With longer lateral wells and more slickwater fracture stimulations, Southwestern Energy Co. wowed energy analysts and investors last week with a reported 56% gain in quarterly output from its core Fayetteville Shale play.

The Houston-based independent said its 3Q2007 gas and crude oil production rose to 30.0 Bcfe, up from 19.3 Bcfe in 3Q2006. By itself, the Fayetteville play in Arkansas had a four-fold increase in gas output, to 14.7 Bcf, compared with 3.8 Bcf a year earlier.

In less than three months (beginning at the end of July and through Oct. 22), Southwestern said its gross gas production in the Fayetteville Shale climbed to 260 MMcf/d from 200 MMcf/d, with the company's three eastern-most pilot areas in White County, AR (Sharkey, Hammerhead, Mako), accounting for 28% of the incremental growth. Notably, two recent completions in the Sharkey pilot ramped up at more than 5 MMcf/d -- the highest initial rates seen by any company in the shale play.

"The overriding factor is the longer laterals" in Fayetteville production methods, said CEO Harold Korell. The impressive results are not in any particular spot; "the larger laterals run through a body of horizontal wells," he told analysts during a conference call Thursday. "The larger fracture stimulations have been mostly in the eastern part of the play, where we were looking at thicknesses of objectives...but it's a battery of things. Our engineers have smartly figured out that the larger laterals and the bigger fracture stimulations work."

Southwestern estimated that it will spend about $1 billion in the Fayetteville Shale this year and participate in 400 horizontal wells, about 70% of which it will operate. Southwestern has about 902,000 net acres in the play (667,000 net undeveloped acres, 110,000 net developed acres held by Fayetteville Shale production and 125,000 net acres held by conventional production).

"We are drilling better wells than we were a few months ago," Korell said of the play. "Production volumes have followed suit...In addition, we continue to see strong results from our conventional Arkoma Basin drilling program and we remain very active in East Texas."

In the quarter, Southwestern focused most of its Fayetteville drilling activity in the areas that had been identified as better performing to date and, where possible, in areas with 3-D seismic coverage. The company has acquired or purchased a total of 320 square miles of 3-D data in the Fayetteville Shale area and expects to have acquired or purchased 450 square miles of 3-D seismic data by year-end.

Through the end of the quarter, Southwestern had drilled and completed 24 slickwater wells with lateral lengths of more than 3,000 feet, and it is forecasting that the average gross ultimate recovery from wells deeper than the 3,000 feet horizontal laterals to range from 2 to 2.5 Bcf/well.

Energy analysts were notably impressed by the success in the Fayetteville Shale. On a day when stocks fell across the board, Southwestern's investors sent the stock price up almost 5% Thursday to around $54.15/share.

Goldman Sachs analysts said Southwestern had "cracked the code" in the shale.

"We believe some recent rates of greater than 3.0 MMcf/d could boost expectations that longer lateral drilling is having an outsized positive effect on well performance," Goldman Sachs analysts said in a note to clients. "The key issue for Southwestern Energy and Chesapeake Energy [also a big player in the shale] is what additional estimated ultimate recovery longer laterals will produce for an estimated $0.8 million or so in additional drilling and completion costs. For Southwestern, we believe expectations are for [gas rates] to be above the top of the 1.5 Bcf/well guidance range prior to longer laterals -- we are assuming 1.75 Bcf/well. This means more than 2.1 Bcf/well is needed from longer laterals, which recent data seems to support."

In its note to clients, SunTrust Robinson Humphrey/the Gerdes Group said, "According to our analysis, the latest horizontal wells in the Fayetteville shale drilled with 3,000-foot-plus laterals appear likely to recover 2-plus Bcf for a drill/complete cost of $3.3 million," and a finding and development (F&D) cost of around $1.65/Mcfe." Compared with previous horizontal wells that were deeper than 3,000 feet suggests a "recovery of 1.8 Bcf for a drill/complete cost of $3.1 million ($1.70/Mcfe F&D cost)."

Deutsche Bank added that Southwestern's "improved performance" resulted from "longer laterals, slickwater fracs and drilling in better areas." In a note the Deutsche analysts estimated average initial production for the 3,000-foot lateral wells was 2.2 MMcfe/d, "while well costs are only about 10% higher at $3.3 million..." Added Buckingham Research analysts, "We reiterate our 'Strong Buy' as Southwestern continues to show rapid growth in Fayetteville production and is currently producing at a greater rate then our fourth quarter estimate." Buckingham noted that Southwestern also "continues to hit it big in conventional gas reservoirs, e.g., the Hale formation, which is unassociated but within its vast Fayetteville leasehold."

Southwestern also revealed that it has acquired about 70,000 net acres in Pennsylvania in the Devonia Marcellus Shale. The company plans to begin drilling on this acreage early next year, but Korell and his executive staff held their plans close to the vest, revealing few details.

Earnings in the quarter rose 52% from a year ago to $51 million (30 cents/share) from $33.5 million (20 cents) in 3Q2006. Net cash jumped 66% to $157.7 million. Southwestern's average realized gas price was $6.66/Mcf, including the effect of hedges, compared with $6.23 in 3Q2006. The company's commodity hedging activities increased its average gas price by $1.17/Mcf in the quarter, up from 19 cents/Mcf a year earlier.

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