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Questar Sitting on Gas as Prices Sting 3Q

November 2, 2009
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Realized gas prices in Questar Corp.'s exploration and production (E&P) unit took a hit during the third quarter, but it wasn't as bad as it could have been thanks to hedges, which mitigated the impact and increased revenues by $156.7 million, or $4/Mcf. Questar CEO Keith O. Rattie would prefer that the Commodities Futures Trading Commission (CFTC) and lawmakers not curtail his and other companies' hedging options.

CFTC Chairman Gary Gensler said last Tuesday he wants to move gas price-hedging transactions to regulated clearinghouses as much as possible (see related story). Rattie said last Thursday during a third quarter earnings conference call with financial analysts that he is skeptical that "so-called speculators" had the nefarious influence on gas markets that is asserted by some.

"The market always responds to this type of regulation [proposed by the CFTC]," Rattie said. "I could see some of the trading activity would be shifted to potentially overseas exchanges. We may see different types of commercial arrangements. For Questar, you might see us discontinue the practice of hedging with fixed-price swaps into the regional pipeline where we actually deliver the gas. It might impact, for example, whether we continue to structure most of our hedges as gas-flow hedges under FAS [Financial Accounting Standard] 133. We may end up going into more fixed-sales contracts, which will undermine the attempts to make price discovery more transparent. This is wrong-headed thinking on the part of the CFTC."

Questar reported $98.2 million of net income for the third quarter (56 cents/share). That's down 52% from the year-ago period when net income was $204.2 million ($1.16). Excluding gains and losses from sales of noncore assets and mark-to-market losses on natural gas basis-only swaps, net income was 60 cents/share in the most recent quarter.

Third quarter earnings before interest, taxes, depreciation and amortization (EBITDA) were $373.7 million, down 18% from a year ago. Reflecting continued voluntary curtailments, Questar E&P third quarter production was 43.8 Bcfe, compared with 45.3 Bcfe in the year-ago period and 43.4 Bcfe in the second quarter of 2009.

Realized natural gas prices at Questar E&P averaged $6.46/Mcf, down 15% compared with the prior-year quarter, and realized crude oil and natural gas liquids prices averaged $52.41/bbl, down 40%.

Questar E&P has hedged about 69% of forecast natural gas and oil-equivalent production for the remainder of 2009 with fixed-price swaps. The company has hedged an additional 13% of forecast remainder of 2009 production with natural gas basis-only swaps. For 2010 Questar E&P has hedged approximately 73% of forecast 2010 natural gas and oil-equivalent production with fixed-price swaps, plus an additional 5% of forecast production with natural gas and oil-price collars.

Net income for the E&P division was $49.6 million, down 66% from $146.8 million in the year-ago quarter.

"Questar has remained financially strong in 2009 despite a steep decline in natural gas prices over the past year," said Rattie. "Natural gas prices are likely to improve in 2010, so we intend to get Questar E&P production turned back up in the fourth quarter, and we're gearing up to deliver strong production growth in 2010 and beyond. We estimate that Questar E&P 2010 production could range from 210-215 Bcfe, up about 15% from 2009 -- and if we execute our five-year plan, Questar E&P could grow production 12-15% per year over the next five years.

"We have good visibility on this growth because Questar E&P has a large development-drilling inventory in perhaps the two most economic natural gas plays in North America -- the Haynesville Shale in northwest Louisiana and the Pinedale Anticline in southwest Wyoming. With recent acquisitions, we now have 43,000 net acres in the core of the Haynesville -- up 39% from a few months ago. In 2010 we plan to increase investment in horizontal drilling in the promising Granite Wash and Woodford Shale plays in the Anadarko Basin, and the Bakken oil play in North Dakota's Williston Basin. Meanwhile, the 'rest of Questar' -- Wexpro, Gas Management, Questar Pipeline and Questar Gas -- continues to contribute solid earnings and cash flow that is relatively insensitive to commodity prices."

Also last week, Questar E&P said it was ramping up curtailed and shut-in gas wells that it deferred earlier this year. Total output currently is around 575 MMcfe/d, but with more gas being sold and increased development, Questar E&P estimated that its net production would jump 15% in 2010 to 210-215 Bcfe.

"We've got great visibility on production growth for the fourth quarter of 2009 and for 2010 and beyond," said Questar E&P CEO Charles B. Stanley. "With our inventory of high-quality development locations in some of the most economic resource plays in North America, we now have confidence in our ability to grow production 12-15% per year over the next five years without an acquisition."

But for now, Questar is still curtailing a good bit of production as it awaits a stronger gas market. There are a number of options for keeping gas off a too-stingy market until things improve, explained Stanley, adding that the company can bring reserves online very quickly as the market improves.

"First of all, we can not drill wells, and we're doing that in the higher-cost pools," he said. "We can drill wells and not complete them. We're doing that at Pinedale [Anticline]; we're doing that in the shallow gas reservoirs in northwest Louisiana, i.e., in the Cotton Valley-Hosston reservoirs. Because we have a rig commitment there and the rig is not capable of drilling deep Haynesville wells, we're continuing to drill and case shallow Cotton Valley-Hosston wells, but we're not turning them to sales right now.

"We also have the option...of drilling and casing but not completing at least 20 wells at Pinedale this year. There's that component of that deferral of production and then the final component is deliberately pinching back on producing rates. We're doing that on wells after flowback and cleanup in the Haynesville [Shale]. We have a substantial amount of gas curtailed at Pinedale and also in our legacy division in the Rockies. So there are components of each of those that are impacting our production volumes today and they will continue to do so in the fourth quarter."

Questar expects full-year 2009 EBITDA to range $1.58-1.63 billion. The company expects 2009 net income to range $2.45-2.55/share, up from prior guidance of $2.35/2.45/share. E&P 2009 production is expected to range 183-186 Bcfe, compared with previous guidance of 180-186 Bcfe. The company estimates that 2010 Questar EBITDA could range $1.48-1.58 billion. The 2010 guidance anticipates $1.20-1.25/Mcf lower realized gas prices compared to 2009. The company estimates Questar E&P EBITDA could range $840-890 million while 2010 E&P production could range 210-215 Bcfe. Questar has established an overall 2010 capital budget of $1.56 billion.

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