1998: Management Confronts a Volatile Environment

Swift Energy entered the year 1998 with plans to drill or participate in 21 exploratory wells and 113 development wells. This number was lower than the 182 wells in the Company’s 1997 drilling program but contained a higher fraction of exploratory wells. By the end of the first quarter, 30 of the wells had been drilled and 26 had been placed in production. As a result, for the eleventh consecutive quarter, Swift posted an increase in its oil and natural gas production. Nevertheless, first-quarter sales were down from the first quarter of 1997 owing to sudden and sharp declines in product prices.

By the end of the second quarter, another 25 wells had been drilled with 15 placed in production. Again, the Company posted its highest production volumes ever, and again oil and gas prices declined.

The Challenge of Increasing Price Volatility By 1998, the oil and natural gas industry was grappling with an annual oil price of $10.87 per barrel—a low not seen in more than half a century when historic prices are adjusted for inflation. Natural gas prices also declined, falling 16% compared to the previous year. The major factors driving this downturn in prices were a warmer-than-normal winter in the Northern Hemisphere that reduced the consumption of natural gas, increases in oil production from OPEC (including Iraq), and a downturn in the Asian economy that weakened that region’s oil demand.

As the first half of the year progressed, Swift’s management recognized that oil prices would not be rebounding in the immediate future due to the convergence of several events: a surplus of production by the Organization of Petroleum Exporting Countries (OPEC), including the resumption of production by Iraq; an unforeseen economic crisis that was under way in Asia; and a mild winter in the Northern Hemisphere. In fact, inflation-adjusted oil prices eventually fell during 1998 to their lowest levels in 50 years. Moreover, gas prices, which had been highly volatile for more than a decade and were in direct competition with oil prices, also sank to unexpected lows.

In a move consistent with Swift’s strategic plan for dealing with cyclical prices, management curtailed the Company’s remaining drilling program and sought to purchase proved in-the-ground reserves whose values had fallen in response to the lower wellhead prices.

As a result, in 1998 Swift Energy made the largest acquisition of producing properties in its history—an $87.0 million purchase of properties in the Austin Chalk trend that included 156 producing wells, over 200,000 net undeveloped acres, and interests in two natural gas processing plants with a combined capacity of up to 250 million cubic feet of gas per day. The properties were concentrated in two fields located on opposite sides of the Texas-Louisiana border—the Brookeland Field (in Texas) and the Masters Creek Field (in Louisiana).

At the time of purchase (in early July), the new properties’ proved reserves were audited at 91.1 Bcfe; however, with a subsequent extensive work program that placed new wells in production, together with additional geological and engineering studies, the Company increased the proved reserves associated with the properties at year end to 130.5 Bcfe, despite the fact that Swift had already produced 11.6 Bcfe from the properties’ reserves.

Also in 1998, Swift Energy increased the interests it owned in some wells by purchasing approximately $100,000 worth of the interests owned by 11 of its income partnerships that were liquidating. At the same time, Swift announced early in the year its intention of offering to purchase all the properties owned by 63 of its partnerships. However, after a long appraisal process whose results did not account for the low oil and gas prices experienced throughout the year, the Company notified the partnerships in mid-October that it would delay its offer until after new appraisals could be made.

With its expanded property base, the Company’s proved reserves at year end totaled 436.1 Bcfe, an increase of 21% from the previous year. Production rose to 39.0 Bcfe, an increase of 54%. But with the average 1998 price of oil and condensate declining by 33% to $11.86 per barrel and the average price of natural gas declining by 22% to $2.08 per Mcf, oil and gas sales rose only 16%—from $74.7 million to $82.5 million.

Swift’s total revenues for the year increased by 10% to $82.5 million. However, because costs do not decline proportionately with prices, net income decreased 48% to $11.7 million ($0.71 per share) and net cash provided by operating activities decreased 2% to $54.2 million.

The Company’s net income was also negatively impacted by a non-cash charge during the year that totaled $90.8 million. Because of accounting rules that require current pricing to be applied to long-term production projections, Swift took a $77.2 million write-down of the Company’s domestic oil and gas properties. In addition, because of economic turmoil in Russia, along with the Russian currency collapse, and economic uncertainty and currency instability in Venezuela, management chose to accept a $13.6 million impairment of the Company’s international capitalized costs. With these charges, Swift sustained a net income loss of $48.2 million, or $2.93 per share.

Swift’s abbreviated exploration and development program in 1998 included 75 gross wells, which yielded success rates of 36% for exploratory wells and 87% for development wells, exceeding industry averages of 31% and 86%, respectively.

Once again the highest number of wells was drilled in the AWP Olmos Field in McMullen County, Texas, where 36 wells yielded 31 successes. During the year the Company also focused on further refining its well-fracturing techniques required for the tight Olmos sand. In addition, it embarked on a fracture extension program in which 103 wells received second fractures to increase production. As a result, the field’s net production level was maintained at 15.5 Bcfe, accounting for 40% of Swift’s total 1998 production. At year end, the field held 51.3% of the Company’s total proved reserves and 41.7% of its undeveloped proved reserves.

In another tight sand region, the Queen City formation in Jim Hogg County, Texas, the Company drilled one exploratory well and three development wells whose full production potentials were to be determined following a post-1998 fracture extension program.

In the Austin Chalk trend, 23 wells were drilled with 18 successes, including three successful wells in the new Master’s Creek Field in Louisiana. Also included were a number of successful wells resulting from Swift’s joint ventures with industry partners: an exploratory well in Colorado County with Chevron USA Production Company, a development well in Washington County with Union Pacific Resources, three development wells in Fayette County with Chesapeake Energy Corporation, and one exploratory well and three development wells in Fayette County with Belco Oil and Gas Corporation. Swift also drilled several other wells in Fayette County.

Altogether, Swift’s Austin Chalk areas contributed 48% of the Company’s 1998 production, and at year end these areas held 42.4% of the Company’s total proved reserves and 54.1% of its undeveloped proved reserves.

In addition to the wells already cited, Swift’s 1998 drilling program included six development wells (with three successes) and six exploratory wells (with two successes). The three successful development wells, none operated by Swift, were located in Oklahoma. The two successful exploratory wells consisted of one drilled by Swift in Cameron Parish, Louisiana, and another drilled by another operator in Converse, Wyoming.

At the end of 1998, Swift Energy had interests in 1,753 producing wells in eight states, and it was operating 836 wells that accounted for 91.1% of its reserves and 84.3% of its production.

Of the Company’s total 1998 production, 72.3% (28.2 Bcf) was natural gas, including 866,232 Mcf delivered under the AWP volumetric production payment agreement of 1992. Of the Company’s total reserves at year end, 80.8% was natural gas.

During 1998, the Company established a $250 million revolving line of credit with 10 of the world’s leading energy banks. This four-year unsecured credit facility, together with internally generated cash flows, helped fund Swift’s 1998 activities. At December 31, the Company had outstanding borrowings of $146.2 million under the new credit facility.

The stock repurchase program Swift began in 1997 was completed on June 30, with approximately $9.3 million of working capital used to acquire 435,274 shares in the open market. This was followed by a new board-approved repurchase program in which approximately $2.5 million was used to acquire another 246,001 shares before year end.

During 1998, the Company’s international activities were focused in New Zealand under Swift Energy New Zealand Limited. In March, Swift surrendered some of its acreage covered in its first Petroleum Exploration Permit for the North Island Taranaki Basin, and the remaining acreage was combined with the second permit, under which the Company was obligated to drill one exploratory well prior to August 12, 1999. The Company also entered into separate agreements with Marabella Enterprises Ltd., an Australian company, to obtain 25% working interest in another exploration permit.

As noted earlier in this discussion, Swift Energy during 1998 re-evaluated the timing of the recovery of its capitalized costs in Russia and Venezuela and accepted impairment charges covering all prior work in those countries.

At December 31, 1998, Swift Energy had 203 employees.

This page was last updated on Wednesday, July 11, 2007, at 04:33:02 PM.

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