AN INTERVIEW WITH ST. MARY’S TONY BEST - St. Mary’s CEO sees geographic diversity as competitive strength

OIL & GAS FINANCIAL JOURNAL: As one of the oldest continually operated oil and gas companies in the US, St. Mary will celebrate its 100th anniversary next year. The company has also made a number of management changes recently, not the least of which is your appointment as CEO earlier this year. Are you pleased with the state of the company today and are you comfortable with the direction it is heading?

TONY BEST: You obviously don’t last 100 years as a company without having talented management teams. If you look at what Tom Congdon and Mark Hellerstein (previous CEOs at St. Mary) and their teams accomplished, they took a small, family-owned passive royalty vehicle to a $2 billion-plus market capitalization full-fledged operating E&P company. They did this through several commodity cycles while generating great returns for our stockholders. My job is to continue that growth and take St. Mary to the next level.

I have been at St. Mary a little over a year, and have been CEO for a little over 4 months. I am pleased with the slate of assets we have - it is the largest inventory of projects in the company’s history. Several of these projects have significant running room and we are excited about those. But without good employees, we’d never realize the potential of these assets. Fortunately, we have great employees at every level of the organization. Those things being said, I know where I want to take the company and that will involve growing/changing our asset base and continuing to grow and strengthen our employee base. The company has a tremendous foundation to build from, and I am very comfortable with the direction we are heading.

OGFJ: What specific steps are you taking to steer the company towards a more profitable course? Do you think the company should be bigger and more diversified, for instance?

BEST: With respect to profitability, I think we have some room to improve our operating margins. We have a balanced production profile (about 60% natural gas and 40% oil), so we have benefited recently from strong crude prices. The best way to improve our margins is to continuously hammer away at operating costs. Being an oilier company, we are always going to trail the operating cost structure of a pure natural gas player, but there are things we can do to lower our costs and we are constantly evaluating those.

We aren’t interested in growing just for growth’s sake. Bigger isn’t always better. What I really want to do is focus on growing per-share value for our stockholders. That means focusing on growing reserves and production economically.

Regarding diversity, we are already a pretty diverse company - in commodity mix, regional exposure, and the types of plays we pursue. I view our diversity as a competitive strength because it exposes us to lots of opportunities. We have five regions, and in each region we have at least one play that can support multiple years of drilling. That is one of the rewards of our geographic diversity.

OGFJ: What are you doing to address costs, both drill and complete and operating costs?

BEST: One specific project that we have begun is a strategic procurement initiative. One of the things I really like about our company is the decentralized regional structure. Each region has a full technical staff of geologists, landmen, and engineers, and can independently execute on their portion of the business plan. Procurement, however, is one of those functions where you can maximize your buying power if you do it on a consolidated basis. For example, we recently completed a review of our pipe buy. By consolidating all the regional drilling pipe purchases we will need for the next 6 months and partnering with a few core suppliers, we think we can realize some significant savings. We are looking across all areas of the company to see where else we can apply this. I have seen this approach work previously in my career, and I am sure that we are going to see some positive results over the coming year.

OGFJ: St. Mary recently split off its Greater Gulf Coast and Permian basin regions, which were formerly combined, into separate operations. What do you expect to gain from this realignment?

BEST: Prior to the Sweetie Peck acquisition that we closed in December 2006, our Permian assets never really had the critical mass to justify a company office in the basin. After that transaction, we knew we’d need to open an office. This was partly tactical and partly strategic. With Sweetie Peck being the largest acquisition in company history, we needed to have an office in the Permian to develop and operate those properties. But having lived in Midland a couple of times during my career, I also know how important it is to have a physical presence in the Permian - “boots on the ground,” as I like to call it.

The Midland office opened in February 2007 and the integration and operation of the Sweetie Peck assets could not be going any better. And once we opened our office, our Permian deal flow increased significantly. The realignment that we announced was simply recognition that the Permian is now of sufficient size to justify being a separate region and have it managed as such.

OGFJ: How well did your 28 years of experience with Pure Resources, Unocal, and ARCO prepare you for the job with St. Mary?

BEST: My collective experience with these fine companies provided me with a wealth of oil and gas knowledge and understanding, both with majors and independents having different cultures, asset portfolios, and business strategies. I have dealt with high-achieving organizations and others that were bottom-quartile performers, so I have a firm understanding of both ends of the performance spectrum and how to maintain the former and how to improve the latter. Through my career, I have seen the differential success of decentralized organizations, and I fully subscribe to this business model. This was one of the key drivers for me in accepting the CEO position at St. Mary.

OGFJ: Every CEO has a different management style. How would you describe yours, and how does it differ from that of your predecessor (Mark Hellerstein, who stepped down in February to become non-executive chairman of St. Mary)?

BEST: Mark and I have very different backgrounds. He was trained as an accountant and has more of a financial background, while I am an engineer and have an operational background. That said, we have very similar business philosophies, including a focus on high ethical standards, growing net asset value, top-quartile performance, and belief in a decentralized organization. These philosophies won’t change with the recent management transition.

My management style is driven by my enjoyment of working with people, and I try to find a way to interact with employees at every level and location within the company. I want them to know that what they do is important and that I appreciate their commitment and support to St. Mary. Equally important, I want each of them to feel as though they’re in the game and not on the sidelines. In my experience, if you give folks a clear view of where we’re going and give them the resources and empowerment necessary to succeed, they will definitely grab the ball and run with it. It’s great to see an excited and highly efficient workforce in action. They are then able to pursue productive and rewarding work, rather than bureaucratic processes. My job then is to get out of the way.

OGFJ: A growing number of E&P companies are forming Master Limited Partnerships. Is this something St. Mary would consider?

BEST: The MLP phenomenon is getting a lot of attention, but I think that you have to make sure that you have the right kinds of assets to utilize that particular structure. They need to be low decline, low capital intensity assets. We don’t think we have those types of assets in the scale you’d need to justify a drop-down MLP. However, we do think there are other ways to take advantage of the growth in MLPs, such as by partnering with or by selling assets to the MLPs.

OGFJ: Reserves replacement is always a major issue to publicly traded companies. Is there a particular region that St. Mary will be looking to expand in to grow its reserves?

BEST: Our goal is to replace 200% of our total production on an annual basis. Our 3-year average replacement percentage is 233%, and our 5-year average is 255%, so we have been successful in terms of our goals related to reserve replacement. We think that consistently meeting the 200% reserve replacement threshold translates to double-digit production growth over time. We look to each of our 5 regions to expand and grow their reserves. One of the advantages of our regional diversification is that each region has unique opportunities to deploy capital effectively and increase reserves. As I mentioned earlier, we have the largest inventory of projects in the company’s history, which are dispersed across all five of our regions.

OGFJ: Do you expect to divest any non-essential or underperforming assets in the near future?

BEST: As I mentioned before, I am pleased with the vast majority of our asset base. We periodically look at our assets to see if it makes sense to divest any assets. There are a variety of reasons to divest assets - they aren’t a good geographic fit, they are high cost, they are non-core to your focus areas, etc. The market is currently giving good value for assets, so we are giving this more consideration than perhaps we have in the past, especially as we see the “MLP effect” on the prices people are paying at asset sales.

St. Mary Land & Exploration is an active producer in the Williston basin.

OGFJ: Is rig availability a serious concern?

BEST: Rig availability is not as big of an issue as it was in early 2006. Back then, you were hesitant to release a rig because you weren’t sure if you’d ever get it back. Rig providers clearly had the upper hand and negotiated good deals for themselves. Things have loosened up since then and it is easier to find rigs now. We have begun to see day rate reductions in some of our regions since the end of 2006 and we are continuing to watch these costs closely. Bottom line - I believe that we can obtain the rigs we need to implement our drilling program.

OGFJ: How difficult is it to find good employees - from professionals to blue collar workers - and what are you doing to assure that you hire and retain qualified people? What do you do to make St. Mary more competitive in this area - compensation, bonuses, better benefit packages, other incentives?

BEST: Finding quality employees may be the single biggest challenge that St. Mary and the E&P industry as a whole will face for the foreseeable future. Recently, I heard that something like 60% of the E&P technical workforce will be of retirement age by 2010. That is a sobering statistic, which makes recruitment and retention critical. We believe that compensation and benefits are an important aspect of recruiting and retaining our employees, and we work to be competitive in those areas. But I think a real selling point is the “people strategy” that we have here at St. Mary. We intend to have a people-centered culture that fosters job satisfaction, individual commitment, and recognition for high achievement. It’s not just the paycheck that helps us recruit and retain high quality individuals; it’s also the quality of the experience.

With our regional focus and knowledge, a low tolerance for BS and the lack of a “rotational assignment” policy, our folks can concentrate on the business at hand without worrying about corporate politics or where they’re going to be moved to next. This approach to business will continue to be a competitive advantage and allow our attrition rate to be well below the industry average. My ultimate goal is for St. Mary to be recognized in our industry as the “employer of choice.”

OGFJ: Would St. Mary consider acquiring another company if the right deal came along, or are you more interested in assets rather than an entire company?

BEST: St. Mary has a solid track record of making successful acquisitions, and they will continue to be a key component of our growth strategy. Our success has come from maintaining a disciplined approach to making acquisitions. The best decisions you make in the acquisitions game are often those where you walk away from lesser quality deals.

We would consider a corporate transaction under the right circumstances. A big hurdle in corporate transactions is the lack of tax basis associated with corporate transactions - that’s a real cost and it can have a significant impact on the economics of a transaction. Corporate deals can also present challenges with respect to transitioning and integrating systems and personnel. Asset transactions tend to be more focused and lack many of the complications of corporate transactions, but they are also highly competitive. The bottom line is that acquisitions, both corporate and asset, are tough but we are determined to maintain our disciplined approach with a view towards growing net asset value per share.

OGFJ: Many old-line companies such as Texaco, Mobil, and Unocal have been acquired or merged with other companies in recent years. What would your attitude be if another company made an offer for St. Mary and how would you react?

BEST: It would have to be a very compelling offer in my opinion for the board to consider it. As a public company, our board of directors would have an obligation to consider a significant offer for the company. However, we have a tremendous track record of creating value for our stockholders, and my intention is to continue to grow net asset value per share and make sure that we are fully valued in the market. We intend to remain an independent company, and consistent top-quartile performance is the best way to achieve that objective.

Tony Best (seated at center) with David Honeyfield (left), senior vice president and CFO, and Javan (“Jay”) Ottoson, executive vice president and COO, at the company’s headquarters in downtown Denver.

OGFJ: As of the fourth quarter of 2006, St. Mary was ranked as the 36th largest US producer by total assets (OGJ200 quarterly rankings). Do you think Wall Street and the financial community fully appreciate your company’s accomplishments and potential? Is your stock undervalued?

BEST: I am not sure Wall Street fully appreciates our potential. I think that St. Mary is a little more difficult to understand because we are more diversified than other companies our size - one simply can’t do an acreage math calculation on us and come up with a valuation. I think we have potential in each of our 5 regions.

In the Rockies, we have a tremendous acreage position and a potentially large CBM play at Hanging Woman basin. In the Mid-Continent, we continue to move up the learning curve in our horizontal Arkoma program, which is currently focused on the Woodford Shale.

In our ArkLaTex region, we are a leader in the James Lime trend. We also have enviable positions in Elm Grove and Terryville fields, which target the Cotton Valley formation. Our activity in the Permian is primarily focused on a tight oil play targeting the Spraberry interval, and that program is moving ahead of schedule.

In the Gulf Coast, that region is currently integrating our recently acquired assets in the Catarina field in South Texas. Catarina targets a shallow Olmos gas play that we have been interested in for a long time, so we are excited to get working on that program. I also believe there are opportunities for us to take advantage of in the white space where we may not currently be active. When I look at the company, I see significant potential for growth.

OGFJ: How will you commemorate St. Mary’s 100th anniversary next year?

BEST: We are planning on ringing the bell at the New York Stock Exchange.

OGFJ: What are the chances that St. Mary will be around to celebrate a 200th anniversary? Will there still be a petroleum business 100 years from now?

BEST: If there is a petroleum industry 100 years from now, you can be confident that it will probably look much different than what we recognize today. If you look at the advances that have been made in the last 25 years in the industry, you realize how technology continually advances and changes the E&P industry. I think that trend will only accelerate.

Not many companies make it to their 100th anniversary let alone 200th, so we’ll celebrate appropriately next year and then get started on our second century in business.

OGFJ: Thanks for taking the time to talk with us.