With a 45% spending increase in 2007 and pipeline contracts for more than 10 times the capacity it currently needs in the Fayetteville Shale play in the Arkoma Basin, Southwestern Energy appears to be preparing its its project for liftoff as a major natural gas production play on par with the Barnett Shale.

Southwestern’s current production in the Fayetteville Shale is only about 85 MMcf/d. However, CEO Harold M. Korell said in a statement released last Friday that the company’s gross production from the play could reach 300 MMcf/d by the end of 2007. By 2009, production from the play is likely to be much higher, given the pipeline contracts that the company signed last week with Texas Gas Transmission.

On Friday, Southwestern announced a 10-year agreement to take 900 MMcf/d of firm transportation capacity (ramping up over time), and an option for another 540 MMcf/d of capacity, on two large pipeline laterals being built by Texas Gas in the Arkoma Basin. The laterals, which together will be able to transport up to 1.85 Bcf/d of gas, are expected to be placed into service in the first quarter of 2009 (see Daily GPI, Dec. 18).

The company also said Friday it plans to boost its spending next year by 45% to $1.3 billion, with much of it targeting the Fayetteville Shale. In addition, next year it plans to more than double the number of wells it drilled in 2006 to about 400-450.

“With Fayetteville Shale drilling expected to double in 2007, more production history provided on new wells and an acceleration in the testing of the acreage, we believe that the risks related to the play will continue to decrease…,” said Friedman, Billings, Ramsey & Co. analyst Amir Arif in a note to clients Tuesday. “Additionally, the news on the firm capacity commitment ramping up over time for 10 years at volumes [10 times] higher than current levels in the play also highlights management’s confidence in the play.”

Southwestern estimates that the average reserves per well in the play will total about 1.4 Bcf of gas. The company holds about 45% of the total acreage in the play. With 80-acre well spacing that amounts to a potential for about 8,000 wells and gross reserves of about 11.2 Tcf of gas.

Based on Southwestern’s estimates, the total play could contain about 25 Tcf of gas. Southwestern’s current proved reserves in the play total about 100 Bcf.

“Our efforts to ramp up activity in the Fayetteville Shale play during 2006 will have a significant impact on our capital and operating plan in 2007,” said Korell. “During 2007, we plan to invest approximately $875 million in the Fayetteville Shale play, which includes drilling 400 to 450 horizontal wells in the play, over 75% of which we will operate, along with a substantial 3-D seismic program.”

The company’s $1.3 billion 2007 capital program is expected to be funded by proceeds from internally generated cash flow, borrowings under its revolving credit facility and/or funds raised in the public debt and equity markets. Assuming the company’s capital program is funded entirely through cash flow and debt borrowings (no asset divestitures or public equity offering), the company expects its long-term debt-to-total capitalization ratio to be 36% at year-end 2007.

Part of the increased capital spending also will be used to test new plays in the Woodford shale and a coalbed methane project in Louisiana.

“While we believe that the Fayetteville Shale play alone provides the company with 10+ years running room at current drilling levels, the additional play concepts provide some additional upside,” said Arif. Both Arif and John Gerdes of SunTrust Robinson Humphrey said based on the company’s drilling plans its shares are significantly undervalued. SWN shares rose nearly 3% Tuesday to $37.79.

Southwestern is targeting 2007 total oil and gas production of 105 to 110 Bcfe, an increase of 45-50% over estimated 2006 levels. Based on early production histories, modeling and assuming continued positive operational results, about 45-50 Bcf of the 2007 targeted gas production is projected to come from the Fayetteville Shale.

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