Southwestern Energy : Third Quarter 2016 Earnings Teleconference Transcript

Participants

Michael Hancock - Director of Investor Relations Bill Way - President and Chief Executive Officer Craig Owen - Chief Financial Officer

Randy Curry - Senior Vice President Midstream Jack Bergeron - Senior Vice President Operations

Paul Geiger - Senior Vice President Corporate Development

Analysts

Scott Hanold - RBC Capital Markets

Doug Leggate - Bank of America Merrill Lynch Charles Meade - Johnson Rice

Holly Stewart - Scotia Howard Weil Arun Jayaram - JP Morgan

Marshall Carver - Heikkinen Energy Advisors Brian Singer - Goldman Sachs

Kashy Harrison - Simmons

Dan McSpirit - BMO Capital Markets David Tameron - Wells Fargo

David Deckelbaum - KeyBanc Drew Venker - Morgan Stanley Ray Deacon - Coker & Palmer Jeffrey Campbell - Tuohy Brothers

Presentation

Greetings, and welcome to Southwestern Energy Company Third Quarter 2016 Earnings Teleconference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. In the interest of time, please limit yourself to two questions. Afterward, you may feel free to re- queue for additional questions. [Operator instructions]. As a reminder, this conference is being recorded.

It is now my pleasure to introduce Michael Hancock, Director of Investor Relations for Southwestern Energy Company.

Thank you, Doug. Good morning and thank you for joining us today. With me today are Bill Way, our President and Chief Executive Officer; Craig Owen, our Chief Financial Officer; Randy Curry, our Senior Vice President of Midstream; Jack Bergeron, our Senior Vice President of Operations; and Paul Geiger, Senior Vice President of Corporate Development.

If you did not receive a copy of last night's press release regarding our third quarter 2016 financial and operating results, you can find a copy on our website at www.SWN.com. Also, I'd like to point out that many of the comments during this teleconference are forward-looking statements that involve risks and uncertainties affecting outcomes. Many of these are beyond our control and are discussed in more detail in the risk factors and the forward-looking statements sections of our annual and quarterly filings with the Securities and Exchange Commission.

Although we believe the expectations expressed are based on reasonable assumptions, they are not guarantees of future performance and actual results or developments may differ materially. We may also refer to some non- GAAP financial measures which help facilitate comparisons across periods and with peers. For any non-GAAP measures we use, a reconciliation to the nearest corresponding GAAP measure can be found in our earnings release available on our website.

I'll now turn the call over to Bill Way to discuss our recent activity and results.

Thanks, Michael, and good morning, everyone, and thank you for joining us on our call today. This year has been one of unwavering focus in SWN and that focus is on our commitments that we laid out in February, namely to strengthen our balance sheet, aggressively improve margin, optimize the portfolio and remain agile, enabling us to be ready to capture opportunities to add value as the commodity price environment improves. We're delighted to be here today to talk with you about this and to talk about another quarter in which we've delivered on those commitments.

I'd like to start by thanking the Southwestern team for all that has been accomplished so far this year. We've tackled a number of different challenges and set the company up for significant value creation as we finish up 2016 and prepare to move on to 2017. This year's accomplishments are a direct reflection of the commitment and dedication that each employee brings to the work every day and I commend you for all that you do and all that you've done.

When we spoke last quarter, we discussed our plans to reinitiate investment in drilling and completion activities as a result of our strengthened balance sheet, the improving commodity price environment and our ability to assure solid returns provided by our commitment to prudent hedging and disciplined risk management. We'll provide more details about this in a few minutes, however I can tell you that the learning, planning and preparation that each of the teams focused on during the pause in drilling and completions activity resulted in an extremely successful reinitiation of our drilling and completion operations.

As expected, we now have five rigs running company wide, two in Northeast Appalachia, two in Southwest Appalachia, and one in Fayetteville. The drilling results have been better than expected, as we've seen record performance in drilling times that are even better than when we halted activity at the end of 2015. However, speed is only part of the story. We've also been able to stay within our targeted zone over 95% of the time which can be as narrow as ten feet.

Steering the well fully in zones supports the completion optimization by placing the entire length of the lateral in the interval that is most favorable for practice stimulation and initiation. These impressive results have been driven by the learnings we captured from drilling and completing wells on paper during the first half of the year and applying these learnings now as we resume activity. Additionally, the utilization of technology such as rotary steerable tools and other technologies are now standard on many of our wells.

The activity in the second half of this year primes the portfolio for a robust 2017. Regarding 2017, while we have not approved next year's capital program, at current strip prices we expect cash flow to be in excess of $1 billion. We've had some questions on maintenance capital for next year, so let me reconfirm that the maintenance capital required to hold 2017 annual volumes flat at 2016 levels is only $700 million given our improved capital efficiency and the benefits flowing from our recent restart activity of approximately 150 Bcf equivalent of incremental 2017 production from the wells that we are drilling and completing during the second half of this year.

With this quarter's impressive restart of activity, we also fully expect to arrest our production decline by the end of the year this year, 2016, after which we will be back on the growth trajectory. Reduced overall decline and resumption of value-added growth are both the results of our work to improve the performance of our vast portfolio. This $700 million in maintenance capital is an all-in capital number including capitalized interest and expenses.

Closing this part of the discussion, while the maintenance capital is approximately $700 million, this is well below the expected more than $1 billion in cash flow for 2017 that I mentioned earlier at current strip prices. We plan to watch the impact of the winter weather on 2017 prices and issue public guidance in February.

Let me now move on to our marketing and commercial activities. As is historically the case, we experience our widest differentials for the year in the third quarter. Our overall discount, inclusive of differentials and transport costs, was $1.03 per Mcf lower than average NYMEX settlement pricing compared to a $1.00 per Mcf lower than average NYMEX settlement pricing during the third quarter of 2015.

This slight widening of the 2016 quarter was influenced largely by regional storage levels being at or near capacity and the percentage of total production from our northeast assets increasing versus guidance. Factoring in the forecasted gains of approximately $0.03 per Mcf on basis hedges currently in place, the company anticipates its total company discount to NYMEX for the year will be at the high end of guidance range or about

$0.83 per Mcf.

We do believe that the current challenges facing the Appalachian Basin are a short-term issue and that the quality and quantity of our transportation portfolio in our Appalachian Basin businesses is robust and allows us both strong access to markets and growth opportunities this year and beyond. Over the long-term, our view on improving regional basis differentials has not changed, and we expect the projected capacity additions out of the greater Appalachian region to come online over the next few years. These pipeline projects have robust economics and are of high-quality and we remain confident that the capacity for these pipeline projects gets overbuilt albeit not without some scheduling challenges on individual projects.

Lastly, we're encouraged by the strengthening of NGL pricing for 2016 and how the NGL demand picture, particularly ethane, seems to be shaping up over the next few years. Given SWN's capacity on ATEX, we are in a strong position to capitalize on rising ethane prices at Mont Belvieu as projects making up the estimated 620,000 barrels a day of new demand begin to come online between now and 2019. With our vast resource position and the optionality provided by the wet gas window of Southwest Appalachia, the increased NGL prices materially enhance the margins provided from that area.

With that, let me turn over to Craig to discuss some of our financial highlights from the third quarter, and then we'll have Jack talk a bit more about some operations.

Thanks, Bill, and good morning, everyone. I thought I would start this morning by summarizing the steps we've taken to strengthen the balance sheet this year since many of them were in progress at the end of the second quarter. In the third quarter, we completed the equity offering for $1.25 billion of which a portion was used to retire $700 million in 2018 debt maturities with $500 million earmarked for resumption of drilling and completion activities.

Additionally, in the third quarter we closed a previously announced acreage divestiture in Southwest Appalachia. As you saw in last night's release, net-debt as of September 30 was $3.2 billion, down from $4.8 billion at the end of the second quarter, and as a reminder when we amended the bank agreement, its structure changed from our historical revolving credit facility. The new credit facility is supplemented by the fully drawn $1.2 billion secured term loan, which we expect to utilize for liquidity purposes and results in large cash balances going forward compared to our historical amounts.

We have made great strides strengthening the balance sheet this year and expect net-debt to EBITDA for 2017 to be in the high 2s assuming current price levels. With these actions and the improved commodity price environment, we are confident in our trajectory and therefore have no other asset sale plans imminent or of a material nature. In the normal course, we will continue to evaluate options and opportunities but are confident with our portfolio and balance sheet where it stands today.

In the third quarter, we continue to add to our hedge position. We have now hedged 535 Bcf of 2017 production of which approximately half of these positions are collars providing upside exposure to improving prices. On these 2017 hedges, we have a weighted average strike price for the swaps and purchase puts of $3.00 per Mcf. We have also been actively adding financial and physical basis hedges to the portfolio where we currently have 75 Bcf protected in the fourth quarter and 196 Bcf protected in 2017.

These hedging activities will help us achieve our expected returns providing downside protection while also retaining upside potential as prices improve. With the financial strengthening steps taken in 2016, we are now positioned to drive value generation with our premier assets.

I will now turn it over to Jack to discuss some of the details of our operational results in the third quarter.

Thanks, Craig. Good morning, everyone. As Bill mentioned earlier, we've successfully reinitiated our drilling completion activities which was a primary focus of the third quarter for operations. It's not often that you completely halt drilling and completion work for six months and then ramp-up to five rigs in such a short period of time as we have this year.

The success of this resumption demonstrates our differentiating agility as a company. While returning to drilling and completions, we did not lose sight of the importance of our 2016 strategic initiatives evidenced by, once again, hitting the top end of our production guidance at 211 Bcfe while continuing our focus on improving margins. In particular, we reduced our lease operating expenses on a unit of production basis for the fifth quarter in a row.

In each of our areas, we continue to push the boundaries of our completion design. We are experimenting with increased proppant volumes with tests in Southwest Appalachia reaching up to 5,000 pounds per foot. We are also challenging ourselves to find the technical limits of these solutions. With such a vast number of drilling locations in the area, determining the optimal proppant loading will significantly increase the value of this play.

Our proppant testing is not just limited to Southwest Appalachia; we are also testing this in each of our other operating areas. In Fayetteville, we are testing over two times as much proppant as our historical averages were. We expect to have some preliminary results on our next call but the early indications are promising.

In Southwest Appalachia, we competed eight wells in the third quarter and plan to connect nine wells to sales by prior to the end of the year. While we did not turn on any wells for sales in the third quarter, we continue to see strong well performance from our Ridgetop Land Ventures pad in Wetzel County which came online in the fourth quarter of 2015.

As a result, we have increased our lean gas type curves for the second time this year to approximately 25 Bcfe based on 7,500 foot laterals. The wells that we have drilled and completed there continue to outperform the offset wells drilled by the previous operator by as much as 40%. As we look forward, this asset provides substantial optionality where capital can be allocated to the wet or dry gas targets depending on commodity prices.

Moving to Northeast Appalachia, we currently have two rigs running which were the first two rigs to be mobilized. As Bill mentioned, the preparation for the reinitiation of activity resulted in some exceptional accomplishments.

For the quarter, we have achieved record total drill depth time of less than eight days from reentry to reentry, which is 5% faster than the fourth quarter of 2015. Included in these results was one well that drilled over 4,700 foot of lateral in just 24 hours; a company record in the area.

On the completion side, we have tested reduced cluster spacing to increase well performance; this, when coupled with the optimized flow techniques we're using expect to materially improve the flow rates. For example, the Racine pad we brought on in Susquehanna County this quarter came online at greater than 50 million cubic feet a day from just 3 wells. We plan to continue testing these techniques in the fourth quarter and we'll discuss further as we get more information.