Five years of change for PDC Energy

Fortunately, we got more than we initially bargained for. As the technology to unlock the horizontal Niobrara and Codell matured, we applied and refined it, driving production growth, and importantly growing our liquids mix and horizontal inventory. In 2010, our Wattenberg production was three million barrels of oil equivalent. We're forecasting about 13 million barrels of oil equivalent for 2015 - that's a compounded annual growth rate of approximately 35%. Today, the horizontal Niobrara and Codell make up the bulk of our high quality oil and liquids drilling inventory while in 2010 they represented a small portion of our total resources.

And finally, one of the biggest changes has been our day-to-day operations. We've gone from being an exclusive vertical driller to an exclusive horizontal driller. As of 2014, our proved reserves were attributed100% to horizontal drilling locations and contained no vertical PUDs.

OGFJ: Your recent analyst day on April 9 highlighted a number of new initiatives for PDC. What were some of the takeaways from the event?

BROOKMAN: First and foremost, we showed analysts and investors that PDC Energy is an incredible growth story with many years of production and cash flow growth. We presented statistical data that supports our high level of confidence in the Inner Core and Middle Core of the Wattenberg. We believe these areas hold an inventory of more than 1,900 low-risk, repeatable horizontal drilling locations with the potential to generate industry-leading returns, even in today's commodity price environment.

Next, we showed how innovations in drilling technologies, completion methodologies, and downspacing, have enhanced our type curves, improved our capital efficiency and continue to add value. PDC Energy is committed to continuous improvement.

And last, we demonstrated the strength of our balance sheet. Our debt-to-EBITDA levels are at the low-end of the industry, providing a strong balance sheet capable of supporting our long-term growth plan. In addition, with our recent equity issuance we've paid off our revolver and empowered the company with the flexibility to accelerate growth if commodity prices cooperate, or grow more modestly if oil stays around $50 per barrel. In any case, the strength of our balance sheet will be there.

PDC's five drilling rigs in Wattenberg are now all self-moving/self-skidding which is expected to increase efficiencies. Four of the rigs are powered by clean-burning natural gas.

LANCE LAUCK: We can't predict future oil and gas prices, so we wanted to show The Street our resilience to the commodity cycle. If oil stays at $50 per barrel flat, which is our pessimistic case, PDC can grow production at a 25% to 30% CAGR for three years and grow our cash flow per share. OGFJ: Due to the current commodity price environment, many E&P companies chose to scale back 2015 capital expenditure budgets to operate within cash flow. As a result, these companies hope to hold production flat or report declines in 2015 production. However, PDC expects to grow production by approximately 50% and outspend its cash flow by about $110 million. Why has PDC chosen to grow production in this environment?

BROOKMAN: The seeds of this decision can be traced back to 2014 when we deployed our fifth rig in the Wattenberg. This one additional rig will drive a good portion of our production growth in 2015. After a rig like this drills an eight well pad, it's a fairly decent amount of time before the production comes online. So all of the incremental production from wells drilled by the fifth rig started at the end of 2014, and in 2015 we will realize a full year of production from them, making for a nice wedge of production growth this year.

The second part is the rationale behind keeping five rigs running. We've had some vigorous internal debates on whether or not we should slow down. Debate is healthy, and in the end, we couldn't ignore the fact that PDC has the balance sheet, asset quality and a large enough drilling inventory to keep five rigs running for years. Lance and his team have excellent modeling capabilities and we believe the best decision is to keep the five rigs running because today the projects are still adding value.

"Our long-term goal is to grow production and cash flow by focusing on our low-risk, high-return inventory in the Wattenberg. This growth will ultimately be complemented by our exploitation program in the Utica. By pursuing these growth initiatives, we hope to drive PDC solidly into the mid-cap space." – Bart Brookman

LAUCK: Our Wattenberg inventory is really important to understand. In total, we have 2,600 economic horizontal drilling locations in the Wattenberg at prevailing commodity prices. At $60 flat NYMEX and $3.25 per MMbtu, inclusive of the differentials in the basin, 1,000 of those drilling locations are capable of generating a 50% or higher return, and 1,700 drilling of those locations are capable of generating a 40% or greater return. So, we have the inventory to make good business decisions to grow from 2015 through 2017, and still have flexibility for the growth to continue into 2018 and beyond.

OGFJ: PDC raised its Core Wattenberg Estimated Ultimate Recovery (EUR) in your Inner, Middle and Outer plays areas, and has driven well costs down to $3.4 million from $4.2 million. What's been the key to success for reducing costs while simultaneously increasing EURs?

BROOKMAN: Reducing costs and increasing EURs are two independent factors. Technical innovation and a better understanding of the reservoir have been the keys to increasing our EURs. Our recovery factors for our 2P inventory are still under 15% in the Niobrara/Codell. We motivate our teams to find new ways to add a point or two to this recovery factor and add value. They are encouraged to try new completion techniques, extended laterals, different frac fluids, additives, proppant designs, perforating schemes, and bio diverts. We know we just have to be patient. We execute, evaluate and change. It can take up to a year to understand how these new techniques are adding value. So, our reserves engineering group works very closely with our operations team on an annual basis to dive deep into the data and persistently move up the learning curve, which has helped improve our EURs.

Secondly, reducing costs is attributable to two major forces - optimizing our operations and generating efficiencies, and having transparent discussions with our service providers to find the appropriate cost structure for both companies. We want a win-win for both PDC and our service partners. There has to be adequate margin for them to continue offering quality service, so we try to take a relationship-based approach to the situation instead of dictating unilateral terms to our service partners. We value these relationships and understand our service partners need to make a margin to be sustainable. Our team has done a great job of finding some middle ground.

"We have such a strong, existing horizontal drilling inventory with tremendous visible line of sight of organic growth that we're really not looking to add anything to our existing programs. With our 2,600 economic locations and 20 years of inventory in the Wattenberg alone, we have to ask ourselves, when would we get to the inventory we acquire?" – Lance Lauck

OGFJ: In March 2015, you issued four million shares in a public equity offering raising approximately $203 million in net proceeds. How did you use that capital?

GYSLE SHELLUM: We used part of the proceeds to pay down our revolver, and we expect the rest to cover our funding gap in our drilling operations for 2015. If we stay on target with our guidance, we expect to end the year with an undrawn revolver.

OGFJ: Given your strong balance sheet and liquidity position, was the equity offering a necessity?

SHELLUM: We get that question a lot. The offering strengthened our financial and liquidity position. Regardless of what the market looks like in 2015 and 2016, if we decide to keep the five rigs running, or ramp up in 2016, we've positioned ourselves to move quickly without having to come back to the capital markets.

OGFJ: Talk with us a little about your hedging position for 2015 and 2016?

SHELLUM: Our hedging program is, and always has been, very methodical. I wish I could tell you we saw this commodity cycle coming, and we put all our hedges in place. The fact of the matter is, for the last five years, we've made it our goal to hedge a good portion of our expected production out a few years. It is important to realize that we do not hedge to make money. Instead, we hedge to de-risk our business plan. As we grow, we continue to outspend cash flow, so in order to protect our drilling program we need a reliable base of cash flow each year. We hedge to protect that. We know the price at which we can generate a good return on our drilling program and we layer in hedges over time at or above our price forecast.

“We’ve made it our goal to hedge a good portion of our expected production out a few years. It is important to realize that we do not hedge to make money. Instead we hedge to de-risk our business plan.” – Gysle Shellum

Our hedges for 2015 and 2016 were put in place in 2013 and 2014. We have 85% of our 2015 expected oil production hedged at $88.61 per barrel and approximately 75% of our gas hedged at $3.90 per MMbtu. In 2016, we have a little over four million barrels hedged at $85 per barrel and 30 bcf at $3.89. We're still working on 2017 but we currently have about 21 bcf at around $3.80. We stay pretty conservative with our hedges and don't use exotic structures. We use pure swaps and costless collars. We have a "keep it simple" principle and will march forward using this same strategy.

OGFJ: How will PDC manage its balance sheet given your active drilling program and production forecast, as well as your goal to maintain your debt/EBITDA ratio to below 2.0x?

SHELLUM: Looking at Debt-to-EBITDA, we are happy with 2.0x and under. In the past, we've gone beyond that for short periods of time, but when we approach 3.0x we start looking for ways to reduce our debt position.

LAUCK: We provided a three-year outlook at our analyst day and as part of that we wanted to show how each of our growth scenarios still allows us to maintain our Debt-to-EBITDA metrics well below 2.0x. In any scenario, our debt metrics are conservative and, we believe, peer-leading.

PDC works with surface owners when locating drilling and production sites to minimize impacts.

OGFJ: Other companies in a financial position similar to PDC's believe this commodity cycle has provided opportunities on the M&A and A&D front. Are you a buyer or seller in this market? Are you the natural consolidator in the greater Wattenberg?

LAUCK: People ask us that question often. In the final analysis, we have such a strong, existing horizontal drilling inventory with tremendous visible line of sight of organic growth that we're really not looking to add anything to our existing programs. With our 2,600 economic locations and 20 years of inventory in the Wattenberg alone, we have to ask ourselves, when would we get to the inventory we acquire? Therefore, we would put a very high threshold on any acquisition opportunity. That doesn't mean that we won't pursue a potential third area of operations outside of the Wattenberg and Utica, but it will be down the road and only after we complete basin studies across the US onshore. And on the divestiture front, we've sold everything that we're going to sell for the foreseeable future.

OGFJ: What about your Utica shale assets? You're only allocating approximately 7% of your 2015 budget to this region. What's the long-term outlook for this area?

LAUCK: You are correct. We're not allocating much capital to the Utica Shale this year. But we're excited about the work our teams are doing there and the resource potential in the play. Over time you can expect to see our overall capital budget increase, and with that, the allocation of capital to the Utica should increase as well. Keep in mind, however, that our Wattenberg program will continue to demand the lion's share of our future drilling and completion budgets, because it is such a high-quality asset.

BROOKMAN: Our estimated ultimate recoveries in the condensate and wet-gas windows where we operate is somewhere between 700,000 and 1.2 million barrels of oil equivalent per well. We just need a little help from the commodity markets, and we need to work on our cost structure for our Utica position to compete with our Wattenberg asset. Our estimated wells costs are in the $7.5 to $8.0 million per well range. You could see us pick up a rig and start drilling in 2016 if we are able to get our costs down or some combination of cost reduction and commodity price improvement manifests. On a 2P basis, we currently carry 50 horizontal wells in the Utica. Looking beyond that, we believe we have somewhere around 200 wells using current spacing rules.

OGFJ: Lastly, what's the long-term goal for PDC Energy? What do you want to be known for in another five years?

BROOKMAN: Our long-term goal is to grow production and cash flow by focusing on our low-risk, high-return inventory in the Wattenberg. This growth will ultimately be complemented by our exploitation program in the Utica. By pursuing these growth initiatives, we hope to drive PDC solidly into the mid-cap space. We'll continue to work on improving productivity, reducing our operating costs per barrel, maintaining our strong balance sheet and diligently transforming our high-quality resource into value. Sometime during the next five years, we could add another quality operating area to our portfolio, but we do not have a compelling need to do that and can be patient. As Lance said, we already have a quality, multi-year organic drilling inventory in front of us.

OGFJ: Thank you all for taking the time to talk with us today.