SandRidge Energy Inc (SD) 2008 Q2 法說會逐字稿

Good day ladies and gentlemen. Welcome to the second quarter 2008 SandRidge Energy earnings conference call. I'll be your coordinator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded for replay purposes.

I would now turn the presentation over to your host for today's call Mr. Dirk Van Doren, Chief Financial Officer. Please proceed.

Thank you. Good morning. This is Dirk Van Doren. Before I turn the call over to Tom Ward our Chairman, CEO and President I need to make opening remarks. Last night we issued press release detailing SandRidge's financial and operating performance for the second quarter of 2008 and we also filed our 10-Q. If you do not have a copy of the release, you can find a copy in the Company's website, www.sandridgeenergy.com. Also you can sign up for releases that will automatically be sent to you and this is located under the investor relations tab. Today we will also use a few slides and those are available on our website under events and also under presentations.

Now for the forward-looking statements. Please keep in mind during today's call our Company will make forward-looking statements which are subject to risks and uncertainties. Actual results might differ materially from those projected in these forward-looking statements. Additional information concerning risk factors that could cause such differences is detail in the Company's filings with the SEC. Today's presentation will include information regarding adjusted net income, adjusted EBITDA and other non-GAAP financial measures as required by SEC rules, a reconciliation to the most directly comparable GAAP measures are available on our website under the investor relations tab. Now let me turn the call over to Tom.

Thank you Dirk. Welcome to our second quarter 2008 earnings conference call. Joining Dirk and me is Matt Grubb our Chief Operating Officer. We have now posted our second quarter numbers and a small slide presentation on our website that I will discuss and walk you through momentarily. We have added the slide presentation because of the complexity of the West Texas Overthrust and how difficult it is to describe what we are doing without some visual aid.

We've been quiet for a couple of months while we continue to drill within the Pinon field and explore both in the Pinon field and across the West Texas Overthrust. Today I will discuss the important test that we have drilled during the last few months and the emergence of a more concrete idea of the geological model we are developing as we access seismic and have a few exploration well bores that are drilling to tie back into our existing seismic and the Pinon field. During the second quarter we finished processing our 3D seismic data across the Pinon field and our interpretation of the field data began in May. So we've only had 3D data coverage over the Pinon field for 60 days and we've already discovered a new fault block which I'll describe in more detail a little later.

Having the Pinon field 3D data is critical because it allows our geoscience teams to confirm and incorporate the regional thrust fault theories and 3D mapping with control from approximately 600 wells drilled to date in the Pinon field. Please keep in mind that Pinon field is fast becoming one of the better natural gas fields in the US. In June 2006 we produced less than 80 million cubic feet of gross gas equivalent per day from our Western division and today we produce over 200 million gross from the Western division of which the growth has been almost exclusively driven by the Pinon field where it's tripled in size to over 600 wells. This number would be about 300 million -- 305 million cubic gas per day if it had not been for the Grey Ranch plant fire which set us back 5 million of methane on a gross basis. We have discovered through the use of 3D that there are at least three major thrust systems that correlate across the entire West Texas Overthrust in an East-West direction. These three systems are the Dugout Creek Thrust, the Warwick Thrust, and the Frog Creek Thrust. These thrust systems combine with the rent system to develop classic reservoir traps.

Our primary reservoir, First Caballos produces gas at 5,000 and 9,000 feet and averages 7 Bcf per well and can be drilled on 40 acre spacing with a recovery of up to 90% of gas in place. We now have 144 wells that produce from this reservoir and are very comfortable with the 7 Bcf type curve for the First Caballos within the Pinon field. This is a spectacular reservoir that until recently was not developed at a fast pace due to the high amounts of CO2 in the reservoir. Our goal is to continue to expand this prolific reservoir and develop sweet methane production in these new fault blocks through the use of our proprietary 3D data and the data from exploration wells as they are drilled. The 3D data set will not eliminate dry holes but will help us identify significant fault blocks to explore it. As I mentioned we now have the ability to see some major geological events that were not known to us just a few months ago. I will now try to describe the major thrust systems across the WTO and the significance they provide to SandRidge.

The first major thrust is the Dugout Creek Thrust. It is the red colored and northernmost thrust system in slide one. The majority of the existing Pinon field sits behind this thrust and is the main northern thrust that we previously called the leading edge thrust. We now believe that most of our second camp development is within this thrust. We can also correlate the Thistle field 15 to 20 miles East of Pinon and McKay Creek field 25 to 30 miles East of Pinon in the same thrust and both of these fields produce sweet gas from shallow reservoir.

The second thrust is the Warwick Thrust. Until our 3D was interpreted across Pinon, we did not recognize this thrust and did not carry it across the WTO. However with 3D seismic, geological controls, from hundreds of wells and supporting production data, we can now map this thrust as a prime contributor to sweet gas production on the first cab on the Eastern side of the Pinon field and as the primary thrust for all of the First Cab production. In other words, as we move across these thrust sheets we are in separate reservoirs. Please look at slide 1 and see the relationship between the Dugout Creek Thrust and the Warwick Thrust within the Pinon field. We can tie the Warwick Thrust across the WTO. The Sabino field, the Longfellow 1820-1 exploration well we are currently drilling and the Big Canyon 121-1 area are all tied together in the second major thrust system. There are also several more minor regional thrusts in this system. As we drill south across this regional thrust and into a new fault block within the Warwick Thrust we have discovered sweet gas in the First Cab but that is 1500 feet shallower in the wells drilled to the North and the East Pinon First Cab sweet producers.

We have tested the West Ranch 42-2 at initial rate of 1.3 million cubic feet of sweet gas from the First Cab and are currently moving to test the Cab section in that well at a depth of about 3600 feet. The Cab A is significant because we are producing a shallow zone in the West Ranch 26-7 at a rate of over 3 million cubic feet of gas a day and it has potential EUR of 4 to 7 Bcf of gas. We now are developing a theory that the shallow zone can tie from the West Ranch 44-1 which is drilling all the way to the Longfellow 916, almost 5 miles across the southern part of the field.

The third major thrust is the Frog Creek Thrust. With the Pinon 3D data we were able to confirm production from the Cab A which lies above the First Caballos. This thrust the Williams 72-1, the only known commercial producer in both the Frog Creek Thrust and the WTO has an EUR of just over 200 million cubic feet of gas at less than 5,000 feet with 96% methane. That well was drilled on 2D seismic and we don't believe it's in the best structural position. We believe that we can drill deeper behind this thrust and encounter the First Caballos at a projected depth of 7500 feet or less and also believe the First Cab here will produce sweet gas. We plan to add several wells to our exploration program in this thrust block in the coming months. We also believe that the Cab A in this thrust is an ideal position to produce commercial gas at very shallow depths.

To summarize, we now see a succession of east to west thrust that lay upon each other, by being thrusted upon each other creating separate multiple reservoirs within each thrust. Please remember that less than a year ago we only knew that there were four producing areas in the WTO, Pinon, Sabino, Thistle and McKay Creek. That without 3D seismic we had to assume we were on deep seated structures. We now have a much better idea of how the thrust systems in conjunction with the rig systems combine for the trapping and fracturing of rock to create traps. We now believe more than ever that we are working with major systems that can be repeated across the WTO. We are confident about the presence of gas across the WTO as we now know that we produce gas in commercial quantity from all three major thrust sheets. For example, the Longfellow 1820-1 is a very important exploration well because we have found gas stored reservoir rock at 12,500 feet. However we do not know if there is adequate pressuring from the Ranch fault system to find commercial gas at this location. We do know that we can tay within the gas field Warwick Thrust and move up to 4,000 feet up depth for another test. This is significant as we explore within South Sabino. The First Cab continues to be the best reservoir for us to explore and we are pleased to find this reservoir behind additional regional thrust at shallower depths in the Warwick Thrust. Our goal will be continue to explore for this prolific reservoir across the WTO.

Today we are not able to correlate the First Cab with reservoir outside of Pinon but believe in the months and years to come that we will be able to make that connection. A better understanding of the subsurface picture in the Pinon field is a key element to successful exploration of our 610,000 net acreage position in the West Texas Overthrust. We are beginning the process of integrating the Pinon 3D data set to our previous 3D shoot in the South Sabino and Big Canyon. We now feel comfortable to increase from our current five rigs up to ten rigs exploring in the West Texas Overthrust during the remainder of 2008 and in 2009. Therefore, we have increased our budget to $2 billion from $1.5 billion for both 2008 and 2009 to further our exploration of our 610,000 net acre land position. We plan to either sell these Texas assets or fund with equity and debt in 2009 to cover the projected cash shortfall. Our production continues to grow and we are producing 295 million cubic feet of gas today with approximately 25 million cubic feet of gas shut in due to the Great Ranch plant fire and well work in the Gulf Coast. However even with this $25 million a day shut in or about 5 Bcf projected net loss for the year we have not had to change our guidance of 100 Bcf of production for 2008. This is a 56% increase from 2007 production. We do plan to have a shut in production restored by January 1, 2009. Additionally our initial production guidance for 2009 is 135 Bcf an increase of 35% over 2008 production. Which we have moved up from our previous estimate of 125 Bcf. We currently have 45 rigs working with 34 drilling in the West Texas Overthrust of which 29 are drilling within the development areas of the Pinon field.

As we've discussed previously, we have divided Pinon into three types of wells. Please refer to slide two. Of the 31 rigs working in Pinon we have 15 drilling for test in the second Cab developing, two rigs drilling for high CO2 First Cab development and 14 rigs drilling for First Cab sweet gas.

As you can see in slide three we have now booked 91 gross Bcf to our initial 11 First Cab sweet wells in Pinon. This is an average of 8.3 Bcf per well and the CO2 content from these wells ranges from 0 to 4%. While this is above our top current of 7 Bcf per well we continue to believe that over time we will fall back in line with the original type curve that has been established from over 100 wells drilled since 1994. Slide four shows 57 wells either currently drilling, projected to be drilled or completed in the First Cab East Pinon. Our goal is to continue to develop the high CO2 reservoir and keep our existing legacy plants loaded until the century plant is ready for deliveries also. At the same time, we want to increase our drilling in the sweet gas First Cab reservoir where there's no infrastructure capacity restrictions.

We have disclosed that we are now in partnership with Optia USA to build and furnish gas to a new plant that by the end of 2011, along with our legacy plants will have high CO2 treating capacity of 1.1 Bcf total of gas per day. Of that 1.1 Bcf of gas, we project to receive approximately 385 million of gross methane gas of which 270 million is net to SandRidge. We are very pleased to enter into this 30 year agreement with such a large and progressive condition.

Our second quarter operation results are very good. Our proven reserves moved up to 1.918 Tcf of gas, an increase of 219 Bcf from the first quarter. The finding cost of developed reserves during the second quarter was $1.37 per Mcf per drilling and $1.80 for all in finding costs including seismic. Our WTO 3D seismic project has been increased to 1500 square miles from 1400 square miles, and we now have shot 950 square miles. We are on scheduled to finish the shoot by the end of 2009.

As I mentioned earlier we continue to have a very aggressive exploration drilling program within the WTO. We have five ongoing exploration projects today. We are currently drilling the Longfellow 916 in South Sabino. The Longfellow 1820-1 in South Sabino, in the Big Canyon 121-1 in the Big Canyon area, the West Ranch 44-1 in South Pinon and are drilling in the First Caballos chert in the West Ranch 29-1 in Southeast Pinon. We are also in the process of completing our first exploration well, the West Ranch 42.2 in Southeast Pinon. While we've reached TD and are currently testing only one well today we do want to bring you up to date on our exploration program.

The West Ranch 42-2 is a 3D seismic test that was led by our geoscience team after we received data over the Pinon field. This well was drilled into a previously unproduced fault block of approximately 3400 acres in the Southeast portion of the Pinon field within the Warwick Thrust. The West Ranch 42-2 drilled to a total depth of 7430 feet and encountered several sections of chert including the First Caballos switch tested sweet gas at a rate of 1.3 million a day and the Caballos A which is now being tested. We are completing this zone, the Caballos A at 3600 feet. The key point are that the West Ranch 42-2 further expands the area of First Caballos sweet production into a fault block that was not previously discovered and was discovered through the use of 3D seismic. In the same fault block is the West Ranch 29-1 which is drilling in the same First Caballos package. Therefore we have encountered two well bores in this new fault block and are completing one of them today. The Longfellow 1820-1 is 15 miles East of Pinon and is currently drilling below 12,800 feet.

We have encountered gas shows at this depth and will wait to log to determine if the well has the potential to be a commercial producer. We can now with 3D seismic projected at 4000 feet high to this location within the Warwick fault block. The Longfellow 916 is a 13,500 foot test that establishes a northern limit of the Warwick Thrust as we move from Pinon to South Sabino. While this well has continued to drill, we project that we will have at least two reservoirs to test, the Cab A, a shallow Caballos chert at 2500 feet and the Woods Hollows sand at 12,500 feet. Gas shows were encountered in both of these intervals.

The Big Canyon 121-1, there's not any news here other than we are drilling at 13,000 feet on our way to projected TD of 15,000 to 17,000 feet and are currently structurally in line with our estimated geological tops. Only the 42-2 and the 29-1 exploration wells were started after we had data from the Pinon 3D shoot. As we drill wells and continue to refine this data, we expect to have a better picture than today of our enormous acreage position. We have also announced that we will be marketing our East Texas assets for a potential sale. The Cotton Valley drilling program has been very good to our Company and we continue to have four rigs working in this area. However if we can monetize these assets and move that cash into the WTO where our finding costs are lower and delay our access to the capital markets, we will do so. If we do not get what we consider a bid that will allow us to do that, we will then anticipate going to the equity and debt markets in 2009 and keep this asset to develop ourselves. We have mentioned in the past that we would raise equity and debt in equal proportions and we continue to use that formula in our model. We now produce nearly 50 million cubic feet of gas net to us from East Texas.

Lastly we have increase our rig count in Oklahoma to five rigs from two and expect that our acreage can accommodate a drilling budget of about $240 million and 10 rigs in 2009. Our Oklahoma net production has grown from 7 million cubic feet a day in January 2007 to 25 million cubic feet a day today on avery limited budget. I believe this highlights our quarter operationally. Dirk?

Thanks Tom. I will focus on a few second quarter highlights, our current financial position and our 2008 initial 2009 projects. The key things we look at are production operating costs, EBITDA, free cash flow and funding needs, if any. Production was above expectations and costs were within our guidance with the exception of production taxes because of higher prices. Adjusted EBITDA was $183 million for the second quarter which was above our guidance in our internal model. This number based on the definition of EBITDA includes $7.7 million from a gain on asset sales during the quarter. Our quota covering capital expenditures were $523.2 million and hence we have negative free cash flow. This was covered with borrowing under the revolver and then via 750 million high yield transaction we completed in the quarter.

Looking at other financial events we experienced an active second quarter and that continued into the third quarter. We completed a $750 million high yield offering in May and this caused our borrowing base to decline to 1.095 billion from $1.2 billion. We hope to move that back to $1.5 billion in September. All the lock-ups on our equity holders ended on May 27, and Tom completed his previously announced purchase of 100 million of common stock in open market purchases during the quarter. The exact numbers are $100.7 million spent for 1.95 million shares or $51.63 per share. And finally we sold rig number 6 for $1.425 million in July and used roughly $400,000 to repay our rig loan. The remainder went to cash, as this rig did not fit our strategy because of its size. We now own 31 rigs and have 12 rigs in the joint venture.

Our current debt position -- our current position as of August 7, was roughly $100 million of cash, 0 drawn on our revolver and $1.81 billion of total debt. Additionally since our last call we have added slightly to our hedge position with 1.8 Bcf in 2008 at 12.28 per MMBTU and 8.41 Bcf at 11.73 per MBTU for 2009. We are now roughly 78% hedged to the second half of 2008 at the equivalent price of 9.14 per Mmbtu, and 17% hedged for 2009 at 10.50 per MBTU.

Let's look at our guidance that was presented in the press release. We have changed two things in our 2008 guidance. Differentials and capital expenditures. We have changed our differentials for 2008 based on what we have seen so far during the year and frankly basis has come in quite dramatically during July, but we'll leave it at the higher level. Capital expenditures have increased to $2 billion with the bulk drilling. Our initial 2009 projections call for a 35% increase in production with flat costs and capital expenditures of 2 billion. Our 2009 projection assumes we do not sell East Texas and North Louisiana assets and any shortfall is funded with an equal mix of debt and equity.

Looking to the remainder of the third quarter we'll be at a few conferences in September so please see our websites for times and dates of these presentations. We have also included in the press release when we plan to release quarterly results for the third quarter which will be November 6. The fourth quarter and the year end which will d be February 27,and we'll file a 10-Q and 10-K on those days with the conference call the next day at 9:00 a.m. And finally our second investor analyst meeting is going to be held on Tuesday, March 3, in New York City at 8:00 a.m. So please mark your calendars. That ends our prepared remarks. We are available to take any and all questions.

(OPERATOR INSTRUCTIONS) Your first question will come from the line of Scott Hanold from RBC Capital Markets. Please proceed.

It's Scott Hanold here.

Hi.

Good morning. Tom, can you talk about now that you have your seismic information a little bit more on hand in the WTO, how do you think now about developing it for versus what you did before? And can you also talk a little bit about your confidence in some of the areas that you are going to step out as far as what you think you'll see? Obviously it sounds like you've seen some gas charge reservoirs. What is the key here? Is it really fracturing at this point in time?

Well, we look at it different today, Scott, than we did a few months ago because now we see -- we were -- if you look back in the RBC presentation, you can see we were focused on the major ridge faults that were moving North and South and now we see the major influence being more or as much as if the thrust fault that moves East and West. So what we are trying to do is use the Pinon field as the analogy to get in the best place to have multiple thrusts upon each other. So in order to answer your question, I'm not sure how long it will take us to find these -- how this comes together outside of Pinon, but within Pinon, what the major difference is is that we can have multiple new fields in a North-South direction which we didn't recognize before.

So as you think of the Frog Creek moving on top of the Warwick moving on top of the Dugout Creek thrust system within Pinon, you have these different faults or thrusts separating each other that are completely different reservoirs that we already know have multiple Tcfs of gas in place. That could actually continue on to the South. So we are incredibly pleased to be able to get in the Pinon 3D and we believe that same system goes all the way across the WTO. However it's a lot harder to go into the South Sabino where we have one well instead of having 600 wells within Pinon. So the majority of our growth still is going to be within Pinon as we try to find additional Pinons in this same geological structure across the West Texas Overthrust. That's why we are expanding the exploration wells. Those exploration wells move into ten won't be all the way out across the WTO. A lot of those will be drilling around Pinon trying to find and grow this tremendous reservoir. I hope that makes sense.

Yes. And just so I understand it right, so, basically what you have seen obviously is encouraging, Pinon obviously you are getting really excited here because of what you found and it sounds like you are going to concentrate efforts in and around Pinon but you're still going to do some of the step out drilling well outside of Pinon just to test the concept out there?

Every well that we drill, and we don't even have logs on 1820-1 but just by drilling through that, once we get logs there, once we get a log on the big canyon well, they'll prove to be very instrumental to determining at what depth you can produce that and if you can get depth to those types of reservoirs. What we want to do is to produce the most amount of gas from the shallowest reservoirs. So if you think of the Pinon field, the big thing is to move back along these thrusts and you continue to be up thrusted. So still very early in the Cab A development but if we can find the 26-7 is a very key well in that we have multiple Bcf producer producing 3 million cubic feet of gas today and shallower than 4,000 feet. If we can find a whole thrust system like that that would be very encouraging for us. That may be -- again maybe. We don't have scientific prove of this yet, but if it could produce at3,600 feet instead of 7,000 feet and find the same type of reservoir that's what we want to do. So we do want to and we will focus on the deep reservoirs but we'll also be focusing on the shallower reservoirs too as we continue to grow.

With that last comment about focusing on the shallow reservoir, when you look at your seismic information, I guess the data points you have so far and the wells you drilled, what can you tell us about depth as you move from West to East in the West Texas Overthrust like the Big Canyon area. What are your thoughts? Does it seem to get deeper there and what are the implications of that?

We do get deeper as we move from the Pinon field to the East. What we don't know yet is as you go over to the East or the multiple thrust in different parts of the West Texas Overthrust that also had you a shallow, so for example we know we can get up depth to the 1820-1 in the Warwick Thrust so we'll try to dig relative to that see how many of those thrusts we can encounter as we move up depth. So I think the difficulty here is there are several different thrusts and as you move East, you can be deep in one thrust and if you move into another thrust you'd be shallower. So we don't have enough information yet today to be able to tell you exactly what the depths of production would be across the overthrust. We think that the same thrusting goes all the way across the overthrust and still will take us some amount of time to be able to find exactly at what depth we're going to be able to find production.

Okay. I appreciate that commentary. One last quick one. On spacing, I think it was the First Cab you indicated I believe that your assumptions are based on 4 acre spacing. Ultimately how tight do you think that could get? Do you think there is that opportunity to get even tighter? If I remember right, I think there is some Pinon areas that are much tighter than that right now.

There are in the prolific reservoirs I think we are very comfortable at 40 because that's what it's been drilled on and we have data that stretches back to 1994. I'm not ready to say we are drilling anything tighter than that.

I appreciate. Thank you.

Your next question will come from Brian Singer from Goldman Sachs.

Can you talk a little more on the Longfellow, on the 9-16 well and the importance of that well from a faulting perspective and pushing the plate?

Sure. I think the first negative would be is that we didn't find First Cab production or a First Cab section in the 916 but now once that we look at it, the positive is that we have this Cab A at a very shallow depth and it ties together back into basically we are hopeful that ties together from the 9-16 down through the 26-7, the 42-2 and we have the same section on the well that's drilling the 44-1. So the positive is that we have not tested it it in the 916 but it looks very good on logs, it's at a very shallow depth. We have also at 12,000 or deeper than that. We have a gas charge zone that we are drilling in now. We have no idea. The Wood Hollow Sand does produce in the field but we don't know if that will produce in the 9-16. So I guess the most positive thing is we have a very shallow zone that we do believe will produce.

Okay. It seems like with some of the limited CO2 quantities you are getting as you move East that the rig is shifting in that direction and just wanted to check out the extent because of the higher return as a result of low CO2 versus any deterioration and rate of return in that legacy Pinon are or just greater complexity there?

If you've seen our slides as you have, the best rates of return we have are drilling First Cab sweet wells. So until we establish a different type curve at a shallower depth we are going to drill as many of those wells as we can.

And lastly if you were to end up not selling East Texas, how do you think about how aggressively you would develop those properties?

East Texas?

Yes.

I think that we would stick with our four to five rig schedules. I don't see us any time soon trying to develop anything deeper because we have most of that land is HPP and other people can drill around it. Actually we see that as being one of the great sales points is that the Cotton Valley in this area is good enough that you can drill just Cotton Valley wells and hold the other acreage and determine if it's any good or not.

Thank you.

Thank you.

Your next question will come from the line of Joe Allman from JPMorgan.

Tom, if you spud these two South Sabino wells and one Big Canyon well on your new 3D seismic but before you had your new interpretation and I know you just commented that that first South Sabino well, the one closest to the Pinon doesn't have the First Cab, can you comment on anything you've seen in the other two, you maybe mentioned it I just missed it, but what about the other two wells? Would you say that those may not be optimal locations based on new interpretation, you haven't seen the presentation of something? One of the formations, rather? Can you comment on that?

Sure. Also, a caveat would be that six months from now we'll probably say that we have new 3D and that help us know even more about the WTO. But having the Pinon 3D shoot is incredibly important because it has so many well bores to tie back in to and gives us the ability to understand the geology so much more across the West Texas Overthrust. So given that and now that we know more of what a character on seismic is to give you a reflector of these Caballos cherts, I would say sure that things would have changed on where we drill at least the wells in South Sabino. However, we need these data points and why we are drilling so deep is that these first wells drilled in each of these new areas are really key so that then you can use that well bore to tie back into your seismic. So it's maybe not fair to say that we would have changed things. It is fair to say that once we drill this well we have a lot more knowledge than we would have before. So we should be able to hone in. The good thing is that we do have gas in each of the thrusts and we are even seeing gas at very deep depths. So that gives me a lot of comfort that we have a gas filled reservoir and we are still in thrust. So even though we cross the thrust on the 9-16 and don't have-- the First Cab could be faulted out or any number of reasons geologically, how come we don't have First Cab there, we are still behind the thrust system because we have Woods Hole Sand in this well bore and we have that Cab. So I am actually very encouraged about the 9-16 and what it means. You can still explore around that and be within the thrust system.

So I guess what I was getting at is like the first well I am not being critical, but that well, whatever the final result of that well it may or may not be representative of other wells you would drill in that Dugout pre thrust. Is that correct?

That's correct. And I would say that any of these wells that we go out 15 to 20 miles away from the Pinon field have a very high risk of just giving us data and not having production.

Got you. And then the other stuff at Sabino well which I guess is Longfellow 1820-1, is there anything that surprised you there, what you've seen or haven't seen there? Same thing with the Big Canyon. Can you talk about what you have seen or haven't seen?

Haven't seen anything in the Big Canyon. We're not down to any potential depths, remember we have a log in the Big Canyon that we are offsetting within a couple of miles. So we are able to correlate to that log and that -- so there's a lot more data in the Big Canyon area just by having the one log to drill from than in the Longfellow 20-1 area. In that well, the 1820-1, the only thing we have seen is a gas charge reservoir. We have not logged it. Today we couldn't tell you that we have a section of chert that we are going to go complete. We can tell you that we have seen gas shows and they appear to be sweet.

Okay. Just in general as you are looking at the 3D seismic and I know you have limited well data in some parts of the filled, are there any issues outside of Pinon that might preclude you from drilling parts of your acreage there?

I'll let Matt take that one.

Well, I really don't see any issues. I think the biggest thing is getting enough exploration rigs to start proving some of these areas and the big thing is really understanding the data at Pinon. We've only had that for about 70 days. But having the data at almost 600 wells of control points that gives us good picture of what produces out here and really it's our -- as our geoscience team focus now is to extrapolate this Pinon theory and this new data across the overthrust as far as terrain, exploration things like that, there's nothing that will prohibit us from drilling or exploring outside of Pinon.

And then lastly just compare what you were thinking about this whole play a year ago to today, a year ago would the acreage outside of Pinon have been more important to your future than it is now just because Pinon has gotten so much bigger and keeps expanding and you found these high rates low CO2 wells? Can you comment on that?

Sure. A year ago all we knew is that we had production of Pinon and a little bit of production at Sabino, Thistle, and McKay Creek over about 40 miles. So we bought a lot of spec acreage just knowing that there was production all the way across the West Texas Overthrust and we new we had key well at the Big Canyon area that had chert had big depths. What we know today is night and day different that we have -- if you had asked me a year ago would I have been concerned about drilling to the South of the Pinon field into the chert, I would say sure because I'd be afraid we would get tight and wouldn't have the fracturing in place to be able to produce.

Now what we see is that this whole layering effect of these new thrusts and there can be additional thrust that we haven't even drilled into yet. We are only talking about three of them, that not only can you move down depth. You are actually up thrusted and you produce zones that are even shallower. So if you would have looked at our IPO slide in November of last year you would have seen two major thrusts, what we call the trailing thrust and the leading edge and today that has entirely changed. What we have defined as the Pinon field is really multiple thrusts that may be out focus too much on everyone looking to the East and West and not enough on the North and South. But there could be multiple Tcf's of gas just within Pinon field yet to be found.

Got you. Very helpful. Thank you.

Thank you.

Your next question will comes from the line David Kistler from Simmons and Company.

Good morning guys.

Good morning.

Just trying to toss some stuff together. When you are looking at these First Cab wells can you talk a little bit about where you guys see cost going as far as the drilling of them, or as you go all the way across all the WTO, would that vary just based on depth, et cetera?

Sure.

This is Matt. As far as cost for the First Cab, as we go from West to East within the Pinon field it does get a little deeper, I guess from maybe 5,000 feet down to 8,500 feet. Costs do increase from maybe 2.5 million to $3 million in that range. The good thing about that is you go from West to East your gas also gets sweeter. You go from maybe a 61% CO2 into a transition of 32% CO2, to another transition 0 CO2. As you go -- as your costs go up a little bit, but the value of your methane or the value of wells go way up because you lose the CO2 and you increase the methane.

What happens as you go from North to South, what Tom just alluded to is that in any given thrust as you go from North to South, you do go down dip. As soon as you cross into a new thrust you pop again to an up dip position. So you can be in the Warwick thrust at a higher position than the Dugout creek, or you can be in the Frog Creek Thrust at a higher position than the Warwick Thrust. So you do gain structure and you get shallower again. What we know -- outside of Pinon going to the East towards out towards South Sabino and then Big Canyon, we just don't have enough data yet on First Cab to really talk about costs at this point.

Okay. That's helpful. When you guys outlined, at least your internal estimates for 3P reserves and then also just kind of the new estimates you gave us for proved reserves. Can you break those down between Pinon sweet and CO2?

Yes. Our total proved reserves in the Pinon field is 1.1 Tcf. Okay? Of that, the total proved from the First Cab is 559 Bcf. So it's roughly half of your total proved reserves in Pinon. From a 3P standpoint, your total 3P reserves for Pinon is 5.09 Tcf. 5.1 Tcf and your total 3P reserves for the Cab One in Pinon is 3.3 Tcf.

Right. Thanks for that. And then jumping over just a little bit to the rig side of things, were you guys looking to jump up to 40 rigs within the WTO. Can you talk a little bit about the new rigs you are securing? I can't recall if you are buying them or if you're just going out on contract. Can you give me a little bit of color on that?

We have been going out on contract, and we've had access to several outside rigs and made 18 months to -- year to 18 month contracts on those.

Okay. And then lastly building off of Joe's question, maybe being a little more specific to what you've seen on the 3D data that you've gotten and as you comp it against the 3D that overlays on the Pinon, is there anything that you are seeing in there that disencourages you as you start to move outside of the Pinon?

No. We don't see -- I think the 3D data has only encouraged us because we see these thrusts going all the way across the Pinon field and as we drilled our exploration wells we are seeing gas. So to me, that's very encouraging and we don't see anything yet that makes us believe that we can't drill in a specific area.

Well, I certainly appreciate the update guys and also for how thoroughly you guys laid out the press release. It made our job a lot easier.

Thank you.

Your next question will come from the line of David Heikkinen from Tudor, Pickering, Holt.

Good morning guys. Just thinking about the geologic complexity, as you move East-West and North-South can you rank, is it welled up, natural fracturing, do we find gas, CO2 content, finding the Cab One? What are the top priorities, anything else that I should have included in that list just as we think about exploration drilling to the South and to the East?

I'll hit it and then turn it over to Matt to get his opinions too. For me, the most important thing is to find the greatest amount of gas at the shallowest depth. Finding costs are important. So as we now focus the South Pinon or Southeast South Pinon is becoming more and more encouraging to me. So the greatest encouragement to me is to understand that we have multiple thrust systems that move to the south near other well bores to where we can expand very rapidly. Also the next thing that encourages me is you have the same thrusts that go all the way across our acreage. And so we will have an aggressive drilling schedule and one thing that we do is we go out and drill very quickly. In fact maybe too quickly on the first couple of wells before we add in the full 3D shoot. But we won't finish our 3D shoot until the end of 2009. We -- but each day that goes by we have more data and as we drill these thrust sheets, we now have a geological model that is different than it was 6 months ago. So I feel like we have even a better chance with each well that we drill to be successful outside of the Pinon field. The Pinon will continue to be the workforce. Matt?

I think Tom hit it right on the nail. That our number one goal is to find sweet gas in the shallow reservoirs and what is really encouraging is to understand these multiple thrust sheets because the more thrust sheets you have as we know it now, the more opportunities you have to explore and to build in shallow. Every thrust we mentioned a few minutes ago you can find up dip or you can find chert up high. So you always have opportunities to go shallow. As far as reserves and we use 7 Bcf for the First Cab and what that really depends on is fracture intensity, that is something we can't predict. We don't know what the fraction intensity is from one place to the other. Really it's really statistical and I think the more wells we drill, the more we'll converge around the 7 Bcf of reserves for the First Cab. The other risk if you will is the CoCO2. We have -- we know that we have high CO2 over to the west side of the field. It gives us sweet on the East side of First Cab and what we don't know is for instance if we go down Frog Creek Thrust with that same CO2, you break down will continue or not. There's a risk there. However the only well we had on Frog Creek Thrust that we know of today is sweet gas. So that is also good news.

Okay. And Matt maybe thinking about the surface topography as you move to the south with the ridges on the surface how easy or hard and how long does it take to get gathering systems to these new exploratory areas?

I think it is challenging. As we move South and in some areas as we move to the East. That is really a well by well and that's something we take into consideration when we go through our technical reviews every week to take locations, we certainly try to explore and drill wells where we can build locations cheaply, where we think we can lay pipe and lay rows to get in and out. There will be some instances where we find a path we may drill two, three, four wells off the same path because of surface restrictions but today we are not there yet.

And Dirk, just to remind me, in your exploratory program the expectation is that you don't have any production for any of that anyway so timing of those wells isn't really going to impact your guidance?

That's true. Of all those wells, we assume that they produce nothing in 2008 or 2009.

Okay. Thanks.

Your next question will come from the line of [Jeff Davies] from Waterstone Capital.

Good morning.

Good morning.

Curious if maybe you can help me understand something in the guidance, showing the all NFD $1.80 for the first six months of the year and despite that you are taking your DD&A for oil and gas up for the full year '08 and then when I look at the midpoint of a '09 DD&A rate of, call it 2.85, it's the same context of where you've been the last few quarters. Just seems like a mixed shift of bringing in those lower cost producing properties. DD&A should go down over time.

That's correct. It should go down over time. Unfortunately, when you look and you get inside the numbers what you realize is e are -- with the NAG acquisition there's a huge amount of reserves booked at a higher cost. So when you move forward, it takes a while to bring those numbers down. The other thing to keep in mind is we are going to try to give you numbers that are in our mind pretty conservative. So we are hopeful that we can beat those numbers. But as we move forward and I think you'll see it more in '10, '11 and '12 you are 100% right. You should start to see those numbers go down. But the NAG acquisition is still going to be around for a while. We scrubbed those numbers pretty hard. I worked with the folks in accounting on those numbers and the folks that do our modeling, hopefully we beat those numbers but I don't want to give you a number that we just get crushed by and don't do. I think you'll start to see that, but I think it is going to take a couple of years before it really gets into the numbers.

One thing about that NEG acquisition that is pretty interesting to me anyway is that we gave $1.5 billion for NEG in November of '06 and some analysts have thought that our East Texas assets might be worth that today.

And then just quickly on the income statement. The reported loss on derivative contracts, that's realized and unrealized in that number right?

That's correct. That number today or at the end of July was negative 10.2. So it has declined dramatically from the end of the third quarter. Obviously with prices coming down and where our hedges are, we are almost -- it's good and bad. It doesn't look as bad on the income statement, but the flip side is we are getting close to being in the money.

But the realized portion is about $58 million; is that right?

Correct. It is not my favorite thing in accounting. We'll just leave it at that. It's very difficult. I think it's very confusing, but it's what we have to live with.

Thank you.

Thank you.

Your next question will come from the like of Jeff Robertson from Lehman Brothers.

Matt, you talked a little bit about fractioning in these thrusts, can you all tell from the seismic anything about the reservoir quality yet?

No. We really can't tell from seismic on the quality of the reservoir. All we can really see is the depth of the reservoirs and we see structure. What we've been doing a pretty good job of in Pinon, is every well we drill we get open hole logs but we also get imaging logs and what that does is it helps us to identify the - it's not quantitative but it's qualitative the degree of fracture intensity in the well and I think once we do enough of those maybe we can maybe get some fraction mapping across the Pinon. And really, that is what makes this play somewhat statistical is that once you know that you have chert and you have a gas field thrust, it's just a matter of drilling enough wells to get to that time curve. That's really about it.

Jeff, that's what is so important about knowing where these thrusts are on the North to South basis at Pinon because the very best fracture enhancement is along the leading edge of the thrust. So as you look at the top part of the Dugout Creek thrust or the top part of the Warwick Thrust or what we believe will be the Frog Creek and each of these minor thrusts in between that, as you get towards the most structurally up dip area along the leading edge of each thrust you have the best production.

So Tom you think the reservoir quality as long as you are in the right part of the thrust there is not a lot of difference between the three different thrusts. Is that right?

Still too early to say that but what we are hopeful of is this Cab A, even though it's at a structurally higher level can have that same fracture intensity. There is no reason that can't be filled. It's thick so you should be able to have the same amount of height. The question is does it have sweet gas which we are hopeful and we see sweet gas in it and can you have the same type of reservoir as the First Cab and the Cab A. We don't know yet. But it looks very encouraging at a shallow depth.

Two other questions on the Frog Creek Thrust, what are your plans to drill some of the exploratory prospects in that? And secondly Tom have you been able to define any prospects for the Ellenberger from the seismics yet?

We have a lots of prospects on the Ellenberger. It's just that we can fill up our CO2 plants with First Cab well. So there's really no reason today to be drilling a lot of Ellenberger tests because you make better economics on drilling First Cab tests and we're waiting to get the plant full and built, the Century Plant built. On the Frog Creek answer, if you look at slide one you'll notice more blue stars in the Frog Creek than on the other thrust. So we are pretty excited about it.

Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question will come from (inaudible) from Highbridge Capital Management.

Good morning.

Good morning.

I had a quick one, if I add up your Q1 and Q3 production I get about 48.3 Bs, and if you analyze what you are doing today that add up to North of 100 and that's your guidance. Could you please clarify what you are assuming for production growth in the second half?

Sure. A couple of things. We had a very good -- I'll answer it a couple different ways, we had a great May. We had -- we started to have a couple wells in the Gulf of Mexico -- or Gulf Coast stand up. We had a great June and then we got the fire in Grey Ranch. While we ended the month and we show a rate of 295, I would not say that we averaged 295 in July. And so can you get to a number that is possibly a little higher than 100, yes. But I guess the way I think about it from a nontechnical standpoint, we had the Pinon field optimized with Grey Ranch operating. And when that went down, our Midstream guys had to really work their tails off to reoptimize the field. That has taken some time and we may see -- we are not sure if we are going to see a down dip in July and August. So I wouldn't be going out and saying we are going to do 105 or 110 and we are sandbagging you. Could we do a little better right now? Yes. But I think we are pretty comfortable with 100 given what has happened with the Grey Ranch and what we saw in July.

And we also anticipate that that production that 5 Bcf of provision won't come back until the first of January.

Right. Thanks.

We may get Grey Ranch on earlier, but we are not sure right now.

Okay. Great. Thanks.

There are no further questions at this time. I will now turn the call back to management for closing comments.

As always we just thank you for being on the call. Thank you.

Thank you for your participation in today's conference. This concludes today's conference. You may now disconnect. Have a wonderful day.