Describing itself as a “lower-risk play on the long term fundamentals of natural gas,” Questar Corp. may have validated its claim with its 2Q2007 earnings and production results. The company increased its natural gas and oil production by 13% and its net income by 24% from a year ago — in spite of the current price environment for Rocky Mountain natural gas production.

Questar’s exploration and production (E&P) division increased production to 35.5 Bcfe in the quarter, up from 31.3 Bcfe in 2Q2006, even though it shut in about 1 Bcfe (net) of unhedged June production and about 1.3 Bcfe in July because of fire-sale prices for Rockies gas. In total, Questar E&P contributed $66.7 million in net income, more than half of the company’s total quarterly profit of $112.2 million.

Because of the low gas prices, more gas will be curtailed in August and September — about the same amount as June and July. However, Questar still expects to hit its previous production forecast of 135-138 Bcfe for the full-year 2007.

“Producers are experiencing the worst Rockies basis blow-out in years,” said CEO Keith Rattie, who presided over a conference call Thursday. However, Questar “should get through this tough summer…relatively unscathed” because of its disciplined hedging strategy, contributions from its Midcontinent program and lower-than-average costs. In addition, Questar is spending more in its Wexpro and gas management divisions, “where returns are less sensitive to short-term fluctuations in commodity prices and [are] better than returns we get from our regulated businesses on both a nominal and risk-adjusted basis.”

In the first six months, net natural gas hedges increased Questar’s E&P revenue by more than $90 million.

“We’ve now hedged 55.5 Bcfe of our second-half 2007 natural gas and oil equivalent production with a mix of fixed-price swaps and Rockies basis-only hedges, which represents about 84% of our forecast second-half production, 76% if you exclude the basis swaps,” Rattie said. “The hedges that we have in place for the remainder of 2007, 2008, 2009 and 2010 are in the aggregate, solidly in the money.”

Questar’s average gas price in the quarter was $6.47/Mcf, a 47-cent increase from the same period of 2006. With the hedging strategy, Rattie said, “we sacrifice some upside on weather-related price spikes, but we do so to protect cash flow, returns on capital and of course, our long-term shareholders, from the kind of drop in commodity prices we have seen this summer.”

He said Questar’s energy trading unit holds firm capacity on the Kern River pipe, which “effectively locks in Rockies basis to California for part of our unhedged volumes. Therefore, returning to that lower risk theme, we’ve taken commodity price risk pretty much out of the equation for Questar owners in 2007.”

Questar’s E&P business gains a competitive advantage because its costs are “among the lowest in the industry,” breaking even at around $3.32/Mcfe in the first half of the year, Rattie said. “That’s up 16% compared to the first half of 2006, and of course we’re concerned and focused on that, but to put it into context, we’re still far below the industry average, which is now above $5/Mcfe.”

Questar is continuing to develop its assets in the Vermillion Basin of Colorado and Wyoming. In the Uinta Basin, the company is evaluating the lower Mesaverde, Mancos, Blackhawk and Dakota formations at depths from about 9,000 feet to more than 16,000 feet, “depending upon where we are in the basin,” said Rattie. The summer drilling plan at Questar’s Pinedale properties is “off to a good start,” with seven rigs currently drilling. The company expects to complete 50 new wells in Pinedale this year.

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