Letter to Stockholders

As Winston Churchill reportedly said, “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” Here at Swift Energy, we have long been optimists. Our ability to seize opportunities in the midst of volatile industry cycles has been the underpinning of our longterm growth, allowing us to become part of an elite group. According to the Oil and Gas Journal’s annual surveys, out of more than 400 public oil and gas companies listed in the 1980s, less than 10% are still in business today in their original form. We are proud to be among them.

1979 Since our founding in 1979, we have consistently fine-tuned our drilling and completion technologies, including hydraulic fracturing, a technology that we first used in our earliest wells in West Virginia.
1981 Terry Swift (right) and a geologist from a service company oversee the setting of pipes in the Sandy #1 well in the tight sands of West Virginia.

In 2009, as we celebrated our 30th year of operation, our optimism was again tested in a time of great difficulty. The oil and gas industry suffered its most severe downturn on record amid a global economic crisis. Monthly average oil prices plunged 73% in seven months from July 2008 through February 2009, and monthly average natural gas prices fell over 70% during a 15-month period beginning in June 2008. The impact on our company, and across our industry, was significant. For the year, we recorded a net loss of $39 million ($1.16 per share), which reflects a $79 million non-cash write-down of our oil and gas properties that occurred during the first quarter of the year. Without the effects of this non-cash write-down, which was necessitated by falling commodity prices, our net income would have been $11 million. Cash flows from continuing operations for 2009 were $226 million, down 61% from $582 million in 2008, and total revenues were $370 million, down 55% from $821 million. Production was 9.1 million barrels of oil equivalent (MMBoe), a decline of 10% from 2008 levels, largely because we curtailed drilling activity in response to lower prices.

These full-year statistics tell only part of our story. While we began with net losses for the first and second quarters of 2009, our quick response to the industry downturn, followed by the partial recovery of oil prices in the second half of the year, allowed us to post positive net income in the third and fourth quarters. More importantly, as oil prices stabilized and we brought costs in line with lower cash flows, we positioned ourselves for opportunities that would arise when the economy turned around. We increased our leasehold acreage in strategic areas. We formed mutually beneficial industry alliances. We took decisive action to strengthen our balance sheet. We began exploiting a new formation, the Eagle Ford shale. And we launched a strategic but conservative drilling program in the second half of the year.

Our investors apparently took notice. By the end of December our stock price had risen 43% from the start of 2009, and our market capitalization had increased over 70% to almost $900 million.

A company’s ability to manage severe downturns such as the one we experienced in 2008 and 2009 is not a given.As the Oil and Gas Journal’s annual survey shows, many of our competitors have vanished in recent decades, yet our company has continued to achieve long-term growth. On a monthly average basis, our stock price has outperformed major indexes over the past quarter of a century. From August 8, 1984 (when we were first listed on a public exchange), through December 2009, our stock price increased over 1,300%, compared to an increase of less than 800% for the Dow Jones Industrial Average and about 570% for the S&P 500. Obtaining results of this magnitude—over a span of decades in which the oil and gas industry experienced several tumultuous cycles—was possible only because of our determination to seek opportunities in the depths of industry turmoil.

How have we achieved outstanding growth when so many of our peers have failed? We believe the difference is due to the principles that have guided our company’s decisions since its founding. Having these unchanging principles at the core of our company is, paradoxically, the reason we can rapidly respond to changes in our external environment. Many times we have harnessed volatile industry cycles and used them to power further growth. In order to do so, we have had to reinvent ourselves. Since our founding in 1979, we have transformed nearly every aspect of our company, often multiple times: the technologies we use, the fields we exploit, and even the people we employ.

1992 Standing on the rig floor of Swift’s first operated horizontal well are current CEO and Chairman Terry Swift (left); his father and founder of Swift Energy, the late Earl Swift (center); and his uncle, Virgil Swift (right), a Swift director emeritus.

In 2007, our employees joined together to formally identify the values in our organizational culture that have enabled us to not just survive but thrive over the past 30 years. The resulting vision and mission statements identified seven specific values that represent our company’s philosophy, the heart of who we are: stewardship, improvement, performance, passion, integrity, trust, and teamwork.

We saw these values at work within the company in 2009 as we took specific steps to navigate the industry’s restructuring.  Our value of stewardship was of paramount importance early in the year when we moved to protect our cash flows as oil prices continued to decline and the global economy fell deeper into recession. We did this by temporarily halting drilling, seeking low-cost ways to boost production, and cutting costs throughout all departments.  Similarly, our commitment to performance meant that we didn’t hesitate to eliminate activities whose performance no longer contributed effectively toward meeting our goals.  This value has proved crucial when we have entered industry downturns in the past. In 2009, our cost-cutting effort was a main factor in helping us lower total costs and expenses for the year (excluding non-cash items) by approximately $70 million as we worked with suppliers and service providers to negotiate lower fees. As part of this reduction in expenses, our lease operating costs alone fell 27% from the previous year.

Our success in strengthening our balance sheet during 2009 demonstrates our dedication to the value of continuous improvement. We began in April by renewing our revolving credit facility with a 10-member bank group at a time when the global credit crisis was still ongoing. We then took steps to reduce our borrowings on this revolving credit facility from a high for the year of over $240 million to zero by yearend.  We achieved this largely through a public stock offering and a public notes offering. The public stock offering occurred in August after oil prices had posted fairly steady gains for several months, closing with net proceeds of $109 million from 6.2 million shares sold at a price of $18.50 per share. The public notes offering of $225 million in senior notes in November was used mainly to redeem our outstanding $150 million in senior notes due in 2011, our only near-term notes obligation, with the remaining proceeds then used to pay down our credit facility. The reduction of bank borrowings, together with cost-cutting and improving cash flows, allowed us to significantly strengthen our balance sheet in 2009.

1984 Swift Energy joined the American Stock Exchange in 1984 under the symbol “SFY” and moved to the New York Stock Exchange in 1991.
1989 We established our oldest core area in 1989 when we became operator of the AWP Field in South Texas.

Just as we did with our finances, we also quickly responded to the external environment in our oil and gas fields, where our strategy has long focused on creating geographic core areas of operation, now primarily in Louisiana and Texas. Our core area strategy ties to our fundamental values in several ways. Our basic value of teamwork, for example, has proven to be an essential ingredient for long-term success, particularly during industry downturns. To implement new ideas quickly and efficiently, we promote communication and cooperation by forming multidisciplinary asset teams for all our core areas. This team approach paid off in 2009 with several innovative initiatives in the field.

Innovative ideas can best be implemented with a high level of operational control that provides the flexibility needed for quick responses to short-term events. This is another way in which concentrating our interests in core areas enables us to take advantage of industry cycles. At year-end 2009 we operated 96% of our proved reserves, enabling us to rapidly scale back on drilling during the first half of the year.  Conversely, when oil prices began recovering faster than natural gas prices during the second half of the year, we were able to quickly launch a relatively low-cost drilling program of shallow oil wells that targeted our two most productive fields, the AWP Field in South Texas and the Lake Washington Field in Southeast Louisiana.

Our high level of operational control allowed us to initiate other low-cost ways to enhance production as well.  We undertook a production optimization program in our Lake Washington Field that included installing gas lifts on nine oil wells. We also shifted sliding sleeves inside the well bores of 29 oil wells, boosting production by moving to more prolific zones. Similarly, we improved production in the AWP Field by performing 29 fracture enhancements on existing natural gas wells.

In addition to shortening our response time to external events, our long-term strategy of creating core areas also allows us to hone repeatable operations, which again exemplifies our value of continuous improvement. In the Lake Washington Field, we took a property discovered in the 1930s, sought ways to apply advanced technology, and found repeatable operations that could be applied to increase the field’s potential. The results speak for themselves.  In 2001, when we first acquired the field, the daily average production rate from the field’s Miocene sands was less than 1,000 barrels of oil equivalent (Boe) per day, compared to our daily average production rate of more than 9,500 Boe per day during the fourth quarter of 2009. During the same period, the field’s proved reserves rose from 8 million Boe to 27 million Boe at year-end 2009, which is in addition to the nearly 47 million Boe we have already produced in our nine years of operation there.

An important repeatable operation we have used to enhance our Southeast Louisiana core area, and also our South Louisiana core area, involves 4,000 square miles of geoscience databases that we have been building for over five years. We continuously improve this geoscience information by acquiring seismic data from other sources, conducting our own proprietary surveys, and, most importantly, merging the seismic data together and then combining it with digitized geological and reservoir data. The result is a set of unique and proprietary geoscience databases that helps us pinpoint drilling prospects, expands our knowledge of the core areas’ underlying formations, and improves our performance in maximizing proved reserves and production. We are using this information to pinpoint the locations of 12 to 20 wells that we plan to drill in Southeast Louisiana in 2010. We are in the early stages of building a similar geoscience database for our South Texas core area.

1994 Swift prepares to gather seismic data for an early horizontal drilling program in Texas.
2004 During the past five years, Swift has developed geoscience databases covering 4,000 square miles in southern Louisiana that can be used to generate three-dimensional subsurface images.

As we did in our Southeast Louisiana core area, we are now studying ways to use advanced technologies to revitalize the fields in our Central Louisiana/ East Texas core area, where we drill horizontal wells to produce from the Austin Chalk. While we plan to drill only one horizontal well there in 2010, the multidisciplinary asset team assigned to this core area is reassessing the fields with the intent of increasing their production profiles through technology such as new drilling equipment and software that enable the drill bit to better stay in zone when drilling horizontally.  We also entered into a joint venture with an experienced industry partner in 2009 as part of our plan to rejuvenate this core area.

Of all our operations, our South Texas core area is currently one of the most visible examples of the benefits of our value of continuous improvement. For nearly two decades, we exploited the area’s Olmos tight sands in the AWP Field by drilling vertical wells that we hydraulically fractured to allow the oil and gas to flow through the formation to the well bore. Throughout this time period, we consistently fine-tuned our fracturing techniques and applied new drilling and production technologies.  Today, we are combining three types of technology—geoscience datasets, horizontal drilling, and hydraulic fracturing—in the hunt for oil and gas resources in this region. The result is that we have expanded the known limits of the Olmos formation in the area’s AWP Field, and we have increased production while lowering costs. At year-end 2009, we had drilled five Olmos horizontal wells, each hydraulically fractured at multiple locations along the lateral leg.  These wells had an average estimated ultimate recovery of oil and gas that is 7.5 to 12.5 times that of a vertical well hydraulically fractured in the field, with only 3.5 to 4.3 times the capital costs. More importantly, this combination of technologies is enabling us to access reserves in the Olmos sand that would otherwise be uneconomical to produce. We now hold approximately 40,000 net acres in our South Texas core area that are prospective for development in the Olmos tight sands, with four more of these horizontal wells planned for 2010.

2008 Our first horizontal well with multistage hydraulic fracturing was the R Bracken 33H well in our AWP Field in South Texas.

Exemplifying our value of performance, we have a long track record of applying the technologies we are using today in the Olmos in ways that help maximize our bottom line. Since 1992—long before the industry’s recent focus on horizontal drilling—we have drilled 132 horizontal wells with an 87% success rate. We first began integrating geologic and seismic data in the late 1980s and began conducting our own seismic surveys in the early 1990s. Our experience in hydraulically fracturing tight-sand formations stems back to our company’s inception, when we drilled some of our first wells in West Virginia’s tight sands. In each of these technologies through the years, we have continuously honed our capabilities and worked to apply them in innovative ways that create opportunities.

2009 Swift Energy currently has four core areas of operation in Louisiana and Texas.

In 2009, we began applying our advanced technologies to a second formation that underlies a broad swath of our South Texas core area: the Eagle Ford shale, which we believe represents the kind of opportunity shaping the future of the natural gas industry.  Production from natural gas shales has grown markedly in recent years: government statistics report that domestic natural gas production from major shales doubled from 2000 to 2005, doubled again from 2005 to 2007, and doubled yet again from 2007 to 2009.  For our company, we believe the Eagle Ford shale has the potential to significantly increase production and proved reserves in our South Texas core area.

We began drilling our first horizontal wells in the Eagle Ford shale in the fourth quarter of 2009, one in our AWP Field in McMullen County and the other in Webb County where our Las Tiendas Field is located. For 2010, our plans are to drill up to six horizontal Eagle Ford wells in the AWP Field and six to ten wells in our other South Texas fields. To accelerate our exploitation of the formation, we also have entered into a joint venture with an experienced industry partner who has a track record of success in shale reservoirs.  This joint venture, in which we have a 50% working interest, covers a 26,000-acre portion of our Eagle Ford acreage in McMullen County, Texas, and will involve drilling up to nine horizontal wells, one of which has already begun. For South Texas as a whole, we hold 75,000 net acres in the Eagle Ford shale formation located in McMullen, La Salle, and Webb counties.

2008 We commissioned our fourth production processing facility in the Lake Washington Field in Southeast Louisiana in 2008.
2009 This core sample is from an Eagle Ford well we spudded in the Las Tiendas Field in South Texas during late 2009.

Looking back on 2009, it is probably fitting that our 30th anniversary occurred during a year in which our industry underwent the worst downward price cycle in modern memory. Cycles have been part of our history almost from day one, and we have created a lot of value for our stockholders by taking advantage of the opportunities that they create. With our core area focus, team approach, and dedication to continuous improvement and pure performance, we are well positioned to take advantage of the current industry cycle, just as we have taken advantage of other cycles in the past. We are confident in the future because of the bedrock values that are the foundation under all that we do: values such as the stewardship responsibilities we feel, not only for our stakeholders’ property, but also for the communities we work in, the environments where we operate, and the people who carry out our mission. We have confidence because of the integrity that we have built into our company—an integrity that breeds trust and a trust that in turn breeds teamwork and passion.

Terry E. Swift
Chairman and Chief Executive Officer,
Swift Energy Company