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SM Energy Raises Spending; Analysts Note Efficiency

SM Energy Co. raised its guidance for 2011 and introduced plans for 2012 that surpass what analysts were expecting as company executives emphasized a sharpened focus on the Eagle Ford Shale in South Texas.

"The capital expenditure and production outlook we are providing today is the result of our successful transformation into a significant North American resource play company. We have built a portfolio that provides line of sight to significant growth over the coming years, while providing the flexibility to allow us to redirect capital when circumstances dictate," said CEO Tony Best.

The company raised its 2011 capital spending plan to $1.55 billion from $1.08 billion.

The primary increase to the 2011 capital budget results from differences regarding the size and timing of the previously announced Eagle Ford shale transactions (see Shale Daily, June 30; June 15), compared to assumptions made when they were originally budgeted.

The reduction in SM Energy's Eagle Ford shale position will not be as large as was assumed at the beginning of the year, the company said. The scheduled closing dates for these transactions are also later in the year than originally budgeted. As a result, higher amounts of production and capital expenditures will be recognized in 2011.

The capital budget is also being increased to reflect the decision to continue drilling in the company's operated Haynesville Shale position in East Texas until its leasehold position is held by production in 2012.

Analysts at Canaccord Genuity Energy Research said SM Energy's guidance for 2012 is "materially above our expectations." SM Energy introduced 2012 production and capital spending guidance of 225-232 Bcfe and $1.4-1.5 billion, they noted. "Critically, the relationship between spending and production implies greater capital efficiency than our prior 2012 estimates of 193 Bcfe and about $1.2 billion."

Denver-based SM Energy is currently running four rigs on its operated Eagle Ford acreage. The focus during the second quarter was to drill spacing pilots and test alternative completion designs. Data from this testing should be available to guide development activities during 2012. Gas takeaway capacity during the quarter continued to be below contracted amounts due to restrictions on downstream third-party infrastructure, the company said.

In the Eagle Ford SM Energy could be producing a lot more if it had the capacity available to get the gas to market, something it expects to happen in the coming months.

"On the Galvan [Ranch] area, right now we're producing about 60 million a day of gross wet gas out of that area. If we could get those wells to line pressure, they would make about 100 million a day," said COO Jay Ottoson. "There's a lot of shut-in capacity...There's a lot of opportunity here as we get additional capacity...We're putting a 16-inch [diameter] gas trunkline -- what we call the spine -- in all the way through our acreage, all the way from the tip of Galvan all the way up through Briscoe, and that will be completed in October, so we'll be able wheel gas to both ends of our gas offtake capacity." Kinder Morgan also is expected to have more capacity online soon, he said. "...[W]e should have quite a bit more capacity available as we move into September. I think we'll be able to crank up rate pretty quickly here."

SM Energy is operating two drilling rigs in the Williston Basin with a focus on horizontal development of the Bakken and Three Forks formations in Divide and McKenzie counties, ND. During the second quarter, the company, along with other operators, experienced flooding ,which delayed drilling and completion operations and required some production to be shut-in. All shut-in production is expected to come back online early in the third quarter as the flood waters recede. A third drilling rig is being added to this play in the third quarter.

SM Energy continues to test its Niobrara position in the northern extension of the Denver-Julesburg Basin in southern Wyoming. During the second quarter three new operated wells were drilled. The Polaris (SM 38% working interest) was completed during the quarter and had a seven-day average production rate of roughly 950 boe/d. The remaining two wells are expected to be completed later this year.

The company has also started permitting for several wells in the Powder River Basin in Wyoming where SM Energy has recently added to its acreage holdings. SM Energy now has 63,000 net acres in the Powder River. In total, SM Energy has 89,000 net acres in eastern Wyoming with potential in the emerging Niobrara play.

During the quarter SM Energy maintained activity in its operated Haynesville position in San Augustine County, TX, using a two-rig program. Due to strong well results and the presence of additional highly prospective up-hole intervals, the company has decided to continue drilling its acreage in East Texas until it is held by production, likely by the third quarter of 2012 with a one-rig program.

SM Energy operated one rig in its Granite Wash program during much of the second quarter, focusing on the liquids-rich wash intervals. During the second quarter SM Energy completed a Cottage Grove well, the Ruth 4-60 (SM 44% working interest) in Wheeler County, TX, which had a seven-day average initial production of 1,378 boe/d, of which 82% was oil. The company said it plans to continue a one- to two-rig program for the remainder of the year on its Granite Wash acreage, all of which is held by production.

The company operated one rig in the Permian region during the second quarter aimed at drilling down-spacing pilots in the Wolfberry tight oil and testing Mississippian targets.

SM Energy reported net income for the second quarter of $124.5 million ($1.86/share) compared with net income of $18.1 million (28 cents/share) for the same period of 2010. The increase was due primarily to a gain on divestiture activity, increased production, increased commodity prices, and unrealized derivative gains recognized in the second quarter of 2011. Adjusted net income for the quarter was $61.1 million (91 cents/share) versus $10.2 million (16 cents/share) for the second quarter of 2010.

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