We are living in a world that is undergoing two simultaneous transformations of global magnitude: one in energy supply and demand and the other in digital communications and information-processing technologies. In the oil and gas industry, these two transformations have converged, leading to a revolution in the way we search for oil and gas. It’s an era for new ideas—or, as our report theme suggests, bright ideas—that can help us become more effective in finding and producing oil and gas during a period of increasingly tight energy supplies. In the face of this transition, there is little time to savor past successes. But the future builds on the past, and our past, including our successes in 2006, gives us a solid foundation.

There is no question that 2006 was an outstanding year for us—one in which we achieved all-time highs in production, revenues, and earnings. Our production rose 18%; revenues went up 45%; and diluted earnings per share increased 36%. Our proved reserves also increased 7%. We believe these successes are a testimony to the correctness of our operational strategy and the dedication of our employees.

That said, great successes usually bring with them new challenges, and a major challenge for our domestic industry is to economically add new oil and gas reserves and increase production at a time when domestic oil and gas resources are increasingly difficult to find. We are confident that Swift can meet that challenge. In 2007, our goals are to increase our proved oil and gas reserves by 4% to 6% and our production by 7% to 10%.

We will be working to accomplish these growth goals in an environment of falling U.S. production. Over the last five years, our nation’s annual oil production has dropped by 10% and its natural gas production by 5%, even as more and more wells have been drilled. But despite the maturing of our nation’s oil and gas resources and the looming peak in world oil production, opportunities for discovering new hydrocarbon pools are still abundant. They are just harder to find in the smaller accumulations and deeper horizons where they reside. Plenty of resources are left in the ground, but the easy-to-exploit resources are generally gone.

As we search for new reserves, we face pressures from rising service costs. After decades of low prices and underinvestment in energy supplies, the world simply does not have the intellectual or physical infrastructure in place to meet rising demands in the industry for skilled workers and equipment. Over the last four years, government statistics show that the number of wells drilled annually is up 87% and total footage drilled is up 102%. In January 2007, demand for seismic crews was up 58% from January 2003. In effect, portions of the service industry have been asked to almost double in size in recent years and despite all that effort, U.S. production continues to fall.

Part of the answer to this challenge is new digital technologies. Some industry observers have proclaimed the coming of the "digital oilfield" or the "digital organization." It is a vision of the future in which digital technologies begin to reshape every aspect of the oil and gas business. At Swift Energy we agree that the digital revolution is indeed creating new opportunities for collaboration and creativity, both within our own organization and between our company and its network of suppliers. The result is new synergies that can reduce our costs and increase our effectiveness in finding and producing oil and gas. Measurement-while-drilling tools have enabled more precise directional and horizontal drilling; improvements in telecommunications have enabled remote monitoring of formation-fracturing stimulations and production; video conferencing has connected remote locations in real time, even on opposite sides of the globe; and digital information systems are improving access to timely financial and operating data.

Nowhere, however, is the impact of digital technologies more important than in the area of seismic imaging. Seismic technologies and computer power have developed hand in hand for over 40 years. When the integrated circuit was first invented in the late 1950s, one of its principal creators was working for an organization that originally began as a geophysical service company. Today, improvements in measuring instruments and computing power are enabling three-dimensional seismic technologies to look deeper into the earth at finer resolutions, allowing us to explore new horizons that have yet to be tapped.

At Swift Energy, we have responded to these capabilities by amassing 4,000 square miles of three-dimensional seismic data from various sources in two South Louisiana areas and merging them to obtain an integrated dataset for each area. The integration of previously distinct datasets generates synergies that improve the quality of all the pre-existing data, allowing us to model the subsurface environment with more accurate images. These seismic data are then integrated again with digitized well-log data, creating even better pictures of subsurface structures. Eventually, the data are further analyzed using a variety of other techniques, some of which not only give us knowledge of subsurface structure but also identify "bright spots" that provide direct indications of the presence of hydrocarbons. The result is a synergistic amalgamation of large amounts of digital data that give us a better picture of under-explored areas where we believe new accumulations of oil and gas resources are likely to be found.

Over the last three years, we have invested $28.3 million in acquiring domestic seismic data and another $3.8 million for similar data in New Zealand. We have also prepared for continued drilling successes by spending another $155.1 million on proved and unproved lease acquisitions and prospect development and $56.0 million on improving our facilities. Of course, some of these expenditures were necessary for our ongoing operations over the last three years, but a significant portion of the costs help lay the groundwork for additional future growth. As a result, our reserves replacement costs in 2006 were higher than we would have liked, about 50% of our average sales price, but we believe those costs will go down as the benefit of our previous investments are realized in subsequent years.

We have clearly felt the impacts of these investments. In 2005, we had two significant exploratory successes based upon our three-dimensional seismic data, our Newport and Bondi wells in Lake Washington. Through the end of last year, we followed those discoveries with seven successful Newport delineation wells (one in 2005 and six in 2006) that have been among the most productive wells drilled in the state waters of Louisiana in the last 50 years. Overall in 2006, we achieved a drilling success rate of 86% in Lake Washington by using our first integrated seismic dataset to determine drilling locations for all our wells, and we expect similar results as we rely on both datasets for drilling in other South Louisiana anchor areas during 2007.

Our seismic-based technology is also enhancing our acquisition activities. In 2006, we made the largest producing property acquisition in our history, the purchase of interests in five primarily onshore South Louisiana fields located in the parishes of St. Mary, Cameron, and Terrebonne. Since we had previously acquired three-dimensional seismic data for these areas and had merged them into our datasets, we were able to identify strategic opportunities associated with the properties prior to their purchase. Equally important, because we already have the seismic data for these fields in place, we will be able to accelerate our exploration and development efforts in the fields and generate new value from the acquisition more quickly than we have for other acquisitions in the past.

Over time, we intend to apply our digital strategy in other regions of operation. In New Zealand, for example, we undertook a 59-square-mile three-dimensional marine seismic survey over our Kaheru prospect in 2006, and we are considering a three-dimensional seismic survey associated with our TAWN property.