QR Energy at Barclays Energy/Power Conference (Transcript)

| About: QR Energy, (QRE)
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QR Energy (NYSE:QRE) Barclays Energy/Power Conference September 4, 2012 3:45 PM ET


Alan Smith - CEO


It’s a pleasure to welcome to our conference for the first time this year QR Energy. With us from the company to do the presentation is Alan Smith, QR's CEO. And I'll turn it over to Alan.

Alan Smith

Well thanks Jeff and thanks to Barclays for putting on another great energy and power conference. I was going to start off by saying we're not another drilling story you're going to hear about this week but based on the number of people in the room, maybe we should be. But it really is a different story. It’s a story about being able to go out and acquire long life, low decline assets and actually turn that into predictable distributable cash flow. So that's really what we're all about. I think we've been pretty busy since we IPOed a couple of years ago, most of you probably know the story. We have done accretive acquisitions. We've executed pretty well. And so I think we're off to a pretty good start.

If you look at our core objectives. Firstly, we desire to deliver superior operating and financial performance. It's our belief that this doesn’t happen as most of this happens or being able to execute well, having an accountability culture and actually going out and creating value within the asset base. I think our year-to-date results speak for themselves. We have met or exceeded our guidance and have had good financial performance to date.

Second, we allocate our capital to maximize recovery and cash flow. We understand that cash flow translates to distributions. I think that's a very important aspect of the MLP strategy. Our year-to-date uplift has exceeded expectations and is above 1,200 BOEs per day. Because margin is important, we've emphasized our earlier projects, which means primarily out in the Permian basin, year-to-date.

And third, we continue to focus on strategic accretive acquisitions. We've had accretive growth through a significant drop-down as well as a third party transaction and we have another drop-down on the way, it's pretty significant. We think it will be there I think in early 2013.

We have ample liquidity today to pursue the upcoming drop-down as we all as selective third party acquisitions. So hopefully that's a good snapshot of how we're thinking about things.

Look at our asset base and some key statistics, you can see here that our reserves are up to about 88 million barrels equivalent, production for the second quarter is about 14,500 BoE's per day, we're heavily developed at over 72% reserve lies about 17 years now. We really look at the Permian and Ark-La-Tex as our two largest areas. We're also activate in the Mid-Continent and the Gulf Coast. The Permian Ark-La-Tex been our largest areas, make up 85% of our production and reserves. And our teams are very experienced in these areas where we have already acquired. We know a lot about them. We operate out here and when we're looking at transactions, we think that gives us a competitive advantage.

I did mention our commodity mix there in those key statistics as we knew we wanted to put a slide together here for you to sort of highlight this. As you can see, we're about 55% liquids on a production basis and close to 80% liquids if you include, looking at our revenue basis including hedges. So a significant liquids component to our portfolio today.

Since there's been really an intense focus on these NGLs and how that might be able to impact shill cash flow, we wanted to bring up that we've only got about 10 to 15% and how you look at that NGLs in the portfolio which is really limited as how much that can impact our distributable cash flow. We don't hedge NGLs. We do significantly hedge oil and natural gas which I'll talk about in more detail here in a minute.

And also I wanted to point out that if you keep up with NGLs that the Conway has been hit a lot harder than Mont Belvieu and we only have about 5% of our NGLs is exposed to Conway. So we think overall a pretty oily setup especially on a revenue basis.

Let`s take a look at our annual capital program and how it's shaping up. We expect our 2012 capital program will end up with about $75 to $85 million of capital spend of which we expect about 52 million of that will be maintenance capital and we have lots of good projects in our inventory which are spread out across our asset base. What that means is we have very little concentration risk which I think is if you're sitting in investor shoes, that's actually a good thing that we don't have those really large concentrations of assets that can lead to some unpredictability. So we have a lot of projects that are spread out across our portfolio.

As I mentioned earlier, our capital is going to be spend in out two largest areas, the Permian basin and the Ark-La-Tex area. We'll spend about 80% of our capital out on a Permian. As I mentioned, its clearly more oiler out there, at least it is in our portfolio. The type of projects we have going on out here are primarily infill drilling, water flood optimization and trying to find ways to enhance our water handling capability.

The Turner-Gregory which is highlighted here on this slide, the Turner-Gregory Unit has been a bright, a nice project for us. We've had some good results here to date with down spacing and instituting a water flood project. So what you can see there in the production plot is that's the response from the infill drilling as those different wells have come online and down and below in the map in you can see that it's pretty densely drilled around us. We acquired this a little over, got access to this a little over a year ago and so I think that we're beginning to see us understand the asset, doing the down space and then actually found this water flood opportunity that we didn’t pay for at the time of the acquisition.

In the Ark-La-Tex area, but one thing I also didn’t say about the Permian Basin is that, we have 65,000 net acres out here in the Permian basin. Based on what you just heard, (inaudible) talk about, there's an incredible amount of potential out here in the Permian basin and we're just now really starting to study that and try to figure out what sits underneath our acreage out here. So we will continue to look at that. A lot of what their talking about is not necessarily our MO but it could be some untapped potential in a really good basin. So we're going to look at that hard.

In the Ark-La-Tex area, we plan to spend most of our remaining capital there. The type of projects that you'll see in the Ark-La-Tex are recompletions, reactivations, artificial project. It's really boring stuff but if you add it up, it really is added into our production. It has good capital efficiency even if these gas prices were realizing some really nice returns out here in the Ark-La-Tex. There are a few areas in the Ark-La-Tex that are more oily, we're seeing some things go on around there that are very interesting to us and we have kicked off some studies also in parts of the Ark-La-Tex area that we think translates into some additional potential.

As far as the price acquisition, we're off to a good start there, integration and hiring the additional people we need, its complete. And we're now just moving into our execution and things so far are going well there.

Let`s talk about acquisitions. Sourcing and executing on accretive acquisitions is really the core of our strategy. That's how we're going to grow primarily. We're not going to always grow the drill bit; we're going to grow through doing accretive acquisitions. And if you’ve heard our story before, you'll remember the theme that we have multiple paths to grow. And we believe that our ability to do meaningful drop down acquisitions, is a significant component of how we can grow peer energy especially when you compare us to peer group.

So let`s look at our drop-down potential. Our sponsor has approximately 5,000 BOEs day, primarily oil production that what's left in the sponsor today will ultimately I think fit QRE. So we'll continue to enhance and ripen those assets so they are ready for QR energy. That's probably other than the one that I'll talk about for just a second, most of those are probably 18 to 24 months out.

But we are currently working on a drop-down that's somewhere in the neighborhood of 50% of that production and I think it's going to be a good asset for us, large oil in place and I think it will be likely occur in early 2013. And the neat thing to remember about drop-downs when it makes sense and with the right assets, that we already operate those assets today over in the sponsors. So we know a lot about the assets, it takes away a lot of the risk associated with acquiring such as integration risk and as you're doing your acquisition analysis, you just know a lot more about these drop-downs.

As to third-party market, we're already seeing a huge uptick in deal flow and I'll talk a lot more about the details on that in a minute. I think there are several things driving that but we continue to utilize our reputation about being a trusted buyer, conventional assets and this reputation of being a solid conventional buyer that's been out there in the space, we are able to get into processes more on a limited basis. We don't likely to show up and go to (inaudible). It's not what we do. And so we are very thoughtful about what other companies are going through, what their needs are and what might spin out of something that they have going on and that allows us to be proactive as we source opportunities.

I think that another unique attribute that we have is, we can partner in JV with sponsor. We like to look at larger transactions. We think that can bring us higher quality assets. We think it's actually good for both entities because what it actually does is, there are certain assets inside a deal we're looking at that may fit QRE better and may get the sponsor certain assets, make get the sponsor better. So we can combine forces or if it sort of fits both companies that run on a bubble then we can look at larger transactions which we think by utilizing the capital that QR Energy has as well as our sponsors that we can be more competitive in the marketplace and look at larger transactions.

A little bit more about the acquisition market. I think as I mentioned, you're going to see a pretty decent increase in what happens here in the second half of the year. The sellers are continuing to bring oil production to the market, there is lots of demand for oil production. We're not seeing as much natural gas properties come to the market yet. The reason I say yet is because I think with these process where they are, as banks place these companies through their bottom base cycle, you could see maybe catastrophic issues with their liquidity, you may see them feel some liquidity pressure which may be the catalyst to see some more assets come to the market on the gas side.

It's our belief that there are ample conventional assets for us to acquire. We recently took the opportunity to look at the convention, what are conventional assets contributing to the North American oil supply and this is a significant number. So I think if you go back and look at the assets have been discovered from the 20s all the way up to 2007 when the shell (ph) revolution really kicked off, there is just a ton of those conventional assets sitting in other people's inventories that aren't their priority today and I think the capital intensity of these resource plays as a big driver of why we're seeing plenty of conventional asset deal flow.

I think another thing that maybe driving the second half of the year increase in deal flow is the politics that are going on. People know that there could be a tax regime change here, so I think that especially the private sellers are looking very closely at it and you're seeing a lot of the deals are seen are coming from the profits, look, I just don't really want to mess with the capital gains, tax issue and see that potentially go up. So we're seeing more deal flow I think are going to come from the province especially.

If you look at the chart there you can see that this onshore mature asset supply market is going to run $15 to $20 billion, we've only done about 8 billion so far. We've talked to the advisors. There's a lot of deals that are in the process of closing. And as I said, I think you're going to see a lot more deal flow in the second half. So I think the point is there is still lots of deal flow for the MLPs.

Let`s talk about our hedging. We think that we have a robust hedge portfolio and that's not by chance, that's be design. As we've told you before, we're big hedgers and I think whenever we do an acquisition, we actually lock in prices, because we want to lock in those cash flows to the extent that we can. I think that's an important part of our strategy. If you look at the chart, we have a very high percentage of our future production is hedged today. More than 85% of our oil and gas is hedged through 2014 and a majority through 2017. As I mentioned, a core part of our strategy, that's why you see us hedge out as far as we do and hedge the quantity that we do early on.

Our average hedge process are pretty darn good, mid-90s to $100 range for oil over the next four years and 515 to 615 on natural gas. I think it's important to note that we are very cognizant of counter party risk and we do try to hedge with strong counter parties and have taken some steps to reduce or lower some of our risk to some of the European banks, of course not Barclays.

If you look at our hedge portfolio versus our peer group, I think this is a pretty telling slide and what you'll notice as you kind of digest this, what it tells you is that we hedge more than our peer group in the first three years but we significantly hedged more than our peer group out in 15, 16 and 17 especially on oil. So we don't try to take the crystal ball and figure out what's it's going to be out there. We just say, these look like we can make good money on these and so we go ahead and lock them in primarily with swaps we have put some colors and put some place but its primarily swaps. Again the key here is our goal is to deliver cash flow stability to our investors both now and into the future.

This is just a slide to display that we have had significant growth not only through fundamentals of our business but also in our distribution. If you look here, we increased our distribution by about 18% since the IPO which works out to about a 12% on a compounded basis. I think this statistic has made us, if you look at it, it's one of the fastest growing MLPs in the space.

So I just wanted to try to summarize here from an investor perspective, why invest in QR Energy and I think that first of all we now have some track record under our belt operationally and financially. We've got accounting is in good shape. Things have been going well there. We now do have (inaudible) eligibility which we think was an important milestone. So we're really set up now to operate the business on both sides of the ball both operationally and financially.

I think that we've delivered strong performance today and think will definitely remain a focus for us going forward. We've demonstrated our ability to do drop-downs and acquire third party assets which has resulted as you can see there significant production growth of almost 200% and reserve growth in the same range and as I mentioned, 18% distribution growth and we're on our way to getting another drop down done as I mentioned likely in early 2013.

I think that we're going to continue with our liquidity to look at some selective third party deals. We think we're at a position here where we can be very selective. There is a lot of deal flow in the market. That actually works to our advantage as that will ultimately mean less competition. Sometimes in our space you get so limited a deal flow that everyone's focused on each little deal that comes out, the more deal flow that's out there, that actually works out a positive for us, because that means everyone will be looking at different opportunities, we'll be very selective. Again, we'll be within our core areas and we'll stay very focused on what the right asset mix is which is again a more mature legacy type assets, lower decline, mature assets. That's what we want to own that have plenty of inventory but its lower risk inventory and again, it's not going to be real sexy. So we have the flexibility there to look at that, we have plenty of liquidity to also look at third party deals.

So we're currently trading at an attractive yield, if you've kept up with us. We think that creates an interesting opportunity for our investors to get a very robust yield while also preserving the right to get some real capital appreciation as we continue to perform. So that's really all the comments that I had today. I'd be glad to take a few questions.

Question-and-Answer Session

Unidentified Analyst

Can you talk about the financing for acquisitions and how you think about the balance sheet and debt metrics and proper mix between equity and debt for the type of deals you're looking at?

Alan Smith

Sure. So this is as I mentioned, we desired to keep a pretty conservative balance sheet. So when we go out and find opportunities, we're typically looking at somewhere in the neighborhood 40% debt that we would put on in particular acquisition. We're also very focused on what the debt-to-EBITDA would ultimately, what would that to do our overall covenants and so we've been able to so far keep that under three to around three which would I think overall longer term, it's probably best to talk about this, but that would be our target and you may see times that we can do the right kind of opportunities where you might temporarily go above three but you'd stay at about four, I think at the end of the day. So I think it’s a conservative model and the type of assets we're buying, having a significant PDP (ph) component to them, which means if we hedge that, we can get a significant borrowing base on that and as you guys know, we did do a high yield offering and we really wanted access from the balance sheet perspective to all the tools in the tool kit. So been able to issue equity, be able to utilize our senior bank facility as well as have a high yield facility there or a high yield market that we've already been to that we can access given the right opportunity.

Unidentified Analyst

I think sometime in early '13 your G&A expense share with the sponsor changes, how will that impact distribution coverages going forward?

Alan Smith

Well so back in May with the Omnibus agreement that was put in place at the IPO had a G&A fee basically that was paid by QR Energy to the sponsor and what he's alluding to, that goes away at the end of this year and QRE will have to pick up its fair share. So I think the key thing to point out there, I can't say exactly how it's going to work yet. Its currently in the works, but it will be an allocation of what's going on with the assets and how much time it takes for our employees to work those assets.

Currently if you follow our financials that you will see that we've been forced by our auditors to utilize the GAAP standard on that and what I can tell you is that probably won't be the number but that's not a bad start, if you’ve got to start somewhere, we'll get that all worked out. Our hope is to get that to you before the end of the year. I think we will do that so that you can understand better what it ultimate means. We certainly have planned it for all along. It's no surprise to us and we don't really guide to our distribution coverage ratios. We do point out that we like to be in a one-two range, longer term and I think you have to think about where we are today if you're modeling it, assuming that we do have another drop-down coming, we feel like we're in pretty good shape with regard to our distributable cash flow in our coverage ratio.

Unidentified Analyst

Alan in one of the question you talked about dropping down plus or minus 50% of the 5,000 BOE of production that the parent owns, can you talk at all about the time line or the other 50% plus or minus when that may fit QRE or whether it will fit QRE in the next couple of years?

Alan Smith

Sure, so the balance of that production, the goal that we have is something sitting over on the sponsor side, that the key difference in our investment criteria between the sponsor side and QR Energy is the sponsor likes to buy things that have a higher undeveloped component and they are comfortable spinning a little bit more maintenance capital to keep the production flat and with a desire to ultimately grow that production. So with that thought, these assets that are sitting inside of the sponsor today, we're always going to try to maximize the value of those assets as well as they'll always to try to do that as well as gift them what I call MLP ready.

We use the term, they've got to get it right. They need to get to the point where there is not a big, if there's been some drilling, there is not a big decline that you're going to inherit, if they were to drop down or if something that's going to skew our maintenance capital the wrong way. So those assets need to become right and whenever they are ready then we are ready to drop them down and we understood that the guys over at QR understand very well how those assets are performing and the capital that they are going to need over the next 12 months and so I think that based on what we most recently reviewed, I am going to stick with, it's probably over the next 18 to 24 months that those assets will be ready to drop down.

Unidentified Analyst

With the 40% debt component and deal flow, what's the goal for acquisitions per year that you’ve kind of envisioned for QR going forward? How many acquisitions you expect to do it? What size? And the total amount per year.

Alan Smith

So I have been doing this a long time. So my background is acquired exploit strategy that's really what I have done for 25 years and one of the things I have learnt from doing that is its really, really hard to predict, some years you're obviously going to be able to find more opportunities to really want to do and other years may not find exactly what you're looking for. So it's really hard to predict how many deals or what size will actually come to the market that we can go do that we like. What I will tell you is that we are focused on having access to the liquidity to be able to do those type of opportunities that make a lot of sense for us and as I just described a few minutes ago, we wanted to access all the different tools in the tool kit if you will, to be able to do that.

I think our sweet spot for doing deals probably ranges somewhere between $150 and $300 million, that is what we think about and we could go on to the north end of that because of the financial flexibility we're trying to build into this and I think with the yields that we're at today, we think our performance is going to ultimately, as we've already had in the past, is going to ultimately went out over time and I think as that happens, we'll be set out to be able to access multiple pass of capital to get deals done. But I think we're very optimistic. We won't look at something that puts us way out of our comfort zone. But we don't waste our time on a lot of really small deals too either because they take just as much time as a larger deal and usually our belief is that if you're looking at those larger deals, you're going to get access to higher quality assets because if someone is selling the bottom of their 80/20 list then we think you're going to get better quality by going at the larger deals because they are going to have to move further up into their list to make those divestitures, so that's sort of how we think about it.

Unidentified Analyst

Alan, I would like to thank you for being here today for the presentation.

Alan Smith


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