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Questar's Gas Output Up 7% -- Even with Curtailments

Questar Corp.'s decision to allocate 40% of this year's exploration and production (E&P) capital spending to the Haynesville Shale and 40% to the Pinedale Anticline proved its worth in 2Q2009, with Midcontinent output jumping 16% and Pinedale production up 13% from the year-ago period. Beyond E&P, Questar's diversified assets demonstrated they were "relatively insensitive" to lower commodity prices, handing the company a distinct competitive advantage, said CEO Keith O. Rattie.

The CEO and his management team held court in a conference call Wednesday to discuss 2Q2009 earnings with energy analysts and investors. Rattie didn't gloss over the bottom line: Questar's profits were down by more than half, with 2Q2009 net income of $78 million (44 cents/share) compared with $173 million (98 cents) a year earlier. But, he said, the quarterly results also had some positives.

"We know these are tough times for the natural gas industry and for Questar, but we continue to weather the storm," Rattie told investors. "We are down from the boom times of 2008, but we're on track to grow production despite cuts to capital spending and voluntary curtailments...No one knows when the U.S. natural gas market will turn up, but it will."

In general Rocky Mountain gas production is trending downward, said Rattie, and that has taken "pressure off the pipes" in the region. "Rockies volumes were hitting the Northeast with growing volumes out of the Marcellus [shale], and Haynesville volumes are growing...We may see a flattening relationship with Opal [gas hub] and Nymex [New York Mercantile Exchange] for the next several years."

A few weeks ago there were worries that gas storage basins would be filled well before the winter heating season. That's not the case today, said the CEO.

Questar's Clay Basin gas storage facility typically isn't full until "around October," said Rattie. The facility was well above 50% capacity just a few weeks ago, and if storage levels had continued to creep up, there could have been "gas-on-gas competition, in fact, probably in September," he said. However, "the pace of storage refill slowed down a lot in last few weeks...and it's now running close to what it would typically be this time of the year. We're able to manage that, and we're pretty much where we typically are at this time," a fact reflected in a Barclays Capital analysis (see related story).

"We see nothing out of the ordinary in Rockies at this point" regarding gas storage, said Rattie. "There had been until a few weeks ago."

Questar generated more than $800 million in 2Q2009 in earnings before interest expenses, taxes, depreciation and amortization. "More important, Questar E&P delivered double-digit production growth in the first half -- despite price-related curtailments and lower capital spending -- driven by continued strong results from our higher-margin Haynesville shale and Pinedale Anticline plays," said Rattie.

Production from Questar E&P, 88% gas-weighted, rose 7% from 2Q2008 to 43.4 Bcfe. The Midcontinent unit, which includes production from the Haynesville Shale, reported output reached 19.8 Bcfe from 17 Bcfe a year earlier. In the Pinedale Anticline output reached 14.1 Bcfe, compared with 12.5 Bcfe. Meanwhile, production in the Uinta Basin fell 2% to 6 Bcfe from 6.1 Bcfe. In the Rockies legacy assets, production dropped 30% to 3.5 Bcfe from 5 Bcfe a year ago.

Questar has six rigs in operation in northwestern Louisiana and one in the Cotton Valley of East Texas. The company holds a working interest in 12 new Haynesville Shale producing wells, seven of which it operates. Thirty-five wells are scheduled for the Haynesville play by the end of the year, said Rattie.

"We've drilled and turned four Questar wells to sales" in the Haynesville Shale since the company's 1Q2009 conference call, he said. "The latest Questar-operated well may be the strongest yet," averaging a 24-hour initial production (IP) rate of 25 MMcf/d. The well, which was ramped up for sales three weeks ago, was "drilled and completed at a cost of just over $9 million." Another well in the region, which was turned to sales in June, had a 24-hour IP rate of 24 MMcf/d.

"We've had wells that are among the strongest drilled by any operator in the play to date," said the CEO. However, low gas prices have forced Questar to voluntarily curtail production from the Haynesville wells to "around 10 MMcf/d," he said.

To prepare for an expected upturn in gas prices, Questar is working to add to its Haynesville Shale position, said Rattie. In addition, Questar is investing in new gas gathering and treatment infrastructure in the region to increase pipeline takeaway capacity. The producer holds about 65 MMcf/d in takeaway capacity under a contract to begin in 2010.

"Some investors still think of Questar as a Rockies producer, but that's not the case anymore," Rattie told investors. "We're allocating 40% of our capital expenditures to the higher-margin Haynesville Shale, the same as to the Pinedale Anticline. Haynesville and Pinedale are two of the most economic [plays] to produce in the United States." The remaining 20% of the E&P spending is "mostly" flowing to the Woodford Shale in Oklahoma.

In its Pinedale Anticline unit, Questar now has five rigs in operation, which is four less than in 2Q2008.

"We came out of the winter this year with 56 wells drilled and cased, and we've turned 50 of them to sales," said Rattie. "The wells averaged about $5.2 million to drill, complete and connect, which is down 17% from the peak in 2008." Questar also is averaging around 23 days to drill and connect the wells in the region. "We've drilled 100% of the 2009 wells in less than 30 days...At this pace, even with only five rigs, we expect to drill and case about 100 wells in 2009." Because of "current market conditions," however, Questar plans to defer completions on about 20 of the wells.

The average realized price Questar received for its gas in 2Q2009 fell 15%, or $1.17/Mcf, from a year ago; oil and natural gas liquids realized prices were down 44%. Hedging, however, mitigated the impact of the sharp drop in prices, with gas hedges lifting quarterly revenues by $167 million ($4.34/Mcf), and oil hedges adding $1.3 million ($1.55/bbl). Net mark-to-market losses on gas basis-only swaps cut net income by $17.5 million, versus a gain of $10 million in the year-ago period.

"Gas prices are down about 70% from their peak in 2008, and they are clearly having an impact on the bottom line," said Rattie. "But our hedging discipline and stable cash flow from other businesses, to a large extent, protected 2009 cash flow."

Questar's midstream and gas utility units helped to assuage low commodity prices, said the CEO.

"When natural gas prices were higher, investors focused solely on E&P and they didn't focus on our other businesses," he said. "Now the other businesses are a source of competitive advantage, and they are proving to be relatively insensitive to commodity prices."

Questar is forecasting E&P output for 2009 to be 5-9% higher than a year ago "despite voluntary curtailments," said Rattie. The company also revised the lower end of its 2009 earnings guidance and now expects full-year net income to range from $2.35 to $2.45/share, compared with previous guidance of $2.30-2.45 per diluted share. Questar E&P also has hedged about 74% of forecast gas and oil-equivalent production for the remainder of 2009 with fixed-price swaps. The company also has hedged about 14% of the remainder of its forecast 2009 production with gas basis-only swaps.

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