Looking to add significant West Texas oil and natural gas reserves, Midland, TX-based Clayton Williams Energy Inc. (CWEI) has entered into a $187.8 million all cash merger agreement with Southwest Royalties Inc., a privately owned energy company that is also based in Midland.

As of March 31, Southwest’s assets included 177 Bcfe of proved oil and gas reserves (62% proved developed), with a breakdown of 58% oil and 42% natural gas. CWEI said Southwest’s current production is 29 MMcfe/d. In addition, the company believes it has identified an additional 53 Bcfe of probable reserves within Southwest’s assets, which are primarily located in the Permian Basin.

“This acquisition adds significant low-risk development opportunities to our program,” CWEI said. “Southwest’s properties greatly expands CWEI’s reserve and production profile in the Permian Basin. CWEI’s proved reserves will increase from 120 Bcfe to 297 Bcfe (148% increase).”

The transaction is also expected to boost the company’s daily production by 40%. The combined property base will have a reserve life of 6.9 years.

CWEI said the stock purchase will include working capital, and certain other assets and liabilities of Southwest and is subject to approval by Southwest shareholders. The $187.8 million price breaks into $1.06/Mcfe of proved reserves and $0.82/Mcfe for both proved and probable reserves. The company added that it intends to finance the acquisition through a new financing package provided by Bank One N.A. and plans to reduce its increased leverage within 12-18 months.

“We believe this acquisition represents a tremendous opportunity for our company,” said Clayton W. Williams Jr., CEO of CWEI. “Southwest’s extensive inventory of low-risk exploitation opportunities complements CWEI’s exploration focus providing a more balanced drilling portfolio for CWEI. This acquisition increases our opportunities in the Permian Basin and substantially increases and diversifies CWEI’s reserve profile.”

CWEI said it expects the transaction to be meaningfully accretive to 2004 and 2005 earnings and cash flow per share. The company added that because both companies’ corporate headquarters are located in Midland, it has been able to identify numerous operational and financial benefits from the transaction. The deal is expected to close not later than May 21.

The production and reserves increase for CWEI couldn’t of come at a better time. On Tuesday, the company reported net income for the first quarter of 2004 of $4.8 million, or $0.50 per share, down from net income of $16.3 million, or $1.73 per share, for the first quarter of 2003. Cash flow from operations was $21.5 million compared to $29.6 million during the same period in 2003.

Explaining the quarter over quarter decline, CWEI tapped lower gas production, offset partially by higher oil prices, as reason for most of the decrease in earnings for the first quarter of 2004. Oil and gas sales decreased 25% to $36.3 million as compared to $48.7 million in 2003. CWEI’s gas production for the first quarter of 2004 decreased 39% to 4.2 Bcf, or 45,901 Mcf/d, from 6.9 Bcf, or 76,622 Mcf/d, in the 2003 quarter. The decrease was due primarily to the declining volumes in the Cotton Valley area and in south Louisiana, the company said.

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