EQT Corporation (EQT) Q1 2008 Earnings Report, Transcript and Summary

Good morning, my name is Rose and I will be your conference operator today. At this time, I would like to welcome everyone to the Equitable Resources First Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. Thank you. It is now my pleasure to turn the floor over to your host, Mr. Pat Kane. Sir, you may begin.

Thank you, Rose. Good morning, everyone, and thank you for participating in Equitable's First Quarter 2008 Earnings Conference Call. With me today are Murry Gerber, Chairman and Chief Executive Officer; Dave Porges, President and Chief Operating Officer and Phil Conti, Senior Vice President and Chief Financial Officer. In just a moment, Phil will briefly review a few topics related to the first quarter financial results, which were released this morning, our hedging strategy and financing plans. Then Murry will provide an update on our drilling program, corridor construction and other mid-stream projects. Following Murry's remarks, we will open the phone lines for questions. But first, I would like to remind you that today's call may contain forward-looking statements related to such matters as our well drilling program, infrastructure development initiatives, reserves, tax position, financing plans, growth rate and other financial and operational matters, including the daily sales volumes. Finally, it should be noted that a variety of factors could cause the company's actual results to differ materially from the anticipated results or other expectations expressed in these forward-looking statements. These factors are listed in today's earnings release, the MD&A section of the company's 2007 Form10-K, the first quarter 2008 10-Q that will be released today as well as on our website. And now I'd like to turn the call over to Phil Conti.

Thanks, Pat and good morning everyone. This morning, Equitable announced first quarter 2008 earnings per diluted share of $0.57, which compares with earnings per share of $0.46 last year. The increase in earnings resulted from higher realized natural gas and natural gas liquids prices, as well as higher natural gas sales volumes, gathering rates, and storage related margins. In addition, during the first quarter of 2007 we incurred costs related to the royalty matter and legal issues and to the terminated LDC acquisition, the details of which we've provided in the past. And of course, those did not reoccur in the first quarter of 2008. Those expenses from '07 were partially offset in the current quarter by higher operating and incentive compensation costs which were detailed in this morning's press release. In addition to higher earnings, operating cash flow was also up in the current quarter by about 84% due to higher sales volumes and realized prices and I will go more into those in a moment. But more importantly due to lower current taxes resulting from increased deductions associated with our ramp up capital expenditure program that we mentioned on the fourth quarter call. Those are primarily intangible drilling cost on the drilled wells and accelerated depreciation on our infrastructure investments. Otherwise, I think the quarter was a pretty straightforward one and our view is that it was a very solid quarter for the company both financially and operationally. I will briefly hit a couple of important highlights for the quarter and then Murry, will give a more comprehensive operational update. Although, we did issue an 8-K on March 7, presenting our annual results in the three segments format for the past three years, this is the first quarter that we are presenting our operational results in the three business segment format. We will also issue another 8-K later today showing the breakout by quarter in the three-segment format for calendar year 2007. You can refer to those documents for additional detail, but I thought I would point out a couple of items that may be of interest under the new three segment structure. First, with regard to the Nora transaction last year, the sale of Nora assets to range in the second quarter of 2007 impacts quarter-over-quarter comparisons for both the production and the midstream segment. For the production segment, we reported sales volume growth of approximately 2% over the last year and current quarter, normalizing for wells sold to range, we think provides the clear picture of our sales volume growth. And after making that adjustment, sales actually increased by 9% over the same quarter in 2007. The [inaudible] range also impacted reported results at midstream. The revenues and O&M expenses related to the operation of the Nora Gathering systems as well as the gathered volumes that were reported in last year's results are no longer included in Equitable's operating and financial results. Although, there is a net negative variance in operating income as a result of the sale, the earnings associated with Equitable's remaining interest in Nora Gathering LLC are reported below the line, if you will, as equity in earnings and those totaled about $1.2 million in this quarter. Of a quick note on average well-head prices, average well-head price was 18% higher than last year's first quarter while the reported sales volumes are on a comparable basis in the release. Bear in mind that prior to the shift to the three segment reporting, the natural gas liquids price was included in the average well-head price at the production unit. Now production contracts with midstream to produce, to process the gas and take the liquids price risk. Midstream pace production for its Btu is based on a natural gas price. In the first quarter, liquids prices were also very strong up by 49% over the first quarter 2007. This incremental revenue was recognized at midstream as gathering and processing revenue. One other quick note on midstream, the other income line, which was $3.4 million in the current quarter, this other income represents returns allowed on FERC projects that are still under construction in our case of the Big Sandy project and this other income will be replaced by midstream revenues and expenses associated with Big Sandy in future quarters. I want to spend just a minute discussing our hedging strategy. As you know, we planned to invest approximately $1.2 billion in drilling and in infrastructure in 2008 the expected returns based on market prices are well in excess of our cost of capital. That said, a significant portion of that CapEx is price sensitive as returns can be impacted dramatically by wide swings in commodity prices. As you know, this management team has been and continuous to be committed to generating a return-on-capital investments that is greater than our cost of capital. And consistent with that objective, we've recently added to our hedge position by entering into a series of cashless collars and let me give you some volumes. We did about 1.5 Bcf for the remainder of 2008, about 12 Bcf for 2009, around 10 Bcf in 2010, around 9 Bcf in each of the years 2011 and 2012, about 8 Bcf in 2013 and about 3.5 Bcf for the years 2014 and 2015. Those transactions have floors that averaged approximately $7 and caps that were in excess of $15. We did choose cashless collars… by the way those transactions that we put in place in the table that you saw this morning have the effect of lowering the average floor and slightly raising the average ceiling on the cost with collar section of the hedging section. We chose cashless collars with a fairly widespread and our objective is not so much to reduce volatility but instead to secure a return commensurate with our cost of capital while allowing for significant upside from there. In addition to balancing our strategic and financial objectives, cashless collars have the added benefit lease versus swaps of somewhat reducing counter party credit risk as well as reducing the need to oppose cash margins. In conclusion, I'll give a quick update on financing, in March we probably completed the first phase of our 2008 financing plans by issuing $500 million in 10-year senior notes with a coupon of 6.5%. The proceeds from that transaction we're used to pay down or short-term debt balance resulting from increased capital expenditures over the last several quarters. In fact, you will see in the queue released later today that our short-term debt balance at 3/31/08 is $12 million, plus $12 million, which is down from $450 million at year-end. Remainder of our 2008 capital plans will require us to raise approximately $700 million in additional capital between now and year-end. As we have stated in the past, we think it's advantageous to remain in investment grade credit rating albeit at a significantly lower investment credit rating than the company had maintained in the past as a result of our changing business mix. And therefore, we will most likely issue a mix of common equity in addition to more debt to meet the balance of our needs in 2008. And with that I will turn the call over to Murry.

Thanks, Joe and good morning everybody. I wanted to give, I intended to give a relatively short operating report because it's only been a month and a half since we had our Analyst Meeting, but it turns out there is quite a bit to talk about. So, this will be a little longer than I had planned. First, I just wanted to give a sort of up to date report on the horizontal, on the drilling in total in the horizontal drilling beyond what was reported in the release for the quarter. Total drilling year-to-date, Equitable's drilled 188 wells of which 99 are horizontal. And for those that are counting that would be me particularly we drilled a total of horizontal... total horizontal well so far in the Appalachian basin of 193. So, we are well along in this horizontal drilling program. As was noted in the release based on the rate at which we're drilling wells this year, horizontal wells we're raising our expectations of horizontals from the previous estimate of 250 to 300 to greater than 300. Currently, we have 17 rigs running in the Appalachian basins, we recall that Methane 2, our deep vertical. That is Marcellus/Utica, which I will get to in a minute and 12 in the horizontal play. We expect our rig count to increase to 22 rigs, we will be adding one coal-bed methane rig and four more for the horizontal program. Let's move on to the P3 reserve development portion of the presentation, the impact of horizontal drilling to that P3 reserve development. Remember that more than 72% of our P3 reserves are classified is coming from Devonian shale. And at this point, those shale reserves are entirely from low-pressure shale, predominantly the Lower Huron shale. As I said before, of which I'll elaborate later, there are several other prominent zones we're testing but the reserve potential for all of these other zones are currently included in our merging play categories. Certainly, there's more to learn about how to drill and complete the Lower Huron shale, particularly as we apply new well geometries and improve our completion effectiveness. But all that being said, you should know that we now consider the Lower Huron play to be bread and butter in the sense that numerous wells have been drilled, they're hooked up to a pipeline system, they are producing and we're selling the gas. Now the infrastructure system is not in the greatest shape, but I'll talk more about that later and we mentioned that on previous calls. Drilling to-date in the Lower Huron continues to confirm both the economics of our horizontal drilling play and a decline curve we have previously published. As a side note perhaps to our tight curve, the economic assumptions that we've included for gathering rate in those models are about $2 per Mcfe, which is a conservative assumption given the number of wells we're drilling and intending to drill and the fact that this gathering rate assumption presumes no gathered volumes from third parties. We believe the ultimate gathering rate will be lower than we are currently assuming and we are working on quantifying that and will be talking about that more this year. As another note but highly relevant to how we think about our P3 reserves, of the wells, we drilled in the first quarter, 63% were drilled on locations classified in our most recent reserve report as unproved. In short, we continue to be encouraged by our bread-and butter play in the Lower Huron from a reserve standpoint, from a technical standpoint and from an economic standpoint. Let's move on to the emerging plays. To remind everyone again, EQT has not booked any reserves into our 3P inventory for any of the plays I'm now going to discuss other than minor amounts that may have come from the few completed wells drilled last year in these plays. Let's take the extension and re-entry category first and I want to talk about the Berea first. We had quite a surprising and pleasing result from our first three Berea wells. The Berea is a Devonian sandstone, usually a pretty tight sandstone. After a little rocky start on the first well where we had difficult drilling in the Upper Berea, we changed drilling geometry and moved down in the formation to drill our second and third wells. The flow rates from these next two wells are impressive. 30-day production rates for the second well, 30-day average production rates, we don't... which we consider IP around here, by the way. Our 30-day IP was 1.9 million cubic feet per day and flow rates from the third well, 30-day IP was 2 million cubic feet per day on average. Obviously that's a significantly larger than most of the other wells that we've drilled. The first well, by the way, which we had the trouble in was about 0.12 million cubic feet per day. It's too early to estimate reserves for these wells as the decline curve for the Berea is expected to differ from the shale type we'd given you, we'll need a few more months of production to make an informed decision on the reserves. The completed costs for these wells, these Berea wells were a little higher than for our shale development well is about $1.4 million to $1.5 million. The Berea drills a bit slower, it’s a sandstone, the formation where we're drilling is a little deeper than normal... normally where we drilled our shales and the well requires a slightly deeper casing point… casing set point before we kick off for the horizontal. Anyhow, the results from the Berea stimulated us to begin testing other collateral unconventional targets in zones that you'd have not yet heard about. Among those zones are a couple of other Devonian siltstones and fine green sandstones called the Benson and Gordon, as well as some other Mississippian sandstone, siltstones and one lime stone the Big Lime, Maxton and Raven [ph] Cliff. We'll be drilling up to 30 more Berea wells this year and we'll drill a number of wells into these other collateral zones. So, that's pretty interesting. On the multilateral, we drilled our first multilateral, we drilled it in the Lower Huron in Kentucky. It is both successful and profitable. The well cost was $1 million, a little higher than we thought but we had a pretty expensive pipeline to put in to at this location. First month IP was a little less than $300,000 a day. Obviously this was a naturally flowing well. The first multilateral was drilled in the hazard area of Kentucky, where we've had good success with fractured single leg laterals, but few naturally flowing horizontal well. So the result from this first try are encouraging. We're going to be drilling a number of multilaterals in other areas of Kentucky this year and in particular, we're going to drill some more in areas where we've previously had a higher percentage of naturally flowing Lower Huron wells from our single leg laterals. Also, we do expect to spud our first stacked multilateral this summer. On the Cleveland year-to-date, we've spud nine Cleveland shale horizontal wells in a total of 17 since the beginning of the program. The Cleveland was interesting because 45% of the wells that we had previously drilled have been natural completions, while profitable the aggregate of the Cleveland wells are declining somewhat faster than the Lower Huron. We believe this is because we're draining the natural fractures that are not accessing the matrix porosity effectively. We plan to re-enter the natural flowing Cleveland wells to frac them and expect to drill up to another additional 50 horizontal wells in the Cleveland this year. On re-entry I just want to reiterate what we mean by re-entry, the re-entry play encompasses approximately 4,700 existing 80-acre units that have been previously penetrated by a vertical well. The new activity that we may carry out at one of these re-entry locations could be real re-entry of an old vertical well, with the additional drilling of a new horizontal leg or it could be drilling of an entirely new horizontal well or wells drilled from the same location. In any event as I had mentioned previously the opportunity in the re-entry play comes from reserve additions due to increased recovery efficiencies from horizontal drilling and not so much from the efficiency of re-entering an old veritical well. We have spud 17 wells in the re-entry play to-date, two last year, 15 more this year including one of the two highly productive Berea wells that I just mentioned, that was actually on a re-entry site. As a matter of fact in that particular location where we drilled the Berea well we now have stack single leg horizontal well one in the Huron and one in the Berea. In summary, we are working the extension and re-entry category of our emerging planned inventory very hard and hope this report gives you a sense of where we are headed and what we've done so far. To reiterate horizontal drilling on our extensive acreage position in Appalachia applies to multiple zones. At this point as you can tell from my comments the inventory of possibilities continues to increase. Moving on to the Marcellus and Utica we have TD-ed [ph] our first high-pressure horizontal Marcellus well in Green County. TVD of 7,700 feet, measured depth of 10,665 feet. This well is currently awaiting stimulation, which is scheduled later this month. As we have said previously, we are building a pipeline to this Green County location in order to have the ability not only to test this well but also to hook it up to a market so we can gather much needed production data. You may also recall our intention to drill a second horizontal well in the Marcellus from this very same Green County location and it is still our intention to do this but we’ve called a bit of an audible along the way. As the result of work we are doing on the Utica shale we believe the Green County drilling location where we drilled that first horizontal Marcellus is also well suited to test the Utica in addition to the Marcellus. So, we decided to go ahead and deepen our second Marcellus test well and take it all the way to the Utica. The well is now targeted for 13,600 feet. The Utica is anticipated to be about 350 feet secure [ph] Current status of the well is that we're drilling ahead at 10,800 feet. After we finished this vertical Utica well, we will complete, test and hopefully produce both the horizontal Marcellus well and the vertical Utica well at the same time. If the Marcellus and Utica both work, which we hope they will, we'll go ahead and drill at least one more horizontal Marcellus well from the same location. Our intention is to drill at least one more Utica well this year at a different location. We are currently drilling a vertical Marcellus test in Wetzel County, West Virginia. We expect to frac that well later this month. We anticipate drilling at least 8 to 10 horizontals and 6 vertical Marcellus wells in 2008. These will be spread across our Marcellus acreage in order to identify the best areas for development. So, that's really all I wanted to say about the emerging play categories at this time. I wanted to move on just briefly to the midstream and really just a very brief report here. Mayking has approximately 25 of the 36 miles of Phase I pipe constructed that's good. We're expecting a third quarter turn in line. That's not news. On Langley, we're still on track for a third quarter turn in line. That is not news. And Big Sandy is commissioning. As a side note, you'll recall that we've had very good growth rates from our Virginia operations in the past few years. This growth is facilitated by Equitable's having constructed sufficient infrastructure in Virginia to carry our increased gas production from those coal-bed methane wells to the market. Growth rate for Virginia was about 18% this first quarter versus the first quarter of 2007. Obviously as we've said many times infrastructure matters. But this kind of growth from Virginia is an encouraging sign that we'll hopefully translate to increased sales growth in Kentucky and West Virginia as new construction comes on line this year. Lastly, given the continued success of the drilling and the progress made on the midstream build, we're becoming more confident that the sales growth rate in our production segment for the next five years will easily exceed our 12% forecast. As we continue to demonstrate sales growth progress this year, we will be providing you with a more specific growth rate forecast. And that really concludes my remarks. And I think Pat we’ll will turn it back to you and then open it up for questions.

That concludes the comments portion of the call. Rose, can you please now open the call up for questions. Question and Answer

Gentleman, your first question comes from the line Scott Hanold of RBC Capital Market.

That was a lot of operational update. I just want to kind of hit a couple of points, just to kind of clarify some information, on the Marcellus wells what is your total high-pressure Marcellus drilling program look like this year?

We’re hoping to drill 8 to 10 horizontals and another six at least verticals this year.

And those are all high pressure.

Yes. Right.

Okay. Are you... when you kind of talk some of the West Virginia wells, are those still in the high-pressure zone or just somehow get two more of the lower pressure?

The ones I mentioned, right, we are drilling the well in Wetzel County, it’s a high-pressure Marcellus well.

Okay.

But to answer your question, the northern portion of West Virginia as best we understand all the data, a significant portion of that well. Our acreage in that northern West Virginia segment is in the high-pressure Marcellus, which is... so the answer to your question is yes, because wells are being drilled in high-pressure Marcellus.

Okay. Got it. And when you... the first horizontal well, Marcellus well, that you're going to be stimulating next month, was that the one that ends up being drilled in the Hamilton and you'll frac down in Marcellus?

Yes. We're still... right, that's the same well. We are still, again the delay there is just waiting to get on pipeline, we will be getting a pipeline there. And then, of course we took this, as I said, we call this audible to drill that second well deeper to test the Utica at the same time.

Okay. And when you talk about potentially producing both the Marcellus and Utica, you're considering the difference in depths, do you pursue there will be potential like pressure issues.

Well. There are going to be two separate wells.

Okay.

They are two separate wells.

Got it. Okay, okay. So, the second well will be another horizontal into the Marcellus.

Well no, the first, just to review... the first well is a horizontal into the Marcellus. The second well at this point is a vertical into the Utica, that's where we're headed, we’ll frac and complete both of those wells. So, one will be horizontal, one will be vertical. See how it goes and produce them. If they work, we'll produce them into the pipeline at that point. Beyond that though if the Utica doesn't work we’ll just back off inside of that current vertical well and then drill out a horizontal Marcellus well through that same exact hole, that's one of the reasons we did this year as we sort of get a relatively cheap look at the Utica with this well. But if Utica works, we will produce. If it doesn't work we'll back off and drill on horizontal Marcellus. If the Utica does work, we'll go ahead and drill on the third well here. The third well will be a horizontal Marcellus well. Hope that clears that up.

Understood and if the Utica does work, would that move up sort of the timeframe of drilling the second one. The second, Utica or would that still be.

No. We are going to drill second one anyhow. We're just getting permits and going to drill I think, yes, a number of wells need to be drilled in that place. So one well is not going to tell a story one way or the other.

Okay. Okay, fair enough. And then going to those multilateral wells, I guess you get to get 300 day type of rate without a frac, can you kind of give us a sense of what do you all think the plan on sort of the multilateral would be at this point? Whether… how do you sort of position them relative to your portfolio? Where would you still want to try to focus is? Or is that still something that’s a in testing mode at this point in time.

I think it's still I would consider it's still in testing mode. I mean the fact that the first one is profitable is a good thing. But we don't know whether that technology is going to be best applied to areas where we previously had no natural flows so that we can actually reduce the cost of accessing gas from where we would have otherwise drilled a single-leg fractured multilateral. We don't know if that's going to be the biggest benefit of multilateral or where or whether the biggest benefit will come from drilling in areas where we have had naturally flowing single leg horizontals and by drilling a multilateral we would be able to increase the flow rate substantially. So I think there is a lot of experimentation to do here and it's sort of like, kind of like the space program, mercury to Apollo, we are sort of on the mercury side of that right now.

Okay. One last question, I'll let somebody else to ask question. Obviously you maintain your year-end production target and then I guess officially move your set a long-range although you did indicate there is upside to that. Obviously, now it's drilling a little bit more than 300 wells this year. Do you anticipate sort of... some are a little bit more uplift by year-end or are you still speaking kind of that 235 number.

Well, yes. Again the 235, we're not changing the 235. So let me be clear about that first. But I think Dave and I have always said that both the 12% long-term growth rate and the 235 short-term rate are milestones and I don't want to move those goalposts until we start to see real results coming from increased production and sales that will come when we believe when the infrastructure is in place. So I'd rather not move those goalposts yet until we see a bit more. The reason I said that I felt we could go beyond 12% is because we're seeing just so much more opportunity here and we had a pretty good first quarter, the 9% is a pretty darn good growth rate. And so we are feeling a little better but I did not give you a new long-term growth rate and I'm not going to change that 235 today.

All right. Fair enough. Thank you guys.

Your next question comes from Shenark Shuni [ph] from UBS.

Good morning, guys. Just a couple of questions here. Just with respect to the Marcellus well that you've drilled. Have you been able to figure out the thickness of the pace for that well and is there plans to shooting sort of seismic and so forth?

Well, we know how thick it is and I just don't know the exact number right off the top of my head because we record [ph] the second well by the way which is right next door and I just don't have the number off the top of my head. But…

You did more than a 100 feet or…?

It's about a 100 feet I think. A little bit more. I just don't know the exact number.

Okay. And then just a follow-up on the previous caller's questions about the drilling program and so forth. Can we assume that you're going to want to maintain the type of pace that you're moving at? I mean give or take how well you drill, how fast you can drill but sort of the same rig program for next year and so forth and so I guess my question would be that I am assuming that you'd a similar capital needs or may be not as much of this but you would have similar capital needs for next year. And would you anticipate coming back to the markets for more capital just for next year's program or are you finding on expanding the program further and so forth, I was wondering if you could comment on that.

Those are two separate questions. I’ll take the first one. First, we are not satisfied with the pace of our drilling program. Yet, we think we're doing a great job ramping it up but Dave and I both want to increase it as much as we possibly can. So, if what I think we've been pretty clear about that. So, at least on the drilling development side of the capital equation, we are hopeful that we'll have enough more permits in places to drill so that we'll go up next year. Absolutely. As far as funding, I think Phil has kind of given you the party line on that and we don't really have many much more to say on financing at this point.

Okay and if I can just turn over to one just operational question. You recorded $42.5 million for this quarter. Clearly that’s to do with the outperformance of stock and so forth and the changes to your assumptions. Can you quantify how much relates specifically to this quarter and how much relates to previous years and so forth?

Yes, it was $42.5 million. This is Phil by the way. $31 million was associated with the prior quarters and so you can expect about $11.5 million per quarter assuming we don't change the assumptions again in 2008. There are currently at a multiply of 2.5 times and a stock price of $70.

So the appropriate amount for this quarter is about $11million and 30…?

$11.5 million.

Yes. $11.5 million and $31 million is for previous year.

That's right.

Okay. Thank you guys. Thank you for answering my questions.

All right.

There appear to be no questions at this time. I would now like to turn the floor back to Mr. Kane for any closing remarks.

Thank you, Rose. That concludes today's call. We would like to just remind everybody that it will be available for a seven-day replay period beginning at approximately 1:30 p.m. today. The phone number for the replay is 706-645-9291, the confirmation code for the replay is 29614313. The call will also be available on our website for replay for seven days. Thank you everyone for participating.

This concludes today's Equitable Resources conference call. You may now disconnect.