37% with swaps at $9.44,
    • 12% with collars with floors at $6.41,
    • 241 Bcf (nearly a third of 4Q gas production) subject to knockouts. I for one think that’s smart, may go over like a lead balloon with analysts, but I really don’t see them being trigerred in 2010 (triggered in a range of $5.45 to $6.75 over the course of the year. )
• Cash at Year End: $1.75 billion (note that that is year end, not as of yesterday, and its also apparently not a net number…see next bullet)
• Announces $500 Million Senior Note Offering.
  • Would not be surprised to see this double in size as well, $500 mm seems to be a trial balloon.
  • Due 2015
• Use of proceeds: to repay the revolver (which they charged up to $1 billion just after the end of 3Q while that was still possible as the financial markets looked to be melting down).
  

• In A Nutshell:
  • Good to see their Haynesville wells improving; would like to see if they walk up the EUR’s to match as the 6.5 Bcfe type curve assumes lower initial production than what we are now seeing.
  • So if the debt deal is to pay down bank debt, the $1.75 billion listed in the cash and cash equivalents in the operations update is what, funny money? I kid because I love.
  • To me they are doing this because the debt window is open, at least temporarily, and the market has an appetite for high yield paper from gassy E&P names if HK’s deal last week is any indication.
  • CHK wants the flexibility, I "really" get that.
  • The market wants them to "really" live within cash flow. I don’t think they want to believe that.
  • I think they should have sold it as helping to pay for their share of the Tiger Pipeline mentioned above (although that may service to worry people about long term gas prices).
  • The problem I have with the deal is not really the deal itself. I mean, in this age of $50 billion here and $1 trillion there, the fact that we are swapping low cost revolver debt for high cost high yield debt (it will price well over 10%) should no long raise an eyebrow, right?
    
  • The problem I have with the deal is that it is CHK going back to the capital markets again. So soon. After another asset sale and another VPP made everyone feel it was safe to go back into the deep end of the shale, here we are again raising money.
    
  • After pointing out how much cash there is at hand and that no debt matures for 5 years…here we are again raising money.
    
  • After promising (again) to live within cash flow…here we are again raising money.
    
  • As you know, I’m a big fan of Chesapeake and I’m a shareholder.
    
    • I love their ability to buy acreage and later monetize it for 10x.
      
    • They never drill their best well at the beginning of the play so reserves rise and costs fall over time and that’s nice. I love the fact that they can get VPPs done through their clever friends at R&D for over $4 per Mcre in this climate.
      
    • But I’d like a little more thoughtfulness that even if your game plan isn’t growth for the sake of growth, and I know it's not, that sometimes it just doesn’t pay to produce an extra Mcfe because it’s there or to do a deal because you can, but that a promise is always a promise.

1) Rig Counts Continue To Fall. Not unexpectedly, both gas and oil counts fell again last week. What is interesting to see is the stronger than to date seen dip in horizontal rig activity. This is where your big wells come from, be it oil from the Bakken or natural gas from any one of a number of supply / demand busting equation (at least that’s the perception) shales. Take away the horizontal activity and U.S. onshore production will follow all the more quickly.

Not to be outdone in wowing the market, President-Elect Barrack Obama was busy over the weekend touting the biggest public works project in 50 years akin to the CCC focusing on bridges, roads, schools and the like so maybe its time to take a look at U.S. Steel (X) which has just been savaged since the summer months ($190 to $30 folks!).