Fewer Drilling Programs in Cimarex Energy's Future

• The Company: Cimarex Energy, a U.S. oil and gas producer.
• The Filing: FORM 10-Q filed with the SEC on November 4, 2008.
• The Finding: In the current environment of lower natural gas prices, especially in the Mid-Continent and Permian Basin, Cimarex Energy expects to drop its operator rig count from the third-quarter high at 42 to somewhere between 25 and 30 rigs by the middle of the fourth-quarter ended December 31. As the company has historically increased production through the drill bit, one would expect downward revisions to add-ons in 2009 production and proved reserves to follow.

The Upshot: Chairman and Chief Executive Officer Mick Merelli told analysts on the third-quarter earnings call that the downside case for an acceptable rate of return would be at $52 NMEX oil and $6 NYMEX natural gas. For example, with $6 realized natural gas prices, well economics at Woodford Shale - Anadarko Basin assets would still generate an acceptable 15 percent internal rate of return. Costs of operations in 2008 are estimated to be between $4.38 and $4.77 per MMcfe (excluding production taxes). Cimarex realized $9.79 and $114.87 a barrel for its gas and oil in the third-quarter ended September 30.

Through September 30, exploration and development (E&D) investments totaling $1.1 billion had been principally split among the three core operating regions, with about 47 percent, 36 percent, and 15 percent spent on Mid-Continent (which includes the Texas Panhandle) programs, Permian Basin, and onshore Gulf Coast opportunities, respectively. For the full year of 2008, the company expects to invest about $1.4 billion in E&D spending. Looking to maintain a “balanced drill bit portfolio,” expect higher risk [higher return] onshore Gulf programs (such as Yegua/Cook Mountain) to carry a higher percentage of reduced E&D total spending in 2009.

Cimarex has historically managed its annual development budget within its cash flow means, as reflected in a healthy debt -to- capitalization ratio of only 12.5 percent. Assuming average realized prices of $7.50 and $70 for natural gas and oil in 2009, the company first call for cash flow next year is between $800 million to $1 billion — which would represent a 28 percent to 43 percent reduction in E&D spending. Merelli said on the conference call that the company — prior to the dramatic drop in energy prices — was fully prepared to fund programs next year at current costs of between $1.5 billion to $1.7 billion. How cutbacks in spending translate to production and reserve add-ons is still to be determined.

For the first nine-months of 2008, natural gas production increased year-on-year 7.5% to 485 MMcfe per day. Looking forward, the company is guiding production to be between 488 MMcfe to 498 MMcfe a day in the fourth-quarter.

The Question: When allocating capital in 2009, how much risk — such as dry holes — is Cimarex willing to absorb when drilling in the onshore Gulf region?