Ardagh Group S.A.
Q2 2008 Earnings Call Transcript

Published: 16 Sep 2008

[Operator:]

Welcome to the Arena Resources 2008 second quarter and six month financial and operating results conference. (Operator Instructions) It is now my pleasure to introduce your host, Tim Rochford, Chairman of the Board for Arena Resources.

[Tim Rochford:]

I'd like to welcome all listeners to the second quarter and six month 2008 financial and operations conference call for Arena Resources. Again, my name is Tim Rochford and I serve as Chairman of the Board for Arena Resources. Joining me on the call this morning is Phil Terry, our CEO and President along with Randy Broaddrick, our Chief Financial Officer and David Ricks, Vice President of Operations. Before we begin I would like to make reference that any forward-looking statements which may be made during this call or within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. For a complete explanation, I would refer you to the release issued this morning. If you do not have a copy of this release one will be posted on the company website at www.arenaresourcesinc.com. Today we will cover the financials and operations for the second quarter and six months ended June 30, 2008. We will also review our results and provide some insight as to the current progress in the third quarter, 2008. At the conclusion of the second quarter overview, we'll open it up for any calls or any questions that you may have. At this time, I'm going to ask Randy Broaddrick, our Chief Financial Officer to review the second quarter and six month financial results.

[Randy Broaddrick:]

For the three months ended June 30, 2008 the company had oil and gas revenues of $62.2 million and net income of $24.8 million. This is compared to revenues f $21.6 million and net income of $7.9 million in the second quarter of 2007. This represents an increase of 188% in revenues and 214% in net income. For the six months ended June 30, 2008 the company had oil and gas revenues of $107.5 million and net income of $43.1 million as compared to revenues of $38.3 million and net income of $13.6 million in 2007. This represents an increase of 181% in revenue and 217% in net income. On a diluted basis, the earnings per share for the three months ended June 30, 2008, were $0.67 or $0.70 per share excluding a $1.5 million non-cash charge for share based compensation. This compares to $0.24 or $0.26 per share excluding an $881,000 non-cash for share based compensation in 2007. For the six months ended June 30, 2008, earnings per diluted share were $1.18 or $1.24 per share excluding a $3.25 million non-cash charge for share based compensation, as compared to $0.43 or $0.46 per share excluding a $1.5 million non-cash charge for share based compensation in 2007. Net cash flow from operations adjusting for changes in operating assets and liabilities for the three month, six month period ended June 30, 2008 were $48.5 million, or $1.31 per fully diluted share and $85.5 million or $2.32 per fully diluted share, compared to $16.1 million or $0.50 per fully diluted share and $28.5 million or $0.90 per fully diluted share in 2007. Additionally, our shareholders equity is now in excess of $422 million. Our production costs for the three and six months ended June 30, 2008 were higher than those for the three and six months ended June 30, 2007. The increase is a result of a variety of factors, including increased rates for essentially all of our services, materials, equipment and labor. We have also seen significant increased for our electrical services as most of the electrical generation in our areas of operations are affected by oil and gas prices. Additionally, we still have to truck water while waiting for permits to convert wells to water disposal wells, which we did not have to deal with as extensively in the first half of 2007. However, we have had more permits approved and more wells converted, so those costs will decrease in the future. We did see further increases in oil and production taxes for the three and six months ended June 30, 2008, when compared to the same period of 2007. Most production taxes are based on values of the oil and gas sold, so our production taxes per BOE increased with the commodity prices and will continue to move up and down with commodity prices. Looking forward, we anticipate our lease operating costs to be in the range of $7.50 to $8.00 per BOE and our oil and gas production taxes to be $5.00 plus per BOE based on current commodity prices for the remainder of 2008. We continue to see an increase in our DD&A for both three and six months ended June 30, 2008 as compared to the same period of 2007. As has always been the case, depletion of our oil and gas properties is of primary contributor to DD&A. A gradual increase in our depletion costs is expected as we continue to develop our properties. This gradual increase is a result of our adding capitalized costs as we develop our properties and adding future development costs as we add additional reserves. As we discussed during our first quarter conference, the acquisitions made throughout 2007 contributed to a further increase in our depletion rate, as with each acquisition we add our acquisition costs to the depletion base as well as all future development costs related to the reserves added. Although our DD&A per BOE was $12.75 per BOE for the six months ended June 30, 2008, we anticipate an increase each quarter to ultimately average approximately $15.00 per BOE for the year excluding the impact of any additional acquisitions throughout the year. Our increases in G&A are the result of increasing payroll as we continue to add more new employees in order to sustain our growth as well as significant increases in our stock based compensation expense as we grant options in order to entice new employees as well as to retain those new and old employees. Management believes that this is necessary to continue to add quality personnel with the experience and knowledge that we need. Stock based compensation increased from approximately $881,000 for the three months ended June 30, 2007 to approximately $1.49 million for the three months ended June 30, 2008. Similarly, stock based compensation increased from approximately $1.52 million during the six months ended June 30, 2007 to approximately $3.25 million for the six months ended June 30, 2008. We anticipate a gradual decrease in our stock based compensation amount each quarter throughout 2008 subject to increases from additional option grants. Other factors contributing to the increase in G&A are increased franchise taxes and financial and auditing fees. Lastly, we have one hedging component in place. The color in effect runs through year end 2008. We had a realized loss in the quarter of approximately $2.49 million after tax or $0.07 per diluted share. We also showed an unrealized loss of approximately $2.45 million after tax as other comprehensive loss which did not affect our earnings. For the six months ended June 30, 2008, the realized loss was $3.49 million after tax or $0.10 per diluted share and the unrealized loss was $2.83 million. Additionally, subsequent to June 30, 2008 we entered into another hedging component in the form of another collar. The new collar has a floor of $100 and a ceiling of $197 on 1,000 barrels per day starting August 1, 2008 running through December 31, 2009. The total volume covered by this collar is 518,000 barrels. As this contract was not yet in effect, there was no impact to our financial statements as of June 30, 2008. In a final note, in June 2008, we entered into an amended agreement on our credit facility, increasing the borrowing base from $100 million up to $150 million. All other terms and conditions of the credit facility remained the same. With that, I'll turn it back over to Tim.

[Tim Rochford:]

We're going to ask Phil Terry, our CEO and President to give us a second quarter operational update.

[Phillip Terry:]

In the second quarter, we drilled 52 new wells on our Furhman Mascho properties in Andrews County, Texas. This brings the total of new wells drilled in the first six months of 2008 to 107 wells. In addition, we performed refracts on 22 existing wells and we continue the improvements and upgrades to our leasehold infrastructure. I should point out to you that the 52 wells represents a shortfall of about three wells. We had budgeted 55 wells to be drilled in the quarter. We behind three wells as a result of drilling two deeper clear fort tests with our company owned rig, and as a result of that we fell three wells behind in our target number. I will say that we are now back on schedule with four rigs and we'll discuss that scheduling as we get into the operations section of our report today. Also in the second quarter, our sales as a result of production were 558, 485 BOE's. This represents a 45% increase over the same period in 2007 and an 8% increase over the first quarter of 2008. Our average net daily production increased approximately 6,137 BOE's per day. The average commodity prices received in the second quarter were $119.23 per barrel for oil and $10.77 per MCF for natural gas. The average sales price for BOE we received in the second quarter was $111.30. That represents a 27% increase from the first quarter of 2008 and a 98% increase from the second quarter of 2007. I'd like to point out that our second quarter update that we issued previously listed sales estimated at 562,000 barrels for the quarter. We actually sold 558,484. The difference was due to a correction factor that we had to apply to the Furhman Mascho net revenue report. The preliminary report incorrectly listed a net revenue that has been corrected, and the numbers that we have reported for our second quarter all are factual and accurate. A gas sales increase due to increased sales at Furhman Mascho. I'll also add that our May and June production and sales were also affected in a negative manner by repeated power failures due to generation and distribution shortages of our power supplier. David Ricks will further expand on those problems and what we're doing to correct them as he gets into the operational report. Also in May and June, production was affected negatively by mechanical failures of several new pumping units. Those mechanical failures were manufacturer's defects. We'll also talk about that and David will explain further in his segment. For the six months ended June 30, 2008, our sales as a result of production were 1,750,526 BOE's. That is a 49% increase over the prior year. The average commodity prices for the first six months of 2008 were $106.02 per barrel of oil, and $10.14 per MCF for gas. The average sales price per BOE received in the first six months was $99.92 compared to $53.01 in 2007 which is an 88% increase. With that, I'll introduce you to David Ricks, our Vice President of Operations, and David will give you a more detailed operations report for the second quarter.

[David Ricks:]

In the second quarter of 2008 we drilled 52 wells at Furhman Moscho and refracted 12 wells, giving a total of 107 wells drilled and 22 refracts for the first six months. The number of wells drilled was slightly down from the first quarter, due to the drilling of the two deep tests that Phil mentioned. The breakdown of those 52 wells; 6 of those were 40 acre locations, 17 were 20 acre locations and 29 were 10 acre locations. Of the 29 10 acre locations, there were 10 wells that contained the abnormally thick [gray burg] on top of the sand. This is in our enhanced fairway of production reserves. Those wells perform quite nicely and a good number of our remaining wells will be drilled in that fairway. As Phil indicated, we have contracted a fourth drilling rig that commenced drilling at Furhman Moscho at the end of the second quarter. With the addition of the fourth rig, we anticipate drilling 74 wells in each of the third and fourth quarters of '08 for a total of 255 new wells in '08. We continue to have good success with our refract at Furhman Moscho and we have identified a number of good opportunities for refracts. We have completed 12 refracts for the second quarter and planning on performing a total of 50 for this year. We continue to spend most of our time at Furhman Moscho and production continues to increase as a result of our efforts. We continue to develop our water plans and we are fairly close to finalizing our plans. After a review of our engineering study, we will be ready to approach the railroad commission of Texas to start the permitting procedures and hearing to form our water flood unit. We hope that we will be able to get our water flood on the docket with the railroad commission early next year for approval. The other activity at Furhman Moscho involves infrastructure improvements, laying new flow lines and increasing our handling capabilities. We continue to convert wells to disposal which has helped our operations and has helped reduce our operating costs. We are experiencing daily power interruptions from our electrical provider and are exploring options for making the power more reliable. Today, we have a generator being set on one of our leases to help alleviate the problem and we will be looking at setting more generators in the future. We are also looking at the possibility of building a sub station out there to provide more reliable power. May and June product was lower than we expected due to the mechanical failures of new pumping units that Phil mentioned, and we have since repaired those. The pumping units were new pumping units on new wells so we lost that production for a period of time but everything has been restored and it's pumping now. And also, we are changing suppliers of the pumping units to get around that problem in the future. We are waiting on the start of pipeline construction to finalize our scheduling of our Yates gas project which will involve the preparation of shut in and temporarily abandon wells for recompletion to Yates. We anticipate the pipeline construction to begin in the fourth quarter and to be completed at the end of the second quarter of '09. Additionally, in the state of Texas, at our Y6 property, we have completed two wells in the first half of '08 and are pleased with the results. The frac program on the new wells has presented the opportunity for some refracts on the existing wells and we are currently identifying the best candidates. As we move forward into the second half of this year, we will convert 3 wells to water injection in the south portion of that Y6 property and we will drill two additional flood locations in the south half of the unit. Moving to New Mexico; at our East Hobbs unit, in the past reports we have reported the fact that we had production interruptions and production curtailment as a result of some high line pressures resulting from extraordinarily high operating conditions from our gas purchaser. We did install new pipeline and new gas compressor in the first quarter of '08 and initially though production increases from the compressor in the first quarter. However, we experienced only a short run from the compressor due to mechanical problems and that has resulted in us replacing the compressor recently, and we expect to see production restored to previous levels and hope to see production increase even more with a long term run from our compressor. At East Hobbs, as we move into quarters three and four of '08, we will convert three wells to water injection. We have identified a water source for injection and we are making final determination as to the best use of that water. Also in '08 we plan to drill two flood locations. These locations offer an excellent potential for us to not only increase production but to increase our reserve base. Also up in Mexico, we are planning on our extended work at North Benson Queen in Eddy County. We currently are working with the BLM for approval of drilling permits and we hope to have approval within 30 to 45 days. We have everything in place to begin drilling once we obtain approval. We have purchased tubulars in advance for this project and we have contracted the drilling rig to begin after BLM approval is in place. And as a result of that, we will be drilling in quarter three and quarter four of '08. We hope to drill 12 flood wells this year at North Benson Queen unit and also this year we plan to refract about 10 wells at the North Benson, and we will start those refracts in the third quarter. At the Seven Rivers Queen unit in Lee County we have planned to drill two flood wells in the last half of this year. This is still a recognizable opportunity for us in terms of increasing production and adding to our reserve base. We plan to refract wells in the second half of this year on Seven Rivers Queen and the remaining of the New Mexico properties will see considerable activity for the remainder of the year. We have 18 wells that are scheduled to be drilled. They will be drilled in quarters three and four and we are planning to refract 28 wells. Again, those refracts will take place in the second half of the year, but we are currently working on infrastructure improvements and on many New Mexico properties, and some have been completed and others are being completed as we speak. Here we have listed 34 wells to drill in New Mexico in the second half of '08. We hope to drill as many as 50 by the end of the year. Phil, I'll turn it back to you.

[Phillip Terry:]

Thank you David for the operations update. Tim, I will turn the reports back to you.

[Tim Rochford:]

In summary, I'd like to just highlight a number of we think some key elements that have taken place and some reminders. We are now drilling our 390th well at our Furhman Moscho lease since we started development back in 2005. In addition, we have refracted another 132 wells. We have just opened our new office at Andrews which serves as headquarters for the drilling company. We now have four rigs running as mentioned earlier at Furhman Moscho and we expect to have up to another three to four rigs running on other assets very soon. Our Yates project is well underway and all properties are scheduled to get attention during 2008. And, for the first six months, all operations excluding acquisitions were cash flow positive. However, we don't anticipate that to continue the second half of '08 because of the acceleration that's going to take place and the activities related to all of our other properties. We have just recently increased our CapEx budget to $248 million. We will drill over 300 wells company wide this year. That's twice as many wells as we drilled in '07, 255 plus wells at Furham Moscho alone which does not include any Yates recompletions. Our all in costs for DD&A remain under $35.00 per BOE and with no additional acquisitions we will see production increase 40% to 50% for the next three to four years, an annual proved reserve growth of 10% to 15% net of production over the next three to four years. Our Furhman Moscho San Andreas wells are paying out in less than six months with $100 oil. We have more than 1,900 remaining locations to drill at Furhman Moscho to fully develop the 10 acre spacing. That's over 1,400 locations that have not been booked at this time. Our borrowing base as mentioned earlier has now been increased to $150 million. We are currently debt free and we have a very strong cash position and we will continue to look for acquisition opportunities specifically in areas that complement our current operations. We are now in the process of opening a Midland office for that reason. This concludes the company's portion of the 2008 second quarter and six month operation review. I'm going to turn it back over to the operator and open it up to any questions that you may have.

[Operator:]

(Operator Instructions) Your first question comes from Neal Dingmann – Dalhman Rose.

[Neal Dingmann:]

Just looking at economics today of both Furhman Moscho and over at the Hobbs, are those continuing to stay steady or are you seeing those improve a bit? Tim I did hear moving over to San Andrews your comment about the six month payout seems to be getting even better in these prices. I was wondering with general economics what you're seeing, say today on a typical well in each of those areas versus a year ago. And then if those economics are improving, it sounds like you could have potentially six rigs running. Is that the case or going out this year?

[Tim Rochford:]

I'm going to let Phil address that but I will comment just quickly on a couple of components there. Yes, we anticipate that in addition to the four rigs that are currently running at Furhman Moscho with all the assets both in the perm and also up at the Y6 in Fisher County, Texas, and possibly even on into Oklahoma, that we could have as many as another two to three rigs running in addition to the four rigs this year. As it relates to the economics, obviously with the price of commodities reaching levels that we've seen, we've been some great payouts. The fact is we're seeing payouts less than six months right now. I just pointed out the $100 just to give you an idea, if in fact oil is moving around and we were to net as little, or as much as $100 we're looking at six month payouts.

[Phillip Terry:]

The per well economics for our San Andres wells remain very positive and very encouraging. We have recently increased our AFV as a result of some pricing parameters that have changed for us specifically the cost of casing, tubing, pumping units and sucker rods. So we now AFV a new well at $647,000 and as a result of that, we went back and ran our models again to see where we were with an individual well, and at $125, that $647,000 that it pays out in approximately five months. It stretches to six months at $100. So our average well continues to be about 150 barrels per day per well and declines to about 20 barrels a day after the first year or so. We turn the money around quickly and we continue to be very encouraged about the performance of the wells at Furhman Moscho.

[Neal Dingmann:]

As far as [inaudible] cause you to want to hedge more in this environment?

[Phillip Terry:]

As you can see, we did put another component in place, and we'll just play that by ear a bit longer. When we see opportunities and we think it's a prudent decision to do so, we're going to do so.

[Operator:]

Your next question comes from David Heikkinen – Tudor Pickering

[David Heikkinen:]

When I think about what you guys are doing around that growth rate talking about power interruptions and installing generators, talking about eliminating trucking and getting pipeline, you're doing a lot of things to drive down your operating costs as well. Can you talk about some of those initiatives, what that will do to your internal operating costs and then predictability and reliability and those thoughts as well.

[Phillip Terry:]

We are continuing to make appropriate changes in the field as we go through our operations. David Ricks identified a couple of critical problems that we have in the area that we really didn't anticipate and I don't think anyone anticipated, and specifically the most significant is we have literally outstripped the power distribution and supply capabilities of our power provider. That is not a universal problem. It is a problem that is particular to one area of our operation, but it is critical because it's in an area that involves our South Furhman Moscho unit which we purchased in the fourth quarter of last year, and we estimate that every time we have a power outage, which basically occurs on a daily basis, we lose 100 to 200 barrels of production. We have gone back to the power provider and have had conversations with them as to what are they going to do to change and correct the problem. We have been told that they are at maximum capacity at the current time and don't anticipate upgrading their system in the near future. That leaves us with a couple of alternatives, the first of which is installation of generating facilities at strategic locations. We have done that in the South Furhman Moscho unit area to alleviate the power draw so we can have enough power to get away from these interruptions. The second and more permanent remedy is building a sub station and that would be a company project, and Arena project that we have not dedicated our efforts in the past to be a power generation or electrical company. But in this particular instance it is to the best interest of Arena and the ongoing project to build such a power station. We are currently studying that. We have outside engineering groups that are providing proposals to us and we'll make a decision and award a contract fairly soon. This will allow us to get away from the interruptions. It will give us a stand alone type power source that will be Arena only, and the ultimate result of that is that it will be a nice payout situation for us. We will save a considerable amount of money over a ten year period, as much as $5 million on power bills over that period. We just regret that we're having to do it. We're not a power company. We're an oil and gas acquisition and exploitation company. So we will do this because it's for the best interest of the company and the best interest of the project.

[Operator:]

Your next question comes from Noel Parks – Ladenburg Thalmann

[Noel Parks:]

I wanted to get you to talk about your thoughts on the acquisition market and the environment both in terms of local to you, the Furhman acquisition you've had a lot of success in doing, and also the acquisition market for properties outside your immediate area there at Furhman Moscho. Just up and down we've seen the commodity prices just what your thinking is in terms of getting agreement on price and terms among parties and whether you're seeing any urgency on the part of sellers or greater reluctance, and again either for your current properties or for other Legacy properties out there that might be attractive.

[Tim Rochford:]

We've been pretty aggressive on looking for opportunities as history has shown here over the last couple of years by expanding any way we can, particularly at the Furhman Moscho area and then beyond the Furhmian basin. And as you can see over the last 12 months or so, we've added a number of additional assets within the Furhmian basin. We continue to see opportunities. I really sense that we're going to see possibly some even further opportunities as we've seen some softening of oil prices. I never thought I'd say that when we're still seeing $140 oil, but in any case, there are a number of projects that we're looking at. We continue to see, I think you've got the motivated sellers for a number of reasons. As mentioned earlier, in my summary points at the conclusion of the overview this morning, you'll recall that I mentioned that we are, and we're in the process as we speak opening up an office in Midland. That office is going to give support to our land department out of Tulsa, but it's also going to be equally important to knock on the doors. We are going to be very aggressively looking for opportunities; whether they're companies or whether they're stand alone assets we think that there's going to be great opportunities as we go forward. We will stay within the guidelines that we set out for ourselves from an economic standpoint, from an operational standpoint. But with the resources that are in place between our cash position, our credit facility, and not to mention again, remember, our borrowing base went to $150 million. We think that soon, as we go into the fall and we're looking at a renewal of our credit facility and a review with our bank group, that we'll see that base increase substantially. So we're going to be well prepared for opportunities that come along. We'll just have to wait and see how they unfold. Phil, if you have anything to add to that, please feel free.

[Phillip Terry:]

The only thing I would add is a personal feeling that I have that there will be additional opportunities for acquisitions both around our Furhman Moscho properties immediately surrounding it with the identification of contiguous acres and acreage that we wish to add to our inventory. There are still a number of small properties when added together wind up being a fairly good amount of acreage that we can add to the project. We have identified many of those. They remain on our radar screen as being objectives that we wish to pursue and acquire. So we have additional potential to add to our Furhman Moscho acreage. In addition, there has been considerable movement in West Texas, particularly in the Midland area in terms of properties and companies selling assets. In many instances there were established Midland and [inaudible] that previously were thought to not be candidates for divestiture and not be candidates for selling their properties, but we've seen that take place. I personally think there will be more of that certainly before the end of this year. A number of considerations that I believe will influence that, one of which is commodity price. People may be encouraged to monetize now. Secondly, there's the factor of capital gains tax treatment and what might happen or what might change with that so we are aggressively going to seek out opportunities the remainder of this year. We're geared to do that. Tim has mentioned that we are opening an office in Midland. We have hired a 25 year plus professional land person as the first employee for that office. The gentleman is well known in the community and we feel like that will open many doors for us and allow us to become even better known in the community, which will help us to acquire properties.

[Operator:]

Your next question comes from [John Leeds – Leeds Capital Market]

[[John Leeds:]

The question I have in regard to the collar. The collar that was in place, doesn't that expire on December 31 this year.

[Phillip Terry:]

The [causus] collar that was put in place that Randy reported on highlighting earlier will expire December 31, 2008. The [causus] collar that was mentioned that did not event, was not an event in the first half of the year, didn't become effective until August 1, 2008 through December 31, 2009.

[[John Leeds:]

And that's 100 hours to 197. Another quick question regarding company owned rigs, anything on the near horizon about maybe trying to expand your own rig count?

[Tim Rochford:]

We now have as everyone knows, pretty much everyone knows, we have two company owned rigs, and we have a great team of people. We've just opened up the office in Andrews there which as I mentioned earlier, serves as headquarter for the drilling company. There's no doubt that we think that we have the ability to expand upon that if we deem it to be prudent. And it really remains to be seen whether or not we add another company owned rig, but time will tell. But we do have the infrastructure in place now so we'll see how that goes, and that's one other item that's on the horizon that we just watch very closely.

[Operator:]

Your next question comes from Stephen Berman – Pritchard Capital.

[Stephen Berman:]

Can you repeat the second half refract plan, how many refracts you're doing?

[David Ricks:]

Furhman Moscho we're going to refract 50 wells this year, will be the total. We've done 22 so far, so we have 28 remaining.

[Stephen Berman:]

Can you talk a little bit about the recent economics on those and costs, incremental, etc? Any additional color there?

[David Ricks:]

On the costs, the costs really haven't gone up that much. We're I believe about $120,000 and the AFV costs on our drilling site has been primarily due to steel products, tubulars, pumping units, and those already exist on the refract so cost really hasn't gone up. The economics are really about the same.

[Tim Rochford:]

I think we've averaged, and corrected me if I'm wrong guys, but I think we've averaged spending $120,000 plus or minus on these refracts and I think we've seen as a result an increased net of about an average of $12,000, maybe a little bit better, maybe as much as $15,000 VOE as a result.

[Stephen Berman:]

And as you've done more of these has the time to do these gone down as you've gone up the learning curve here? Has that helped keep the cost pretty stable?

[Tim Rochford:]

I think so. In fact, as I recall we were spending closer to maybe $150,000 when we first started the program, so I think there's no question from the learning curve, our guys have that down. There's no doubt about that. And with as many candidates as we still have there, we're going to still see some good things ahead. So spending $120,000 plus or minus, adding 15,000 BOE's as a result you can figure that the numbers pay off just in months.

[Stephen Berman:]

Did I hear someone say that 200,000 barrel impact from some of these issues in the second quarter on production? Did I hear that right? I heard a number. I'm not sure what it was. You were talking about some of the issues, the mechanical, the pumping issues and the power failures.

[Tim Rochford:]

I think what was referenced was that we have at times because of the power outage issues, and not to mention the mechanical issues, and by the way, I know that was cleared up, but just to underline that, those issued have been cleared up. We have changed suppliers and that is no longer an issue. But when it was taking place along with the power outages, and Phil I think mentioned, we'd see on days as much as 100 to 250 barrels that we would lose, not permanently, but for the time being, The reserves aren't going anywhere it's just that we lag in the production.

[Stephen Berman:]

Is there any way to quantify what impact that might have had just in Q2, these issues?

[Phillip Terry:]

I can give you some relatively good numbers along those lines. I mentioned, and the number you're probably recalling is the 200 barrels a day that I mentioned that we lose when the South Furhman Moscho unit power goes down, and we've been suffering power outages on almost a daily basis at that particular unit. And as David told you, we are installing today an electric generator out there to have power provided directly to that site at South Furhman Moscho so we'll correct that problem very quickly. The problem with the pumping units affected a number of wells and at one time, we had eight new wells that were down because of gear box failures. And all of those wells unfortunately, were in very good areas. Many of them were in the areas where we have the thick section of [grey burg] on top of the sand, and the bottom line is, those wells in the first month will make 3,000 to 4,000 barrels each and we lost that for a period of two weeks, and in some cases a month until we could get all of those pumping units replaced. So we feel like we lost a significant amount of production in May and June as a result of the pumping unit failures and the electrical problems. We've now corrected the pumping units. All of those are in operation as David mentioned. And we're now addressing the electric problem as South Furhman, so I can tell you that July numbers are considerably better than June, and we anticipate August the remainder of the year to continue to grow along projections that we set forth.

[Operator:]

Your next question comes from [Dan Vinassa – Private Investor]

[[Dan Vinassa:]

I heard about this collar, 100 versus 199. I don't quite understand that. Could you explain that in a little more detail?

[Tim Rochford:]

Actually, it's a $100 threshold on the base on the bottom side and $197 ceiling on the top side. That allows the company to enter into an arrangement where it costs us nothing – that's the costless collar. It costs us nothing in terms of putting this component in place. What it really means is, if the market, the spot market which we're selling into were to drop below $100 a barrel for that 1,000 barrels and day that we have hedged in that collar, we would be paid the differential between what was below that $100 up to $100. So if it was $90, we would receive the extra $10 for example. On the other hand if the price of crude went through the ceiling of $197 and went to $205, we'd be paying the difference between $197 and $205. That would be a check that we would write for that differential for that 1,000 barrels a day.

[[Dan Vinassa:]

So you can sell all the production you produce?

[Tim Rochford:]

Oh yes. Absolutely.

[Operator:]

Your last question comes from Noel Parks – Ladenburg Thalmann

[Noel Parks:]

Could you just refresh my memory? Looking ahead to the water flood at Furhman Moscho, how many of the existing wells that you have there are going to be suitable for converting to injector or are you looking at the old Legacy wells, not the ones you drilled recently, or are you going to be in a position to re-drill old wells to make them suitable as convertors or as injectors as producers?

[Phillip Terry:]

The existing wells, as you called them the Legacy wells, will be utilized to the fullest extent. We anticipate that many of those wells will be converted to water injectors. Of course they must first pass a mechanical integrity test that indicates whether the casing is good, but given that, assuming that is the case, we will utilize as many of those wells as we possibly can. As we move forward with full implementation of the water flood, we don't anticipate the need to drill any injection wells. We will convert existing wells; either old wells that existed when we bought the property or in some cases, newly drilled wells further down the line, or further down the line in time. But we don't anticipate ever getting into a position where we're drilling injection wells. That kind of conversion work is relatively simple and relatively quick and the expense involved in rather minimal as far as a well bore is concerned. Essentially, you remove the production equipment and install injection tubing and then just begin the water injection process.

[Noel Parks:]

I know you guys over the last year have done some looking at the Clear Fork at Furhman Moscho, I'm wondering what's next on the list for unexploited zones either there at Furhman Moscho or at other properties? What might we look forward to there?

[Phillip Terry:]

We did drill the two deeper tests to investigate the possibility of Clear Fork and some of our key areas. Unfortunately for us, those two tests showed that the Clear Fork was not productive at those particular locations. Those wells were then completed as San Andreas wells. We certainly have not given up on deeper exploration on our own leases and we're also in a position now to begin to investigate and explore free standing prospects. By that I mean, we have signed an exploration agreement with an independent geologist and geophysicist in Midland, Texas who will generate prospects that we may then investigate and evaluate and many of those that we'll be working are areas that we now own leases so we'll first look there. Secondly, we'll begin to expand our horizons to other areas in the Furhmian basin near our Furhman Moscho. But the beauty of west Texas, in particular the Furhmian basin and the west Texas portion of that Furhmian basin is the multi-pays from the shallowest of depths, in our case 3,000 feet at which the H is found to deeper horizons including the Devonian and the Ellenberger. So we want to take advantage of that, and in a very controlled manner, begin to investigate the possibility of deeper production through these prospects that will be generated.

[Noel Parks:]

Could you just refresh my memory, in New Mexico, your different fields there, what is the typical well look like, either a target IP or EUR you're expecting there?

[Phillip Terry:]

It's somewhat difficult to put a typical well together in New Mexico because we're working in different zones. At the East Hobbs San Andreas unit, those wells have a history of producing the old wells historically produced in excess of 100,000 barrels each. Many of those wells have cumulative production of several hundred thousand barrels. We currently estimate that those wells would make around 200,000 barrels over their lifetime and the initial potentials range from 50 barrels and day to 150 barrels per day. San Andreas at that particular area is found at about 4,500 feet. As we move to our other areas, we have the predominant zone which we produce in the other leases would be the Queen formation, and those wells have a slightly different performance characteristic. Their IP's would be less but generally speaking, you're talking 50 to 75 barrels a day with individual recoveries from 30,000 to 75,000. In some cases, the Queen is found at very shallow depths. For instance at the North Benson Queen it's much shallower than we find it at the Seven Rivers Queen, so as a result of that depth change the recoveries change. But economics are good for all of the projects.

[Operator:]

We have a final question from the line of [Bob Schearing – Schearing Oil Capital]

[[Bob Schearing:]

You said that if you built an electrical sub station you would save $5 million in electrical costs over 10 years. Roughly how much would it cost to build this sub station and ultimately is it something that would be saleable? Could you sell electricity through the grid?

[Phillip Terry:]

We have received one estimate so far from a third party engineering group that estimates the cost of that facility would be $1.5 million. And the savings over a 10 year period would be about $5 million. We don't anticipate selling excess electricity to the grid. That is a possibility if we choose to do so, but at this point in time we want to establish a reserve power base that will allow us to continue our development in those key areas and eliminate the interruptions in service and power.

[[Bob Schearing:]

Those economics sound pretty good. So over 10 years, you save $5 million. You're saving $500,000 a year on a $1.5 million. That's pre tax I assume. It sounds like the electrical business is not a bad business to be in.

[Phillip Terry:]

It's not our specialty but in this particular instance, we are forced into doing this and we will take appropriate action very quickly.

[Operator:]

There are no further questions.

[Tim Rochford:]

We know that it's a very busy time. There are a lot of calls and we appreciate all those that have shown their interest and their continued support. And once again, we appreciate being on the call, and have a great day.