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Exco Dropping Rigs but Still Looking for Opportunities

With a eye on natural gas prices, Dallas-based Exco Resources Inc. is dropping more than half of its drilling rigs in the Haynesville Shale this year, cutting one rig in the Marcellus and deferring well completions in natural gas plays. However, CEO Doug Miller said Friday there are "huge opportunities" to buy distressed properties, which the company intends to pursue.

Miller and his management team spoke with energy analysts for almost two hours to discuss quarterly earnings and 2011 performance, as well as their strategy going forward.

"It's been a wild year, to say the least," Miller said in his opening remarks. A year ago, he noted, the company was attempting to go private and natural gas prices were a bit more cooperative (see Shale Daily, Jan. 14, 2011). "We had a challenging year, even though we had quite a few accomplishments. Our operations guys set all kinds of records" and the company continues to "upgrade and change."

His thinking about taking the company private came when the gas market was stronger and "we wanted to be a buyer and a consolidator of gas...We thought gas would be $3 to $4 for a couple of years...I think what's happened is that gas has gone down further than we thought. If we'd gone private, we'd be down 25% right now, but gas has gone down farther and accelerated from what I had expected...

"We also expected to see more of a demand increase...Power that we expected to be a gas user at the end of 2012 we're starting to see already. A lot of people are benefiting from low natural gas prices...chemical manufacturers, fertilizer manufacturers. We expect those guys to begin hedging at these prices right here."

Low gas prices haven't just put a dent in Exco's plans to go private -- they also have forced the company to drop rigs and curtail well completions.

"In response to very weak natural gas prices, we plan to significantly reduce our drilling activities during 2012," Miller said. "We plan to operate an average of nine rigs in the Haynesville Shale and three in the Marcellus Shale during 2012, compared to 22 rigs in the Haynesville Shale and four in the Marcellus Shale during 2011. We will continue to manage our balance sheet, cash flows and debt levels to ensure that we have an appropriate level of liquidity."

This year Exco expects to spud around 70 operated wells in the Haynesville and will "slow the pace of completions to a total of 81 wells in the Haynesville/Bossier shale in 2012, including 52 carried-in wells from 2011, and end 2012 with 41 wells to be carried into 2013 for completion."

In the Appalachian Basin, where Exco's holdings are spread across Pennsylvania and West Virginia, the company now has four horizontal drilling rigs operating and will drop one this year. It plans to drill 47 gross (12.9 net) operated development wells and two gross (0.5 net) operated appraisal wells. "All of our planned 2012 drilling activity is located in areas that either have sufficient natural gas markets and immediate take away capacity or a defined strategy to be sales ready by year end 2012," the company stated.

Exco has "historically emphasized acquisitions of producing properties with upside potential as an important part of our strategy," and that will continue, said Miller. "We plan to actively seek conventional and shale producing properties for acquisition during 2012, including properties with natural gas, natural gas liquids and oil production. We also plan to continue to exploit our oil and natural gas liquids upside on our Permian Basin holdings...

"In spite of the current negative bias toward natural gas, we have significant reserves, acreage and infrastructure assets in the two most prolific and low cost natural gas plays in the country, and we will continue to prudently develop our assets."

The company had no shortage of gassy output in the final quarter of 2011 or for the entire year. Gas and oil production increased to 51 Bcfe in 4Q2011, or 552 MMcfe/d, which was 58% more than in 4Q2010. The Haynesville Shale carried the load with output of 37 Bcf, or 407 MMcf/d -- almost three-quarters (73%) of total production in the period. By comparison, Exco produced 19 Bcf, or 206 MMcf/d in the Haynesville in 4Q2010, which at the time was 59% of total output.

Last year Haynesville production accounted for 71% of Exco's total output, compared with 2010, when it accounted for around 49%. In fact, Exco noted that East Texas/northern Louisiana production last year would have been even higher had it not been for shut-ins beginning last May at TGGT Holdings LLC, a treating facility operated jointly with BG Group. Gas was curtailed for an "accelerated tubing program, an increased emphasis on choke management and the deferral of certain well completions." The facility is expected to begin treating volumes again by the end of March.

Efficient operations continue to be a driver. Exco's direct operating costs averaged 47 cents/Mcfe in 4Q2011, which was about 25% below costs in 4Q2010. Last year operating costs averaged 46 cents/Mcfe, which was 39% lower than in 2010. In the Haynesville Shale operating costs averaged only 8 cents/Mcfe last year.

"We're not shutting in Haynesville gas but we are looking at the portfolio," said Miller. We do have some uneconomic gas wells [outside the Haynesville and Marcellus] and we are shutting those in. I think everybody across the industry has 10-15% of wells that should be shut in because they are losing money at these prices..."

Besides curtailing gas output, "since the beginning of the year, it's been all hands on deck looking at costs across every venue, especially on the operations side...During 2012, you will see some significant cost cutting going on."

The priority for Exco this year is to maintain the balance sheet, said Miller. The company has a financially fruitful joint venture (JV) with BG Group within the Haynesville and Marcellus, and that will help with capital funding this year, he noted. But the funds won't necessarily target more drilling.

"What we're trying to do is get as much cash available as we can because we see a lot of opportunities out there," said the CEO. By Miller's count, there may be as many as $30 billion worth of oil and gas merger and acquisition (M&A) deals on the market today. BG has deep pockets, but so do a lot of other companies, he added.

"We've been approached by several large institutions for JVs in acquiring conventional gas, and we are working on that as we speak. There are opportunities to buy conventional gas, and that means just buying, not drilling. We've also been approached to do a JV in buying shale gas. With somebody putting up the drilling dollars, we'll evaluate that. A lot of things are cooking. There are four to five oil deals on the market and we've got people in the field reviewing those. We expect some bids on that in the not too distant future.

"Again, we are focused on liquidity. We are focused on M&A out there."

Asked when Exco might accelerate its gas drilling again, Miller said, "I think at $4. Again, we're one of the few that has spots were $4 lights up a lot of locations. It depends on the costs." In certain areas, Exco is able to make money at $3/Mcf gas. "The M&A will drive where we go with th rigs...and it depends on the costs...Drilling costs, frack [hydraulic fracture] cos, location costs...we're working on them all And [oilfield service companies] are being cooperative. Those guys don't want to move out of the area..."

It's likely Exco would ramp up more gas drilling "between $3 and $4 prices. But I don't think we'll go crazy even if gas went to $5."

If Exco remains a public company, "which is not my desire, we have to buy oil," said Miller "One thing that is missed in this cycle is that never have I seen the gas to oil ratio get out to 40 or 50 to one. I'm shocked about that. It kills gas. It kills us.

"I think once we start exporting gas around the world, that will change. Here we are producing at $2.50, and we've got countries buying gas for $14, $15. The power guys better get all they can because once gas starts getting shipped, other countries are willing to pay a lot more than power guys are willing to pay."

Miller said he'd be a "fool not to continue to buy gas at these prices..."

As to when Exco might try again to take the company private, Miller couldn't say. Like many of its peers, the company's value has diminished in the past year because of the drop off in gas prices. "I can't guarantee that we're going to be private so we're looking at oil plays right now...What's our company worth? I can't tell you. I have an idea what it's worth. It's worth more than it's being traded right now...I wish we'd gotten private...so I wouldn't have to do all this stuff [with shareholders and conference calls] but there's nothing on the table to go private. We've been approached by some private equity guys but I'm still limping from the last one."

Exco lost $166.7 million (minus 78 cents/share) in 4Q2011, versus a loss of $72.9 million (minus 34 cents) in 4Q2010. Mark-to-market losses accounted for $36.4 million of the latest quarter's losses, compared with a gain of $60.3 million in the year-ago period. Adjusted net income in the latest quarter totaled $19.2 million (9 cents/share), versus $24.3 million (11 cents) a year earlier. Cash flow was $137 million in 4Q2011, compared with $106 million in 4Q2010. For 2011 cash flow totaled $554 million, ahead of $396 million in 2010.

The producer spent $168 million on development and exploitation activities in 4Q2011, drilling and completing 165 gross (23.2 net) wells, compared with 79 gross (41.2 net) wells in 3Q2011.

"We now have 8,404 gross (4,090.7 net) wells in our portfolio of which 94% are operated," Exco noted. "Our total capital expenditures, including leasing, net of acreage reimbursements from BG Group, were $200 million in the fourth quarter 2011." This year the capital budget totals $470 million to fund drilling and completion of 176 gross (77.2 net) wells, among other activities.

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