Fayetteville Shale-focused producer Southwestern Energy Co. has decided to wait out low natural gas and oil prices and will cut more rigs and more money, the CEO said Tuesday. The news came after the producer reported that it more than doubled its gas and oil production in 1Q2009 from a year ago.

Southwestern, one of the first movers in the Arkansas shale and a technological dynamo when it comes to directional drilling, “had a very productive first quarter, despite the effects of the recent decline in natural gas prices,” CEO Harold M. Korell told energy analysts during a conference call Tuesday. “Our production from the Fayetteville Shale continues to climb as we move up the learning curve in the play.”

The company’s gross operated production from the play reached 850 MMcf/d at the end of March, compared with around 400 MMcf/d at this time last year, Korell said. Total gas and crude oil output for the period was 63.9 Bcfe, which was 64% higher than in 1Q2008 when the company produced 39.1 Bcfe. In 1Q2009 the Fayetteville Shale’s output contributed to 50.2 Bcf of output versus 23.6 Bcf in 1Q2008.

“While we feel confident that natural gas prices will be higher for the longer term, the price of gas has fallen approximately 35% from year-end 2008, thus causing a noncash impairment of our oil and gas properties,” said the CEO. “As a result of the continuing low commodity price environment, we are reducing our planned capital program for 2009 by an additional $100 million down to $1.8 billion, which is approximately flat with our 2008 capital investments. The important thing to know is that commodity prices move in cycles, and with the decreased drilling activity in our industry we are now positioned for an upturn in commodity prices.”

The company currently has 19 drilling rigs running in its Fayetteville Shale play area, 15 that are capable of drilling horizontal wells and four smaller rigs that are used to drill the vertical portion of the wells, Korell said. “The company plans to exit the year with 11 rigs capable of drilling horizontal wells and four smaller rigs, and currently expects its gross well count in the play during 2009 to be 600 wells (75% operated), which is about the same number of wells drilled during 2008.”

Even though it will be running fewer rigs, the company still is forecasting output to jump 49% from 2008 — and hit a higher point than it previously forecast. Southwestern now is forecasting that 2009 output will be 289-292 Bcfe versus an earlier estimate of 280-284 Bcfe. Of this year’s total output, 238-240 Bcf is expected to come from the Fayetteville Shale, the company said.

Through March Southwestern had drilled and completed a total of 938 operated wells in the Fayetteville Shale play, of which 856 were horizontal wells. In the first three months of 2009 the company’s horizontal wells had an average completed well cost of $3.1 million, an average horizontal lateral length of 3,874 feet, and an average time to drill to total depth of 12 days from reentry to reentry. This compares with 4Q2008’s average completed well cost of $3.1 million, an average horizontal lateral length of 3,850 feet and an average time to drill to total depth of 13 days from reentry to reentry.

Adjusted earnings in 1Q2009 were $125.5 million (36 cents/share), which excludes a noncash ceiling test impairment of $908 million ($558 million net of taxes), versus net income of $109 million (31 cents) in 1Q2008. Including the impairment, Southwestern reported a net loss in the first three months of 2009 of $433 million (minus $1.26/share). Net cash from operating earnings rose 31% to $373 million from $283.7 million for the same period in 2008.

Including the effect of hedges, Southwestern’s average realized gas price in 1Q2009 was $5.94/Mcf, down from $7.70 in 1Q2008. Without the effect of price hedges, Southwestern’s average price received for its gas production in 1Q2009 was around $1.08/Mcf lower than average New York Mercantile Exchange (Nymex) spot prices, versus 57 cents/Mcf lower than Nymex prices in 1Q2008 “due to widening basis differentials,” the company said.

“Beginning in the second quarter of 2009, the company believes that average basis differentials going forward will be lower than the differentials experienced during the second half of 2008 and first quarter of 2009,” Korell said. “As of April 24, 2009, the company had protected approximately 45.1 Bcf of its second quarter 2009 expected gas production from the potential of widening basis differentials through hedging activities and sales arrangements at an average basis differential to Nymex gas prices of approximately 25 cents/Mcf, excluding transportation charges and fuel charges.” For the second half of 2009 Southwestern has “protected approximately 49.1 and 36.4 Bcf, respectively, at average basis differentials to Nymex gas prices of 25 cents/Mcf and 20 cents/Mcf, excluding transportation and fuel charges.”

Last year most of Southwestern’s gas from the Arkoma Basin was moved to Midwest markets, Korell explained. When Phase 1 of the Fayetteville Lateral portion of the Texas Gas Transmission system (Boardwalk Pipeline) was placed in service last December, he said there was more capacity available to the Midwest markets. On April 1 both the Fayetteville and Greenville Laterals were placed in service, and the company began transporting a portion of its gas to East Coast markets. Then earlier this month, Korell said, “Texas Gas announced that there would be temporary reductions on the Fayetteville Lateral due to various activities, including maintenance and pipeline inspection.

“The exact completion date for these activities is unknown, but is expected to occur by the end of the third quarter. As a result, transportation on the Fayetteville Lateral as of April 24, 2009 was approximately 700,000 MMBtu/d, and the company’s capacity was approximately 500,000 MMBtu/d to Bald Knob, AR, including 365,000 MMBtu/d to Lula, MS. The company expects that the remainder of its Fayetteville Shale production will continue to be transported on other pipelines to Midwest markets until these issues are resolved.”

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