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Southwestern's Fayetteville Shale Output Climbs 71%

Southwestern Energy Corp.'s share price soared in heavy trading Friday after the producer's better-than-expected 1Q2008 profit and natural gas production topped Wall Street forecasts. Lifted by the Fayetteville Shale, gas-heavy production jumped 71% from a year earlier -- "crushing expectations," a UBS analyst wrote.

The Houston-based independent was trading up around 18% a share ($6.66) at $44.25 Friday afternoon after opening at $40.28. More than 9.65 million shares had traded hands before 3 p.m. EDT; average daily volume in the past three months has been around 5.6 million shares.

Net profit in the first three months more than doubled to $109 million (31 cents/share) from $51 million (15 cents) in 1Q2007. Results are restated for a two-for-one stock split in March. Energy analysts polled by Thomson Financial had pegged profit at 25 cents/share. Operating revenue climbed 84% to $524 million from $285 million, and gas sales rose 70% to $361 million.

"We had a very active and productive first quarter," CEO Harold M. Korell told analysts during a conference call Friday. "Our results in the Fayetteville Shale continue to improve, resulting in strong growth in our production volumes. Gross operated production from the Fayetteville Shale reached approximately 400 MMcf/d on April 14, up from approximately 155 MMcf/d a year ago. We have also begun to see the impact of our James Lime activity in East Texas."

Southwestern's natural gas and crude oil production totaled 39.1 Bcfe in 1Q2008, compared with 22.9 Bcfe for the same period of 2007. The increase primarily resulted from increased production from the Fayetteville Shale, which totaled 23.6 Bcf in the quarter, up from 8.2 Bcf in 1Q2007. On the increase, Southwestern revised its production guidance for 2Q2008 to 41.5-42.5 Bcfe (up from 36-37 Bcfe).

Average realized gas prices rose to $7.70/Mcf, including the effect of hedges, compared with $6.71/Mcf a year ago. Commodity hedging activities increased Southwestern's average gas price by 24 cents/Mcf, compared with 52 cents in 1Q2007. Disregarding the impact of commodity price hedges, the company's average price received for gas production in the first three months of 2008 was 57 cents lower than average New York Mercantile Exchange spot prices.

Southwestern invested $376.5 million in its exploration and production (E&P) program in the first three months, up around $75 million from a year ago. The company participated in drilling 169 wells, with 52 successful, 115 still in progress and two dry wells -- a 96% success rate. Total capital investments for 2008 are projected to be $1.46 billion, with $1.33 billion set aside for the E&P segment.

Most of the E&P budget was directed at the Fayetteville Shale play, where Southwestern spent $285 million and where it placed 76 operated horizontal wells on production across its 907,000 net acres. Through the end of 1Q2008, the company said it has drilled and completed a total of 557 operated wells in the play, including 493 horizontal wells. Of the horizontal wells, 446 wells used a combination of fractured stimulation techniques. By mid-April gross operated production rate from the play was 400 MMcf/d, including 11 MMcf/d from 12 wells producing from conventional reservoirs. Net production was 295 MMcf/d.

Late last year Southwestern launched a project to demonstrate the benefits of a full-scale development strategy in a four-square mile area of its Southeast Rainbow pilot area in Conway County, AR. By April 15 the producer had spud 22 wells in the area, 21 of which were drilled to total depth and all of which were drilled on multi-well pads. "Of the 21 wells drilled to total depth, the average well spacing was 100 acres and the average completed lateral length was 3,100 feet," the company stated. "At this time, 14 wells have been fracture stimulated," and "of these 14 wells, 10 wells have been production tested at an average rate of 2.6 MMcf/d and four are shut-in waiting on additional compression capacity that is currently being installed."

The cost to drill and complete the 10 pilot wells was about $2.6 million/well; by comparison, offset wells within a two-mile radius of the pilot project had an average initial production rate of 2.4 MMcf/d and an averaged completed well cost of $2.8 million/well. The rest of the pilot wells will be fracture stimulated and placed on production by the end of June, the company said, and the pilot area results will be used to determine finding and development costs on a full-scale development basis, optimal well spacing and recoveries, benefits of longer laterals, benefits of simul-fracing, optimal infrastructure designs and other improvements and efficiencies.

The Fayetteville Shale is not Southwestern's only ace in the portfolio. A conventional drilling program is under way in the Arkoma Basin, and production was 5.9 Bcf in the quarter, slightly up from the 5.5 Bcf in 1Q2007. In East Texas, production jumped to 8.1 Bcfe, compared with 7.6 Bcfe a year earlier.

What piqued analysts' interests during the conference call Friday was Southwestern's Angelina River trend, which spreads across four East Texas counties. There Southwestern is targeting both the Travis Peak and James Lime formations. Twelve wells were drilled in the trend in the first three months; the James Lime's four operated wells had gross initial production rates ranging from 5 MMcf/d to 14.4 MMcf/d. Southwestern's current net output from the James Lime is around 12 MMcf/d from five nonoperated wells. Because of its James Lime success to date, the company plans to participate in 21 net wells in its Angelina River trend this year.

In addition, the re-emerging Marcellus Shale in the Appalachian Basin is one of Southwestern's "new ventures," but Korell and his management staff were hesitant to disclose too much on the conference call. Southwestern has about 100,000 net undeveloped acres in Pennsylvania, and it has drilled and is currently completing its first vertical well on the acreage. At least two more test wells are planned in the play this year.

In a note to clients UBS said Southwestern's report was strong enough to prompt the banker to raise its 2008 production growth target to 53% from 37%.

Friedman, Billings, Ramsey & Co. Inc. (FBR) analysts said the early East Texas results "show promising upside. FBR maintained its "outperform" rating and said that "in the coming 12 months, the key driver left for price appreciation is improvements in new well results, which are still being achieved and should further improve next quarter with multi well pad drilling results."

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