Warren Resources Inc. Q2 2009 Earnings Call Transcript

| About: Warren Resources, (WRES)
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Warren Resources Inc. (NASDAQ:WRES) Q2 2009 Earnings Call August 5, 2009 10:00 AM ET

Executives

Norman Swanton - Chairman & Chief Executive Officer

Tim Larkin - Executive Vice President & Chief Financial Officer

Ken Gobble - Chief Operating Officer & President of Operating Subsidiary, Warren E&P

Analysts

Mark Lear - Sidoti & Co.

Christina Pluta - RBC Capital Markets

Duane Grubert - CRT Capital

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2009 Warren Resources Inc. earnings conference call. My name is Tom, and I’ll be your coordinator for today. At this time all participants are in listen-only mode. We’ll be conducting a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the presentation over to Mr. Norman Swanton, Chairman and CEO of Warren Resources. Please proceed sir.

Norman Swanton

Thank you. Good morning everyone. Thank you for joining us for Warren Resources second quarter 2009 financial and operating results conference call. I’m here with Tim Larkin, our Executive Vice President and CFO. Ken Gobble, our COO and President of our Operating Subsidiary, Warren E&P is also joining us from Wyoming to discuss our operating results.

Before I turn the microphone over to Tim to cover the financial results, and Ken to discuss our oil and gas operations, I would like to briefly comment on the second quarter of 2009. Warren was able to increase its oil and gas production by 8% over the same period of 2008, and held production essentially flat for the second quarter of 2009. Second quarter 2009 however continued to be a challenging one for the oil and gas industry and Warren Resources.

Although there was a pricing improvement for oil in the second quarter of 2009, we witnessed average realized oil prices of $54 per barrel for the second quarter of 2009, representing a decline of 52% from the $113 per barrel realized prices during the second quarter of 2008. Our second quarter 2009 average realized natural gas price before hedges of $2.67 per Mcfe, also decreased by 70% from $9.05 per Mcf realized prices in the second quarter of 2008.

Capital markets have seen gradual improvement, but caution remains and many investors are still on the sidelines. Our proactive program to improve our liquidity, experience good progress as we generated positive cash flow from operating activities of $8.5 million for the second quarter of 2009, compared to breakeven in the first quarter of 2009.

We successfully reduced our capital expenditures by over 90%, and achieved our near term goal and bringing our capital expenditures into line with discretionary cash flow. We will continue to follow this strategy of improving liquidity in the near term, until we are confident that oil and gas commodity prices, capital markets and capital availability have generally improved.

As earlier reported, our $120 million conforming borrowing base under our senior credit facility led by GE Capital which is due in November 2012, was reaffirmed after our spring 2009 predetermination. Additionally, we are in full compliance with all terms and covenants under our credit facility and we believe we will continue to be in compliance through 2009.

We are continuing to pursue other measures to further improve our long term liquidity and ready ourselves for resumption of drilling in 2010 or after markets improve. As earlier publicly mentioned, we are actively looking at possible core and non-core asset sales, joint ventures, volume metric production payments, and other monetization of assets strategies.

With that brief overview, I will turn that call over to Tim Larkin, our CFO. Tim.

Tim Larkin

Thanks Norman. Before I discuss the company’s second quarter 2009 financial results released earlier today, I would like to remind everyone that all statements made during the conference call that are not statements of historical fact, constitute forward looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results could vary materially from those contained in the forward looking statements. Factors that could cause actual results to defer materially from those in the forward statements are described in our Forms 10-K and 10-Q, other periodic filings with the SEC and our press releases.

As Norman mentioned, the second quarter was a solid quarter for us. We had operating income of $1.8 million, while generating a bottom line profit of $600,000 before the unrealized loss on hedging activities. We generated $8.5 million of cash flow from operations for the quarter, while successfully reducing CapEx to $1.7 million. Also, we maintained production at 2.4 Bcfe or 26 million cubic feet per day, which represented an 8% increase in production over the second quarter of 2008.

Production from our two oil fields in California totaled 237,000 barrels during the second quarter, a 6% decrease over the 252,000 barrels produced during the second quarter of 2008. Additionally, gas production from our Atlantic Rim project was strong and overall gas production increased 42% to 930 million cubic feet during the second quarter, compared to 657 million cubic feet during the same period in 2008.

The average realized oil price for the second quarter of 2009 was $54 per barrel, compared to $112 per barrel during the second quarter of 2008, a decrease of 52%. Our Wilmington oil differentials from WTI prices were $6 per barrel during the second quarter. Wilmington differential for July was approximately $7 per barrel.

During the second quarter we had a realized gain from hedging activities of $376,000 and an unrealized non-cash loss from future hedges of $9.8 million. On average, realized gas prices for the second quarter were $2.67 per Mcf, compared to $9.05 per Mcf in the second quarter of 2008, a decrease of 70%.

As a result of reduced commodity prices, oil and gas revenues for the second quarter decreased 56% to $15.2 million compared to 2008. Total operating expenses decreased 14% to $13.4 million during the second quarter of 2009. Lease operating expenses decreased 17% to $5.4 million due to reduction in lease operating expenses primarily due to more focused operations.

DD&A increased by 15%, primarily due to increases in production. DD&A was $2.21 per Mcfe in 2009, compared to $2.08 per Mcfe in 2008. General and administrative expense decreased 37% to $2.8 million during the second quarter. 2008 G&A expense included a year end bonus accrual of $750,000. Additionally, Warren has reduced its payroll expense.

Interest expense increased as we had a higher outstanding balance under our credit facility during the second quarter of 2009, compared to 2008. For 2009, net cash provided by operating activities was $8.7 million during the first six months of 2009, compared to $30.3 million in 2008.

We have further reduced our full year 2009 capital expenditure budget to $9 million. Warren has bought $115 million under its senior credit facility, which has a borrowing base of $120 million. As previously disclosed, Warren has entered into certain oil and gas price swap contracts. As a result the company has locked in a minimum level of cash flow from operations.

As the operator of the WTU and NWU oil assets in California, and co-joint venture of the Atlantic Rim project with Anadarko, the company has the ability to modify its capital expenditure budget as commodity and financial markets change. We reported third quarter and full year 2009 production guidance in our press release released earlier today.

Now, let me turn over the microphone to Ken, who will provide you with a brief operational update. Ken.

Ken Gobble

Thank you, Tim. I would like to update Warren’s operational details for the second quarter. Warren was able to significantly reduce operating expenses during the second quarter. Lease operating expenses excluding taxes, compression and transportation were reduced to $1.55 for net Mcf equivalent. This represents a decrease of 36% compared to the first quarter of 2009.

Fully loaded lease operation expenses including taxes, compression and transportation decreased to $2.30 per net Mcfe. This decrease in expenses was achieved by a wide range in effort to reduce costs. Limited well pulling activity in our Atlantic Rim project, due to lower gas prices was a contributing factor. Operating expenses were also positively impacted by the effect of lower product prices on taxes and fuel gas used to generate electricity.

Warren began implementing a rigorous supplemental pipeline testing program in both the WTU and NWU in California during the quarter. Oil production was modestly curtailed as this program was executed. To-date, close to a 100% of the well flowline and injection line have been tested in both units.

Warren expects a decrease in pipeline related incidents as a result of this augmented testing program. Warren continues to progress for a resolution of the regulatory issues with the South Coast Air Quality Management Districts or AQMDs restrictions concerning some clients with air quality standards, and permission to install the best available control technology equipment in the WTU.

Although, the AQMD elected to extend the 30 day public comment period for the CEQA document from May 15, until May 26, Warren believes the agency is nearing completion of their review of all comments received. The AQMD is now in the process of preparing written answers to the relevant comments. Warren expects the CEQA document will be certified and permit applications will be approved when the AQMD has finished this final phase of the process. AQMD gas flaring issues do not effect current production.

Laboratory work for the Alkaline Surfactant Polymer Flood or ASP of the Upper Terminal oil zone in the WTU was completed during the quarter. The final report included optimum chemical combinations for flood injection fluids, as well as recommendations on water chemistry to be used. As expected, the study results indicated good potential tertiary recovery from the Upper Terminal reservoir in the WTU.

The company is now working to determine the level of additional reservoir analysis to perform prior to implementing an ASP pilot in the WTU. Once this additional reservoir work is completed and depending on market condition, the company will progress with pilot facility design and construction.

Warren’s gas production increased during the second quarter, although growth was limited by reduced capital expenditures on infrastructure. This is a trend that Warren expects to continue until gas prices begin to recover.

Gas production in the Doty Mountain Unit continues to show good potential from the fracture stimulation program. Additional work in the unit is currently on hold due to the current gas pricing environment. The company is experiencing a positive narrowing of Rocky Mountain regional gas pricing differentials, with the recent weakness in Henry Hub gas pricing during the first quarter of 2009.

Thank you and now I’d like to turn the call back over to Norman for any questions.

Norman Swanton

Thank you, Ken. Operator, we will now take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Lear with Sidoti; please proceed.

Mark Lear - Sidoti & Co.

Good morning, a very good quarter.

Norman Swanton

Hey, Mark thanks.

Ken Gobble

Good morning, Mark.

Mark Lear - Sidoti & Co.

Just in terms of the production guidance, and where you are in gas production right now, I guess Ken if you could give me an idea of what’s going to happen in the fourth quarter, that we’d get a decent ramp in production on the gas side?

Ken Gobble

We are expecting prices to firm up as withdrawal kicks in. Right now, especially through the injection season, we were seeing significant production, show facts on some of our non-operated properties outside at the Atlantic Rim.

Mark Lear - Sidoti & Co.

I guess also thinking about prices looking better as you look out in to ‘10, what are you thinking in terms of possible hedge additions and locking in basis now?

Ken Gobble

I think a good portion of that will really depend on when the withdrawals start hitting the storage numbers. Looking at the strip, I think there’s defiantly some strength as you mentioned in 2010. I would expect that we will grow into that as prices tend to firm up Mark.

Mark Lear - Sidoti & Co.

Congratulations on really getting the cost down. I guess if you could kind of give me an idea of how LOE and G&A kind of will shakeout through the rest of the year, maybe terms of annual declines. I mean is that kind of going to stick looking out into the back half?

Ken Gobble

I think so. I think you can use these numbers pretty comfortably for the second half of 2009. With some exception, I did mention that we’re positively impacted by lower prices on taxes of course.

Mark Lear - Sidoti & Co.

Right.

Tim Larkin

On the G&A side; Mark, this is Tim. Again, I think we’ve done a very good job of reducing G&A on all fronts, primarily reducing headcount and some voluntary reductions in salary. I think that we expect to continue to keep G&A in check for the balance of the year and continue to look for ways to reduce it.

Mark Lear - Sidoti & Co.

And I saw you guys did not report pricing including realized derivative gains, I was wondering if you have that handy.

Norman Swanton

Yes, I do. Our realized gain for the quarter was $376,000 and our unrealized loss for the quarter was $9.8 million, and that’s the breakout of the $9.5 million of loss on derivative financial instruments.

Mark Lear - Sidoti & Co.

Right, what did it translate to though in a sale price per Mcfe and per barrel?

Norman Swanton

We had a gain on the gas side and a loss on the oil side. Mark, I have to give you a exact breakdown later. We were realizing gains on the gas hedges of approximately $400,000 per month. So the realized gain on the gas hedge was approximately $1.2 million. So therefore the realized loss on the oil hedges was approximately $800,000.

Mark Lear - Sidoti & Co.

Got you. Thanks a lot.

Norman Swanton

Thank you

Operator

Your next question comes from the line of Christina Pluta with RBC Capital Markets; please proceed. Christina, your line is open.

Christina Pluta – RBC Capital Markets

Good morning. I was wondering if you could give us an update on the compressor that you are installing in Wyoming and how you’re expecting production increase if you’re on hedge with those. Then also if you could talk about how you’re viewing oil prices in general and if you’re thinking about starting drilling again in the California?

Tim Larkin

Compression in Sun Dog, that expansion has taken place. We had additional compressors scheduled to arrive later in 2009 and right now we have available compression capacity in the Sun Dog Unit. We are constrained on compression in the Doty Mountain Unit, and I would expect that we may redirect one of those compressors in the Doty Mountain, that was scheduled to go into Sun Dog.

Oil pricing is looking very strong here and I think just depending on liquidity, we’ll determine our timing to getting back to drilling in the WTU.

Christina Pluta - RBC Capital Markets

Okay, thank you.

Operator

Your next question comes from the line of Duane Grubert with CRT Capital; please proceed.

Duane Grubert - CRT Capital

Hi, guys. I was wondering if you could talk a little bit about maybe sector completions styles. We’ve seen a lot of activity on the gas side with people doing more aggressive completions. Is there anything going on like that, that might change the way you complete wells in California? Are people trying new things that you might also be interested in, other than the ASP?

Ken Gobble

From a completions point of view out there, really we’re focused. Going forward our development plan would probably be more focused on highly targeted, cherry picking the geological zones in those turbidite formations out there with horizontal.

I think from the work that we did in 2008 in both the Ranger sinusoidal project in the North Wilmington Unit and also the work that we did in the Tar horizontal, Duane, I think we were very satisfied with the result of those completions as far as damage goes.

Keep in mind, that we’re not dealing with rocks that have low permeability or tend to have more fracture porosity than matrix porosity. So I think that kind of leads to a bit of a difference in what’s going on in the modern completion front.

Duane Grubert - CRT Capital

Then kind of a similar question; what you’ve learned about the waterflooding activity over the past couple of years, without adding a bunch of wells, is there anything that is different in the way you might approach a waterflood?

Ken Gobble

I would fallback to my previous comment on more selected, highly targeted horizontal development, as opposed to that seven spot pattern that we utilized in the Upper Terminal. I think that would probably lead to more successful results, even in the waterflood, especially in the Ranger formation in the WTU, but also in the Ranger in the North Wilmington Unit. I think that pilot that we have operating in North Wilmington, clearly demonstrates that that is probably a preferential development scheme, as opposed to the seven-spot.

Duane Grubert - CRT Capital

Okay, and then finally you’ve talked about gas basis and hedging a little bit. Can you talk about oil hedging? Is there a target that you might have in terms of hedging the oil volumes?

Norman Swanton

Do you want to field that one, Tim?

Tim Larkin

Yes, Duane we currently have hedges of 1300 barrels a day in 2009 and about 1200 a day in 2011 and we’re continuing to monitor the market and considering possibly layering in a hedge there is 2010, but we’re keeping an eye on things.

Duane Grubert - CRT Capital

Okay, thank you very much.

Tim Larkin

Thanks Duane.

Operator

(Operator Instructions) This concludes the Q-and-A session for today’s conference. I would like to turn the call back over to Norman Swanton for closing remarks.

Norman Swanton

I would like to thank you all for joining us today and for your interest in Warren Resources. Thank you and good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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