Cimarex Energy Co. Q3 2008 Earnings Call Transcript

| About: Cimarex Energy (XEC)

Cimarex Energy Co. (NYSE:XEC)

Q3 2008 Earnings Call

November 4, 2008 13:00 pm ET


Mark Burford - Director of Capital Markets

Mick Merelli - Chairman and CEO

Tom Jorden - EVP of Exploration

Joe Albi - EVP of Operations

Paul Korus - VP and CFO


Gregg Brody - JPMorgan

Eric Hagen - Merrill Lynch

Jeff Robertson - Barclays Capital


I would like to welcome everyone to the Cimarex third quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator instructions)

Thank you. I would now like to turn the conference over to Mr. Mark Burford. Please go ahead, sir.

Mark Burford

Thank you everyone for joining us today. We have issued our financial results for the third quarter, of which a copy and the press release can be found on our websites and we'll be making forward-looking statements in today's call. So I'll refer to the end of our press release which does discuss this forward-looking statements.

Here in Denver, on today's call, we have Mick Merelli, our Chairman and CEO; Tom Jorden, Executive Vice President of Exploration; Joe Albi, EVP of Operations; and Paul Korus, VP and CFO; and Jim Shonsey, our Vice President and Controller.

And with that, we will go ahead and jump in the call. I will turn it over to Mick Merelli.

Mick Merelli.

Good morning. Thanks for joining in this on today's call. Looking back at the third quarter of 2008, we have seen quite a bit of volatility in both commodity prices and our stock price. Operationally, we had solid results with growing production. Our quarterly cash flow was $414 million, nearly as high as our record second quarter cash flow of $431 million.

We realized oil prices over $114 a barrel and gas nearly a $10 an Mcf. Our production averaged 485 million cubic feet a day equivalent despite having 15 million cubic feet a day equivalent on average deferred in the quarter as a result of the hurricanes. So this would imply without the disruption from the storms, our daily production would have hit 500 million cubic feet a day equivalent.

So we had a good third quarter, but now the landscape is changed significantly. These shifts started before the third quarter ended where we saw our gas realizations fall sharply by the end of September. We've seen particularly low Mid-Continent gas prices, and as we reported in our press release, low quarter-end gas prices resulted in us taking a full cost pool write-down.

Through September 30, 2008 our exploration and development investment totaled $1.1 billion. For the full year of 2008, we expect to invest about $1.4 billion. That was then, going ahead we are reducing our operated rig count from third quarter high of 42 to something less than 30. We're still working on that. What we invest in 2009 will be impacted by many things but obviously the most important ones are going to be the commodity prices and drilling and service cost. We have lots of opportunities but what we have to do at this point is to test them for what the economics of the projects look like on a go forward basis.

We will run flat price cases using current service cost and we'll stack up the returns and make the decisions on what we drill. We are still rolling up and evaluating our 2009 plans and I would expect that we'll keep within our investment next year will be something around our cash flow and that will probably start slower in the first part of the year but stay tuned that all of those things can change.

So we'll maintain a disciplined approach, we will run all of our investments using a strip corrected appropriately for quality and location. We'll also run sensitivity cases we have in the past at $6 flat gas and $50 flat oil and those would of course be corrected for quality and location. We will constantly adapt our programs and we've been through this before and what we found is there always are things that work so that we'll have some level of profitable drilling investment.

Right now because commodity prices are changing, the costs are changing. We are not too sure where those things are going to be, so essentially my message to you is we are slowing down a little bit while we are trying to understand where our best programs are and where we should differ and where we should move ahead.

With that, I'm going to turn it over to Tom Jorden and he can give you some details on our drilling programs

Tom Jorden

Thank you, Mick. I am going to just give some highlights of our third quarter and then a little preview of what we're looking at in terms of our 2009 planning process.

And the third quarter and really year-to-date, we've had a very active drilling program and we're seeing great results from a lot of our plays, in particular our horizontal oil plays in Permian Basin or horizontal Woodford Shale play in the Anadarko Basin of western Oklahoma, and then onshore Gulf Coast in our Yegua/Cook Mountain program. They are also having another outstanding year.

Year-to-date, we have drilled 376 grows, or 232 net wells for the nine months that ended September 30, 2008. We completed 95% of those as producers. Exploration development capital for the first three quarters of 2008 totaled $1.1 billion and we're on track and expect our full year 2008 exploration development capital projected to be $1.4 billion.

As Mick said, we're in the environment now where we're seeing lower gas prices in the Mid-Continent and Permian Basin. We're expecting to drop our operator rig count from the third quarter high at 42 to somewhere I would guess between 25 and 30 rigs by the middle of the fourth quarter.

We're in a little bit of a shoulder here, where we are seeing last year's services cost with this years’ prices. So we're trying to adjust our program accordingly. We are very committed to making good investments and making sure that wherever we deploy our capital, we're getting good rates of return under various prices scenarios.

As Mick said, our downside case is a $50 NYMEX oil and $6 flat NYMEX gas price. We adjust that for local market differential conditions and we expect to see a decent return on capital with that and prices are getting uncomfortably close to that. So, we're making some tough decisions. We're lending some rigs down. We are absolutely committed to maintaining investment discipline through this environment.

Our program year-to-date has split, were about 47% Mid-Continent and that would include our Mid-Continent and our Texas Panhandle program, about 36% of our total capital year-to-date has been Permian Basin, and then about 15% is onshore Gulf Coast and just a few percent into other opportunities.

Looking into '09, as we pour our plans for '09, first and foremost, I want to underscore that we are dedicated going into the year to live within our cash flow. That’s certainly going to be our target. So, we're probably going to be looking at cash flow that’s significantly reduced from this year.

I would expect our percentages to be close to what we did this year. Probably, you can look for a very solid Permian Basin oil program. We've got lot of nice horizontal programs that can stand some price sensitivity. Our Woodford Shale program in '09 will be an active and ongoing program. That program certainly can stand some price sensitivity.

W still take geological risk. We are looking to grow our Gulf Coast program next year. Our Yegua/Cook Mountain program has had fantastic results this year. We have a couple of additional 3D [shoots] that are in the various stages of planning, and we look for a fairly active and aggressive onshore Gulf Coast program that will probably be a higher percentage of our total program, than the 15% this year.

We're going to maintain a balanced portfolio of opportunities, and that includes both gas and oil opportunities. As I said, our horizontal Permian oil continues to be a real nice contributor for us and we'll see that continue into next year.

We'll also have conventional Gulf Coast 3D targets as I've said. We'll have unconventional targets and the primary target there as our Woodford Shale in the deep Anadarko Basin. Horizontal programs are primarily our Bone Spring program, our Wolfcamp and Abo programs of Southeast New Mexico.

So, we're in the process of going through our programs, looking at our costs carefully. Our teams are all looking at where they can cut their costs, where they can't. We are working with our vendors to try to get service cost down. I'm sure Joe will comment on that further.

Now I'd like to turn to the call over to Joe Albi, our Executive Vice President of Operations.

Joe Albi

Thanks, Tom. Although, somewhat masked by the impact of hurricanes Gustav and Ike, as Mick mentioned, we really did have a good third quarter from our production standpoint.

We ended the quarter with average net daily equivalent production of 485 million a day, which is 5 million a day higher than the revised guidance we've provided in our press release and follow-up call merely after the hurricanes where we had projected guidance of 475 million to 480 million a day.

Our peak shut-in following the storms was approximately a 125 million a day and that happened or transpired on September 14th. We have most of that back on line by early October. I do have to command on our guys. They were pretty hard put to get our production back on line and as such the storms only had an overall net impact approximately 50 million a day on a quarterly production, which is a bit less than we had anticipated immediately after the storms.

As Mick mentioned when he start up the call here without the storms, we would have been producing around 500 million a day for the quarter and that would have allowed us to report yet another quarter of continued production growth. So we are definitely on the uptake from a production standpoint. We still have approximately 11 million a day of our non operated offshore production shut-in and majority of that is anticipated to be back online before the end of the year.

Despite the hurricanes, our total third quarter production of $484.4 million a day was up 8% from our Q307 average of $448.5 million a day. We see nice production growth in both oil and gas. As compared to last year's third quarter, our net oil production has grown 10% from 20,537 barrels a day in Q307 to 22,607 barrels a day in Q308 and our net gas production has grown 7% from $325 million a day in Q307 to $349 million a day in Q308.

During Q3, we continued to see significant production growth in each of the core areas that Tom mentioned. As compared to the third quarter of '07, our Q308 equivalent daily production increased 19% in the Mid-Continent, 14% in the Permian and 6% in the Gulf Coast. Our Texas Panhandle and Woodford programs were the drivers behind the 19% increase we saw in the Mid-Continent, while the 14% increase in the Permian, as well as our increase in total company oil production was driven by our Permian Basin horizontal oil plays.

Our Permian oil production grew 37% from 9,557 barrels a day in Q307 to 13,078 barrels a day in Q308, an increase which lifted total equivalent production in the Permian region to 165 million a day to the third quarter which was a region record for the company. In the onshore Gulf Coast area, our net production increased 6% from 67.5 million a day in Q307 to 71.3 million a day in Q308. This increase being fueled primarily by the successes of our Yegua/Cook Mountain program during the early part of the year.

Looking forward, for fourth quarter, we are projecting production guidance as we've stated in our release this morning, of 488 million to 498 million a day and this figure takes into account an estimated 8 million to 10 million a reduction for the impact of our hurricane related shut-in production and a reduced rig count during the fourth quarter.

This ramps the Q4 results in a projected full year production for the company of 484 million to 487 million a day which is a respectable 10% increase from 2007 after we account for property sales. As far as '09 is concerned, we'll be at a better position to more accurately predict production guidance after we complete our planning process and see a bit more of how the commodity market behaves here as we close out the year.

A few words on our exploitation program. With total capital spending of a $104 million down at the end of the third quarter, our '08 exploitation program looks to be on track to meet the lower end of the $125 million to $150 million range we mentioned in our last call. Through Q3, we've now completed a total of 243 significant exploitation projects, 60 of which are new wells and 183 re-completion and our work over projects.

In the Permian area, the majority of our exploitation capital has been directed to our Southwest Westbrook field located in West Texas. Through Q3, we've spent $23 million in the field completing most of our planned 2008 development activity after now drilling 34 wells and performing 23 re-completions.

As we move forward from here our focus is now on getting more water in the ground, in order to optimize flood conformance in those areas that we fully developed. Also in the Permian our New Mexico has team has done just a fabulous job of lowering LOE through compression and chemical program optimization and by instituting a proactive cost control program at the field level. The group has also had a nice impact on production by performing a dozen or so significant work over and/or re-completion projects since the beginning of the year.

In the Kansas and Mid-Continent areas, we have drilled 17 wells and performed a 107 work over and/or re-completion projects representing $46 million in capital since the beginning of the year, $10 million of which has been direct towards our Walnut Bend field located just North of Dallas where we have performed 35 re-completions and 3 deepenings, $9 million has been directed to Southern Oklahoma and Texas Panhandle where we have performed 15 re-completion projects and $8 million has been directed towards the Panoma and Kansas Hugoton areas where we have drilled 16 wells and performed 44 re-completions and/or workovers.

With the end of the year approaching, our production group is now focusing on our 2009 production and exploitation plan. The plan will focus really around three simple objectives. Number one, maximizing our operating income, number two, optimizing a reduced exploitation capital budget and three, accelerating our activity to get it done sooner in a year. Over the past year, the group has made great strides to improve base property production and at the same time lower LOE. That said, there is still much to do, when I will go in '09 will be the high grade and capture those opportunities.

Just a couple of comments, I want to make on the cost side before turning the call over to Paul. First is on the steel market and pipe. After increasing approximately 125% since January, the steel market has remained relatively flat since September and, in fact, appears to be showing signs of softening.

We anticipate [tubular] cost will probably remain fairly flat here during Q4, but we're seeing increasing evidence of supplier inventories and have seen drops in raw material costs, such as scrap metal, which is down 75% the last three months.

With all that, we believe the cost of pipe is likely to come down in the first quarter. We're already seeing price are up for Chinese pipe and believe that the US mill are same to follow.

Price drops for steel would be a welcome sign to us. We've looked into various programs and tubular costs alone have increased our well cost by anywhere from 4% to 5% since beginning of the year.

A note that I want to make, a plug for our materials group, during the last year they have done just a great job of monitoring the market and keeping us right ahead of our rig schedule, while balancing our inventory of pipe.

Our average onshore rig rates continue to hover around $18,000 a day, but we're seeing some initial signs of relief, albeit, small, with a few of our contractors dropping day rates by approximately 10%.

We have yet, however, to see any other significant cost reductions from our other service providers. That said, we're continuing our efforts to push down cost where we can and we're challenging our well designs to get cost levels back in line so that they can work in a lower product price environment.

So with that, I’ll turn the call over to Paul.

Paul Korus

Thank you, Joe. Today I thought I would just comment a little bit about our liquidity situation. Of course, a company with 12.5% debt-to-cap ratio is usually not one that you have to be much concerned about liquidity. But I do just want to remind everyone about where we are at.

Our September 30th balance sheet shows that we had a little over $200 million in cash and no bank debt. So I did want to remind everyone that we did have a transaction in October, where we essentially use the bulk of that cash. But still we do have cash on hand and continue to have nothing drawn on our credit facility.

On our credit facility, our borrowing basis is always calculated to be something in excess of $1 billion depending on the bank pricing that's been used. Besides of our note, however, that we entered into in 2005 is of $1 billion figure, which is always been the cap on the borrowing base. And the banks are in the process right now reaffirming our borrowing base of $1 billion.

However, because we've also lived within cash-flow, when we set up that facility, we only ask for and paid for 500 million of commitments and we still have that. So even if something unforeseen would have happened where we needed to borrow our credit facility, we can easily borrow our $5 million overnight. So we're in very good shape.

So some questions maybe about where we are going to end the year. We had little over close to $1.2 billion in cash flow through the first nine moths. Of course, those were very good prices.

We've realized $9.79 for our gas in Q3. In Q4, given the basis blowout that we've witnessed in the Mid-Continent areas to a large degree and to some extent as well on the Permian Basin.

We could have as much as a $2 differential from Henry Hub in the fourth quarter, which might put our gas realization around between 5 and 5.50 or so. With oil trading where it is recently like of hovering around 70ish in our standard $3 differential from there, we should still cash flow in the fourth quarter, something close to $250 million or at least $200 million to $250 million, which would add that where we for the first nine months.

We should be above $1.4 billion cash flow for the year, which would mean we would basically have funded our exploration and development program and used our cash on hand to pay for the acreage acquisition that we did last month. We're in good shape for this year to end approximately with no cash and no bank debt.

As we look ahead to 2009, and as Joe mentioned, we're in very early stages, but like everybody else we have excel spreadsheet too. We plug in strip pricing and then consider what might happen to gas price differentials next year versus this year, at $7.50 gas, even if we assume that our average differential doubles next year compares to what it was this year, this year should average $0.15 which is, of course, lot lower than the fourth quarter.

So if you use a $1 differential, which still net 654 for our gas and our oil price would still hover around $70, and we'd still have $1 billion of cash flow. So that should fund a pretty healthy program. But as Mick mentioned earlier, that we may start the year in anticipation that the strip is too high, because we have a number of concerns about the level of gas production in the country and really the stickiness of the rig count that we haven't witnessed a reduction in country's overall rig count especially for gas.

So we're going to start a little slower, maybe some that would analyze to 800 million. As the year unfolds if strip prices hold or get better, we have the flexibility due to increase it because we certainly are opportunity rich.

This is the way we are approaching the world right now. As everyone said, stay tuned but we have never had a year where we did not grow production and, of course, is living within our cash flow. So the $64 question is, where will cash flow be and where will cost be? Because it's entirely possible that $800 million to $1 billion of investment could fund a level of activity that’s not proportionately lower than what we accomplished this year.

With that, we'll turn it back to the operator and entertain your questions.

Question-and-Answer Session


Thank you. (Operator Instructions). Your first question is from the line of [Gregg Brody] with JPMorgan.

Gregg Brody - JPMorgan

Good afternoon.

Mick Merelli


Gregg Brody - JPMorgan

Just trying to figure out what the Mid-Continent base pull out might to do your end reserves in terms of, I know you are taking down, you are doing this bookmark, but how does it affect your proven reserves then at the end of the year?

Paul Korus

Well, we do not know where prices are going to be at year end. The way reserves work as well as the fuel cost ceiling test works is you have to use the prices on the last date of that period. So like at September 30, we were looking at gas prices in the Mid-Continent area of between 4 and 4.50. We had lower since then but now today, we are back up in that range. So I would be surprised if we in December, at that level of prices and so really when to expect significant impact on our proved reserves in the Mid-Continent area.

Gregg Brody - JPMorgan

Yes, that is helpful. I know you have been long-term believers in not hedging and obviously that paid off well this quarter. You have seen the affects of it this quarter. Any change in the thought process as you see prices come down, obviously there is not a huge opportunity to hedge but just going forward if you see the opportunity?

Mick Merelli

No, we do not know anymore about what future commodity prices are going to do and we do not know anymore now then we have know before and our debt is still low. If we run our data for whatever reasons and we would have to look at hedging but without that and the only reason for us to hedge with low debt is that we know something about the future and we really do not. We are still in the same position.

Gregg Brody - JPMorgan

That is consistent with what I thought, you will tell me before. All right. Thanks a bunch.

Mick Merelli

Boring but consistent…

Gregg Brody - JPMorgan

That is it.


Your next question is from the line of Eric Hagen with Merrill Lynch.

Eric Hagen - Merrill Lynch

Good Morning and first off, just to commend you on your capital discipline and secondly, just a question on what you are seeing in the A&D markets and anything that interest you and if you were to participate in acquisitions, what regions might you be interested in? Would you stand the Mid-Cont and try to use these low prices till we get some bargains there? Or try to diversify outside of it?

Mick Merelli

We are really not seeing all that much right now. Of course, we are always interested. We are a company that every three or four years, whatever it has been, has found something to do. There is always a possibility. Right now, there is nothing on our radar screen that we are really that interested in, but we always pay attention to what might be an opportunity out there. It would be, more likely for us, it would have to be an opportunity that really fit us from a business standpoint. We are more interested in that than bargains that we do not know what to do with after we get them. So, we will be watching what is going on but the chances are we will not find what we want.

Eric Hagen - Merrill Lynch

So, Mick, following up on that question, would there be any chance for a corporate level transaction, may be a solid producer who has higher debt levels, a good inventory that you know, and some overlap regionally or is that just out of the question?

Mick Merelli

No, it is not out of the question but we just have to see. That is obviously an advantage, we are low debt and we are high cash flow. So, I mean, those kinds of things can happen but it would not be from a bargain type of thing we can get the reserves. It has to be something that really matched for us over the longer haul and if we find something like that we would be interested.

Eric Hagen - Merrill Lynch

Great, thanks, and once again, a good quarter.

Mick Merelli

Thank you.


(Operator Instructions). Your next question is from the line of Jeff Robertson with Barclays.

Jeff Robertson - Barclays Capital

Good afternoon. Tom, can you talk a little bit about, under normal basis, conditions and your different basins, can you indicate which place you think have the highest returns, as you think about allocating capital in 2009?

Tom Jorden

You bet, Jeff. No, first and foremost, Yegua/Cook Mountain has the highest rate of return. That is been a consistent theme of ours, for a number of years, that that is some 3D seismic, rifle shot targets, carries some geological risks. They are actually not that sensitive to changes in costs and changes in commodity price.

Biggest problem of that play is dry holes. So, we do good science. We have a great set of prospects going into the remainder of '08 and '09. As I said, we are looking to significantly grow that program. So, first on our list we have Yegua/Cook Mountain.

Some of our Mid-Continent programs will still look good under various sensitivities. The deep Woodford Shale has quite a bit of robustness to pricing and cost. So, we will look for a fairly active Woodford Shale program in the Anadarko Basin and, of course, I would say fairly active, I use that deliberately and will depend on our cash flow and just where our overall needs are in terms of preserving our land. The other recent transaction we did is by and large a land that is held by production that was important to us because of means of we conducted the timing.

So the Yegua/Cook Mountain, the Anadarko Basin, Woodford Shale, our southern Oklahoma that is some of the fields we picked up from the Magnum Hunter transaction, Eola Robberson, Madill and Cumberland. Some of those economics looked very good under various sensitivities of cost and pricing. So I would look forward a fairly significant activity there.

Then our horizontal oil plays in the Permian Basin looked good. We are doing everything we can to cut costs. They are certainly under a pressure with oil prices coming down and costs really have not a moderated yet to the extent that we expect them to.

We are doing a lot of soul searching and rolling up our sleeves, trying to figure out ways we can cut our cost. Just some examples there, I was on the phone this morning talking to some of our guys who were limiting mud logs. When we do not need them, we are looking at smaller hole size, we are looking at less expensive service cost, we are eliminating logs and coring programs, where they are not necessary.

So those programs I think you will see filling the capital need that we have. One of the nice things about our program now, is we really are opportunity rich. Prior to this moderation in pricing, we were fully prepared to fund program next year at current cost that would be $1.5 billion to $1.7 billion based on in-house identified opportunities.

So we are in process of high grading. We are going to pick the best opportunities and be prepared to accelerate or decelerate depending on conditions.

Jeff Robertson - Barclays Capital

Paul, did you say you will start the year on about $800 million pace? Did I hear that right?

Paul Korus

Yes, with the reductions that are underway right now, that is about where we would be moving into January.

Jeff Robertson - Barclays Capital

Okay. Then lastly Tom, how long do you think it takes for service cost to catch up with commodity prices? Is it solely depended on the pace which you recall?

Tom Jorden

Joe is going to jump in here but my answer is too long.

Joe Albi

I agree with Tom and I am surprised it has not quite happened already. I think it is just a matter of time. If the lower product prices stay where they are it certainly will happen by itself. We are seeing it in the steel, we are starting to see prop become more available.

There is a lot of horsepower out there for stimulation work. If that activity slows down in conjunction with the rig rate slowdown, those costs will come down. Day rates will follow soon. I think the days for a long-term rig contracts with guarantee day rates, those probably are starting to welter away and you may see more of our rig contractors if they do want term using a floating day rate, and once the term erodes, then we will probably be back to the old world where you can work on a day rate basis. So, we are just watching and waiting, but we are also, at the same time, I say that, pushing on these guys.

Jeff Robertson - Barclays Capital

Thank you.

Mick Merelli

Thanks, Jeff.


There are no further questions at this time.

Mark Burford

Well, thank you everyone for joining us today. We appreciate the interest, and if you have any questions, please call-in and we will be happy to talk with you and we look forward to seeing you or and/or reporting to you again in the fourth quarter.

Thank you very much for joining us today.


Thank you for participating in today's conference call. You may now disconnect.

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