A 17% increase in production in the second quarter 2002 wasn’t enough to offset “vertically challenged” Rockies prices for Tom Brown Inc. (TBI), which reported net income of $4.8 million or $0.12 per diluted share as compared to $26.2 million or $0.65 per diluted share during the same period of the prior year.

CEO Jim Lightner said, however, he was “very pleased with this year’s operational performance. TBI’s second quarter of 2002 production hit a record level of 245 MMcf/d or 17% over last year’s second quarter.” He also pointed to reductions in operating expense as keeping the company in the black. For the year, he expects production to be 12% greater than 2001.

“Our operational success is being muted in bottom line profit by extremely high and volatile Rocky Mountain basis differentials. We are working to limit the impact of the differential by entering into basis swaps,” Lightner said in an earnings conference call.

With 86% of its production coming from the Rockies area, the company has been strongly affected by the “Rockies differential, which has been very volatile this year,” Lightner said. He pointed out that the CIG bidweek differential from Nymex averaged minus 38 cents in the first quarter and minus $1.25 in the second quarter. The basis has been widening in the third quarter with CIG’s July index $2.08 under Nymex and August off $1.39. Lightner said TBI’s companywide differential for the second quarter was $1.04 and could increase to about $1.30-40 in the third quarter.

TBI has installed some basis swaps for 23 million MMBtu, or 20% of Rockies production, for the fourth quarter at 58 cents under Nymex and for 27 million MMBtu in 2003 at 70 cents under Nymex. “We are expecting the CIG differential to improve in fourth quarter, as it usually does,” Lightner said, but the company is limiting its risk.

“I believe the supply/demand situation, which is getting tight, will one of these days result in fairly strong prices on Nymex and I think the Rockies as well,” but he can’t predict when that will be.

With its current hedge position TBI expects to have a companywide differential to Nymex in the fourth quarter in the 65-70 cent range. The CEO said the company was slowing down capital spending in some areas, based on prices, in the second half of the year to stay within cash flow. But, “We continue to be strongly positioned for the future with a robust portfolio of exploration and development opportunities in our core areas.”

Lightner said there are various opinions as to whether the completion of Kern River’s 950 MMcf/d expansion sometime between May and November next year will help the Rockies basis differential. “The reason it has blown out is that this is a great area. It’s one of a few areas around the country with growing production.” Nevertheless, he highlighted promising results TBI is seeing in its E&P efforts in other areas, particularly Texas and Canada.

Questioned whether TBI would shut in production due to the low prices, Lightner said he preferred the word “curtail. We can and do curtail production when the daily market gets really ugly,” but there are “issues” such as royalty and lease payments that limit curtailment.

Right now TBI is continuing development in a “slow and determined manner,” putting in fewer development wells rather than boosting production with multiple wells.

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