XTO Energy Inc. reported record second quarter production Wednesday and tipped its hat to sharply reduced drilling costs while increasing its production growth target for the year.

“With strong cash flow margins and 75% of second half production hedged at an equivalent price of $10.69 per Mcfe, operating cash flow for 2009 is headed towards a record $6 billion,” said Chairman Bob R. Simpson. “Looking ahead to 2010, we anticipate a recovering economy, decreasing natural gas supply and increasing natural gas demand. Through our hedging program, the company has already secured an equivalent price of $11.33/Mcfe on about 40% of expected production. With these convictions, XTO is increasing its 2009 production growth target to 20%, from 16%, while modestly increasing our capital budget to $3.6 billion.”

In the second quarter the company produced 2.89 Bcfe/d, up 32% from the second quarter 2008 level of 2.2 Bcfe/d, and up 6% sequentially from 2.73 Bcfe/d in the first quarter of 2009. Second quarter gas production averaged 2.35 Bcf/d, up 31% from second quarter 2008 production of 1.80 Bcf/d. Oil production was 69,200 b/d, a 35% increase from the second quarter 2008 level of 51,300 b/d. Natural gas liquids (NGL) production was 20,700 b/d, a 33% increase from the prior-year quarter rate of 15,600 b/d.

The average gas price for the second quarter decreased 17% to $7.08/Mcf from $8.51/Mcf in second quarter 2008. The average oil price was $107.14/bbl, an 18% increase from last year’s second quarter average price of $90.89/bbl. NGL prices averaged $25.52/bbl for the quarter, 57% lower than the 2008 quarter average price of $58.87/bbl.

“All told, our operating efficiencies are strengthening with exceptional production results, drilling costs down by about 30% and lease operating costs now below 95 cents/Mcfe,” said CEO Keith A. Hutton. “During this quarter, Barnett Shale net production increased to 621 MMcfe/d, up 5% sequentially and 34% year-over-year. In the Eastern Region, the company’s largest producing area, daily net production averaged 903 MMcfe in the quarter, up 27% year-over-year, including 16% growth in the Freestone Trend. Expanding success in the Fayetteville and Woodford shale plays fueled 18% sequential volume growth in our Mid-Continent Region. In this area, gross daily operated production reached more than 85 MMcfe in the Fayetteville and 75 MMcfe in the Woodford, where a combined nine drilling rigs are at work. Our team continues to define our highly prolific Haynesville Shale acreage with four drilling rigs active, and a target of 60 to 70 MMcfe in daily production from this play by year-end. Finally, in our Bakken Shale program, the Three Forks/Sanish reservoir continues to raise expectations as three new wells were completed with daily rates above 1,500 boe per well.”

Simpson, who founded the company, told financial analysts during a conference call Wednesday that the good times will continue for XTO as the company’s recent performance is not merely the result of good acquisitions and hedging that won’t repeat. “…I think the feeling that this tremendous prosperity is artificially created by fortuitous hedges from a bygone era is wrong,” he said.

Volume growth and recovery in the commodities markets are already being achieved, Simpson said. “…[W]e think this cash flow machine continues at numbers similar to where we are now, and that’s the surprise, I think, for the investment community as that unfolds somewhere around a $7 [Nymex] gas strip, our cash flow would be virtually unchanged next year. So it doesn’t take much more from around $6.20 where it is today to get a full recovery and a full cash flow sustaining this record cash flow we’re now enjoying.”

Going forward, Simpson said he’s not worried that gas prices will be held down by the economics of the most desirable gas play — “that would be choose your play, whether it’s Marcellus or Woodford or Barnett or Haynesville” — shale. “The reason is you can’t get enough volumes out of any one of those areas because the infrastructure is not there and the decline curve that’s in place where the industry’s too fierce.”

Service costs won’t be staying down either, Simpson allowed, but XTO will take what it can get on that front. “The upturn will come first with the commodity and for the producer. So I’ve always enjoyed being the producer instead of the service guy, and I still do, and I think we have an edge. But if you look at the recovery, it’s coming [to service costs],” he said. “…[P]robably mid-next year would be my guess.”

For the time being at least, XTO won’t be seeking at acquisitions. “The acquisition market, I really haven’t seen a return of it in aggregate, and specifically for this company we’re not particularly interested because we have so much opportunity that we have on board already,” Simpson said. “There’s no need to stretch the point and strain the company for more opportunities when they’re so bountiful within.

“We don’t need a franchise acquisition, and we certainly don’t need an acquisition that would involve our equity, which I submit continues to be undervalued and not a tool to create value with at the moment in terms of issuing it. So we’ll keep that discipline for you and look forward to great quarters as we go through the rest of this year.”

XTO shares closed down 1.5% Wednesday at $41.96.

Revenues for the second quarter were $2.27 billion, a 17% increase from $1.94 billion the prior-year period. Earnings were $496 million (86 cents/share), compared with second quarter 2008 earnings of $575 million ($1.12). Adjusted earnings were $509 million (88 cents/share), compared to second quarter 2008 adjusted earnings of $553 million ($1.08).

Operating income for the quarter was $898 million, an 11% decrease from second quarter 2008 operating income of $1.01 billion. Operating cash flow was $1.51 billion, up 23% from 2008 second quarter operating cash flow of $1.23 billion.

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