Warren Resources Q4 2007 Earnings Call Transcript

| About: Warren Resources, (WRES)
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Warren Resources Q4 2007 Earnings Call March 4, 2008 10:00 AM ET

Executives

Norman Swanton - Chairman, President, Chief Executive Officer

Timothy Larkin - Executive Vice President and Chief Financial Officer

Analysts

Leo Mariani – RBC

Mark Lear - Sidoti

Jack Aydin - KeyBanc Capital

Operator

Good day ladies and gentlemen and welcome to the fourth quarter and full year 2007 Warren Resources earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Norman Swanton, Chairman and CEO. Please proceed.

Norman Swanton

Welcome, ladies and gentlemen, to Warren Resources fourth quarter and full year 2007 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 Inc, is also joining us to answer any questions you may have after we discuss our financial and operating results.

Before I turn the microphone over to Tim to cover the financial results, I would like to briefly review our operations for 2007. From a production and proved producing reserve growth perspective, Warren Resources had a record year in 2007. During 2007, production increased to a record 6.2 billion cubic feet (Bcfe) of gas which represented a 64% increase over 2006. Fourth quarter oil and gas revenue increased by 137% to $19.7 million compared to $8.4 million for 2006. We also increased our proved developed producing reserves (NASDAQ:PDP) by 33% to 89 Bcfe or 25% of total net proved reserves as of December 31, 2007. This compares to 67 Bcfe of PDPs or 19% of total net proved reserves in 2006.

Estimated total net proved reserves at year end 2007 were a record of 356 Bcfe. The PV-10 of our net proved reserves was $1.05 billion at December 31, 2007 and $464 million, or 44%, of the PV-10 consisting of PDPs. We believe we still have a large source of unbooked potential oil reserves in the Wilmington oil field in California from redevelopment of deeper oil and gas reservoirs, use of high technology horizontal drilling, reservoir analysis, and application of enhanced oil recovery techniques such as alkaline surfactant polymer or ASP flood to potentially create additional oil reserves beyond our waterflood oil reserves.

Additionally, expansion of our large Atlantic Rim coal bed methane project in Wyoming should fuel reserve growth for a number of years to come.

In 2007, although we have confronted challenges as our production increased, we continue to build the foundation to deliver strong production and reserve growth for the years ahead in all of our core drilling areas. Accordingly in 2008, we believe that we can continue to deliver strong production growth.

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

Timothy Larkin

Thanks, Norman. Before I discuss the company’s fourth quarter and full year 2007 financial results released earlier today I would like to remind you that all statements made during our 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 differ materially from those in the forward-looking statements are described in our Forms 10-K and 10-Q and other periodic filings with the SEC and our press releases.

As Norman mentioned the fourth quarter of 2007 was a very good quarter for us. Oil production from our two oil fields in California totaled 226,000 barrels, a 60% increase over the 141,000 barrels produced during the fourth quarter of 2006. Net income for the fourth quarter was $4 million or $0.07 per share, which represented a twelvefold increase over 288,000 recorded in 2006. Total revenues for the fourth quarter increased to 110% to $20.2 million, compared to 2006. Oil and gas revenues increased 135% to $19.7 million compared to 2006 and increased 18% over the third quarter of 2007.

Also during the fourth quarter production was 1.8 Bcfe or 19 Mcfe per day. This represented a 61% increase over 2006. We achieved these results despite the fact that the WTU production has been limited due to the gas flare and trucking issues as discussed in our press release issued earlier this morning.

During the fourth quarter, Warren produced 226,000 barrels of oil and 394 million cubic feet of gas. Increased oil production primarily resulted from growth through the drill bit at our WTU in California.

The average realized sales prices for fourth quarter of 2007 were $79.32 per barrel, which included a $1.33 per barrel hedge loss and $4.56 per Mcf compared to 2006 prices of $49.76 per barrel and $5.79 per Mcf.

Total expenses increased 74% to $16.1 million during the fourth quarter of 2007 compared to 2006. DD&A and lease operating expense increased by 94% and 58% respectively, primarily due to increases in production. Additionally, general and administrative expense increased as we continued to hire more qualified personnel to support our growth in operations.

Regarding the full year 2007 results, 2007 was a record year for us. Net income increased 83% to $11.1 million during 2007 compared to 2006. Total revenues for 2007 increased 71% to $62 million compared to the prior year. Oil and gas sales increased 90% to $59 million and production increased 64% to 6.2 billion cubic feet of gas equivalent or 17 million cubic feet per day. The average realized sales prices for 2007 were $64.60 per barrel, and $4.81 per Mcf compared to 2006 prices of $55.36 per barrel, and $5.73 per Mcf.

For 2007, net cash provided by operating activities increased 122% to $28 million, compared to 2006 cash flow from operations of $13 million. As of year end the company had borrowed $46 million under its $250 million credit facility. As of December 31st, we had $23 million in current assets. Our current borrowing base and option totals $125 million, which left us availability of $79 million as of December 31. We plan on funding our 2008 capital expenditures budget with our senior credit facility, cash flow from operations and existing cash on hand. We expect another borrowing base increase on or about April 1, 2008.

We reported first quarter and full year production guidance in our press release dated February 5 2008. Our full year 2008 oil production guidance of from 1.2 million barrels to 1.4 million barrels anticipates resolving the gas flair limitation issue with Southern California Air Quality Management District during the second quarter of 2008. We also anticipate having two active drilling rigs during the last three quarters of 2008. If these events do not occur, oil production maybe negatively affected.

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

Norman Swanton

Thanks, Tim. Based on our reported fourth quarter 2007 and year-over-year growth in production, PDP reserves, and financial results I believe that despite certain challenges we’ve accomplished, we provided a detailed operational update in our fourth quarter and full year 2007 earnings release this morning. So today I’d like review our outlook for 2008 focusing on our two core operating areas: the Wilmington oil field in California and the Atlantic Rim coal bed methane project in Wyoming.

In the Wilmington Townlot Unit (WTU) we had to limit oil production since the fourth quarter of 2007 due to lack of daily trucking availability, facilities constraints and gas flare limitations. On the trucking problem, we fully expect that this bottleneck will be eliminated in mid-March 2008 once a new 10-inch crude oil pipeline is completed and activated.

This pipeline connects the oil-shipping meter at the WTU with a receiving oil meter at the nearby Conoco Phillips oil refinery. Additionally in February 2008 a 400-foot crude oil connecting pipeline was connected to and is fully operational between our NWU shipping meter and the Conoco Phillips refinery.

On facilities issues, we plan to complete the construction phase of the drillings project and complete other infrastructure improvement in the WTU by the end of the first quarter of 2008. There will be additional lighter work to be completed primarily related to electrical issues later in 2008. This should facilitate increased production, eliminate the impacts from construction activities and improve the timing of drilling and completion activities at the WTU. Warren has one drilling rig operating in the WTU central facility and plans to add a second drilling rig later in 2008.

Limitations covering the level of flared natural gas produced at the WTU has resulted in curtailment of between 300 and 500 barrels of oil per day at the WTU. Previously, in order not to exceed permitted flare gas levels, we acquired six micro turbines for the WTU to convert some of the produced natural gas to electric generation.

We reached agreement with the local applicable agency, the South Coast Air Quality Management District (AQMD) for six micro turbines to be activated and they are currently in operation. The WTU production returned to the 3,000 barrel a day level with excess natural gas being burned in the micro turbines to both generate electricity and reduce emissions.

As production continues to grow, we purchased a high-efficiency gas flare that would result in higher production and lower emissions than the existing flare. We’ve applied to the AQMD to permit the operation of the new high-efficiency flare which would allow continued growth into 2009.

Depending upon production growth in the longer term, we believe it will be desirable to dispose of all the produced gas through reinjection or sale to an end user. As we continue to drill Tar, Ranger, and Upper Terminal wells, we are evaluating additional potential horizontal drilling targets as we previously did in the D-1a sand and our first 20 successful horizontal wells. There are several prospective sands within the Tar formation -- the Ranger sands, the UP Ford -- and possibly deeper formations such as the basement shifts. Additionally, we are examining the tertiary potential of ASP for both the WTU and NWU.

As far as the North Wilmington Unit (NWU) current production is approximately 425 barrels of oil a day. We are anticipating the commencement of a future drilling program in the NWU once our geological and geotechnical analysis of the oil reservoirs is completed in the first half of 2008.

On the Atlantic Rim CBM project we expect 48 out of the 59 new producing wells drilled in the Sun Dog unit of the Atlantic Rim coal bed methane project will be placed in production in the March 2008 before the current winter wildlife stipulations take effect. The remaining 11 CBM producers will be placed in production later in 2008. Additionally, we had a 5% participation in drilling 33 coal bed methane wells in the Catalina Unit in the Atlantic Rim Project. In both of these projects, preliminary results are encouraging. We expect the dewatering time should be reduced significantly, resulting in higher gas production rates in the early years of production.

Current daily production from our Atlantic Rim coal bed methane project is approximately 7.5 million cubic feet a day, of which Sun Dog accounts for 5 million cubic feet of gas a day. We do not anticipate that we will see significant production growth until both the new producers and additional water injection wells stabilize later in 2008. Based on these anticipated results, we plan to drill 245 gross wells in the Atlantic Rim project in 2008.

After eight years of hard work, we are very excited about commencement of development drilling phase of the Atlantic Rim coal bed methane project.

In my closing remarks, our strategy for 2008 and beyond is to deliver on our commitment to create sustainable growth and shareholder value by executing our plan of developing our large portfolio of proved undeveloped reserves in the Wilmington field in California and expanding the development phase of our high quality Atlantic Rim coal bed methane project in Wyoming.

With that overview, we will take any questions.

Question-and-Answer Session

Operator

Your first question comes from Leo Mariani - RBC.

Leo Mariani - RBC

A quick question on your new wells at Sun Dog. Just to make sure I am clear this, I guess at this point you got your wells drilled but have yet to hook any up and you basically are doing that as we speak and plan to have 48 of those wells hooked up by the end of March here, is that right?

Norman Swanton

That is correct; bottom line, yes.

Leo Mariani - RBC

With your CBM plays over there, just curious to see what type of production levels you guys are seeing at some of the other units in terms of continued increases at [Doddy] or Blue Sky recently?

Timothy Larkin

We have several wells down at [Doddy] with all the completion units there and the Sun Dog unit really focused on trying to finish up completions there. So we’ve really been a bit behind dealing with some well maintenance at [Doddy] but we are looking at writing about 1.8, 2 million a day in [Doddy].

We are also looking at probably here in the second quarter to going in and doing some stimulation work on the [Doddy] wells. And then of course in 2008 a lot of our drilling will be pushed down towards the Blue Sky area to try to tie that area into Sun Dog. Hopefully some of the dewatering efforts can make some improvements on production there.

Leo Mariani - RBC

Turning to your operations there on the oil side, obviously it’s little uncertain as to when this gas flare issue is going to resolved, but just to be clear, you guys think you need to have the higher efficiency flare in place before you could see any increases on production at NWU? You are not going to get any increases when the pipeline comes in place. Is it really the gas issue that is the limiting factor at this point?

Norman Swanton

Well, now it’s the gas issue. Before, there were three factors at the same time. For all intents and purposes, the shipping of the oil which became a major problem because of the inconsistency and lack of availability of oil trucks, the pipeline is imminent in terms of activation and that will no longer be an issue or constraint. So really the only remaining constraint that we currently have is the limit on the flare gas and the means to increase production but lower the aggregate of emissions.

Leo Mariani - RBC

Is there anything that prevent you from re-injecting some of that produced gas into the reservoirs at this point to increase production?

Norman Swanton

Actually that is a potentially viable option, however anything that you do in these oil fields will require some kind of permits. But beyond the flare, the hi-tech gas flare which would satisfy our needs, the reinjection of produced gas in the WTU is a definite possibility, but there are some additional permits required for that. Is that correct Ken?

Ken Gobble

Yes. That is correct. That’s one of the solutions that we have been working on for some time Leo, gas reinjection.

Leo Mariani - RBC

Have you applied for permits at this point or are you still trying to figure out what your ideal solution is?

Ken Gobble

Really, right now we are doing is looking at overall emissions and designs for the permit application process.

Operator

Your next question comes from Mark Lear - Sidoti.

Mark Lear - Sidoti

Is the NWU tied in with the environmental issues you are having right now with the WTU at all?

Norman Swanton

No, it’s not.

Mark Lear - Sidoti

Would it be possible to move the focus over there in the near term while you are dealing with some of these environmental issues? I know you touched on you were looking more towards second half. Is there any possibility to accelerate that to continue the increase in production out there?

Norman Swanton

I wanted to make sure that we had our geology reservoir analysis nailed down for the best results once we commence drilling in the NWU. We are well along that way and I believe that in the next few months we will drill our first horizontal well in the Ranger in the NWU and at this point we really will try a sinusoidal or wavy horizontal well to catch more reserves with one well bore but we will see on that.

Once we establish that we have got the right application like we did in the WTU with the horizontal play in the D-1a sand then we can go to town on the NWU.

Mark Lear - Sidoti

You had mentioned or touched on derivatives a little bit in your financials. That’s the first I heard about you guys doing any sort of hedging or anything. I was just wondering if you could go over what you put on and what your plans are in that regard in the future.

Timothy Larkin

We bought puts in November of 2007 for 700 barrels a day for all of 2008; approximately 256,000 barrels in total and the puts back in November cost $1.71 per put, so the total investment was 438,000. As you know, oil prices have been continued to be very strong and they were very strong for the balance of November and December and so that security decreased in value of approximately 300,000 at year end.

Mark Lear - Sidoti

What was the strike on those puts?

Timothy Larkin

$70 per barrel.

Mark Lear - Sidoti

Are there any plans to add to those?

Timothy Larkin

Currently no plans to add to that hedge.

Mark Lear - Sidoti

Tim just to get into a little more specifics on the increase in G&A, do you see that continuing at that level moving forward?

Timothy Larkin

Well I think G&A for the quarter was $5.1 million and $1.7 million of that was a one-time year end bonus amount. So I think on an ongoing basis G&A will probably be closer to the $3 million to $3.5 million a quarter.

Mark Lear - Sidoti

So there is $1.7 million in non-cash expense?

Timothy Larkin

No, the $1.7 million in the annual bonus which is one-time and then there was $500,000 of non-cash stock option expense but that will be ongoing.

Operator

Your next question comes from Jack Aydin - KeyBanc Capital.

Jack Aydin - KeyBanc Capital

The question about G&A you have answered, but how is the drilling right now in WTU or how many wells did you drill in the fourth quarter? What are you doing now over there in terms of the drilling?

Ken Gobble

We do have an active rig in WTU. Pretty close to the end of the year we cut the Rayburn’s rig loose so we were running a two-rig program for the majority of Q4.

Jack Aydin - KeyBanc Capital

So the fourth quarter, so far you have no drilling there?

Ken Gobble

No, we still have one drilling rig active in WTU.

Jack Aydin - KeyBanc Capital

So how many wells did you drill in the fourth quarter?

Ken Gobble

The total count was right around nine wells I believe in Q4.

Jack Aydin - KeyBanc Capital

Norm, you mentioned that production probably will not approach 3,000 barrels a day until those issues are resolved. Could you breakdown, I know you gave us the production for the NWU is about 425 barrels a day. So looking at your guidance for the first quarter, the high and low end, we should assume that’s the level one way or another is going to be the NWU?

Norman Swanton

Jack, when I use the 3,000 barrels a day and 425 barrels a day, that’s gross production. Guidance expresses the production in net production.

Timothy Larkin

The guidance incorporates the curtailment in the WTU for both the trucking issues and the gas flare issues and it reflects the NWU production fairly constant because we haven’t started our development activities in ‘08 and as Norman said, the production is on a net basis. The NRI in the WTU is approximately 82.3% and the NRI in the NWU is 84.6%.

Jack Aydin - KeyBanc Capital

So what is your net production running right now from NWU?

Timothy Larkin

Net production from the NWU is 425 barrels times 84.6%.

Jack Aydin - KeyBanc Capital

No, the WTU?

Timothy Larkin

The WTU is currently curtailed by the issues mentioned on our call and it’s right around 24.80. It has been a little higher recently, the last couple of days closer to 27, right Ken?

Ken Gobble

Well, I was speaking net. Net production is running 24, 24.80 somewhere right in there Jack, pretty close.

Operator

Your next question comes from Leo Mariani.

Leo Mariani - RBC

Just a quick question regarding the rig here at WTU. You obviously announced in your press release a little bit of a delay for the second rig showing up. Can you give us a little background or why you decided to go out there and pull the Rayburn rig in December? Is that just because you figured you can increase the production really into the end of March or April or something? Just trying to get a sense of why the curtailment in drilling activity?

Timothy Larkin

Leo, there are really two primary reasons. The contract on the Rayburn’s rig was up and they were asking for an escalation of terms on the contract and the rig markets loosened up a bit from when that two-year contract was signed. We thought that we could perhaps get more favorable terms which we still believe we can from another contract.

Really the second reason was the footprint of the rig with our sellers relatively complete the footprint of that Rayburn’s rig covered up a considerable number of drilled wells that we could not complete in a timely fashion. So that was something that we also were hoping that we could address with a little bit smaller footprint.

Leo Mariani - RBC

Do you have any leads on getting another rig here, besides the one that you had in your press release that is a little bit delayed?

Robin Li

We definitely do, and that was something that came up here just recently so that is something that we continue to explore and I don’t believe there will be large issues in securing a second rig.

Leo Mariani - RBC

Staying on NWU here, can you talk to some of your recent well results out there in the field? You mentioned the nine wells in the fourth quarter. How many wells have you drilled out there at this point, quarter to date and talk a little bit about some those wells in production?

Timothy Larkin

In the NWU or the WTU?

Leo Mariani - RBC

WTU, I meant yes.

Timothy Larkin

The WTU, as Norman has mentioned, we are in a curtailment situation there where we have got several wells that we haven’t tested yet that are drilled just due to the limitations on oil transportation and the flare. So really nothing has really changed that I can speak to on where the rigs were compared to what the newer wells are doing. We are still seeing the flood wells coming on somewhere right around 20, maybe a little more than that barrels a day. Really the break in drilling is going to I hope gives us a good chance to go back and really analyze our water management plan on injection. So we are pretty excited about that, finishing up our geological work there.

Leo Mariani - RBC

Jumping over to the Atlantic Rim, you have these 48 wells that you are hooking up by the end of March here. What do you expect in terms of production response there? Can you maybe just walk us through what we should be looking for and whether or not you think you are going to have any second quarter production impact from those?

Timothy Larkin

Yes, we expect second quarter impact, most of those 48 wells are actually tied in ready to go. Right now where we are at as far as getting those on production is finishing up some injectivity tests on our injection wells. We would hope that in the next week to ten days if we start to seeing those wells come online. Hopefully by the end of March we will see everything up and running and hopefully some stable production by then.

As far as initial rates, this is really going to be pretty much an acid test here, the new wells at Sun Dog. I think we forecasted those wells coming on somewhere right around 100 a day, and looking for somewhere 100 to 120 Mcf a day increase within 12 months.

Leo, that was more or less patterned off the original well, so I believe there is a good chance that that could be somewhat conservative, but only time will tell. Very difficult to forecast this first batch just coming out of a pilot stage. The initial results look promising.

Operator

Your next question comes from Jack Aydin.

Jack Aydin - KeyBanc Capital

Norm, you mentioned about the ASP. How far along are you in that? Could you just bring us up to date and does it require any permits to go ahead and do it?

Ken Gobble

Jack, we’ve contracted [SureJet] who you maybe familiar with down in the area to do all of our reservoir analysis and geology on the core work. They are going to suggest what they believe will be the best chemical and polymer makeup for the flood. Now we expect their answer to be complete in approximately six months. We have been looking at the design work for the pilot stage here quite heavily in the last three or four weeks. Of course, tertiary recoveries are a pretty hot item, there is a lot of competition for resources out there. It looks like we could probably have our pilot equipment built and put together probably by year end.

Now there will be permits required, of course anything that has potential emissions or construction will require permits out there. So really our timeline right now is to try to have all of our equipment and infrastructure designed, say in the next 90 days, ready to go to permit applications with the hopes that we can move that through system out there, somewhere around the end of the year when our equipment would be ready and we could begin construction and actually get that on the ground.

So realistically, probably what we are looking at is starting the flood probably some time hopefully into Q1 ‘09. I think that’s relatively realistic.

Jack Aydin - KeyBanc Capital

I have been told there is a delay, there is a waiting period, lag period for getting that equipment.

Ken Gobble

You know, that’s all built by a company here in Casper who we have been in very close contact. I don’t know if you know those guys but they put together most of the equipment for almost every polymer flood in the US and overseas. We have been having very consistent meetings with the test group over there and we are pretty certain we can have that pilot built by the end of the year.

Jack Aydin - KeyBanc Capital

Good. Good luck.

Ken Gobble

Thank you, Jack. That’s something we are very excited about. I think with the results that we’ve had in the flood to date in the WTU and looking at some of the results from pilots that have been out there in the LA Basin I think it is something that could be very promising for the company on expanding our reserve base there and getting it out of the ground a little quicker.

Operator

At this time we have no further questions. I would like to turn the call back to management for closing remarks.

Norman Swanton

I would like to thank all of you for joining us today and for your interest in Warren Resources. I hope we’ve conveyed to you how excited we are about executing on our operating plan and capitalizing upon the enormous potential in front of us for the balance of 2008 and beyond. Thank you and good day.

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