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SM Energy Burdened by Glut, Contributes to It

Eagle Ford and Bakken shale player SM Energy Energy Inc.’s third quarter profits were drowned in glutted oil and natural gas markets. But drilling times are down, completions are more effective, and well results are improving in core development programs, CEO Jay Ottoson told analysts Wednesday.

"Look, I know it's easy to be gloomy and really short-term focused right now because of all the volatility in commodity prices and the low level of commodity prices; but if you're going to be in a ship in a storm, SM Energy is not a bad ship to be on, and we're actually really excited about some of the improvements we're making in our business," Ottoson said.

Production for the third quarter was 16.1 million boe, or 174,500 boe/d, up 22% compared with 13.1 million boe, or 142,500 boe/d in the third quarter of 2014. Total production increased sequentially, adjusted for second quarter asset sales, and exceeded the company’s expectations by 600,000 boe, despite an 11% sequential decline in nonoperated Eagle Ford production, the company said.

Profits were another story, though.

Net income was $3.1 million (5 cents/share) compared with $208.9 million ($3.05/share) in the third quarter of 2014. Adjusted net loss for the third quarter was $23.3 million (minus 34 cents/share) compared with adjusted net income of $98.6 million ($1.44/share) in the third quarter of 2014. Lower adjusted results are mainly due to a 51% decline in average prices received per boe, partially offset by a 22% increase in production and 15% decrease in production costs per boe, the company said.

Lower commodity prices, offset by higher production and lower costs, affected adjusted earnings before interest, taxes, depletion, amortization and accretion, and exploration expense (EBITDAX), too. The figure was $259.4 million for the third quarter of 2015 compared with $406.2 million in the third quarter of 2014.

Among 10 analysts surveyed by Zacks Investment Research, the average of expectations was for an adjusted net loss of 27 cents/share, so SM Energy's quarter came in worse than expected.

Pricing in the third quarter reflected a 52% decline in West Texas Intermediate oil prices, a 30% decline in Nymex natural gas prices and a 54% decline in natural gas liquids (NGL) prices from the prior-year period. The company had 48% of oil production, 34% of natural gas production and 40% of NGL production hedged during the quarter.

Operating costs in the third quarter included lease operating expenses of $3.86/boe, down 72 cents from the prior-year period, and transportation expenses of $6.27/boe, 5 cents from the prior-year period.

Seven active operated rigs include four in the Eagle Ford, two in the Bakken/Three Forks and one in the Powder River Basin. At year-end, SM Energy said it anticipates releasing one rig from the Eagle Ford program and adding one rig in the Permian Basin. The company deferring most completions in the Eagle Ford and Bakken/Three Forks and plans to increase completion activity around year-end.

Total 2015 capital expenditures are estimated at $1.28 billion; through the first nine months they totaled $1.1 billion.

During the analyst conference call, Ottoson focused on the positive.

"We are reducing drilling times, optimizing completions and generating better well results in our core development programs, he said. "For example, drilling and completion costs for our operated Eagle Ford wells in the third quarter were down nearly 50% from our 2014 average. At the same time, we have been conducting several pilot tests in high-productivity areas of the Eagle Ford and Bakken/Three Forks intended to prove up additional economic drilling inventory. Test results to date have been positive and have translated into higher than forecast production."

In the Eagle Ford, third quarter net production averaged 134,500 boe/d, including both operated and nonoperated wells. Daily production increased 31% from the third quarter of 2014 and increased 3% sequentially from the second quarter of 2015, despite an 11% sequential decline in nonoperated production. Completion costs per lateral foot during the third quarter were down 54% compared with the 2014 full-year average. Drilling costs were down 28% over the same period.

The company has scheduled nine Eagle Ford multi-well pilot tests intended to test the potential for inventory expansion across its acreage position through downspacing, infill drilling and the addition of the Upper Eagle Ford interval. Wells have been drilled and completed in five of the nine tests, with the remaining tests expected to be completed next year. So far, results are "encouraging," the company said.

Third quarter production from the Bakken/Three Forks program averaged 22,200 boe/d and was 85% oil. Production increased 27% from the third quarter of 2014 and decreased 7% sequentially as the company continues to drill in the area but not complete all wells drilled. As of the end of the third quarter, SM Energy had an inventory of 47 gross and 39 net operated wells drilled and uncompleted in the area.

Drilling days in the Bakken/Three Forks this year are down 11% on average from 2014. The company recently drilled a Divide County Bakken well, spud to rig release, in 10 days. Enhanced completions are driving 20-30% increased recoveries per well as the company employs plug-and-perf/cemented liner completions. Overall, costs in the area have been reduced by 20-25% per well compared with similar wells in 2014.

"Looking into 2016, we plan to focus our activity on our programs that generate the best returns..." Ottoson said. "[W]e expect to allocate an increased portion of capital to the Permian and Williston basins. Fundamental to the 2016 operating plan will be aligning capital spending with estimated EBITDAX to optimize cash flow and inventory expansion, resulting in differential value creation in 2016."

Ottoson told analysts that management is "looking forward to getting back to drilling in our Sweetie Peck asset [in the Permian Basin] now that we've gotten our activity levels adjusted down to our cash flows. Although I don't have an updated cost story here yet because we've been inactive for a few months, we are bidding and we certainly see costs coming way down."

In the Permian, SM Energy is drilling mostly Wolfcamp B wells, although the Lower Spraberry is promising, Ottoson said. A Middle Spraberry well is drilled but not yet completed.

"If you just look at the Wolfcamp B, however, it is very clear that our disciplined completion testing program has produced great results," Ottoson said. "We are doing a lot of detailed petrophysical work on all our plays. And we're focusing a lot of attention on exactly where in the reservoir we land our wells in order to achieve the best performance, maximize recovery and stack more wells into each spacing unit."

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