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E&P Budget Cuts All Around -- Except at Southwestern Energy

Tight credit markets and uncertain forecasts for 2009 led more oil and natural gas producers last week to announce drastic reductions in their 2009 capital expenditure (capex) plans. That is, except for a notable exception: Southwestern Energy Co.

Unlike most of its peers to date, Southwestern last week announced it would increase its 2009 planned capex by half a billion dollars, laying out a $2 billion plan that is well ahead of this year's $1.5 billion program. Most of the money, $1.5 billion, would be directed toward the Fayetteville Shale in Arkansas, where Southwestern is one of the leading leaseholders and producers. It also expects to drill 10 more wells than it had scheduled for 2008.

"2008 has been an incredible year for Southwestern Energy," said CEO Harold M. Korell. "We have seen significant improvements in our well performance in the Fayetteville Shale over the past several quarters, resulting in remarkable growth in our production levels and, correspondingly, our earnings and cash flow."

Times are tough all over, he said, but Southwestern is ready for the challenges ahead.

"The turbulent times in the financial and commodity markets are having a considerable impact on both the national economy and our industry," said the CEO. "As a result, we will enter 2009 with both caution and optimism. We believe the future for Southwestern is very bright and that 2009 will be another record year for our company. The company is well positioned with an extremely strong balance sheet and financial position and an opportunity set that rivals any in our industry with our Fayetteville Shale play."

Southwestern is sticking with its plans to operate 20-21 rigs in the Fayetteville play next year, and it wants to drill around 620 horizontal wells (470 operated), compared with an estimated 520 wells in 2008.

Combining all of its onshore gas-prone plays, Southwestern is forecasting 2009 production of 280-284 Bcfe, which is 48% more than this year. In total, the company plans to drill around 720 wells in 2009, which is 10 more wells that it estimated for this year.

The current financial position and balance sheet "are in excellent shape as we enter 2009," Korell noted. Next year's capex is to be funded through a combination of increased cash flow, more than $200 million of cash on hand and "modest" borrowings under a $1 billion revolving credit facility. And the long-term debt-to-total capitalization ratio "will be little changed from year-end 2008," ranging between 24% and 26% by the end of 2009.

"While we understand that these are uncertain times, our low cost operations, our track record of improving performance in the Fayetteville and our financial flexibility will allow us to add significant value for our shareholders," said Korell.

Most of the capex is targeted for Arkansas, but Southwestern also plans to maintain an "active" program in its other onshore plays, which include the Arkoma Basin, East Texas and Marcellus Shale, "yet at reduced levels compared to 2008."

Energy analysts were enthusiastic about Southwestern's plans.

"Production growth in 2009 should average 48%, higher than our estimate of 41%," and "we believe, it is very manageable, with the current balance sheet strength," wrote FBR Capital Markets' Amir Arif and Mitesh Thakkar. The balance sheet, they said, "remains in good position. Based on our $5/Mcf Henry Hub gas price and the company's 48% hedged position, we estimate that operating cash flow will be $1.36 billion...The long-term upside "could be very significant."

SunTrust Robinson Humphrey/the Gerdes Group (STRH) analysts said the news from Southwestern implies an "almost 20% increase in fair value." STRH increased its production forecast for Southwestern by 6% to 284 Bcfe, and said that the company's ability to maintain its 20-plus rig count in the Fayetteville Shale "exemplifies the company's drilling efficiency increases."

For now, Southwestern appears to be one of the few that views 2009 with cautious optimism. Barclays Capital analysts said last week that worldwide, producers will reverse the six-year trend of rising budgets and will cut 2009 spending by 12% from this year's levels to around $400 billion. U.S. spending is expected to show the sharpest declines, dropping 26% to $79 billion from 2008's $106 billion.

"However," said the Barclays team," it is important to note that given the fluid economic conditions and volatility in oil and gas pricing, operators are continuing to revise budgets and the spending cuts could be understated."

Chesapeake Energy Corp. already has announced it would cut spending next year by about half (see NGI, Dec. 15). Barclays also expects to see big spending cuts by other gas producers, including Devon Energy Corp. (44%) and EOG Resources Inc. (34%). U.S. spending by ExxonMobil Corp. is seen dropping 17% to around $450 million.

Citing "uncertainties" in the marketplace ConocoPhillips and Devon both said last week that they will delay revealing 2009 capex plans until the new year. Oklahoma City-based Devon will announced its plans in conjunction with the disclosure of 2008 results. ConocoPhillips will postpone its results to January.

"With the markets experiencing so much volatility, we have chosen to see how conditions continue to evolve before we announce our 2009 capital plans," said Devon President John Richels. "Although we are not yet ready to announce our 2009 budget, we intend to roughly match our capital expenditures to cash flow. This will result in decreased activity as compared to 2008. However, we will remain flexible as the year unfolds and modify our capital investments accordingly."

Natural gas explorer SandRidge Energy Inc. last week reduced its capex to $500 million, down from an early October guidance of $2 billion. It plans to cut its U.S. onshore rig count to 12 by the end of the month, down from 47 rigs in September. The Oklahoma City-based independent said the revised budget would allow it to operate "within its cash resources and increase production by 10% over expected 2008 production."

"During the fourth quarter, we have reduced our planned 2009 capital expenditures from $2 billion to the current $500 million in response to the weak commodity and economic environment," said SandRidge CEO Tom Ward. He noted that "even with a reduction of our capex to $500 million, we can grow our production by 10%" in 2009 from 2008.

SandRidge explores and develops leaseholds in the gas-prone Cotton Valley Trend in East Texas and in the West Texas Overthrust.

Houston-based Mariner Energy Inc.'s 2009 capital budget of $431 million is 70% less than this year's spending plan. However, CEO Scott D. Josey said that if commodity prices rise and industry costs fall, more money could be allocated for exploration and development.

Despite spending cuts, Josey told energy analysts during a conference call that the company is still forecasting production growth of around 20% and "significant" cash flow. Because Mariner has "minimal leasehold commitments" and because it operates most of its properties, the company has more discretion over its capital spending Josey said.

In the Gulf of Mexico, Mariner's budget includes the start-up of production at new fields and a diverse exploration program to test several "high-potential prospects," he said. Capital spending in the Permian Basin will focus on the delineation of recent discoveries and infill development drilling activities. The budget is based on oil prices of $55/bbl and natural gas prices of $6/MMBtu. Full-year 2009 production is forecast to range from 135 Bcfe to 150 Bcfe.

Mariner typically runs its price forecast at $55/bbl oil and $7/Mcf gas, he said. "In the deepwater, the prospects there still work in this [price] environment because these are significant prospects that we are drilling. On the shelf, most of the work is recompletion work, and we do it with boats, and for the most part we do not need a rig, so there are very quick payouts. All of the shelf prospects...even at the lower commodity price forecast, we still generate good economics."

Onshore, however, "we believe the cost there needs to be reset, which is why we're going to slow down our activity there," he said. In the Permian Basin leasehold, "we need to see commodity prices improve or the cost structure to come down."

By reducing its spending in the coming year, Mariner is "running the risk of slowing growth," Josey acknowledged. However, everything Mariner is planning for 2009 "is consistent with the things we've done in the past. We've always strived to live within our means."

Meanwhile, onshore gas explorer Edge Petroleum Corp. and privately held Chaparral Energy Inc. Wednesday scuttled a merger plan citing "no reasonable expectation" that financing could be completed by the Dec. 31 deadline. The majority owner of Chaparral is co-founder Mark Fischer; Chesapeake purchased a 32% stake in the company in 2006.

Under the merger agreement announced in July, Oklahoma City-based Chaparral had planned a reverse merger in which it would buy Edge and become a public company (see NGI, July 21). The agreement hinged on successfully refinancing Chaparral's existing borrowing base revolver to $1 billion from $600 million, as well as selling stock through a $150 million equity infusion from Magnetar Financial LLC, a private equity firm.

With the merger canceled, Edge Wednesday said it would work to repay "any borrowing base deficiency, to the extent it is able to do so, using a combination of cash on hand, adjustments to future capital spending, and potential cash proceeds from any transactions consummated as a result of Edge's strategic alternative review process. However, there can be no assurance that any of these alternative methods of repaying any borrowing base deficiency will be attainable, especially in light of current conditions in the financial and credit markets and the oil and gas industry."

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