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With Record Production in First Quarter, Ultra Cuts Capex

Ultra Petroleum Corp. said that while it produced record volumes during 1Q2012 and was optimistic about its plans to target oil shale in the Niobrara, it would follow the example of its joint venture (JV) partners in the Marcellus and cut capital expenditures (capex) for the rest of the year.

During a conference call with financial analysts to discuss the Houston-based Ultra's 1Q2012 earnings on Thursday, CEO Michael Watford said low natural gas prices were forcing the company to cut $100 million from its capex program for the year, bringing it down to $825 million. The company spent $1.5 billion on capex in 2011.

"Going forward for the remainder of 2012, you will see our activity level slow, capital expenditures decline and production flatten," Watford said. "Given that we are a natural gas company, we think this is the prudent path."

The CEO added that the capex cut was not adjusted for a potential midstream asset sale. "With monetization of our liquids gathering system, our net capex for the year is closer to $625 million. Our capital budget is front-end loaded, and we spent 35% of our capital forecast in the first quarter. We will not continue to invest at this pace, and our activity will slow."

Watford said Ultra had released four rigs in Wyoming, incurring $4.8 million in cancellation fees during the first quarter. The CEO said that figure represented more than half of the cancellation fees the company expects to rack up by the end of year.

"The capital expenditure reduction is pretty evenly split between Wyoming and Pennsylvania, about $50 million each," Watford said. "In Wyoming, the reduction will come primarily from Ultra-operated well completion deferrals. In Pennsylvania, our [JV] partners are reducing their activity in our joint venture areas, and we are continuing to not participate in uneconomic projects at today's gas prices."

Ultra holds approximately 112,000 gross (56,000 net) acres in the Jonah and Pinedale natural gas fields, located in southwest Wyoming's Green River Basin. In the Marcellus, the company holds 250,000 net acres, including 80,000 net acres where it has a 50% working interest. Ultra's JV partners in the Marcellus are Royal Dutch Shell plc and Anadarko Petroleum Corp.

Watford said continuing low natural gas prices were putting Shell and Anadarko "in a flight to quality mode," causing them to scale back activities in their areas of mutual interest (AMI).

"In fact, Shell's planned activity on our joint venture area has changed significantly since it was initially defined last December," Watford said. "Their original plan called for just over 180 wells to be drilled in 2012. They have now reduced their original plan by 70 wells, about 40% and currently plan to drill 112 new wells this year."

Watford added that Anadarko was reducing its rig count from four to one in their AMI. "From a well cost perspective, [Anadarko is] improving while drilling deeper and longer for the same cost as Shell. Currently, their well costs are below $7 million, and they are targeting $6.3 million to drill and complete their wells."

But the CEO said Ultra is bullish on the more than 136,000 net acres it has acquired in the Niobrara Shale in Colorado. Watford said the company has drilled three vertical test wells targeting oil shale, and was in the process of assessing the area's resource potential.

"In all three wells, we collected a substantial amount of geological and engineering data that includes full log suites, rotary sidewall cores and 475 feet of conventional core. Analysis of this data is currently underway, and we are initiating plans for our first horizontal test that will likely occur this summer."

Ultra produced a record 68.8 Bcfe during the quarter (up from 55.8 Bcfe from 1Q2011), which Watford attributed to better performance in Wyoming and Pennsylvania. The company had estimated that its production in 1Q2012 would range from 64 to 66 Bcfe.

In addition to lower natural gas prices, the basis spread between Opal and Dominion Transmission has weighed on Ultra's financial performance in recent months. In June 2009, Ultra became an anchor shipper on the Rockies Express (REX) pipeline, signing on for 200 MMcf/d of firm capacity for a 10-year term that commenced in November 2009. Ultra signed that contract to take advantage of higher relative gas prices in the Mid-Atlantic versus those in the Rocky Mountain area, and it did so when the basis differential between Opal and Dominion was still high. From May 2007 through June 2009, the median Opal-to-Dominion South spread was $2.87/MMbtu. However, from July 2009 through May 2012, the median spread shrunk to just $0.48 cents. Things have been particularly worse over the last twelve months, during which time the median Opal-to-Dominion spread has fallen to $0.185/MMbtu. That spread was just $0.05-$0.06/MMbtu in January through March of 2012, but it has rallied a bit since, climbing to $0.24 and $0.19/MMbtu over the last two months.

To put the shrinking Opal-to-Dominion basis spread into perspective, Rockies Express is authorized to charge a maximum interruptible commodity rate of $1.66/Dth between its Zones 1-3, which covers the Opal-to-Dominion route. There is no mention of what Ultra is paying REX in firm demand charges in its 2011 10-K filing, but in its 4Q2008 earnings conference call, the company noted its demand charges on REX would ramp to $1.07/Dth when the pipeline became fully operational in 2009.

According to the same 10-K filing, Ultra estimated that its future demand charge obligation on REX as of December 31, 2011 was $776.3 million.

REX began service on its REX-East leg, which originates in Audrain County, MO, up to Lebanon, OH in June 2009, and completed the final Lebanon to Clarington, OH segment of REX-East in November 2009.

Ultra's operating cash flow totaled $185.7 million ($1.21/share) for the quarter, compared to $216.3 million ($1.40/share) for the same quarter during the previous year.

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