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SM Energy Making Permian Priority, Restarting Eagle Ford Drilling in Q1

Denver-based SM Energy Co. said Wednesday it plans to focus most of its capital on the Permian Basin as it digests acquisitions there. Plans for the first quarter include restarting drilling in the Eagle Ford Shale, where production declined during the third quarter.

"Following completion of both our Rock Oil [see Shale DailyAug. 8] and QStar [see Shale DailyOct. 18] acquisitions in the Midland Basin, totaling $2.6 billion, and several noncore property divestitures totaling $980 million in gross proceeds, we will be focused on oil production from our pro forma 83,750 net acre position in the Midland Basin and natural gas/NGL [natural gas liquids] production from our operated 161,475 net acre position in the Eagle Ford," CEO Jay Ottoson said.

"Our operations team is quickly integrating activities on our acreage acquired from Rock Oil, actively incorporating learnings from completion improvement and downspacing tests, and continuing to trade and bolt on acreage across our positions to enable the drilling of longer lateral wells. We are executing our due diligence on QStar and closely monitoring field operations where early rates on a recent 9,700-foot well look terrific.

"We are keenly focused on bringing value forward in the Permian Basin, and our continued improvements in well performance and the potential to increase long lateral inventory are key drivers of value creation."

Company-wide third quarter production of 14.2 million boe, or 153,880 boe/d, was 31% oil, 25% NGLs and 44% natural gas. Production was down 12% compared with the third quarter of 2015, primarily due to decreased activity in the Eagle Ford, and down about 1% compared to the second quarter of 2016, as expected declines in Eagle Ford natural gas production as well as an early closing on the New Mexico divestiture were largely offset by increased oil production from the Permian and Williston basins.

Realized prices in the third quarter averaged $23.25/boe (before the effect of commodity derivatives). The average realized price was up 2% compared with the third quarter of 2015, primarily due to a higher oil component in the commodity mix and improved NGL prices, and up 14% compared to the second quarter of 2016, predominantly due to a 44% increase in benchmark natural gas prices.

During the third quarter, the company drilled 16 gross/16 net operated wells and completed 63 gross/61 net operated wells. The drilled and uncompleted (DUC) inventory at the end of September was 82 gross/79 net operated wells plus 27 net nonoperated wells.

Third quarter Permian net production was 986,000 boe (10,700 boe/d) and was 74% oil. Production increased 16% sequentially with activity that included drilling seven net wells and completing nine net wells.

Since the end of the quarter, SM Energy completed the acquisition of more than 26,000 net acres in Howard County, TX, for $991 million and announced agreements to acquire an additional 35,700 net acres in Howard and Martin counties for $1.6 billion. The second set of transactions is expected to close in December and is expected to result in expanding the total Midland sub-basin position from 21,975 net acres at the end of the second quarter to 83,750 net acres by year-end. The company added a third rig to its Permian program with the close of the first acquisition and anticipates running four rigs by year-end.

SM Energy is gearing up for increased activity in the Permian with integration of the acquired Rock Oil assets. The company also has its employees monitoring operations on the QStar assets where drilling recently commenced on a three-well pad. QStar recently completed a 9,700-foot lateral well with an average 14-day production rate of 1,830 boe/d.

At Sweetie Peck, the company is conducting downspacing tests to about 400 feet in the Wolfcamp B and Lower Spraberry. Across the basin, the company continues to bolt on adjacent acreage positions, including nearly 1,300 net acres adjacent to the original Rock Oil position since the announcement of the acquisition, as well as negotiate trades with neighboring operators to maximize the potential for drilling 10,000-foot laterals.

SM Energy plans to primarily focus its capital program on the Permian. A budget for next year is yet to be determined.

Third quarter Eagle Ford net production was 10.4 million boe (113,400 boe/d), of which 8.0 million boe was operated and 2.5 million boe was third party-operated. Consistent with an earlier forecast, production declined about 4.9% sequentially related to declining natural gas volumes. During the quarter, the company drilled three wells and completed 25 wells in the area. New completions were located in higher oil/lower natural gas areas.

SM Energy said it expects to restart drilling activity in its operated Eagle Ford program in the first quarter and continue completing DUCs during the fourth quarter. The company continues to employ co-development of the Lower and Upper Eagle Ford formations along with drilling longer laterals and enhanced completion designs.

The company is in the process of marketing its third party-operated Eagle Ford assets, including its ownership interest in related midstream assets, and anticipates completing a sale in the first quarter.

Third quarter Rocky Mountain net production was 2.7 million boe (29,800 boe/d) and was 81% oil. The Rocky Mountain region includes Williston Basin and Powder River Basin assets. Regional production from only Divide County, ND, was about 0.9 million boe (9,350 boe/d). During the quarter, SM Energy drilled five net wells and completed 26 net wells in Divide County. The majority of newly completed wells experienced delayed initial production resulting from downtime while pumping units were installed. The company is currently operating one rig in the Willisto.

Fourth quarter of 2016 production is expected to range between 13.3 million boe and 14.0 million boe.

SM Energy reported a third quarter net loss of $40.9 million (minus 52 cents/share) compared with net income of $3.1 million (5 cents) in the third quarter of 2015. The decline was primarily due to significantly higher cash and noncash derivative gains in the year-ago period, partially offset by lower impairment expense, higher gain on divestiture activity and lower depletion, depreciation and amortization expenses, each in the 2016 period. In addition, interest expense in the third quarter of 2016 included a one-time cash charge of $10 million for a committed second lien facility, in conjunction with the announcement of the acquisition of assets from Rock Oil Holdings LLC, that the company did not use and ultimately terminated.

The adjusted net loss for the third quarter was $29 million (minus 37 cents/share) compared with an adjusted net loss of $23.3 million (minus 34 cents) in the year-ago quarter.

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