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Questar: Forward Curve Smiles on Future Production

Dismal gas prices and a charge for Rockies basis hedges took their toll on Questar Corp. in the first quarter, but CEO Keith Rattie said the company is "weathering the storm" as he looks to a Nymex forward curve that "remains in steep contango" and growing production that will be worth a lot more as the economy and gas market recover.

Net income fell 64% in the first quarter to $67.2 million, or 38 cents/share, compared to $185.8 million, or $1.05/share, for the first quarter of 2008. Results from the most recent quarter include a net after-tax mark-to-market loss on natural gas basis-only swaps of $84.7 million, or 48 cents/share, compared to a net after-tax gain of $8.6 million, or 5 cents/share, a year earlier. Excluding mark-to-market gains and losses, Questar earned 86 cents/share, compared to $1.00/share in the year-ago quarter.

"We've lowered EPS [earnings per share] guidance to account for higher Questar E&P depreciation due to price-related negative reserve revisions," Rattie said last Thursday. "But we're maintaining 2009 production guidance, despite some provision for price-related production curtailments. Questar E&P grew production 19% in the first quarter -- driven by a 44% increase in the Midcontinent.

"We've hedged about 73% of Questar E&P's remaining 2009 production at attractive prices, and Questar's five other businesses all generate earnings and cash flow that are relatively insensitive to energy prices. Equally important, our balance sheet is strong, we have adequate liquidity, and we remain focused on returns -- we've shifted capital to projects that deliver acceptable returns even in today's distressed market."

During a conference call with financial analysts last Thursday Rattie said that while the company's traditional hedges on production have worked out, "basis hedging has thus far backfired on us.

"A year ago when Henry Hub prices headed above $10 we decided to hedge basis to protect our core Pinedale [Anticline] play from pipeline bottlenecks that seemed certain to cause the Rockies basis differential to explode in 2010 and 2011. If you take yourself back a year, we were anticipating BLM [Bureau of Land Management] approval of year-round drilling at Pinedale. Questar and the other Pinedale operators on a combined basis were talking about ramping up from less than 300 new wells per year to over 450 wells per year, and at that pace, even if production from the rest of the Rockies remained flat, growing volumes from Pinedale alone were going to overrun the export pipe capacity out of the rockies in 2010 and 2011.

"Obviously, when we hedged basis we implicitly assumed that natural gas prices wouldn't crash. Well, natural gas prices have crashed. The Rockies rig count has plunged 60% from its peak last September and forward basis has collapsed."

The same factors that torpedoed Questar's basis strategy have also delayed an open season for its proposed Rockies Alliance Pipeline (see NGI, Nov. 3, 2008), in which Questar's Overthrust Pipeline Co. has a one-third interest as do partners Alliance Pipeline and recently announced partner Spectra Energy. "While Rockies producers want to see this pipeline get built, they're probably going to be hesitant to sign long-term contracts under these conditions," Rattie said.

Business segment results:

Questar said it now expects full-year 2009 net income to range $2.30-2.45/share, compared to previous guidance of $2.50-2.70/share. This revised guidance assumes a higher Questar E&P average depreciation, depletion and amortization rate per Mcfe as the result of first quarter price-related reserve revisions. The company estimates that Questar E&P 2009 production will range from 180 to 186 Bcfe, unchanged from prior guidance and up 5-9% from 2008.

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