Ardagh Group S.A.
Q4 2008 Earnings Call Transcript

Published: 3 Mar 2009

[Operator:]

Welcome to the Arena Resources 2008 fourth quarter and year end financial and operations results. (Operator Instructions). It is now my pleasure to introduce your host, Mr. Tim Rochford, Chairman of the Board for Arena Resources.

[Tim Rochford:]

Thank you, operator. I’d like to welcome all listeners to our fourth quarter year end 2008 financial and operations conference call. Joining me this morning of course is Phil Terry, our present CEO, our Chief Financial Officer Randy Broaddrick, and David Ricks our Vice President of Operations. Once again, I’m Tim Rochford, Chairman of the Board. Before we begin, I would like to make reference that any forward-looking statements which may be made during this call are 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 our release issued this morning. If you do not have a copy of the release one will be posted on the company website at www.arenaresourcesinc.com. Today we will cover the financials and operations for the fourth quarter and 12 months ended December 31, 2008. We will then open up and review some of the foresight and activity that’s taken place for the first quarter of ’09 and at the conclusion of the fourth quarter and year end review we’ll open up for any questions that the listeners may have. At this time I’d like to ask Randy Broaddrick to review our fourth quarter and year-end financial highlights.

[Randy Broaddrick:]

For the three months ended December 31, 2008 the company had oil and gas revenues of $32.9 million and net income of $13.6 million as compared to revenues of $35.1 million and net income of $9.4 million in the fourth quarter of 2007. This represents a decrease of 6% in revenues and a 44% increase in net income. For the 12 months ended December 31, 2008 the company had oil and gas revenues of $208.9 million and net income of $83.6 million as compared to revenues of $100.1 million and net income of $34.4 million in 2007. This represents an increase of 109% in revenues and 143% in net income. On a diluted basis the earnings per share for the three months ended December 31, 2008 were $0.35 or $0.37 per share excluding a $1.49 million non-cash charge for share-based compensation. This compares to $0.26 or $0.29 per share excluding a $1 million non-cash charge for share-based compensation in 2007. For the 12 months ended December 31, 2008 earnings per diluted share were $2.20 or $2.31 per share excluding a $6.58 million non-cash charge for share-based compensation as compared to $1.02 or $1.10 per share excluding a $2.5 million non-cash charge for share-based compensation. Net cash flow from operations adjusting for changes in operating assets and liabilities for the three and twelve-month periods ended December 31, 2008 was $29.3 million or $0.76 per fully diluted share and $169.4 million or $4.47 per fully diluted share. This is compared to $27.1 million or $0.76 per share and $77.8 million or $2.31 per share in 2007. Shareholder’s equity increased $224 million from $258 million in 2007 to $482 million at year end 2008. We saw a reduction in our production costs for the three months ended December 31, 2008 though we still saw an overall increase in production costs for the year ended December 31, 2008 when compared to the same periods in 2007. Costs for oil filled related services and materials tend to move up and down in conjunction with commodity prices. Throughout the first nine months of 2008, as we saw increased commodity prices, the prices we paid for the services and equipment we require to run our operations also increased. During the fourth quarter of 2008, when we were seeing dramatically decreasing commodity prices, the costs associated with operating our properties began to come down. As a result of the current commodity prices many vendors and service providers began lowering their prices. We have pushed for further reductions across all of our vendors and have seen positive results. To offset some of these decreases certain of our services continue to remain high. Among others, electrical services is one of those that has not come down as significantly. Lastly, like all of our overall production costs, we saw a reduction in production taxes. Most of our production taxes are based on values of the oil and gas sold so our production tax expense is directly correlated to the commodity prices we are being paid. During the fourth quarter, with declining commodity prices, our production tax expense was lower. However, for the year as a whole with the higher commodity prices during the first half and into the third quarter, the production tax expense increased compared to the year ended December 31, 2007. Our lease operating expense for the year ended December 31, 2008 was approximately $7.63 per BOE. Looking forward, we anticipate a decrease from this amount. However, with the uncertainty regarding commodity prices, the actual expense that we will see for 2009 is difficult to predict. We will see a decrease in our oil and gas production taxes given the current commodity price level, likely closer to the $2.00 range give or take based again on current commodity prices. However, as I mentioned previously, oil and gas production taxes are directly affected by commodity prices so this item will fluctuate with commodity prices. We saw a significant decrease in our depreciation, depletion, and amortization for the three months ended December 31, 2008 but we still saw an increase for the year as compared to the same periods in 2007. As has always been the case, depletion of our oil and gas properties is the primary contributor to our DD&A. A gradual increase in 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. However, we saw a particularly noticeable decrease for the fourth quarter 2008. The reason behind the decrease in the fourth quarter was the removal from our reserve report of some of the lesser producing wells that were considered economical at year end 2007 but that were not economical at the commodity price levels at year end 2008. While we removed reserves as a result of this, we also reduced future development costs on these wells. These wells cost the same to drill as similar wells with greater production potential and the ratio of reserves to development costs was greater than our current depletion rate. For the three months ended December 31, 2007 we saw the opposite effect as these reserves were booked for the first time, having not been economical at prices at year end 2006. For the year 2008 we did see an increase in our depletion rate resulting from normal business as we develop our properties and add additional reserves as a result of that development. Under our currently projected development plan which is largely dependent on commodity prices, we anticipate an increase each quarter in 2009 to ultimately average approximately $14 per BOE for the year excluding the impact of any additional acquisitions throughout the year. Our depreciation expense for 2009 should remain fairly consistent with 2008. As has always been the case, depletion is the dominating factor in our overall DD&A calculation and will continue to be. Our increases in G&A are the result of increasing payroll as we have added more new employees in order to sustain our growth as well as significant increases in our stock-based compensation as we have granted options in order to entice new employees as well as to retain both new and old employees. Management believes that the issuance of these options was necessary to attract and retain quality personnel with the experience and knowledge that we need. Stock-based compensation increased from approximately $4.1 million for 2007 to over $6.6 million for 2008. We anticipate a decrease in our stock-based compensation amount for 2009, as a result of some of the options becoming full vested during 2008. Any options granted during 2009 would cause further increases above the anticipated amounts. Lastly, we now only have one hedging component in place in the form of a caller. One hedge ended at December 31, 2008. Our remaining hedge continues through year end 2009. As a result of the hedging component, we had a realized gain in the fourth quarter of approximately $3 million, after tax, or $0.08 per fully diluted share. Further we showed an unrealized gain of approximately $8 million after tax as other comprehensive income, which was not included in our earnings. The year 2008, we had a realized lost of $2.7 million after tax or $0.07 per diluted share and the unrealized gain was $13 million. Going forward, we are constantly evaluating potential hedging arrangements. We fully intend to add additional hedge instruments if and when the timing and pricing is right. Because we are not leveraged, we are not forced to enter into hedges that may not be in our best interest over the long term. We will continue to evaluate and may or may not place additional hedging instruments in place during 2009. Further, we do still have our credit facility in place. That facility is a $150 million line of credit with a $150 million borrowing base. We did not have any amounts drawn on the credit facility at year end. Looking forward, we are visiting with a number of member banks and potential new members to the credit facility. While we do not have a signed arrangement in place, we are confident that the facility will be renewed and that it will be renewed at a higher level. With that, Tim, that’s everything for the financials for the fourth quarter and year end, 2008.

[Tim Rochford:]

Thanks, Randy, appreciate that. Now, I’d like to ask Phil Terry, our present CEO to recap the fourth quarter and year-end operations.

[Phil Terry:]

Thank you, Tim. Good morning to all of you that are listening to us this morning. We appreciate your interest and participation. Arena Resources had another good quarter, being the fourth quarter of 2008 and an excellent year in 2008, both from a production standpoint and reserve standpoint. We drilled a total of 54 wells in the fourth quarter of 2008, with most of those wells being at Fuhrman Mascho, where we drilled a total of 48 PUD locations. Forty-four of those locations were San Andres wells and the remaining four were Yates Gas wells. We also drilled five wells in Lee County, New Mexico and one deep test well in Gaines County, Texas. This brought our total of new wells drilled in 2008 to 231. In addition, we performed refracs on 35 existing wells and we continued to add to our infrastructure through improvements of our lease-hold facilities and equipment. In the fourth quarter of 2008, our sales, as a result of production, were 642,593 BOE. This represents a 46% increase over the same period in 2007, and a 4% increase over the third quarter of 2008. Our average daily net production increased to approximately 6,985 barrels BOE per day. The average sale price per BOE in the fourth quarter was $51.31 compared to $79.45 for the same period in 2007. That decrease in price is represented by a 35% decrease. For the 12 months ended December 31, 2008, our sales as a result of production were 2,336,954 BOE. That is a 49% increase over 2007. Our average net daily production for the year increased to 6,385; the average sales price for the year was $89.37 compared to $63.89 in 2007. That increase in price is a 40% increase. Moving to our year-end reserves, our 2008 year end proven reserves are 65.6 million BOE. That compares to 55.4 million in 2007. That is a 22.5% increase when adjusted for 2008 oil and gas sales. The estimated present value, at a 10% discount rate of the future net cash flow thrown off by those reserves, is $651.5 million, using an average received price of $38.30 per barrel and $4.35 per Mcf for natural gas. I should point out to you that Arena Resources uses a price received because that price is one that we are contractually committed to receive; therefore, in compliance with SEC, we take a deduction from the NYMEX price for WTI crude. Breaking down our reserves a little bit further and in a little greater detail for you, our reserves are made up of 38% developed reserves, 31% of those being proved, developed, producing. That 31% is an increase in total barrels of about 39% over the year. The remaining 7% are proved, developed, non-producing, and that number is actually a decrease from 2007 due to some re-categorization and some changing of locations from being PUD locations to being probable type that will be included in the coming years. Thirty-six percent of our reserves are PUD primary. That represents a 27% increase over 2007 and the remaining 26% are PUD secondary, and that is roughly the same as we had in 2007. It’s a slight increase, but very little. Our total proved reserves increased 18.4% after production, 22.5% adjusted for production, so we managed to replace production plus grow our reserves by 18.4%. Our 2000 reserve report includes 499 Fuhrman Mascho PUDs. That represents a fraction of the PUDs that we have left to book, but we are booking those according to a schedule that will allow us to drill them over the next three to four years. Of those PUDs, as we move through them, I can identify them for you. We have 30 40-acre PUDs; 80 20-acre PUDs; and 389, 10-acre, for a total of 499. As Randy mentioned earlier, we did have some revisions to reserves. Our 2008 revisions saw 79 wells dropped from our 2007 report as a result of being uneconomical at the current prices. But we were able to offset those reductions by the increases for the wells that we have in our new PUD category, since we were able add additional PUDs as a result of our drilling and development done in 2008. So we have a net gain as a result of the PUDs that we have on our books at this time. In early December, we laid down our rig, I'm sorry, in December we laid down our rig number one. We’re currently drilling with only rig at Fuhrman Mascho. Our activity was reduced in the fourth quarter due to reduced commodity prices and a drastic decrease in those prices. We eliminated Fuhrman Mascho contract drilling rigs; at Fuhrman Mascho, we cut down to two rigs in the third quarter and then eliminated one of those rigs in December of 2008. We postponed drilling scheduled and budgeted wells in the fourth quarter in New Mexico, other than East Hobbs and one well at Hale State and one on the Phillips Lea. David Ricks will give you more information and detail about those wells. The wells that we did not drill are still viable projects. We will still do those, but we will wait for commodity prices to become more attractive, before we drill those wells. We also postponed all PUD activity in Oklahoma. As I mentioned earlier, we did laid down rig number one in December; we’re currently drilling with our rig number 10 and will continue to employ rig number 10 to drill Fuhrman Mascho wells through the foreseeable future at Fuhrman Mascho. Our activities for 2009 will include development work for the Yates. Our Yates gas project is moving along nicely. David will give you a more detailed report of that activity. But we’re scheduling to begin work to re complete wells from idle categories to Yates producers when the pipeline is ready to receive gas, and that could occur in the second half of quarter number two. We also have budgeted to drill 36 new Yates wells with rig one sometime in the second half of 2009 given attractive commodity prices. Our 2009 budget calls for us to drill 72 new Fuhrman Mascho wells, and that is through utilization of one rig only. The actual number may be somewhat different than that, but that’s our budget amount. We also have 60 recompletions, 60 Yates recompletions budgeted. Those will be done by a contract work over rig and will involve working on preexisting wells that just need to be recompleted from San Andres to Yates. We also have 36 new Yates wells budgeted, which will be drilled by rig number one as I mentioned. Further, our 2009 activity will include waterflood initiation at Fuhrman Mascho and some of our other areas in New Mexico and Oklahoma. And we’ll also continue to increase and upgrade our infrastructure. Our total CapEx as we speak is budgeted at $75 million for 2009. This amount, and I need to stress this, this amount is subject to change as commodity prices increase or decrease if we see those prices increase and we have the flexibility to regain our momentum and increase our activity as a direct relation to commodity price. In closing I can tell you, we can grow production with this budget and we can also support the expenditures with predicted cash flow and we can do so at realized prices of $30 per barrel. And just as a note we are above that price in terms of our realized crude price that we are now receiving. We will continue to grow our production on reserves and we will at – but not at the expense of our cash position. We have a nice cash position now. It is our goal to maintain that position and use it for opportunities that we feel like will present themselves in 2009. With that I will turn you over to David Ricks to give you more detail about operations.

[David Ricks:]

Thank you, Phil. In the fourth quarter of 2008, we drilled 44 San Andres wells and 48 wells at Fuhrman Mascho for a total of 48 wells. Plus we refrac'd three wells resulting in a total for the year of 225 wells drilled and 35 refracs. Of those 44 San Andres wells drilled 14 of those are 10-acre locations, 24 of those are 20-acre locations and six are 40-acre locations. Of the 14 10-acre locations there were six wells that contained an abnormally thick Grayburg on top of the sand. These wells are located in our enhanced fairway of production and reserves. Two of the more recent completions in this area had initial potentials of over 250 barrels of oil per day. We have also completed a couple of wells recently in our South Fuhrman Mascho unit with IPs over 230 barrels per day. We’re very excited about these two areas of the field and plan to spend most of our drilling dollars in these areas through the remainder of 2009. We currently have one company rig drilling operating at Fuhrman Mascho and we are in the process of drilling our 14th well of the year and of the first quarter. And this puts us on pace to drill approximately 20 wells this quarter. We’ve budgeted a total of 72 wells for the year '09 but at this rate we may drill as many as 80 wells. We continue to have good production increases with our refracs at Fuhrman Mascho. We completed three refracs in the fourth quarter for a total of 38 for the year, but we are going to spend our refrac program until product prices improve. We continue to spend most of our capital at Fuhrman and production continues to increase as a result of our efforts. We are developing our waterflood plans and we plan on approaching the Texas Railroad Commission to start the permitting and hearing procedures to form our waterflood unit. We hope we will be able to get our waterflood on the docket with the railroad commission for approval in 2009. Aspen pipeline began pipeline construction for our Yates gas in November of '08 and anticipates completion of the line in the second quarter of '09. We are currently preparing 60 idle and low volume San Andres well bores to recomplete in the Yates. The wells are currently being tested for mechanical integrity and will be fracture stimulated after the completion of the pipeline. We drilled four Yates gas wells late in the fourth quarter of 2008 in advance of the pipeline to provide better evaluations on reserves and volumes in the Yates formation. We are fracture stimulating the first of these four wells this week and anticipate completing one a week thereafter. At East Hobbs San Andres unit in Lee County, New Mexico, we began drilling four wells at the end of the fourth quarter. The four wells are in various stages of completion and we will give an update in our next report. Also at East Hobbs we have converted one producing well to injection and plan on converting four more in 2009. We drilled two wells in the vacuum field on our Phillips Lea and Hale State leases in Lee County in the fourth quarter, and finished completion of these wells in the first quarter of 2009. These wells are online and prove to be commercially productive. These properties were acquired in the second quarter of 2008. In Oklahoma we have completed a geological study in the Morrow sand on our OMU, Midwell and Hanes properties is Cimarron and Texas Counties. We will be reconfiguring injection patterns on these properties to more efficiently sweep the remaining oil reserves as a result of our study. Additionally we have budgeted and scheduled work for our Y6 lease in Fisher County, Texas for 2009. We will upgrade injection facilities and convert three producing wells to water injection. This concludes my operations report and I’ll turn it back to Tim.

[Tim Rochford:]

Thanks, David, thanks Phil, Randy. In summary we are now drilling our 491st well at the Fuhrman Mascho lease since starting our development program in 2005. In addition we have refrac'd another 139 wells. Currently, one company owned rig is running at Fuhrman Mascho; this should yield between 70 and 75 San Andres wells drilled this year. As mentioned earlier, our second company owned rig is scheduled to begin drilling our Yates wells by mid-year. And management is continued to be committed to maintaining operations and development activity within existing cash flow. We are also ready to accelerate development when we see better production margins. We will continue to look for acquisitions specifically in areas that complement our current operations. We also believe there will be increased opportunities as a result of current economic environment. And with our strong cash position and our unused credit facility, the company is well postured to take advantage of those opportunities. At this time I’m going to turn this back over the operator; concludes our portion of the presentation. We’ll open it up operator for any questions the listeners may have.

[Operator:]

(Operator Instructions) Your first question is from the line of Neal Dingmann – Wunderlich Securities.

[Neal Dingmann:]

Just want to tell you guys solid quarter, just a question with a follow-up. Obviously your costs continue to be one of the lowest our there in the group. Are you continuing to see how much further can these costs both come down? Let’s look at on Phil’s sort of LOE of the operational side as well as financially on Randy’s side. And then does that make sense to I guess if costs continue to come down, would you continue to produce or does it make sense to look at other acquisitions in your core area?

[Tim Rochford:]

Good question. Let Phil and of course Randy address those questions pertaining to them directly. But Neal, there’s no question that we’ve already entered into a window where we’re beginning to see possible potential opportunities for acquisitions as you know. And we do believe that as a little more time elapses here that the cost of acquiring reserves may in fact be a whole lot more favorable than our drilling cost as we speak. But the nice thing is whether it’s – regardless of which side of the ledger it’s on, we’re postured to take advantage on either direction, but Phil, if you don’t mind answering those for Neal?

[Phil Terry:]

Neal before I get into my treatment of it, David can provide you with some pretty interesting statistics as to where we are now with our AFE for our new PUD wells at San Andres and also what we’re seeing in terms of price of goods and services and lease operating expenses. David?

[David Ricks:]

On our AFE costs for drilling at Fuhrman, those were AFE’d in ’08. It had gotten up to 647,000 per well and now we are AFE’d at just under 500,000 per well. A big result of that is tubulars. For example 5.5 casing peak price for us was about $24.00 a foot and recently we just purchased some for just over $9.00 a foot. Although that’s the biggest portion of it, we are seeing the service side come down too and that pertains to our LOE also. We have gone to the vendors and asked them to give us some relief and we’ve gotten some very favorable results from that. It’s very dynamic right now. It’s coming down every day. It’s kind of hard to say where it will go to but a lot of the vendors are providing 20% decreases for us.

[Phil Terry:]

Obviously we are pleased that the contract side of our business is responding and realizing that prices have to come down. A major component in that price decrease obviously is the price of tubular goods. David enumerated what those are. We’ve also seen additional reductions in just about all of the goods and services that we purchase. So as far as lease operating expenses, the big item that is coming down but we can’t really predict what the ultimate climate will be, that’s the cost of electricity. That is our one major component and the single largest lease operating expense item that we have. That’s followed by chemicals that we use on our production side and then also some contract services that we provide that we have to do on a monthly basis to sell our oil. But, all of those things are coming down. The electricity costs are coming down as a result of the fuel surcharge being removed from their billing so we’re seeing a pretty drastic decrease. To answer the latter part of your question as to do we continue to drill or do we look for acquisitions? We are certainly mindful of where we are with our commodity price. Our drilling activity for 2009 involves drilling wells that have the opportunity to generate a maximum rate of return for us. Those are going to be wells that have potential of 60,000 barrels or greater. Those wells still have favorable economics even at $30.00 a barrel. A 60,000 barrel well has an internal rate of return opportunity or potential of a little north of 50% at $30.00 a barrel. As you move down the scale obviously it deteriorates, or that rate of return deteriorates. We don’t anticipate getting too far away from drilling the better wells. David mentioned we’re seeing some excellent results now and the Grayburg Fairway and in the South Fuhrman Mascho. We are going to zero in on drilling only the better wells, on drilling those wells that have higher potentials that pay out quicker, that add to our production, and give us the greatest reward for dollar spent. Will we look for acquisitions? Certainly. As Tim said, we feel like there are going to be really good opportunities that come down the road. We can’t enumerate at this point and time how many or where but we’re certainly going to concentrate our efforts in the Permian Basin and maintain our focus in that area that we now work.

[Operator:]

Your next question is from the line of Noel Parks – Ladenburg Thalmann.

[Noel Parks:]

I did want to go back to the Fuhrman Mascho South well you discussed, I think you saw 230 barrel a day. And two if I might that are considerably better than the average that you assume for wells in Fuhrman Mascho, if you could just verify that? And can you just tell me about the characteristics? Is it just thicker formation or something else that has made the wells in that area so good?

[David Ricks:]

Yes, that’s correct. South Fuhrman, the IPs we’re seeing are on those two wells over 230 barrels of oil per day. Yes, there’s a little bit more pay there. That’s part of the reason. But, South Fuhrman’s one our larger leases and it’s a particular area on the northern end where we’re seeing these good results that we’ve just now started to exploit and so we feel like we can move the rig back over there and complete some similar wells and kind of define the whole area which we haven’t really done yet.

[Noel Parks:]

How many do you think it will take to define the area or roughly what is the amount of acreage that looks like it’s in this good spot?

[David Ricks:]

I really don’t have a number on that at this time.

[Phil Terry:]

The South Fuhrman is a property we purchased in the fourth quarter of ’07 if you recall. It was and is an existing waterflood secondary recovery project. What we found in this new area, or not a new area, this area where we drilled the new wells, one we have better pay as David pointed out and we also are postulating that we may be reaping the benefits of water injection over time. The wells that we have completed have higher initial potentials. They have a better production profile. They don’t decline as quickly. And so we really can’t tell what aerial extent will be involved until we get the rig back over and do some additional work. We’ll begin to step out from these wells and follow it actually until we see a downgrading in results but we’re very excited about it. It could involve a number of wells. We’ll move our rig back down to that area after we've drilled some more of the Grayburg wells.

[Operator:]

Your next question is from the line of Chad Mabry – Rodman & Renshaw.

[Jeff Hayden:]

Quick question for you just as far as the M&A goes and your thinking regarding it. I mean there are obviously going to be some packages out in your neck of the woods which will become available, some pretty sizable. You know how you finished the year with about $60 million cash, $150 million on the revolver, it sounds like that could even be going up. Could you just talk about what size appetite you could have, how much you might actually kind of push the debt as far as making an acquisition versus when would you possibly try to seek other sorts of financing if you really see something you like?

[Phil Terry:]

That is an excellent question. Let me respond this way that it is a fact that we do have that facility in place. There’s a zero balance on it now. Currently it’s at $150 million and as Randy touched on earlier we anticipate and we’ve had some pretty good input from some of the members in the banking group that that number should be increased and we're encouraged with that. Our cash position is still considerably north of $50 million so combined even with today’s base it gives us some pretty good room to maneuver if we see something that we really think we have to own. I really believe that a little more time has to take place before we see maybe even some opportunities that will improve from where they are today but we are seeing some projects. The size of those projects can vary. We’re looking or we’re starting to see opportunities from the few million to as much as possibly north of $200 million. Do we feel comfortable stuffing up to a $150 to $200 million project? If we know that we’re buying this, if we feel absolutely comfortable that we’re buying this at an excellent price and an entry price that we think that we can really get excited about then we’re prepared to step up and do that. There are alternative opportunities for financing beyond our credit facility. Most of you folks are familiar with some of the projects that are going on today and how they’re financed. We, on an ongoing basis, hear from a lot of different groups as it relates to ideas and so we’re prepared. We’re certainly not being shy about it. We’re looking for that next opportunity for the company but at the same time I want to be, I want to caution that, that may take a while. I think most of you are aware that there's some pretty good sized projects out there now, but we're not so certain that the numbers are going to be correct for us, so we're going to have to play that by ear, but it was an excellent question.

[Operator:]

Your next question is from the line of Stephen Berman – Pritchard Capital Partners.

[Stephen Berman:]

A couple of questions on pricing here, can you talk about on the oil side, the differentials currently what you're seeing relative to WTI?

[Tom Rochford:]

Yes, we are certainly in that window where there is a differential and it has been averaging and maybe David or Phil has an exact to the penny but I will tell you that in round numbers we have been seeing a differential between WTI and what we're receiving for the sour content of approximately $10.00 plus, and Phil or David maybe you have a closer number there, but I know that's going to be pretty close.

[Phil Terry:]

Yes, that number is correct, Steve, if you look at WTI NYMEX, when that price gets back to us there is a deduction by the purchasers for West Texas intermediate in West Texas, and then from there we have another deduction for sour crude. Historically, our differentials have been $5.00 to $6.00 in the fourth quarter of 2008, and early 2009 we've seen that differential increase to somewhere $10.00 to $11.00. It has been a little higher at times. It seems to have closed up in GAAP but we're still seeing a pretty significant haircut.

[Stephen Berman:]

And where should we be modeling this going forward through the balance of the year? Can it tighten from here, or should we still think in terms of $10.00?

[Phil Terry:]

Well I think it certainly can tighten and I think we're all hopeful of that but I think the prudent way to model that going forward would be to use the $10.00 number.

[Stephen Berman:]

And on the Yates Gas side, is that still looking economic, it's something with a Henry hub three plus kind of handle on it?

[Tim Rochford:]

Yes, Phil, in fact we were chatting this morning, early this morning, we were crunching some numbers and maybe you can just take a moment and review.

[Phil Terry:]

Yes, certainly, our price threshold for our Yates Gas is based on El Paso Permian, and I'm going to pull up my plans today, El Paso Permian as of this morning is around $2.70 which translates to us as you take the 30% haircut, we are up around $1.80 if my math is correct, and just verify that. Yes, $1.89. Our numbers work down to $1.60, obviously the economics are not terribly good at current prices but they do support working on recompleting existing wells. I mentioned in our presentation earlier this morning that we had 36 new wells budgeted. We're going to look at those as we move through the year to make a final determination before we actually drill them. We have about 100 wells right now in inventory that we can recomplete, and those wells work at current economics.

[Stephen Berman:]

One last question, any plans on any five-acre tests this year from the Mascho?

[Phil Terry:]

Yes, Steve, we anticipate drilling a few five-acre wells, few being four to six. We have obviously some very nice areas that we want to test. We want to test that five-acre idea. The first areas would be in that Grayburg, that thick Grayburg Fairway, and then given the success of our recent South Fuhrman Mascho Unit wells, we may want to step in and drill some on a little tighter spacing basis there, but we'll drill at least four. We may drill six or so.

[Operator:]

Your next question comes form the line of Irene Haas – Canaccord Adams.

[Irene Haas:]

Hi, Tim and Phil, you guys have seen a number of these cycles, so what I would like to ask you, is how is your commodity outlook? There has been a number of questions on this conference call already regarding acquisition. My question is, how patient would you be and exactly what kind of criteria you looking for. Are you willing to wait a year or two if there's nothing that sort of fits your criteria?

[Tim Rochford:]

Yes, let me take a run at it and then I'll ask Phil to comment on that as well. I think that's an excellent question and I think it's something that we all think about on a daily basis, and you need to feel comfortable as an interested party in Arena, and shareholder of Arena, that there's no sense of urgency on our part. It's not like we have to go out and close on an acquisition to find something to do. As you know, we have ample opportunity to grow this company, even at current levels as mentioned earlier in the presentation, but I really honestly believe personally that it's going to take a little more time. I think expectations for sellers is a bit high still, and I think that as we move in the latter half of this year, potentially maybe even in the second quarter. But I think it's going to have to get closer to the second half of this year before we start seeing maybe expectation softening a bit on the seller side, and then maybe even with confidence that's building on the buying side, from the buyers side, confidence building as it relates to commodity prices, we'll see more of these deals actually close. As it relates to a timing standpoint as part of your question, if it takes a – if that one great acquisition is a year away or a year and a half away, then so be it. Like I say, we have plenty to do in the interim.

[Operator:]

Your next question is from the line of Mark Lear – Sidoti & Company.

[Mark Lear:]

Just kind of hitting on some of the results from your, I guess 40-acre drilling in Fuhrman Mascho, so I assume that would be some of the newer acreage you guys have acquired, just kind of want to get a feel for what the results are as you step out in the field a little bit.

[Phil Terry:]

Mark, we've been very pleased with the results that we're seeing on our newly acquired acres and those acres are for the most part, university leases that we have purchased at university sales. We will continue to drill wells on those leases on those new properties in order to hold them and protect the acreage, but to answer your question, we've seen results that are very, very similar to our other areas of operation. We continue to see performance of the 40s, 20s, and 10s, being almost identical. In some cases, we're seeing our 10-acre wells actually being better than the 20s and the 40s. In many instances, in that Grayburg fairway, we've drilled 20-acre wells that are going to produce twice as much as the 40-acre wells. The reason for that is many of the 40s were not open in all of the zones that we're opening our wells in, but the 40-acre results have been very good. We continue to fold in a development plan that will allow us to get at least one well on each of those leases in order to protect them so as to not run the risk of not having leases terminate, and as long as our results continue we will be able to do that. And it's part of our stated goal this year to protect all of our new lease properties. Our 40s have done very well, our 20s, and 10s are very rewarding, and as David mentioned, we're seeing some excellent wells now in both the Grayburg fairway and the South Fuhrman where we've had the opportunity to have some water in the ground for awhile.

[Mark Lear:]

Got you, and I think it was last quarter you mentioned you were drilling a test up in Gaines County. I was wondering if you had any results from that well?

[Phil Terry:]

Yes, we drilled that well and we have finished our completion operations, and unfortunately there were no commercial zones present in the well bore. We had some shows of hydrocarbons but not in sufficient quantities to produce, so unfortunately that particularly location did not work out for us. There are still some opportunities to drill on the acreage that we have remaining, and we're doing a geological study at this point in time to determine where we would go and how many more wells we'd drill.

[Operator:]

Your next question is from the line of Derrick Whitfield – Canaccord Adams.

[Derrick Whitfield:]

Congrats on a great year end, and let's see, most of the questions have been asked, but with your East Hobbs project, what level of price realization would you need there to be profitable or achieve acceptable returns?

[Tim Rochford:]

I’m sorry you’re talking about specifically the East Hobbs?

[Derrick Whitfield:]

Yes that’s correct.

[Tim Rochford:]

I – maybe David can give us some color on that with reference to margins and numbers but I can share with you that East Hobbs is very profitable right now at its current production rate but if there is any more specific numbers related to that Phil or David maybe can offer that.

[David Ricks:]

Yes Derrick the East Hobbs as Tim said is one of our most economical properties. Our lifting cost per barrel are lower than any other lease that we have. They historically are less than $5 per barrel and in many instances are much lower than that in some months. We continue to be able to operate profitability there and we can do so at current rates. And I need to add that New Mexico crude oil pricing is about $2.00 a barrel higher than West Texas. Don’t ask me to explain that but the state line does represent a different price threshold. So we actually received a little more for our product there plus it’s on pipeline. But East Hobbs continues to be a very good project. As David mentioned we drilled four wells. We’re in the process of testing those wells to determine their rates. We’re very excited about the property we’ve converted one well to injection in the fourth quarter we’ll do another one. I’m sorry we’ll do four more this year to expand our waterflood to a patterned waterflood and we anticipate that we’ll start seeing results of that in – not this year but by this time next year we’ll start to see some increases as a result of our water injection expansion.

[Derrick Whitfield:]

Great. One last question if I could. You talked about the South Fuhrman Mascho earlier and how you believed you’re receiving some increased recovery associated with water that is already in the ground there. Could you guys project at this point what kind of secondary to primary recovery or ratio you see or feel that you would get eventually?

[Tim Rochford:]

Yes I think we can. Phil, we just recently been reviewing that so maybe we can add a little to that.

[Phil Terry:]

Derrick, we feel like on a very conservative basis that we’d be looking at secondary and primary ratios of about 0.6 to 0.7 and again those, we feel like those are very conservative. As we move through our development program and continue to drill wells and have more wells in those areas and have that spacing per well decrease, it is very likely and has been demonstrated in other San Andres floods that that recovery ratio will go up. From our standpoint although our reserves are done at about 60% to 65% ratio it’s not outside a level of expectation to think that we could receive as much as one to one. As you get closer to a full 10-acre spacing most of these waterfloods in the San Andres do approach one to one type numbers. But we’re very excited about that. We’ve seen nothing at all at this point in time to discourage us from expanding our activities in our waterflood operations and secondary recovery.

[Operator:]

Your next question is from the line of Leo Mariani – RBC Capital Markets.

[Leo Mariani:]

Follow-up to the question about South Fuhrman Mascho just curious about what your gross and net acreage position was down there?

[Tim Rochford:]

On the South Fuhrman Mascho the acquisition that took place in the fourth quarter of ’07 I know we’ve added to that position but does anyone have that information handy where we can reach and kind of give kind of a ball park for our acreage position.

[Randy Broaddrick:]

Excuse me 1,680 acres as part of the main South Fuhrman

[Tim Rochford:]

And then what we’ve done is we’ve added to that with some additional bolt on acquisitions so we’re probably – would it be safe to say that we’ve added another 25% to 50% do you think Phil, in that neighborhood?

[Phil Terry:]

I would say that is probably a pretty good number, Tim. Leo unfortunately you don’t have the benefit of looking at the map I’m looking at but we have in addition to South Fuhrman, Tim pointed out that we’ve been adding other leases and properties in the same area. So that 1,680 acres that represents the South Fuhrman only. And then you can probably add another oh I’m going to say another 1,000 to 1,500 acres around it. So maybe even double it. Close to double it in size right. So we’re very encouraged obviously at the results we’re seeing. We’ve drilled a number of wells at South Fuhrman and in the other areas the results have been fairly typical compared to the rest of the field, typical being anywhere from 35 to 45,000 barrels, some 50,000. But the wells that we reported to you and Dave talked about are considerably better than the average. So we can’t tell you exactly now how many acres would be involved in this area of increased production but we’ll, by the next quarter we'll have a little better feel for that.

[Tim Rochford:]

Just like to offer a little more information as it relates to the overall size of the Fuhrman Mascho which includes not only the South Fuhrman Mascho but all the lease positions that we have is it now exceeds 34,000 acres and so you can get a good feel of what’s taking place there in terms of the opportunity for development years to come.

[Leo Mariani:]

Is that overall acreage number is that a gross number or net number?

[Tim Rochford:]

Yes that’s a gross number.

[Leo Mariani:]

Do you have a net on that?

[Tim Rochford:]

Net is about say 75% of that, so somewhere around the mid 20s.

[Leo Mariani:]

Okay. Staying with Fuhrman here just curious to know if there's any plans to try to diversify your oil sales away from who's currently buying them in order to put some competition in there and improve that product realization at some point.

[Tim Rochford:]

Yes, as a matter of what we are and Phil, maybe you can give us a little updated color on that.

[Phil Terry:]

Yes. Leo you are certainly in tune with an objective that we have and that is to get our crude oil to a point where we can have more competition. And in order to do that we are going to – we need to get a pipeline connection that will allow us to transport these barrels to Midland. Now, when we can get to the Midland, Texas tank farms then the crude oil buying world opens up to us. How do we get there? We’ve pursued a number of alternatives; I won’t bore you with all the details but what we’ve discovered now it is best for us to take on this project and do so without partners We have a couple of alternatives that we are now pursuing. There is one pipeline connection available to us that is less than five miles away and we have been notified that that access is there and they have capacity to take our barrels. We also are looking at another project that might involve a few more miles of pipeline but in either case we have – certainly have economic incentive to take on this project. That incentive comes in the form of elimination of a transportation fee. We’re now charged a $1.40 per barrel to have this oil trucked. We can affect and change that transportation rate quite significantly. We feel like that as a result of having a pipeline connection we can get that – we can eliminate $1.20 of that. So if we have economic justification in the form of $1.20 per barrel for every gross barrel that we produce and that now is in excess of 7,000 barrels a day out there. So this is a project that you will see us move up in our priority list. We had been working with some third party people and as it turned out there were some issues involving financing the project we just said let’s finance it ourselves and take on this project and get this done. So it has moved up in priority and it will be accomplished this year.

[Leo Mariani:]

Okay. Curious to see if you folks have got any thoughts on production guidance for 2009 I think you had previously talked about double digit growth. Obviously with a reduced budget are we still looking for a double digit overall production growth this year?

[Phil Terry:]

Yes we’ve never really given formal guidance but I’ll share with you with the one rig that is currently running now at Fuhrman Mascho and you know even with some question of when this second rig comes in with reference to the eights whether its earlier in the year or more of mid-year, we’re still going to see double digit production growth and double digit reserve growth.

[Operator:]

Your next question is from the line of Brad Pattarozzi – Tudor Pickering Holt.

[Brad Pattarozzi:]

Following up on the production growth question where are you currently in Q1?

[Tim Rochford:]

I’m sorry what was your question?

[Brad Pattarozzi:]

What is your current production?

[Tim Rochford:]

Current production Phil is averaging –

[Phil Terry:]

We are about just south of 7,100 net barrels per day. We're about 7,080 barrels I believe if I'm correct, David?

[David Ricks:]

That's about right. Actually, Phil, I've got us at 7,040.

[Phil Terry:]

Seven thousand and forty? Okay. We've had some difficulties and without boring you with all the details we've had a lot of shut ins caused by our gas purchases. We've had to flare gas in January. We're now flaring gas again due to some pipeline problems that our purchaser is having, but we're very pleased with our oil production. We're actually seeing it grow as a result of these new wells that we're putting on and our PDP stream could decline by 20% by year if you ceased all drilling and we're actually – are able to maintain that production with just one rig running. So we're seeing at that 7,040 net barrels per day we feel like we're going to be able to maintain that rate at or near that rate for the foreseeable future. As long as we're able to complete these wells that we're completing now we'll be able to generate even greater growth.

[Brad Pattarozzi:]

Okay, could we narrow double digit growth a little? Is it possible to get 20% off one rig or are we talking more 10 to 15%?

[Phil Terry:]

I think we're talking more between the 10% and 15%. Right.

[Brad Pattarozzi:]

Okay. And looking on the $75 million CapEx, could you break that down by region, by area?

[Phil Terry:]

Yes, you are seeing the bulk of that, the major portion of that will be at the Fuhrman Mascho and of course that centers around the rig that's running there now. The company owned rig and we're talking about drilling between 70 and 75 wells. In addition to that you're then looking at the Yates project kicking off here by mid-year and again, that's at the Fuhrman Mascho location. So you can see that the bulk of the activity will be concentrated in Andrews County.

[Brad Pattarozzi:]

And when you're talking about 75 million is that based on a dollar per barrel received, say $30.00 a barrel received or what are you thinking in terms of?

[Phil Terry:]

We're calculating that at a net after differential adjustment of approximately $30.00 yielding to the company.

[Operator:]

Your next question is from Richard Tullis – Capital One Southcoast.

[Richard Tullis:]

Going back to the Yates, Phil, could we go over the economics of drilling the new Yates wells? What's the current cost outlook and what sort of gas price do you need to move forward with those wells?

[Phil Terry:]

Our reserve study, I'm looking for my notes to make sure, our reserve study has $350,000 as a total well cost for a Yates well. If we drill that well right now David could give us a little better feel for it, but I know we would probably be able to reduce that price by 10 to 15% and ultimately we know they'll go considerably lower. I had run some numbers quite some months ago at a cost of – if we could get them down to $250,000 for a total well cost and have a typical well that comes in somewhere 300 to 400 Mcf a day and declines at 40%. You then – you don't generate great economics at today's prices, but you generate acceptable. At 350 we take a long hard look at whether or not we want to drill new wells and as a result of that, given what we're seeing right now I would tell you that we would probably not drill new wells. But we would divert our attention to existing wells that we can recomplete for $125,000 to $150,000 each.

[Richard Tullis:]

Okay. What's the commitment to Aspen at this point?

[Phil Terry:]

Our commitment to Aspen is to on a best efforts basis to recomplete up to 90 wells per year and it is our objective to do that as long as we have a price structure that allows us to be profitable. Our ultimate goal is to develop 30 million BTUs per day.

[Richard Tullis:]

So there's no commitment for you to drill new wells at all?

[Phil Terry:]

No. No. It really doesn't matter how we accomplish the production whether it's through recompletions or through other means. If we acquire their leases and attach them to our property level there. And we have a number of new leases that we have acquired that have Yates rights and we bolted on a number of acquisitions in 2008 that are contiguous to our firm in Mascho, so we – that project continues to grow along with our San Andres project.

[Richard Tullis:]

Do you have enough recomplete wells to fulfill your commitment if we go – if we stay in a prolonged low gas environment say for a year or so?

[Phil Terry:]

We do. We currently have north of 100 wells that are on the TA'd list, temporarily abandoned list, and David and his field people are now in the process of determining mechanical integrity on all of those wells. We'll stockpile them. Once we determine they mechanically sound and when the pipeline's finished then we'll just come in and perforate, acidize and frac and bring the wells back on. So it's a relatively simple and very quick process. And as we go through time if we continue to receive $30.00 a barrel there will be more wells that fall out of economic operation at $30.00 a barrel and our plan is to convert as many of those as we can to Yates wells provided they're not needed for secondary recovery operations in the San Andres.

[Richard Tullis:]

Okay. What's your EUR estimate on new wells, new Yates wells? Is it still, I don’t remember, around $40,000, $40 million?

[Phil Terry:]

The Yates wells essentially we feel like have an opportunity based on 160 acres to produce somewhere around 450 net million, about 0.4, 0.45 Bcf.

[Richard Tullis:]

Okay.

[Phil Terry:]

We feel like that's pretty conservative. Ultimately these wells may be drilled on 40 acres spacing as tight as they are, but that's what we're using now on a per well basis.

[Richard Tullis:]

At what oil price would you take that second rig that's idle now and put it back on oil projects if say gas prices stay low for an extended period?

[Phil Terry:]

Probably looking at something in the neighborhood of north of $50.00 for us to take the second rig and put back on drilling San Andres wells. You've got to remember with that $50.00 north thereof we'll be yielding somewhere in that $40.00 number.

[Richard Tullis:]

What's the difference between running the first rig at the current oil prices and running the second one at $50.00

[Randy Broaddrick:]

The first rig we're just really, as Phil and David pointed out, we're really cherry picking. We're really going in and being very selective and we're drilling right in the sweet spots and so we've high-graded. Our guys have high-graded hundreds of locations, potential locations at these higher yielding levels so with one rig we can be very busy for the next couple of years just doing that alone. If we can see a lift in that commodity price it will make sense to bring the second rig in and we may even step down that threshold a bit.

[Richard Tullis:]

Okay, I understand. Has the data room opened for the range asset sale yet?

[Randy Broaddrick:]

I understand that the room opens up the latter part of this week.

[Operator:]

Your next question is a follow-up from Chad Mabry – Rodman & Renshaw.

[Jeff Hayden:]

Jeff again, I just want to get more of a clarification on Leo's question when he asked about the 34,000 acres of Fuhrman Mascho. You said 75% net. Is that the net revenue interest at 75%

[Randy Broaddrick:]

Yes, it's in round number, Jeff. Just in round numbers.

[Jeff Hayden:]

Okay, so working interest is roughly 100% on that acreage?

[Randy Broaddrick:]

I'm sorry?

[Jeff Hayden:]

Working interest?

[Randy Broaddrick:]

Yes.

[Jeff Hayden:]

Roughly 100%.

[Randy Broaddrick:]

Yes, that's correct. Yes.

[Jeff Hayden:]

And then I know it's early but we'll see if you guys want to answer this one, any idea on what the exit rate could be as far as Yates production for 2009?

[Randy Broaddrick:]

Good question. I'll let David and Phil take a swing at that. Of course and that's assuming that what we have budgeted for activity now doesn't change because of commodity prices, but guys what does that look like?

[Phil Terry:]

Jeff, I've done some pretty conservative numbers I think in just trying to get an idea and a feel for what kind of additions we can look at this year. As we get into – keep in mind I started my work in the third quarter and basically said the pipeline would be finished and ready to accept gas in July. It may move up and it looks like it will, but be that as it may, I targeted that we would have an incremental increase of 55,000 equivalent barrels in the third quarter and 162,000 equivalent barrels in the fourth quarter for a total addition of 218,000 for the year. And those numbers are derived by recompleting 60 wells and drilling 36 new wells. It may change and likely will change to more, maybe 100 recompletions as opposed to 60. But essentially those are the kind of additions that we're talking about and the numbers are roughly the same. We're – whether we recomplete and drill a total of 106 or recomplete them. So we're going to move forward and hopefully as we move forward we'll at least see some stabilization or perhaps some increase in price, but as long as we can stay north of 270, 260 per Mcf El Paso Permian then we can operate profitably and recomplete the wells. So you'd be looking at an addition of 218,000 equivalent barrels for the year.

[Jeff Hayden:]

Okay and that was reserve adds?

[Phil Terry:]

Production adds.

[Jeff Hayden:]

Production, okay, and I missed the splits that you have to get to that 218? What was that?

[Phil Terry:]

Fifty-five thousand barrels addition in the third quarter, 162 and change in the fourth.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Tim Rochford:]

Okay, thank you operator, and we'd like to thank everybody for taking time this morning and showing the interest in the company. We had some great questions and I think there was some really great presentations made by management. Once again thanks and have a good day.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.