Will Southwestern Energy's Move Into This Liquids-Rich Play Pay Off?

In an effort to diversify its production and reserve mix away from natural gas, Houston-based energy producer Southwestern Energy (NYSE: SWN  ) has gradually amassed sizable stakes in a handful of prospective oil-rich plays across North America.

Continuing that trend, the company made a big move into Colorado's liquids-rich Niobrara shale, where many of its peers have seen tremendous success. Will the company's move pay off?

Photo Credit: Anadarko Petroleum

Southwestern's Niobrara acquisition
Southwestern announced earlier this month that it had inked an agreement to purchase roughly 312,000 net acres in northwest Colorado's Niobrara formation from Quicksilver Resources and SWEPI, a wholly owned subsidiary of Royal Dutch Shell, for approximately $180 million, subject to closing conditions.

Southwestern plans to fund the acquisition, which is expected to close in the second quarter of this year, through its revolving credit facility. The company expects to commence operations in the Niobrara as early as June of this year, joining a handful of energy producers seeking to tap the shale's vast unexploited resources.

Companies including Anadarko (NYSE: APC  ) , Noble Energy (NYSE: NBL  ) , and Whiting Petroleum (NYSE: WLL  ) were drawn to the Niobrara because of its massive resource potential, relatively high percentage of liquids, and low development costs of about $4 million per well -- about half the cost of the average Eagle Ford or Bakken well.

Companies seeing success in Colorado
All three companies are seeing solid results so far. Anadarko, for instance, grew its average production in Colorado to more than 56,000 barrels of oil equivalent per day last year, up by a staggering 250% from 2012 levels, while Noble grew fourth-quarter DJ Basin production volume by an impressive 16% year over year to a record 100 MBOE/d.

Whiting Petroleum's growth has been even more rapid, with its net production from the DJ Basin's Redtail prospect as of Feb. 1 already up by a whopping 58% from fourth-quarter 2013 levels. Having identified more than 3,300 potential drilling locations across its acreage, the company is eager to accelerate development in the play this year.

In addition to rapid production growth, all three companies are seeing highly competitive returns in Colorado, with Anadarko generating rates of return in excess of 100% at current prices. As these companies further optimize their drilling techniques and benefit from major infrastructure improvements in the coming years, their costs should continue to trend lower and returns higher.

A good move for Southwestern?
If Anadarko, Noble, and Whiting's results are any indication, Southwestern's soon-to-be acquired Niobrara acreage could be exactly what the company needs to deliver higher-margin, liquids-weighted growth. As growth from its core asset in the Fayetteville shale has slowed in recent years, Southwestern has turned to new liquids-rich exploratory projects to drive future growth.

It has amassed sizable stakes in prospective plays, including 2.5 million acres in New Brunswick, Canada; 460,000 net acres in the Lower Smackover Brown Dense formation of southern Arkansas and northern Louisiana; and 302,000 net acres in eastern Colorado's Denver-Julesburg Basin. Unfortunately, results from these plays have so far failed to impress.

For instance, management's commentary on five recently drilled wells in the Brown Dense formation suggested inconsistent well results. So Southwestern has a lot riding on the Niobrara, where successful drilling results could be a true game changer for the company, providing a major boost to future cash flow given the higher margins associated with liquids production.

As Southwestern prepares to begin drilling in the Niobrara, investors may want to keep an eye on any announcements regarding its progress or any revisions to its resource estimates, development costs, estimated ultimate recoveries, and rates of return in the play. Any positive surprises along these lines could be a catalyst to push shares higher.

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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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