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Fayetteville Leader Grows Production 50% Since May 1

Houston-based Southwestern Energy Co. said that gross production from its Fayetteville Shale play has now reached 30 MMcf/d, up from 20 MMcf/d on May 1. The company said the production increase is due to several factors, including the recent delivery of more drilling rigs, an increase in well completion service resources and generally improving well results.

"The delivery of our fourth company-owned rig brings our operated rig count to 10 and the recent availability of additional fracture stimulation equipment and crews is allowing for an increased pace of development," said CEO Harold Korell.

Southwestern is by far the dominant player in the Fayetteville Shale. Others active in the play are Chesapeake Energy, Edge Petroleum, Noble Energy, XTO Energy, KCS Energy [to be acquired by Petrohawk Energy Corp. (see NGI, April 24)], Maverick Oil & Gas, privately held Hallwood Petroleum LLC, Contango Oil & Gas Co., and Shell, the first major to enter the play (see NGI, Jan. 23).

According to Arkansas Oil & Gas Commission and company data gathered by RBC Capital Markets, Southwestern leads the pack with 79 completions in the Fayetteville and 175 completions and permits total. Chesapeake and XTO each have three completions with total completions and permits of 17 and 4, respectively.

As of June 12, the average initial test rate for 35 of 37 completed Southwestern horizontal wells, excluding two horizontal wells that had mechanical problems, is 2 MMcf/d.

Recent horizontal wells completed with slickwater fracture stimulation are displaying shallower initial decline rates, potentially pointing toward higher estimated ultimate recoveries than wells stimulated with nitrogen foam. Costs of recently completed slickwater horizontal wells have averaged approximately $2.1 million per well.

"We know that the initial rate reported for each well is not necessarily the best indication of future performance," RBC said in a research note May 9. "...[T]he slickwater frac wells seem to have lower IP [initial production] rates than other horizontal wells but may be better producers over time. However, the IP rate is the earliest indicator of the possible success or failure of a well and the IP rates likely have to be reasonably high to meet or exceed the 1.3 to 1.5 Bcfe type curves that SWN has modeled."

Southwestern said that, while service costs continue to rise, it has been able to mitigate that through the utilization of a surface hole drilling program and increased efficiencies from its new built-for-purpose drilling rigs.

"There has been considerable recent discussion in the investment community about well costs in the play" (see NGI, June 12), said Korell. "Our competitive well costs, when compared to other operators in the play, can be attributed to more efficient drilling equipment, lower costs associated with operating our own rigs, shallower wells, varying lateral lengths and, we believe, generally being further along the learning curve."

Still, it takes money to progress along that learning curve, noted Raymond James & Associates Inc. in a research note on the company published last week. "Costs of recently completed slickwater [frac] wells averaged $2.1 million versus $1.8 million as of May 1, reflecting the company's experimentation with varying levels of frac treatment," Raymond James said. "We expect Southwestern's costs per well to decline once the company determines an optimal frac technique, outgrows the typical learning curve, and benefits from subsequent economies of scale."

Raymond James also said it is lowering its second quarter earnings estimate to 19 cents/share, reflecting a modest reduction in volumes for the quarter. "Although we acknowledge the market's favorable response to Southwestern's positive update, we continue to view SWN shares conservatively until we see more data points from the Fayetteville and other operated areas."

Friedman Billings Ramsey (FBR) said last week it would hold its "outperform" rating on Southwestern and $52/share price target. "We continue to believe that the company provides long-term value and that a significant portion of the risk embedded in the Fayetteville Shale will be reduced in 2006; but we remain cautious regarding the macro environment over the next 30 days until some of the natural gas overhang is removed during summer." FBR also said it expects well costs to decline. "We expect the company to be able to lower the drilling costs once the play evolves from an experimentation mode to a manufacturing mode."

Southwestern currently has 10 drilling rigs running in its Fayetteville Shale play area, eight of which are capable of drilling horizontal wells, and two smaller rigs are being used to drill the vertical section of the horizontal wells. Four of the 10 new drilling rigs that the company contracted to buy in 2005 have been delivered and are drilling. Southwestern recently entered into an agreement to purchase one additional rig capable of drilling horizontal wells and entered into agreements to fabricate two smaller rigs which will be used to drill the vertical section of its horizontal wells.

The company expects to have 18 to 19 rigs drilling in the play area by year-end 2006, 15 of which will be capable of drilling horizontal wells. Delays in rig deliveries in late 2005 and early 2006 slowed the pace of Southwestern's drilling program in the first half of the year. While the company still expects to drill 175 to 200 wells in the Fayetteville Shale play area in 2006, the earlier delays in rig deliveries have impacted the company's second quarter production, which is currently forecasted to be approximately 16.5 Bcfe. However, Southwestern's oil and gas production guidance for calendar year 2006 remains unchanged at 74 to 76 Bcfe, an increase of 21% to 25% over its 2005 production.

Southwestern expects to continue to evaluate its large acreage position in the Fayetteville Shale play by testing an additional 17 to 22 pilot areas during the remainder of 2006, which includes testing four to six additional pilot areas by the end of July.

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