The turning of the tap on the Rockies Express (REX)-West pipeline, expected Jan. 1, won't come a minute too soon for Questar Corp., whose exploration and production (E&P) business shut in about 4.4 Bcfe (net) of unhedged Rockies gas and natural gas liquids (NGL) production in response to low regional market prices during the third quarter.

In mid-September Rockies gas into Kern River could be had for 7 cents (see NGI, Sept. 24).

REX-West should alleviate the current transportation bottleneck, the company said. Now, executives at Questar, which is also in the pipeline business, are chomping at the bit to get in on the next export pipeline out of the Rockies, a project for which the time to start is now, they said.

"We told the [Questar] board that we're going to give our pipeline team a new mandate, and that's to be the catalyst to make another major Rockies export pipeline project happen sooner rather than later," Questar CEO Keith Rattie told analysts last week. "If you believe the production growth promises that Rockies producers are making to their investors, we're going back to 'basis-blowoutsville' in the Rockies in 2011 or 2012, even with the completion of the final phase of REX. So the next major pipeline project, which could take up to four years from inception to start-up, the work needs to start now."

He isn't alone in seeing Rockies pipeline opportunities beyond REX (see NGI, Aug. 20) as the Rockies gas boom is expected to continue (see NGI, Aug. 20).

Rattie was quick to note that Questar doesn't have an existing export pipeline franchise out of the Rockies that it needs to defend. It does, however, have gas production that needs to get to market, "so our pipeline team can be objective in facilitating this dialogue with both Rockies producers and end-users about where the next pipe needs to go."

Questar's Overthrust Pipeline was an early piece of the REX puzzle as the project was coming together (see NGI, Nov. 28, 2005). Rattie said last week that Questar supported efforts to build REX by spending $300 million to build out its own system as an interconnect to the east-bound megaproject and that Questar Pipeline's efforts on behalf of the REX project "probably accelerated the completion of that project by about a year." In August Questar announced its participation in the development of a Rockies header system (see NGI, Sept. 3).

"If [Questar] Pipeline's efforts create an opportunity to own part of the [next Rockies pipeline] project, great, and we may fund our investment by forming an MLP [master limited partnership] around our Overthrust Pipeline," Rattie said. "But our bigger corporate objective is to protect returns on capital in our E&P business. So the performance metric for Questar Pipeline that matters is to cause the next pipeline to get built ASAP."

Questar can help with that, Rattie said, because of where it sits between producers and end-users.

"We have relationships in the key markets [for Rockies gas] that I think are going to be essential [to the next Rockies project]," Rattie said. "I'm not sure that the producers in the Rockies, given the uncertainty about long-term access to public lands are going to be able to step up for all of the capacity in the next major pipeline project out of the region. We need to get some market support, and by that I mean long-term contract commitments from end-users in wherever the target market is."

Charles Stanley, CEO of Questar Market Resources, said Questar and other Rockies producers will fill another pipeline when it's built.

"As a producer in the region and talking to the other producers, there's already growing focus on what the next step is for export capacity out of the region," Stanley said. "If you follow all of the active drillers in the Rockies and you add up the aggregate production growth, we need to start yesterday on another pipeline to serve this region to make sure we don't see another repeat of [the Rockies basis blowouts of] this year. I think people realize that the large amount of capital that's being invested in the resource plays in this region, not only in Wyoming but also in western Colorado and eastern Utah demands additional export capacity."

Stanley said producers stepped up to foot the bill for REX, contributing about 10% of their production to the project, because they saw the benefit of improving Rockies basis for all of their production. "If they commit a portion of their production volumes to a new project, and it may only be 10% of the production volume, but if each producer does that then the remaining 90% that's not committed directly benefits from the narrowing of basis. That's the sales technique that Mr. [Allan] Bradley [Questar Pipeline CEO] will be deploying as he talks to producers to convince them that they need to support this project."

REX West includes five mainline compression stations, two hub stations (Meeker and Cheyenne) and two lateral stations and interconnects with Overthrust near Wamsutter, with the Lost Creek Lateral and with the Echo Springs Lateral. The 1,678-mile, $4 billion REX is a joint venture of Kinder Morgan Energy Partners, Sempra Pipelines & Storage and ConocoPhillips. The project was planned to bring Rocky Mountain natural gas east to markets across the Midwest and Northeast. Gas demand in those regions is expected to grow by approximately 25% to more than 13 Bcf/d by 2015.

In the meantime, until REX is complete and Questar and the rest of the industry come up with the next Rockies mainline, Questar can hold its own, even when Rockies prices are anemic, Rattie said. The company has 2.4-2.5 Bcf/d shut in this month, "and we're looking at pretty low prices for November, so you shouldn't be surprised if we curtail volume in November," Rattie told analysts. Hedging is stronger in December, so all production could be back on-line then, he said.

"Questar got through a summer of low prices in the Rockies in pretty good shape for four reasons. First, we've stuck to the hedging discipline we imposed on ourselves back in 2002. In the first nine months of 2007 natural gas hedges increased Questar E&P pretax income by about $174 million, and we have hedges in place for the remainder of 2007, 2008, 2009, 2010...they're solidly in the money overall. Second, we're not just a Rockies producer, over a third of Questar E&P production came from the Midcontinent. Our Midcontinent team grew production 6% in the first nine months of 2007. That's above plan, done with mature assets and on the heels of 21% growth in 2006. Third, we're deploying more capital in both Wexpro [which develops reserves for Questar Gas] and Gas Management where returns are less sensitive to short-term fluctuations in commodity prices. Fourth, income from our regulated businesses is not sensitive to commodity prices."

Questar Corp. grew net income 19% in the third quarter of 2007 to $113.3 million (64 cents/diluted share), compared to $95 million (54 cents/diluted share) for the third quarter of 2006.

"We now expect 2007 net income to range from $2.75 to $2.80 per diluted share, compared to prior guidance of $2.60 to $2.68 per diluted share," said Rattie. "We're also providing initial 2008 net income and production guidance, mindful of the uncertain outlook for natural gas prices and public land access in the Rockies."

Full-year 2007 earnings are expected to range from $2.75 to $2.80/share, compared to previous guidance of $2.60 to $2.68/share. The company said it expects that better-than-forecast performance from Wexpro, Gas Management, and Energy Trading will offset the impact of lower gas prices in the fourth quarter. The company expects Questar E&P 2007 production to range from 136 to 137 Bcfe, despite approximately 5.4 Bcfe of net production shut-in through the third quarter due to low gas prices in the Rockies. The guidance assumes additional shut-in gas volumes during the months of October and November and that the Rockies basis differential will average $3.35/MMBtu for the remainder of 2007. Questar said 2008 net income could range from $2.85 to $3/share.

Questar E&P reported production of 33.9 Bcfe in the third quarter compared to 33.8 Bcfe in the prior year period. Higher realized gas, crude oil and NGL prices more than offset a 14% higher average production cost structure, resulting in a 16% increase in third-quarter 2007 net income to $76.4 million compared to $66 million a year-earlier. Natural gas basis-only swaps increased net income $5.6 million in the 2007 quarter and reduced net income $3.2 million in the 2006 period. In the prior year quarter, Questar E&P recognized $24.6 million of pretax gains on asset sales. Exploration expense in the third quarter of 2007 totaled $1.6 million compared to $16.8 million in the prior period, which included $14 million of dry hole expense.

The E&P business has hedged about 82% of forecast natural gas and oil-equivalent production for the fourth quarter of 2007 and 68% for the full-year 2008 with fixed-price swaps. Additionally, the company has hedged about 8% of forecast fourth quarter 2007 production and 9% of full-year 2008 production with natural gas basis-only swaps.

The company estimates that a $1.00/MMBtu change in the average New York Mercantile Exchange (Nymex) price of natural gas for the remainder of 2007 and full-year 2008 would result in less than a 1 cent and about an 8 cent change, respectively, in earnings per share. A $10.00/bbl change in the average Nymex price of oil for the remainder of 2007 and full-year 2008 would result in about a 1 cent and 6 cent change, respectively, in earnings per share.

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