PDC Energy, Inc.
Q2 2008 Earnings Call Transcript

Published: 11 Aug 2008

[Operator:]

Welcome to the Petroleum Development Corporation second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce Rick McCullough, President and CEO.

[Richard W. McCullough:]

With me this afternoon is Bart Brookman, our Senior Vice President of Exploration and Production. I’d like to first call your attention to the disclaimer and point out that we will be making forward-looking statements and encourage you to read this cautionary language. If you’ve read our press release and as you will hear this afternoon, PDC has just completed an exceptional quarter. This will mark the fourth consecutive quarter that we will file our SEC filings on time and our operating and financial fundamentals steadily improve. However, like other E&P companies recently and maybe more so than most, our stock has been down significantly in the last few weeks. While I don’t profess to understand the vagaries of the equities market and realize that there may be many factors, some of which could be psychological in nature that impact stock prices, I question the extent to which our stock has been impacted. While I realize that energy prices in general and the Rockies’ gas prices more specifically have fallen in the last few weeks, what I also know is that PDC’s fundamentals have probably never been better and our immediate future never brighter and that is what Bart and I hope to share with you today. A year ago we included this chart for the first time, this pie chart, in our 10Q showing that while we do have 80% plus of our assets in production in the Rockies, only about 35% to 38% of our sales are tied to CIG pipeline pricing. Following the release of that chart our stock began a steady rise in price and as we continued to deliver on our projections, met our financial reporting requirements, issued our first 3P reserve estimates and generally realized higher and higher gas and oil prices our stock price rose to prices in the mid 70 range in June of this year, before per life prices began to fall. However, recently as CIG basis began to widen again, particularly on the forward curve, we have seen our stock price fall back more than many of our peers and for this reason I want to remind everyone of this 35% to 38% CIG relationship and also remind you that because our Wattenberg production has a significant oil component, our total gas and oil realizations out of the Rockies have actually been improving substantially. Then when you combine this with our hedging of CIG production throughout 2008 and 2009 we are actually much better positioned to withstand CIG price erosion than perhaps a lot of people realize. If you follow our company you may recall that for the first time in our history we shared three-year productions with the market in February of this year. That showed that we had the potential of doubling our production and tripling EBITDA over the 2008 to 2010 time period if we executed on roughly a $300 million a year drilling plan and realized gas and oil prices in the $7.00 per Mcf and $78.00 per barrel range. We believe that execution of that drilling plan is important for our company to demonstrate to the markets our ability to operate successfully at this growing level of operations. Since last February our board and our executive team have remained very focused on the successful execution of this plan. Because of our plans to debt finance approximately $130 million of our original 2008 CapEx budget you have seen us become more aggressive, although some may say conservative, in our hedging of production at prices above our forecast. As prices continue to rise through June we, like many of our counterparts, have recognized non-cash losses on our derivative instruments. I think most of the investor community understands these losses and how they come about but what you may not realize is just how quickly these non-cash losses can swing to gains. Through the first six months of 2008 we have recognized $126 million in these non-cash losses. However, with falling prices in July and to date in August we probably have seen a total reversal of these losses. In fact, if we recorded these changes on a monthly basis we would have recorded an $88 million gain in July alone. So what you will hear today is that our fundamentals are stronger than ever. As you can see in this chart this is a trend that has been improving steadily over the last couple of years and has continued through the second quarter of this year. Our second quarter production was right on forecast, up 40% over the same quarter last year and our actual realized sales prices, net of realized hedging losses, up $9.48 in the second quarter was up over 55% over 2007 levels. But look at what is happening to cash flow and EBITDA. If you annualize second quarter EBITDA you will see that it is almost tripled over 2006 levels and even if you discount the fact that our annualized operating cash flows have grown more than seven times our 2006 levels, and you attribute this back to the size that we were back in 2006, it’s hard to ignore the fact that our cash flows have grown just 250% since the second quarter of 2007 alone. But is this really the right way to look at the rest of 2008 or 2009 in light of the recent price decline and the widening of basis on CIG? Well, consider this

[Barton R. Brookman Jr.:]

As you can see from the graph the company has a very strong history of production growth. I am happy to report that this trend continues in 2008. We had a 37% improvement Q-to-Q, 07/08 improvement on production. I am happy to report the majority of that growth was due to organic activity, drilling, refracs and recompletions, a very small contribution from our Castle acquisition that was closed in late 2007. We had a record level production for the quarter of 8.8 Bcf equivalent, 18% of that is oil, 82% of that was natural gas. The company is currently on track to produce 39 Bcf equivalent for the year 2008. This is slightly increased from prior guidance by 0.4 Bcf due to a recently approved expansion of our drilling program in the Wattenberg field. It is estimated that our 2008 net exit rate will be approximately $132 million a day equivalent. Currently, our production is in line with the forecast at approximately $105 million a day net. As you can see from the graph, we have a very strong increase in third quarter and fourth quarter. There are really two significant components of that growth. The first is in the Northeast Colorado assets. We’ve recently started a compressor station and a pipeline system that accommodates a good portion of our recent drilling and in the Piceance Basin, the fracture retreatments due to winter months are not allowed and we have difficulty with the weather so those are pushed into the spring and summer months. We have a very aggressive accelerated schedule over the next two months and will be having 15 to 20 new wells come online. Looking at the 2008 production forecast, we’ve given you a breakout by area and then by area within the Rocky Mountains. You can see the Rocky Mountain area has 33 Bcf of the 39 Bcf projected for the annual production or 84%. We have a nice distribution amongst our basins in the Rockies

[Richard W. McCullough:]

We’d like to turn the call over to Q&A.

[Operator:]

(Operator Instructions) Your first question comes from Michael A. Hall - Stifel Nicolaus & Company, Inc.

[Michael A. Hall:]

Can you touch on the Pennsylvania leases or Marcellus leases, Pennsylvania and West Virginia? The 35,000 net, are those official yet? Do you have all the rights on those? Is that cleared up at this point?

[Richard W. McCullough:]

Yes, it is. We have identified our deep rights and traditional legacy acreage shallow rights and our land group has been diligent in working on this over the last six months to a year. And currently our inventory’s at 35,000 acres.

[Michael A. Hall:]

Can you talk about what counties that’s in?

[Richard W. McCullough:]

I don’t have that right off the top of my head.

[Michael A. Hall:]

What about any existing gathering infrastructure that you have there?

[Richard W. McCullough:]

Most of this acreage is in the areas of our existing production so there is gathering infrastructure in place.

[Michael A. Hall:]

Would it be suitable do you think for Marcellus production?

[Richard W. McCullough:]

That is yet to be determined.

[Michael A. Hall:]

Looking on the cost line, LOE production costs in general. Can you help me think about number one, what maybe is the full company production tax rate or severance tax rate?

[Richard W. McCullough:]

What I can tell you Michael is our severance taxes for the quarter were right at $0.79 an MCFE. And if you look at the total production costs, the $0.19 increase from the first quarter was all attributable to production taxes. So there are a number of other items moving up and moving down within that category of course, but the main driver of the difference was production taxes.

[Michael A. Hall:]

So no LOE or any cost creep on that front still at this point?

[Richard W. McCullough:]

Fortunately not in this quarter.

[Michael A. Hall:]

Were there any tornado impacts or anything along those lines from the Wattenberg Field?

[Barton R. Brookman:]

No, there were not. Some minor damage to tank batteries but from a cost basis and production interruption, no damage.

[Michael A. Hall:]

Rick, looking forward on the LOE in particular, any thoughts on the ability to maybe bring that down at all on a per unit basis?

[Richard W. McCullough:]

Michael I think that we do believe that it will continue. It flattened this month and began to trend down. As you probably know, we had roughly about 17 BCF of production this first half of the year. We’re projecting closer to 22 BCF the second half of the year so if we’re able to keep sustaining the cost levels, we should begin to see that track down.

[Michael A. Hall:]

Can you remind me what exactly you have remaining in North Dakota? And given the strong results the industry’s seen, as I remember you’ve still got some acreage up there, is there any intention to take another look at that acreage?

[Barton R. Brookman:]

The answer is yes. We’ve got approximately right over 30,000 acres, the bulk of it in Burke County, and we have a technical evaluation underway. As you’re aware we sold a portion of our assets there to Marathon last year but the balance of our acreage we have a technical team working on it and they are going to be making a recommendation on potential development to us sometime before the end of the year.

[Operator:]

Your next question comes from David Tameron - Wachovia Capital Markets LLC.

[David Tameron:]

I’m looking at the ‘09. I look at current production guidance X-Right 132. ‘09 production implies an average rate for the year of 134 if I’m doing my math right on that and assuming you saw the same 48 BCF target.

[Barton R. Brookman:]

The 49 BCF target sounds to me like that’s a fairly conservative number.

[Richard W. McCullough:]

David I think the way we have been looking at it, just again to remind you that the pro forma numbers that we issued at the beginning of the year that showed targeted 2009 production was off of a generic $300 million CapEx sustaining that level. What we’ve done thus far in 2008 is actually through revisions to our 2008 CapEx is we’ve accelerated as I mentioned about 9 BCF of production, 8 of which falls in 2009. So we have not come out with any official guidance for 2009 actual CapEx for production but if you just use that pro forma information, the 2009 is actually up about eight BCF over what we had originally put out.

[David Tameron:]

Clarify that for me. So you’re saying that 49 BCF on apples to apples is eight BCF higher or that 49 should be going up by eight BCF?

[Richard W. McCullough:]

If you just keep the same assumption about $300 million of CapEx that we made at the beginning of this year, it would be eight BCF higher.

[Barton R. Brookman:]

You should know we have not done our formal model in ‘09. That is yet to be completed.

[Richard W. McCullough:]

Nor have we finalized the CapEx.

[David Tameron:]

I’ll say I won’t hold you to it but I’m sure I will later down the road. If you look at your capital budget, since we’re on that topic, what price level is the magic level where you would revisit your budget for ‘09? What are costs you’d need to slow down spending, is it a $7.00 number, $8.00 number, $6.00 number?

[Richard W. McCullough:]

We probably would look at it, as you would guess, basin by basin. As you can see if you look at some of these numbers we shared this afternoon our cash margins are extremely high at the current levels, so I think we could afford to see some pretty significant reduction in pricing before we would begin to curtail spending. We don’t specifically have those kinds of numbers readily at hand. I don’t think it would be anywhere near the $7.00. Would it happen at $5.00? Possibly.

[David Tameron:]

That puts at least some type of collar around it. And along those same lines, obviously you’ve seen the numbers. You’re trading at call it $1.30 on 08 proven reserves. Have you looked at all or thought at all about doing a buy-back right now and maybe using some of that additional CapEx for that? I don’t know if it’s an issue but how do you look at that trade off and is there anything you can do to unlock some value particularly given how much everything’s gotten beaten up?

[Richard W. McCullough:]

I think economically it might make sense. I would tell you that the high yield bond deal and I think this is typical in all high yield bond deals; it does put limitations on the amount of stock that we could buy back.

[David Tameron:]

Do you know off the top of your head what that number is? And regardless, would you consider buying back stock up to that level?

[Richard W. McCullough:]

I think if you look at the document it’s pretty limited.

[David Tameron:]

On the reserve revision, you mentioned the 30 BCF was due to pricing. Of the additional add, was it simple drilling? Did you change any of your pre-well reserve numbers per well metrics coming out of any of the Wattenberg or the Piceance when you book those when looking at mid-year?

[Barton R. Brookman:]

No, it was not a modification of our type curve; it was the additional proved reserves due to extending the field. We had some Niobrara that we began booking in the DJ Basin and then in Appalachia we actually had an identification of some down spacing opportunities that are scattered within the 3P. But there were not any actual modifications to the type curves.

[Operator:]

Our next question comes from Leo Mariani - RBC Capital Markets Corp.

[Leo Mariani:]

If I’m looking at your 10Qs right, it looks like you had a current tax refund that was relatively substantial. Can you give us a little bit of color on what’s going on there?

[Richard W. McCullough:]

I think Leo what’s happened is we’ve gone back and looked at some of the state by state apportionment of income and actually realized that we were apportioning too much income to some of the states that had higher tax rates, so we’ve gone back and revised those for the open years. And for the current year we actually had a pretty significant refund associated with that. It’s pretty much a non-recurring item because of the fact that I think we’ve caught up all at this one time for the open years and the current year, but it still was a nice catch.

[Leo Mariani:]

Can you give us just a little bit more color on this royalty litigation provision that you talked about and you said you were pretty close to resolution? Can you give us any sense of what you think the outcome could be here and just a little background on the dispute?

[Richard W. McCullough:]

Just generally I can say this is the matter that we had disclosed earlier, the Colorado issue. I think as we disclosed in the Q we have had some meetings and are involved in arbitration. Beyond that we really can’t say any more about the specifics. It’s an ongoing negotiation.

[Leo Mariani:]

I think you talked about drilling some Marcellus wells here. Do you have the rigs sourced for that and do you have any sense of when you may spud your first Marcellus well?

[Barton R. Brookman:]

We’re working on the rig availability. We’re anticipating spudding the first well early fourth quarter.

[Operator:]

Your next question comes from Mark Lear - Sidoti & Company, LLC.

[Mark Lear:]

Could you give me an idea of how much of your Marcellus acreage is believed to be in areas that are over-pressured?

[Barton R. Brookman:]

No, I don’t have that. I’d have to have some of my technical resources in here to answer that. I can say it’s adjacent or within what we classify as the main fairway of the Marcellus that runs through West Virginia and the heart of Pennsylvania.

[Mark Lear:]

Just remind me what you were doing at Barnett. These were vertical tests to this point if I’m not mistaken?

[Barton R. Brookman:]

No, these are horizontal wells.

[Mark Lear:]

Looking through the balance of ‘08, can you just walk me through what’s getting you the big sequential increases in production through the third and fourth quarter and what specifically is happening to drive that?

[Barton R. Brookman:]

I believe the one slide had two of the projects noted. Mid-June we started what we call our stones throw gathering system in Northeast Colorado and it gathers approximately 35 wells currently and by the end of the year I believe that number’s going to be about 60 wells. But it was a major hurdle for the production surge in that basin which really occurred towards the end of June and will continue through the balance of the year. So that’s the first piece. The second piece is in Piceance. We are limited in our frac operations through the winter months. It was a very severe winter this year so the fracs were initiated probably later in 2008 than we would like. They really kicked off April-May timeframe so we are right in the middle of that of hydraulically fracturing our well bores and getting them down line. And as I said earlier, we’ve got a large quantity of wells that will be put in line over the next two months.

[Mark Lear:]

Do you have a number in terms of the backlog there?

[Barton R. Brookman:]

The backlog in Piceance I believe is around 30 well bores.

[Operator:]

Your next question comes from [Curt Starbor - Arberdeen Asset Management].

[[Curt Starbor:]

A quick question regarding the marketing program, I’m just curious if you could talk about that to get a sense of what differentials we should expect going forward?

[Richard W. McCullough:]

My understanding is this is a new agreement that runs the end of 2010 and basically the biggest benefit is we’re realizing a much higher closer to a NYMEX based realization and I think it’s probably on the order of 10% to 12% better realizations that what we had seen historically.

[Operator:]

Your next question comes from Eric Seeve - Goldentree Asset Management.

[Eric Seeve:]

Thank you for laying out your percentage of MCFE sold by market. I’ve not had a chance to go through the Q yet. Can I trouble you to lay out both as a percentage of your production exposed to CIG and your total production, how much is hedged in back half ‘08 and ‘09?

[Richard W. McCullough:]

Eric I’d say it probably varies depending on if you look at current production levels; it’s probably 80% in that range.

[Eric Seeve:]

80% of total production or of CIG exposed production?

[Richard W. McCullough:]

Both probably, and we may actually have a little bit more hedged on CIG but it’s in that 80% range. If you’re looking at current production and production growth, it’s probably still in the 65% to 70% range.

[Eric Seeve:]

Next question is on projected year-end reserves. Based on the data that you provided the finding and development costs even when you factor in the positive 30 BCF revision associated with increased pricing, the F&D costs are excellent. Using your year-end forecasted reserves the second half of the year F&D costs project out to be less than excellent and I’m just trying to understand if the difference between the first half and the second half that you’re being conservative, is it simply the way that the bottom’s up model works, or is there something else going on?

[Barton R. Brookman:]

825 is the number we were comfortable with based on our current available engineering and we did not want to jump out and throw out a number that we could not back up.

[Eric Seeve:]

Is there anything different about the nature of the drilling you’re doing the second half of the year versus the first half?

[Barton R. Brookman:]

No. But we always have our friend called pricing that was the unknown, so we wanted to make sure we were accounting for that recognizing we had a very strong surge in prices mid-year.

[Operator:]

Your next question comes from Michael A. Hall - Stifel Nicolaus & Company, Inc.

[Michael A. Hall:]

First, can you talk about your recompletion program in the Wattenberg and where you stand in terms of inventory there?

[Barton R. Brookman:]

Yes, we’ve got a large inventory of projects. We’ve implemented approximately I believe 90 so far this year. We’ve got another 30 planned. Next year with some of the new drilling and with the Niobrara completions we will be somewhere around the 100 to 150 projects. We feel that’s a pace we can continue for several years out. I don’t have the exact 3P numbers in front of me but again it’s a large quantity of projects.

[Michael A. Hall:]

Can you remind me what those cost and what you’re getting when you recomplete in terms of production and incremental reserves?

[Barton R. Brookman:]

These will be approximate but $250,000 to $300,000 for the recompletion depending on the technique and the frac. And reserves range from 22,000 barrels equivalent to 50,000 equivalent depending on the project.

[Michael A. Hall:]

And that is or is not included in your 3P?

[Barton R. Brookman:]

The bulk of them are included in the 3P.

[Michael A. Hall:]

As you think out longer term, the market was and I don’t know if it is any more paying for optionality in the E&P space. How do you think maybe about optionality at PDC looking past maybe even the three-year mark in terms of where you see the long, long growth on this company?

[Richard W. McCullough:]

I think Michael the key to the longer term growth is some of the things that we talked about probably in the annual meeting, and that is we’re gearing up a specific dedicative acquisition with the divestiture team. We continue to be looking at being conservative yet more focused on our exploration efforts and again I think you’ll see us continue to look at trying to pick up incremental opportunities for future drilling and future capital commitments through those two efforts.

[Operator:]

Your next question comes from David Tameron - Wachovia Capital Markets LLC.

[David Tameron:]

Just a clarification here and a question to Goldentree’s question about hedging. You said you have 80% of 08 production essentially hedged and 65% next year?

[Richard W. McCullough:]

I think what I was saying is I think if you look at current production levels we’re probably 80% hedged today in 2008. We’re probably a little less than that in 2009. What I was saying is if you try to factor in what 2009 production would be it’s probably more like 65%.

[Operator:]

There are no further questions at this time.

[Richard W. McCullough:]

Thanks everyone for participating this afternoon. We hope this information was helpful and wish you a good afternoon. Thank you.