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Southwestern's Appalachian Output Soars But Price Slump Forces $1.7B in Impairments

Southwestern Energy Co. demonstrated in 3Q2015 why -- even as prices remain in the dumps -- it remains a consistently successful operator in the onshore by delivering record production from Appalachia and better wells from the legacy Fayetteville Shale.

The Houston-based exploration and production (E&P) company reported net losses in the quarter of $1.766 billion (minus $4.62/share), versus profits of $211 million (60 cents) a year ago. The $1.746 billion in impairments for natural gas and oil properties accounted for almost all of the losses. Adjusted net income was $77 million (1 cent/share), versus $616 million (50 cents) a year ago. Operating revenues declined to $749 million from $928 million.

Production, still gas-weighted, was 249 Bcfe, 27% higher year/year. Gas output rose to 228 Bcf from 196 Bcf. The turn to gathering more oil and liquids, however, was evident, as oil production increased to 562,000 bbl from 51,000 bbl, while natural gas liquids (NGL) jumped to 3.03 million bbl from 11,000 bbl. In the midstream segment, volumes marketed increased to 288 Bcfe from 229 Bcfe, while volumes gathered declined to 186 Bcfe from 247 Bcfe.

"We once again delivered excellent operational results while managing through the challenging commodity price environment," CEO Steve Mueller said Friday during a conference call. He said the decision to bolt on Chesapeake Energy Corp.'s acreage in Appalachia last year has proven to be a solid one (see Shale DailyOct. 16, 2014). Already, the wells in West Virginia are performing better than the acquisition analysis, while the northeastern acreage in Pennsylvania reported double-digit gains.

"Our acquired acreage in Southwest Appalachia continues to provide exciting results, which we feel only scratches the surface of its potential considering we have been operating these assets for less than 10 months," Mueller said.

Total Appalachia production in 3Q2015 was 130 Bcfe, composed of a 41% increase to 93 Bcf from Northeast Appalachia and 37 Bcfe from Southwest Appalachia. Fayetteville production declined to 118 Bcf from 126 Bcf, but fewer wells were drilled and they still produced more than legacy assets.

Southwestern's forte is operational efficiency as it focuses on combining technology and continuing to experiment. Bringing costs down while keeping production higher proved to be a winning strategy again.

In northeastern Appalachia, Southwestern placed 26 wells on production during 3Q2015 with operated output of 1,237 MMcf/d gross. The average initial production (IP) rate on 19 wells over 30 days was 5,752 Mcf/d. Average lateral length was 5,512 feet, with costs per well about $5.6 million. That compares to 2Q2015, when the average IPs were 6,594 Mcf/d on 21 wells with average laterals of 5,853 feet and costs of $6.8 million/well. Drill times fell sequentially to eight days from nine.

Southwestern's northeastern Pennsylvania drilled portfolio at the end of September included 137 wells in Bradford County, 231 in Susquehanna County, 25 in Lycoming County and 131 other wells put on production within the last 18 months.

"The pressure drawdown in the reservoir, hence the production rates from all of our wells in Northeast Appalachia, are managed to maximize the ultimate recovery from the wells," COO Bill Way said. "The impact of this program is exhibited in all of the curves with the relatively flat production for the first 365 days before the wells begin normal declines."

Southwestern "continues to improve its completion design and the performance history from the most recent wells is beginning to reflect these improvements."

The company also made progress to prove up the northern part of its acquired acreage in Tioga County, PA. The Kohler 2H, a 4,000-foot lateral well drilled and completed by Chesapeake in 2012, during 3Q2015 had a constant rate flow test of 5 MMcf/d for two weeks with minimal bottom hole pressure drawdown.

Including the Lepley 6H well, which tested in 2Q2015 also at a 5 MMcf/d rate for two weeks from only 1,822 feet of the lateral, Southwestern's 29,000 net acres in Tioga County now have been derisked.

"Infrastructure development has been initiated and this acreage will be drilled beginning in 2016," Way said. Southwestern also is looking for a joint venture partner to work in Tioga County to help fund the program.

Delineation continued as well in Susquehanna County, with the Colwell North 3H, the farthest eastern extension well in the county, flowing at an IP rate of more than 4 MMcf/d without compression. Compression is expected to be added by the end of the year.

"Even with limited data from this well during flowback, the eastern extent of our acreage in Susquehanna County looks even more encouraging," Way said.

In the 10 months Southwestern has been working in Southwest Appalachia, the company has set several records, including longest completed lateral, most proppant in a single well, most pounds of sand per foot and most stages per well, Way said. Sixteen wells were drilled in the quarter, with average lateral lengths of 6,376 feet and time to drill to total depth of 18 days. Five wells were placed to sales.

"Compared to historical offsets, the company is achieving better results by drilling in a tighter target interval, enhancing the completion design and utilizing pressure drawdown management," Way said.

For example, he pointed to three wells on the Charles Frye pad that were placed on production in 3Q2015. They were drilled "100% in the target landing interval and were completed with over 2,000 pounds of sand per foot."

The amount of proppant used on the three wells represented an increase of more than 55% from the average of the offset wells. Normalized for lateral length, the average estimated ultimate recovery per lateral foot was 54% higher than the offset wells previously drilled and completed by Chesapeake.

Southwestern also recently spud its first Utica Shale well in Marshall County, WV, which is expected to be completed late this year and placed on production in early 2016. Additional Utica wells are anticipated as part of the 2016 drilling program, with the number and location of these wells to be finalized as part of the still-in-flux budget process.

Within the E&P segment, low commodity prices resulted in an operating loss of $71 million, versus year-ago income of $189 million. Commodity price declines hit Southwestern across the board, with average realized gas prices (with hedges) falling to $2.12 Mcf from $3.43 and without hedges to $1.77 from $3.21. Average oil prices declined to $33.40/bbl from $97.71, while NGL prices fell to $4.72 from $35.57.

And danger still is lurking from the basis differentials in Appalachia, Mueller said. Like most producers, the company typically sells its gas at a discount to New York Mercantile Exchange (Nymex) settlement prices, which includes a basis differential, third-party transportation charges and fuel charges. Disregarding the impact of hedges, the average price received for gas production was about $1.00/Mcf lower in 3Q2015 than average Nymex settlement prices, versus 85 cents/Mcf lower in 3Q2014.

At the end of 3Q2015, Southwestern had protected 82 Bcf of its remaining 2015 expected production "from the potential of widening basis differentials" by hedging and sales at an average basis differential to Nymex of about minus 17 cents/Mcf.

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