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After a Great 2013, What’s Next For Natural Gas in the Marcellus?

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Houston-based natural gas producer Southwestern Energy (NYSE: SWN  ) delivered outstanding performance last year. Not only did the company significantly improve well performance and productivity, but it also maintained its industry-leading cost structure. Let's take a closer look at some of Southwestern's major improvements over the past year and why they position it for a strong 2014.

Photo Credit: Flickr/Nicholas A. Tonelli.

A year of records
Southwestern had a truly exceptional year in 2013, marked by company records in production, reserves, net income, EBITDA, and cash flow. Full-year oil and gas production rose 16% year over year to 656.8 billion cubic feet equivalent, fueling a 60% jump in the company's exploration and production operating income to $879 million, while proved reserves surged 74% to roughly 7 trillion cubic feet.

Combined with higher natural gas prices and reduced costs, this surge in production fueled 45% year-over-year growth in the company's adjusted net income to $703.9 million, or $2 per diluted share, and a 24% year-over-year increase in cash flow from operating activities, which jumped to a company record of $2 billion.

Improving performance in Marcellus and Fayetteville
These record figures were largely the result of the company's stellar performance in the Marcellus shale, where production skyrocketed 181% from its 2012 level and total proved reserves more than doubled. Southwestern's best Marcellus wells were drilled in Bradford, Lycoming, and Susquehanna counties, with a newly operational Susquehanna County well achieving an impressive peak 24-hour production rate of more than 32,000 cubic feet per day. 

The company posted similarly impressive results in the Fayetteville shale, where cumulative gross operated production surpassed 3 trillion cubic feet last year. Crucially, Southwestern achieved its highest average initial production rate per Fayetteville well last year, while simultaneously driving down well costs to their lowest average level since it first began drilling in the play back in 2004. In addition to improving well productivity and lowering well costs, the company is also spending a whole lot less money to find and develop its resources.

Last year, Southwestern's finding and development, or F&D, costs fell to $0.56 per thousand cubic feet equivailent, or Mcfe, the lowest level in company history. That's more or less in line with other low-cost peers such as Range Resources (NYSE: RRC  ) , Cabot Oil & Gas (NYSE: COG  ) , and Ultra Petroleum (NYSE: UPL  ) , whose F&D costs averaged $0.61, $0.55, and $0.53 per Mcfe, respectively. The fact that Southwestern's F&D costs are comparable to these companies is especially impressive because the majority of its reserves and production are located in the less economical Fayetteville shale, while Range and Cabot are overwhelmingly concentrated in the Marcellus.

What's next for Southwestern?
These major improvements bode extremely well for Southwestern and, in my view, position the company for another year of double-digit growth in production, earnings, and cash flow. Even though Southwestern is only increasing its capital budget by about $50 million this year to roughly $2.3 billion, it expects to deliver 14% year-over-year growth in production.  

While both production and capital investment in the Fayetteville are expected to remain flat, the company anticipates growing Marcellus production by a whopping 60% this year while actually reducing its capital investment in the play from $870 million in 2013 to $760 million in 2014 -- a testament to improved capital efficiency thanks to higher well productivity and lower costs.

In addition to the Marcellus, Southwestern's liquids-rich prospects offer tremendous upside potential. Investors should keep a close eye on the company's progress at Brown Dense, where it will initiate a 10-well development program that should shed further light on the play's potential, and the newly acquired oil-rich assets in Colorado's Niobrara shale, where Southwestern expects to begin operations as early as June.

Success at either of these plays could be a true game changer for Southwestern. It would not only help diversify the company's production mix, but could also fuel even stronger cash flow growth thanks to the higher margins associated with liquids-rich drilling.

While Southwestern Energy is on track to deliver another year of strong earnings and cash flow growth, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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