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Southwestern Cutting Fayetteville Drilling for Marcellus

Proving that different shale plays have different economics, Southwestern Energy Co. plans to cut spending in the Fayetteville Shale and increase spending in the Marcellus Shale this year, the company said Tuesday.

While Southwestern doesn't plan to curtail any production in the Fayetteville, the dry gas play in Arkansas that it helped launch over the past decade, the 2012 budget suggests that its acreage in the dry gas corridor of the Marcellus in northeastern Pennsylvania might be a better deal in the current price environment.

"This year has already started out to be a challenge, but as I tell our employees, our goal is not just to survive. It's to thrive," CEO Steve Mueller told analysts during a fourth quarter conference call on Tuesday.

Mueller said Southwestern's portfolio and low cost structure would make that happen, noting it had enough well locations in the Fayetteville profitable at a price of $3/Mcf to last all of this year and next year, too. Although the company plans to drop four of its 11 rigs in the play this year, it said production would still rise. If it continues to run only seven rigs in the play in 2013, though, production would quickly "flatten."

In addition to cutting spending in the Fayetteville, Southwestern plans to "drill the very best wells," even if that means "inefficiencies," such as drilling only the best well from a multi-well pads for the time being.

Southwestern's focus on the Fayetteville Shale has been a driving factor behind that region's growing contribution to the overall U.S. supply picture in recent years. The company's net natural gas production in the Fayetteville Shale grew from just 11.8 Bcf in 2006 to 436.8 Bcf in 2011. Overall, the Fayetteville Shale represented roughly 4.0% of total Lower 48 marketed natural gas production in 2011, up from a mere 0.1% in 2006, according to data from the company, the Arkansas Oil & Gas Commission and the Energy Information Administration.

The company posted record earnings and production in 2011, though.

Southwestern earned $637.8 million in 2011 ($1.82/share), up 6% from $604.1 million ($1.73) in 2010, largely on the back of increased midstream activities. Despite a 24% increase in production in 2011 to 500 Bcfe, upstream profits actually fell slightly year over year due to lower natural gas prices and higher operating expenses associated with the increased production levels, the company said.

Southwestern earned $158.5 million (45 cents/share) in the fourth quarter of 2011, up slightly from $149.5 million (43 cents) in the final three months of 2010, as low gas prices and increase operating expenses associated with higher production levels partially offset a 20% increase in production.

"We're expecting that we're in the price range we're going to be for this year and next year," Mueller said, and Southwestern is waiting for fundamental market changes. As of Monday, Marcellus gas in northeastern Pennsylvania traded for a combined average price of $2.60/Mcf, down 7 cents, while Fayetteville gas traded for an average price of $2.50/Mcf, down 5 cents, according to NGI's Shale Price Index.

The recently announced $2.1 billion capital budget for 2012 is down from $2.2 billion spent in 2011. Southwestern plans to spend $1.1 billion for the Fayetteville, down from $1.3 billion, and $526 million in the Marcellus, up from $332 million. Southwestern plans to cut spending in the Ark-La-Tex region and its "new ventures," including its new Canadian operations, but plans to increase its midstream budget.

As a result of its smaller than expected budget -- Southwestern announced a $2.3 billion capital program as recently as December -- the company also cut its production guidance for the year by 10 Bcfe, to 560-570 Bcfe. Of that, 465-470 Bcfe will come from the Fayetteville and 60-65 Bcfe will come from the Marcellus. Southwestern produced 436.8 Bcf from the Fayetteville and 23.4 Bcf from the Marcellus in 2011.

The Marcellus is an increasingly important component of Southwestern's portfolio. After taking part in 21 horizontal wells and producing 1 Bcf from the play in 2010, the company participated in 45 wells last year -- 18 in Bradford County and 27 in neighboring Susquehanna County -- producing 23.4 Bcf. Considering that only 23 of its 70 wells drilled to date are in production, all in Bradford, that growth could continue this year, but production is limited to around 133 MMcf/d because of midstream constraints, the company said.

As Southwestern increases its firm capacity this year, it will likely increase development too, Mueller said.

The Fayetteville continues to be home field, though. The company drilled 650 wells (580 operated) in the Fayetteville last year, increasing its reserves to 1.2 Tcf at a finding and development cost of $1.13/Mcf.

Southwestern's all-in finding and development cost was $1.31/Mcfe in 2011, up from $1.02/Mcfe in 2010.

Its Fayetteville wells cost $2.8 million on average, the same as last year despite longer laterals, with an average initial production rate of 3.3 MMcf/d. The Marcellus wells cost $6.4 million on average. Despite having shorter laterals than the Fayetteville wells, the Marcellus appears to be producing at higher rates.

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