Jonny Brumley

W?hile some other E&P companies are struggling to stave off bankruptcy or avoid credit problems, Fort Worth-based Encore Acquisition Co. is looking to have a successful year, thanks to its production profile and hedging program.

Despite tales of gloom and doom during the current recession, Encore president and chief executive Jonny Brumley says the company is well positioned to handle the current low commodity prices that are giving other E&Ps pause.

He attributes this to Encore’s portfolio of long-life properties, which have an average 13-year reserve/production life and include shallow waterfloods, as well as a lucrative hedging strategy for the year. The company has assets primarily in West Texas, the northern Rockies and the Haynesville shale, with proved reserves of 185.7 million barrels of oil equivalent at year-end 2008.

Brumley says the company tries to do something big every year. In 2006, for example, it entered a West Texas joint venture with ExxonMobil Corp., and in 2007 it accumulated a large Bakken shale position. Last year, it entered the Haynesville play. This year, the company is seeking access to CO2 sources to assist in its horizontal drilling in the Rockies.

The company plans to try out a CO2 pilot program in the giant Cedar Creek Anticline oil field or the Bell Creek oil field in Montana, and Brumley hopes that recent efforts by the new White House administration to curb carbon emissions will be a boon for these plans.

Brumley talked with Oil and Gas Investor about how the company assembled its unique portfolio, how having flat production helps it economically and what its plans are for its existing properties.

Investor In this current downturn, what is Encore’s focus?
Brumley Really, what we’re focusing on is generating free cash flow and paying down debt. We have a really shallow decline base, and we were 90% hedged for 2009 at $95 oil, so this is going to be a good year for Encore. We recently monetized those hedges for a gain of $190 million.
Our budget is quite a bit smaller than our discretionary cash flow. It’s $310 million, and our cash flow is going to be more than $520 million, because of the hedges. We’re focused on our three main areas as far as drilling goes: the Bakken, the Haynesville and the West Texas joint venture with ExxonMobil.

With current production costs, Encore is better off than many companies are because we can maintain our operations by using half the cash flow.

Investor That sounds like one of the company’s main metrics.
Brumley That’s core to our business. What that allows you to do is keep your company very healthy, and keep your production flat. When you come out of this, you’re really going to be in a good position because you’re not forced to drill your projects in a year like 2009, where commodity prices are extremely low and service prices haven’t come down to the commodity prices. If you’re drilling now, you’re not getting the maximum rate of return because prices are too low.

Investor Will you need to raise capital in 2009?
Brumley No, we’re so far inside cash flow that we’re not going to need to hit the market. In fact, we will reduce debt.

Investor Tell us about your plays.
Brumley The Haynesville and Cotton Valley are starting to work really well. The ArkLaTex region just continues to surprise us to the upside. We entered that region in 2004 and wanted to get into a good part of the Cotton Valley play. We were lucky to make an acquisition in Elm Grove Field. That’s one of the best fields in the ArkLaTex region. It’s one reason why we keep getting upside—because good areas like Elm Grove keep getting better.
We’ve pieced together a good Haynesville position in the best parts of the play. Really, all three of our focus areas are doing well.
Our West Texas joint venture also keeps surprising to the upside, where we’re drilling better wells in Pegasus Field. We’re seeing initial production rates of 4.8 million cubic feet per day, and we originally estimated 3.5 million per day.
The Bakken has also been great. We are fortunate to be in the highest-rate-of-return oil play in the Lower 48—the Bakken shale. We wanted to be big in the Bakken because it is the only large oil play. Oil has better economics than gas, so we are glad to be a part of the Bakken.

Investor How did you get into the Haynes-ville shale?
Brumley I think that, if you’re going to drill wells, most of your opportunity is in gas. People have been looking for oil since the 1900s, and since oil sells for 10 times the price of gas, the margin is always better. But since so much oil has already been found, it forces you to drill for gas.
The Haynesville is one of the best gas plays in the Lower 48, and the Bakken is the best oil play in the Lower 48, so we’re happy to be in both.

Investor Tell us about the joint venture with ExxonMobil.
Brumley We went to them with an offer to farm into one field in West Texas. They said they didn’t want to work on a deal that small. Instead, they had some really good West Texas fields but wanted to retain a lot of the upside, so we came up with the idea of working these gas fields in the Permian Basin together. These are basically Mobil legacy fields.
We had to drill 24 commitment wells, and we’d get paid back out of production. We’ve drilled all of those; now, when we drill, we get 30% working interest. So there’s great benefit for both companies. This is a true joint venture with our technical staffs collaborating and exchanging ideas. I think the mutual respect each company has for the other is why this deal has worked so well.

Investor Would you consider more joint ventures or farm-outs?
Brumley I think we would. Right now we have a lot we’re working on. These joint ventures are quite big and require a lot of staff, so you want to make sure you have all your ducks in a row before heading out to start one. I think our house is getting in good order where we might want to talk to some other people about this in other areas where we have experience.
One of the areas in which we do really well is horizontal drilling. That’s one of the reasons ExxonMobil was drawn to us, because we have redeveloped the Cedar Creek Anticline. We’ve drilled a lot of horizontal wells and we’re good at it.

Investor How are your Cedar Creek operations progressing? Do you have leads for a CO2 source?
Brumley It’s going very well. The main feature of the Cedar Creek Anticline is it’s such a shallow-declining play; production basically stays flat. Our strategy is to have a portfolio of properties that can be held flat for half the cash flow. Cedar Creek is the main reason we can do that and why 2009 will be such a good year from a production standpoint. Cedar Creek’s decline was actually much shallower in early 2009 than we were predicting. That is great news for such an important waterflood.
For CO2, there are quite a few sources. That part of the country is active for power plants, coal-mining operations, large gas plants that emit a lot of gas, and such. You’re seeing pressure from the Obama administration on CO2 emitters, so that’s going to open a lot of opportunities for us and we should be able to pick up CO2 supplies for a good price.

Investor Are you hoping to be a net asset buyer in 2009?
Brumley We’ll always try to be opportunistic. Right now, I don’t see us buying a whole lot, especially until we pay down some debt. We have such a big inventory, the focus is on free cash flow. Right now, we are really positioned well, and just need to be patient and let prices rebound.
We would probably divest our Overton Field in East Texas when the market comes back, and maybe our New Mexico assets.

Investor Will you put more assets into the MLP, Encore Energy Partners?
Brumley I think we would be interested in making an acquisition at the MLP level or doing another drop-down. It all depends on the market, and right now we’re waiting for the asset market to come down.

Investor What should Wall Street understand about Encore’s potential?
Brumley We are a unique company with a unique strategy. We have three low-risk plays that sit on top of a low production base. One, we drill very prolific wells for the amount of capital we invest, and two, our production is relatively flat. Both of those radiate quality.
That’s unique to have 65% of your production coming from these shallow waterfloods with this good upside. Wall Street also needs to understand how much more money you make in oil as opposed to gas. Our margins are just so much better than our gas-oriented peers. It pays to be oily.