How Lucrative Eagle Ford Shale Gas Play for Swift Energy?

Terry Swift, chief executive of Swift Energy (SFY-$20.00), announced on the second-quarter earnings call that the E&P company is planning to commence drilling in South Texas’ emerging Eagle Ford shale-gas play and expand horizontal drilling operations in the Olmos tight-sand formations of its AWP Field. With North America awash in natural gas and the commodity price environment showing no signs of improvement, does it make economic sense to increase drilling activities—especially where some gas pockets are estimated in some spots to be as deep as 12,000 feet?

Management believes that its balanced approach to growing reserves and production—total proved reserves at December 31 were comprised of approximately 43 percent crude oil, 42 percent natural gas, and 15 percent natural gas liquids - located onshore and the shallow waters of Louisiana and Texas, permits the company to adjust production output to prevailing market sensitivities. For example, a 35 percent sequential increase in second-quarter oil prices offset a 26 percent decline in natural gas prices, resulting in a 14 percent increase in average prices per BOE in the second quarter of 2009 to $36.71. Production revenue increased nine percent to $82.9 million over comparable first quarter 2009 levels.

With the pricing decline, chief operating officer Robert Banks insisted to analysts on the call that the company could make money at $4.00 gas—if it could continue to push down drilling costs. For the second-quarter, G&A decreased year-on-year 26 percent to a composite $3.36 a barrel, resulting from workforce reductions; Production costs fell year-on-year 34 percent to $8.34 per barrel, due to lower natural gas and NGL processing costs, and lower plant operating costs.

The Energy Information Administration reporting that inventories of U.S. natural gas in storage were at a multi-year high sent the Henry Hub price of natural gas falling below $3.00 (per MMBtu) for the first time since August 2002. At June 30, Swift Energy had in place price floors in effect through the September 2009 contract month for crude oil. The oil price floors cover notional volumes of 645,000 barrels –expected to cover between 69 percent and 73 percent of third-quarter production — at a weighted average floor price of $62.00 per barrel. The company, however, has not hedged any natural gas scheduled for delivery in the third-quarter.

With the pricing of natural gas unlikely to rebound in the second-half of 2009, the 10Q Detective believes Swift management is being too optimistic on its ability to profitability develop its newer properties in South Texas. It is doubtful that the successful focus on controllable per unit cost in anchor fields in Louisiana and Texas can be applied with similar success on unconventional reserves, such as the Eagle Ford shale play or the Olmos tight-sand property. The rock layers that hold the reserves in both geological formations are very dense, so the gas doesn't flow easily. Completing such wells are enormously expensive—requiring more advanced—and expensive-fracturing and horizontal drilling technologies. If the company can economically recover gas from such unconventional properties at $4 a thousand cubic feet, investors have a lucrative investment opportunity—as opposed to a merely ‘promised’ one.

Editor David J Phillips holds a short interest position in Swift Energy. The 10Q Detective has a Full Disclosure Policy.