December was a busy month for Southwestern Energy Co. Most notably, it closed one of the three largest E&P transactions in 2014, a $5 billion blockbuster, as the industry panicked in the midst of plummeting oil prices at year-end. Typically quiet in the deal market, Southwestern pounced on a 400,000-acre-plus carve-off from Chesapeake Energy Corp. and partner Statoil in the southwest Marcellus Shale. The position covers 18 counties in northern West Virginia as well as in Washington County, Pennsylvania, in a region that is attracting more and more operator activity extending the Marcellus to the south.

To finance the deal, the Houston-based producer first secured a $5 billion bridge loan, led by BoA, which was taken out when the company tapped the equity and debt markets, also with BoA, for its long-term financing, completed while the capital markets had all but seized up for most other E&Ps.

With this deal, Southwestern immediately adds 370 million cubic feet equivalent (MMcfe) of daily production—about half gas, half liquids—and 2.5 trillion cubic feet (Tcf) of proved reserves. More importantly, the acquisition brings some 45 Tcfe in estimated recoverable resources in the Marcellus, Utica and Upper Devonian. In 2015, Southwestern has dedicated more than $500 million in capex to the program.

“This asset is scalable to at least the same size as our Fayetteville Shale asset is today,” said Southwestern president and COO Bill Way. “We’re already the fourth-largest gas supplier in the U.S., and this will take us further down that path. It’s a third core opportunity for us, and it’s a significant value for us going forward.”

With an enterprise value topping $11 billion, Southwestern Energy is a large-cap E&P that seems to fly under the radar. That could be because the majority of its revenues and reputation are produced from the once-lauded but now low-key Fayetteville Shale, a dry gas play it discovered 10 years ago. While it is one of three primary acreage-holders in this Arkansas play, Southwestern is the sole company still running rigs presently—and proudly so. A dedicated drive to lower costs across all channels has created a cash cow, even at $4 gas. A model of unconventional resource harvest, Southwestern’s Fayetteville production exceeds 2 billion cubic feet per day (Bcf/d), with another 5,000 wells or so still to drill.

Additionally, in its second core area, Southwestern holds nearly 300,000 net acres in the northeast Marcellus Shale with production of more than 1 Bcf/d and room to run. In tandem with the West Virginia acquisition, the company in December also bolted on 47,000 acres in Susquehanna County, Pennsylvania, from WPX Energy for $288 million with 50 MMcf/d of production. Maybe as important as the undrilled upside is the 260 MMcf/d of firm transport that came with the land.

Just before completing the Chesapeake deal, Southwestern consolidated its operations from several locations into a sleek new 500,000-square-foot headquarters. The double glass building sits on more than 15 wooded acres just south of The Woodlands, Texas, and sports a conference and wellness center on site.

Also in December, Southwestern elevated Way to president in addition to his COO duties. Way, who holds an industrial engineering degree from Texas A&M University and an MBA from the Massachusetts Institute of Technology, came to Southwestern in 2011 from BG Group. He began his career in 1981 with Conoco.

Oil and Gas Investor sat down with Way at the company’s new headquarters in late January to learn more.

Bill Way

Investor: Why did you choose West Virginia to establish a new core area?

Way: We’ve been looking at the West Virginia/Ohio area for three to four years. That part of the country has some of the best rock, world-class size and scale of assets, and stacked pays. The rock in West Virginia has the potential to deliver significant volumes of gas and significant value to the company. We’ve identified more than 5,300 long-lived well locations that we can drill over the next 20 years.

Because it’s a large play that’s already blocked up with contiguous acreage, we can leverage our existing vertical integration capabilities that we use to drive down costs effectively in the Fayetteville, and can further leverage that vertical integration even to our northeast Pennsylvania assets.

In terms of its potential, it’s on par with the Fayetteville. When you combine it with our northeast Pennsylvania asset, we’re looking at double-digit growth opportunities for the company. That’s just entering the play, and we expect to grow that even more significantly.

Investor: What’s the significance of this acquisition to Southwestern?

Way: It is transformational. We’re doubling our well inventory and establishing ourselves in a large, liquids-rich and dry gas play in a niche area. The location of this gas and the rock quality bring significantly better economics and a long-lived growth potential.

Our acreage has Marcellus, Utica and Upper Devonian, and the Marcellus is both wet and dry. The value that’s there, the organic quality and the ability to take a large-scale play and be able to drive dramatic growth over a short period of time, intrigued us.

If you take a look at our northeast Pennsylvania assets, which are some of the best in the Marcellus in that area, we’re realizing 100 to 150 Bcf per section. In southwest Pennsylvania and certainly in West Virginia, you’re talking upward of 300 Bcf per section of gas in the rock.

Investor: Did the fall of oil prices after the deal was announced affect the economics?

Way: Obviously, when considering well economics, if you have a liquid component then it’s an impact. But as we looked at the economics of these wells, just the gas content alone generated enough to support our requirement to deliver $1.30 for every dollar we invest. The liquids portion is additive.

On the whole, our company is not very sensitive to liquids, as we’re a majority gas player. Certainly, our margins on the acquisition backed off a bit because of the oil price, but when you look at it overall and take the gas price and oil price combined, it’s a long-lived inventory not very sensitive to liquids. We have more than 2,500 wells just in the Marcellus to drill in this new play at $4 gas. And at $3, that number drops by only a couple of hundred wells.

Investor: Did the downturn hinder your ability to finance the deal?

Way: Trying to finance a project of this magnitude when oil and gas prices both were coming down could be challenging, but both our debt and our equity offerings were well over-subscribed, and we were able to finance it. That’s because we’re an investment-grade company with a track record, and we’ve been able to manage and flex our capital portfolio to ensure that we remain investment grade.

We met with Moody’s and Standard and Poor’s, every one of our bondholders and most of our long-term shareholders, and they have confidence in how we invest. Our minimum requirements around the 1.3 PVI [present value index] that we adhere to from the drilling rig floor to the board room, our ability to flex and move our capital around, and to maintain financial discipline, gave confidence to those groups.

Investor: How does your balance sheet look post‑deal?

Way: To retain an investment-grade rating, you need to keep debt-to-EBITDA ratios below 2x. Right now, with the addition of the debt we brought on, we’re slightly above that. Our plan over the course of the next two to three years is to get our ratios back to where they were pre investment, and we have specific plans on how to get there. One option is to look at divestitures. We’re now working on divesting our small gas-gathering business in Appalachia, and then we are looking at selling conventional assets in the Arkoma and East Texas area.

Investor: What’s your operational plan for the newly acquired area?

Way: We expect to drill between 50 and 60 wells this year with one rig now and ramping to four in the latter part of the year. Next year we’ll drill 70 to 80 wells, and do that for a couple of years. Eventually, we’ll ramp up to more than 200 wells a year as we continue to grow. When we move into the Utica by late 2017 or early 2018, that pace could increase.

Investor: Where will you focus first?

Way: In this economic environment, certainly our focus will be wet gas Marcellus wells. So we’ll do quite a bit of drilling in the wet gas area in the north in the three major areas where we already have gathering. While you get additional volume on the dry gas side, any time you’ve got liquids present, the economics will be stronger. But again, even the dry gas wells are economic to us in terms of our 1.3 PVI hurdle, depending on gas price. We’ll certainly focus on the best economics.

Then, as the rest of the gathering system comes into play, we’ll be able to spread out. We like to move the gas once we drill the wells. We’ve also got a bit of land capture to accomplish as well.

Investor: Can you discuss the progress of your northeast Pennsylvania Marcellus assets?

Way: We entered the Marcellus in northeast Pennsylvania five years ago. We applied lessons learned from our Fayetteville Shale program and reduced costs per well by 20%, while increasing well productivity. We did that by looking at how we land wells, how we set and how we sand load the laterals, for example. We took wells that were 3,500 to 4,000 feet in the lateral and went to 7,000 to 7,500 feet and longer, increased the sand loading, and in turn generated greater returns.

Since then, we’ve gone from zero production to a 1-billion-cubic-feet-a-day volume ramp. We’ve made a 200% well productivity gain since day one—these wells are some of the best there are.

In Susquehanna County, we’re testing landing zones and different frack recipes and, in fact, even different stage-spacing tests.

We’ve now begun testing in the Upper Marcellus, and we’ll look at other intervals that could bring in additional well locations and reserves. We picked up some additional acreage in Tioga County and in westerly Susquehanna into Bradford County. We’ve had well results that look encouraging, and we plan to continue delineating our Tioga acreage during 2015 while the gathering system is constructed.

Investor: You’re known as one of the lowest cost producers. What does Southwestern do to drive cost efficiencies?

Way: In our largest asset, the Fayetteville Shale, we chose to vertically integrate that business and employ nearly a thousand people in all of the other various businesses that support drilling and completing a well, including ownership of our own sand plant, which is one of the largest components of our savings. We incentivize our people to get more and more out of the cost of a well. They drive down costs per well, and drive up innovation around how we flow back wells. We’re still drilling there economically even at today’s gas prices.

For example, we drill and complete wells, then shut them in and let them rest for 60 days. The wells come online in some cases with a greater volume, but in all cases with no flowback water. When you can take $100,000 out of the cost of a $2.5 million well just by not having to haul water, that is significant. And that is just one example of countless improvements we apply to these wells. We’ve had 10 of our very best wells that we’ve ever drilled in the Fayetteville just in the last year.

We will take that to West Virginia and the northeast Marcellus and do the same thing.

Investor: What’s your outlook for natural gas? Are we in a perpetual supply glut?

Way: We see the long-term view of gas being $3.75 to $4.25 for the foreseeable future. We believe the industry cannot supply the growing demand of gas and make a necessary return on those investments in a majority of these plays with gas prices much below $4. When that happens, you’ll see a supply response that will lead to quite a bit of pullback in the industry and more discipline.

On the top end of that curve, when gas goes much above $4.50 to $5, you begin to see demand response come back. Some of these areas that can’t drill and produce economically today begin to come back online.

We’ve engineered our company to be a winner at $4 with an ability to flex our capital on either side of that. You’re going to have anomalies down, and we’ll manage through those with flexing our capital and our drilling plans. We’ll take advantage of it on the upside.

We think the industry is more disciplined now than in the past, largely because of more disciplined financing.

Investor: Is there hope on the horizon from other demand drivers such as LNG and gas-fired utilities?

Way: You’ve got significant upward demand coming from power, both in terms of coal-to-gas switching, but also in additional power demand in the Southeast and Gulf Coast. We see LNG exports happening, but maybe in a more muted way than some of the high-end projections. Additional exports out of the country by pipeline to Mexico and even into Canada, as our supply remains very robust and the economics for Canadian gas stay distressed, will add to the demand side. The industrial demand is strong, too, as gas prices stay in this $3 to $5 range.

But we see supply and demand continuing to grow together, and thus our view on gas prices being where they are in that $4 range.

Investor: Why did you choose to make an acquisition over elevating one of your exploration plays?

Way: You don’t always time exactly when you find an opportunity and then go grab it. We’ve been working on our exploration plays and we’re in various stages of development. I’ve got an unstimulated 700 bbl/d well in the Brown Dense that, if I can replicate it, is a quite attractive business. We’ve also got our Sand Wash play being tested. We’re learning every day and finding new opportunities.

Still, we’ve been studying acquisitions for some time. We’ve had a difficult time getting an acquisition to work in the oil plays that meets our hurdle rate. We’ve been asked often if our hurdle rate gets in the way. We think our 1.3 PVI hurdle rate is what makes our company an investment-grade company, and we will not compromise that.

With this particular opportunity, there was so much volume and so much stacked pay potential, and we happened to be in a financial position to act on it. We are adding it as a third leg to the stool, not because we were in some kind of trouble—we had double-digit growth in our legacy businesses that met all the returns we needed. It’s just such an opportunity for us to leap forward. We took it.