Questar Corp., which is preparing for the likely spin-off of its exploration and production (E&P) business later this year, on Wednesday reported a mixed earnings report for the first three months of 2010, in part because of lower natural gas prices.

The Salt Lake City-based producer, which is 90% weighted to gas, said net income jumped 124% in 1Q2010 from the year-ago period to $150.3 million (85 cents/share) from $67.2 million (38 cents) in 1Q2009. Excluding unrealized gains and losses on gas basis-only swaps and the sale of some property, net income was $129 million (73 cents/share), down from $150.7 million (86 cents) in the prior-year period.

Questar E&P production rose 10% from a year ago to 51.5 Bcfe from 46.9 Bcfe. Quesar E&P’s net realized gas prices averaged $4.97/Mcf in 1Q2010, down 25% from the year-ago period. Average realized crude oil and natural gas liquids (NGL) prices were $61.80/bbl, 81% higher than in 1Q2009.

“We’re off to a pretty good start,” CEO Keith Rattie told financial analysts during a conference call. “All Questar business units continue to execute well.” Earnings before interest, taxes, depreciation and amortization (EBITDA) were “flat with a year ago, despite a 25% drop in net realized natural gas prices.”

Four of the five major Questar business units — Wexpro, Gas Management, Questar Pipeline and Questar Gas — all posted record first quarter net income and EBITDA, the CEO added.

As expected, many of the analysts’ questions during the conference call centered on Questar’s potential plans to spin off its E&P unit, which were announced last week (see Daily GPI, April 22).

Rattie noted that one of the E&P unit’s competitive strengths is that it has “one of the lowest cost structures in the industry.” Major E&P projects are spread from the Rockies to South Texas, anchored by a “good inventory” of wells in the Pinedale Anticline in Wyoming. Questar also has expanded its exploration efforts by taking stakes in the Haynesville, Woodford Cana and Bakken shales, as well as the Granite Wash.

The management team was quizzed about the reasons for an E&P spin-off, which would be tax-free to the company and to stakeholders. Although the transaction would not be done before the second half of this year — and would require final approval by the company board of directors — Rattie spoke as if the split were a certainty.

“We think a spin-off of the E&P business will create two top-tier companies…,” Rattie told analysts. Questar has been “driving growth in E&P, and we transferred E&P from primarily the Rockies to becoming a multi-basin producer. In doing so, we delivered double-digit growth in a low cost structure.”

“We think we have an attractive inventory of future development opportunities…and good visibility on growth…We have a good foundation on which to continue to grow in an already successful E&P.”

Questar, he said, “is on track to grow production by 12% this year, 12-15% compounded growth over the next five years…without an acquisition and consistent with gas prices on the current curve.” Questar’s current assumption for New York Mercantile Exchange gas prices in 2010 is $4-5/Mcf, down from its previous forecast of $5-6.

Questar’s varied business units “tend to get overlooked,” said Rattie. “The bottom line is that this transaction would unlock significant value for shareholders.”

In fact, Questar’s share price has gone up since the spin-off was announced. Near the market’s close on Wednesday, the stock was up 40 cents on the day, trading around $48.46/share.

Some have questioned whether Questar will move forward with the E&P spin-off, and one analyst asked, “Is the spin-off news merely a ‘trial balloon?'”

“We don’t do trial balloons,” the CEO shot back. “It’s certainly not the case in the most strategic move in Questar’s history…We’ve been working in earnest since last October…We first thought of restructuring in 2008 when the markets collapsed…”

There are, of course, obstacles that could delay or even derail the spin-off, including a “no” vote from the board, market conditions, or a lack of approval for the transaction to be tax-free to Questar and the shareholders. The letter to the Internal Revenue Service was submitted “a couple of months ago,” said Rattie. “Depending on its workload, it could take two or three months.”

Wexpro, which produces gas for utility affiliate Questar Gas, said quarterly net income increased 13% to $21.2 million. Wexpro produced 13 Bcf of cost-of-service gas for delivery to the utility.

Questar Gas Management’s net income doubled to $23.2 million from $11.4 million year/year, driven by a 343% increase in net keep-whole processing margin and a 41% increase in gathering margin — driven by increased throughput on newly constructed gas facilities in the Haynesville Shale.

Meanwhile, Questar Pipeline’s net income was up 17% to $17.2 million from increased revenues from transportation and NGL sales. Questar Gas saw its net income rise 4% on customer growth and higher margins.

Questar is forecasting 2010 EBITDA to range from $1.48 billion to $1.58 billion, up from previous guidance of $1.45 billion to $1.55 billion. Questar E&P 2010 EBITDA could range from $830 million to $880 million, up from previous guidance of $820 million to $870 million. The company also raised Questar E&P 2010 production guidance to 212-217 Bcfe, ahead of prior guidance of 210-215 Bcfe.

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