Laredo Petroleum de-risking acreage in Wolfcamp zones and Cline shale

AN INTERVIEW WITH RANDY FOUTCH, CHAIRMAN AND CEO OF LAREDO PETROLEUM

Laredo Petroleum de-risking acreage in Wolfcamp zones and Cline shale

EDITOR'S NOTE: Despite its Texas border-town name, Laredo Petroleum isn't based in the Lone Star State. Its headquarters are in Tulsa, Oklahoma. Chairman and CEO Randy Foutch recently took some time to talk to OGFJ about his company.

OIL & GAS FINANCIAL JOURNAL: Randy, this isn't your first time at the helm of an oil and natural gas company. You've successfully grown and built numerous oil and gas companies over your career. But in all your years, did you ever think that the US would be in a position to surpass Russia and Saudi Arabia to become the world's largest oil producer?

RANDY FOUTCH: I certainly did not foresee that, and I think anybody who tells you that they did would have been incredibly smart. Many of us at Laredo spent most of our career describing the importance of oil and gas to the US economy, businesses, and security in the framework of a declining supply. Now, we have a different story to tell – a story describing a supply of natural gas that will be here for generations. And, for the first time, we can have a real conversation about North American oil and natural gas security. We can now debate what hydrocarbon security or independence actually means. I don't believe it necessarily means we won't import. It may mean that we import and export. But now we can have a legitimate debate about the political changes that need to happen.

As for how this has happened, we believe there are three dramatic game-changers that have led us to this point. The rotary drill bit, the ability to drill offshore, and what we view as the most important: the technology to drill the long-reach laterals and fracture the shales.

"The bulk of our 2013 CAPEX program. about 77% is focused on drilling our Permain asset. From a drilling standpoint, we are delineating our acreage to completely identify the extent of the different zones across our position in the Garden City area." — Randy Foutch, chairman and CEO of Laredo Petroleum "The bulk of our 2013 CAPEX program. about 77% is focused on drilling our Permain asset. From a drilling standpoint, we are delineating our acreage to completely identify the extent of the different zones across our position in the Garden City area." — Randy Foutch, chairman and CEO of Laredo Petroleum

OGFJ: Do you believe that the industry is working to better educate the American public as we move toward energy independence?

FOUTCH: That's a great question Don. I believe we are positively impacting more and more people today – people who historically are not familiar with the industry. I believe that the American public needs to better understand the contributions that our industry provides. And I believe that we as an industry need to do a better job communicating the benefits that our industry provides to mainstream Americans.

The oil and natural gas industry is one of the most extensive and critically important industries in the world today. Our industry touches the lives of every day Americans in ways that most people probably never think about. From the cars we drive to the cell phones we use to the televisions we watch, petroleum products have significantly raised our standard of living. The increased standard of living is further made possible, in part, by our access to clean, affordable energy. And not only does affordable energy raise our standard of living, it also provides us with a huge advantage over countries that don't have access to cheap, reliable energy.

Laredo's production facilities and storage tanks in the Permian.
Laredo's production facilities and storage tanks in the Permian.

The data points in the oil and gas industry are equally compelling when it comes to job creation. Think about all of the jobs that are created by industries that use petroleum products – technology, health care, consumer goods, and of course the oil and natural gas industry itself. Millions of jobs are created by our ability to extract hydrocarbons in a safe, efficient, and environmentally friendly manner.

And lastly, many Americans don't really understand our industry. They don't know what fracing means. Many don't understand what surface operations or downhole operations really mean. In my opinion, there's still a lot of educating that needs to be done on both sides of the aisle.

OGFJ: There's been a lot of talk recently about building liquefaction plants and terminals here in the US to export natural gas. What are your thoughts on this issue?

FOUTCH: As you know Don, the US currently runs liquefaction plants where LNG is being exported. So the real question is, "Should we significantly expand our exports?"

There are several reasons why I think it would benefit the US. First, we have private ownership of mineral rights, which many countries do not have. Second, we have an existing infrastructure that enables us to safely and efficiently transport natural gas. And, finally, we have the capacity to produce an additional four, five, or six billion cubic feet per day of natural gas for export without negatively impacting the supply levels for our own daily consumption. These factors, combined with the additional jobs that would be created to support this new sector, all argue in favor of building new liquefaction plants.

OGFJ: That said, where do you see natural gas prices during 2013?

FOUTCH: Don, I have seen a lot of change in my career. I've had my fair share of accomplishments. But one area that I have not excelled in is my ability to accurately predict prices. What I do believe is that we will see increased volatility, but within a much narrower range. If natural gas prices increase too much, supply will be brought on that will mitigate and drive natural gas prices back down. So in my view, it's not a commodity that is priced-based on low supply – it's a commodity that will be priced on the cost of supply. And I think that's a big difference.

Laredo Petroleum drills up the Permian
Laredo Petroleum drills up the Permian

OGFJ: Let's dig down into Laredo Petroleum and your operations. You recently announced a CAPEX budget of $725 million. Which projects will receive the lion's share of the budget and how will you fund these projects?

FOUTCH: Don, you are correct. We've allocated $725 million to our CAPEX program in 2013, which is more in line with the level we are used to. To give you some background, our 2012 program was revised up to $900 million in order to gain additional data on our primary asset in the Garden City area of the Permian basin. In 2012, we wanted to drill additional wells through the Middle and Lower Wolfcamp, as well as continue to drill and test the Cline Shale and Upper Wolfcamp. We wanted to "start the clock," so to speak, on these production profiles. Although we have one of the largest inventories of scientific data in the area through downhole cores, sidewall cores, and seismic data, the only way to get performance data is to actually drill the well and let it produce for 12 to 18 months. Now that we have a lot of the scientific drilling completed, our 2013 budget has now returned to a normal level.

So, the bulk of our 2013 CAPEX program, about 77%, is focused on drilling our Permian asset. From a drilling standpoint, we are delineating our acreage to completely identify the extent of the different zones across our position in the Garden City area.

In addition to delineation, we will continue development drilling across the Permian. Keep in mind though, it's not developmental drilling in the traditional sense of the word. It is more exploitation drilling. We have not begun a full-scale development program of our acreage. In order to do that, we need to understand the entire acreage position better. The better we understand the position, the more efficient we can deploy capital to fully develop our asset.

From a funding standpoint, we want to demonstrate that we can fund a larger and larger portion of our capital expenditure program on an annual basis from internal sources. But we do anticipate that we will outspend cash flow since we are in the early stages of developing infrastructure and building out our well inventory. The outspend percent of our total capital program, however, will continue to decrease.

At this point, we do not believe we are capital constrained. We are really data constrained. We are very deliberate in our approach to not outrun our data. And of course, about 5% to 10% of our overall capital program will be used on new opportunities and testing new ideas.

OGFJ: What type of production growth are you guiding for 2013?

FOUTCH: With a strong focus on the Permian basin, we believe we will be able to grow our oil production about 25% on a year-over-year basis, which will result in total production growth of about 15% for the year.

OGFJ: What does your company's 2013 hedging program look like?

FOUTCH: Hedging is something we look at on a regular basis. While we are not very good at predicting commodity prices, we are quite good at finding oil and gas and then developing it at a very cost-effective value. What we want to do is ensure that we're going to be able to fund a reasonable capital program to exploit our assets. We want to make sure that we can pay our employees, keep the lights on, and cover the interest on our debt-service costs.

So, we look at hedging as a way to underpin all of that. We look at what is the minimal value that we need to be able to execute among those three objectives. We really like buying floors, which allow us to execute our program but still give us the upside associated with our production.

OGFJ: At a recent oil and natural gas conference you used the term "Captured the Prize." Can you elaborate on this phrase and its significance to Laredo Petroleum?

FOUTCH: We started talking about "Capture the Prize" in 2011 in reference to the potential we saw in our spending plan for 2012. This was my euphemism for de-risking some of the target zones on our acreage. In 2012, we wanted to make progress on converting a lot of our acreage from potential into a higher category of reserves. We accomplished that.

We now know that not only is our vertical program economic, which we knew several years ago, but that we now have four horizontal zones that are economic. And we've proven that. Approximately 70,000 acres of our 140,000 acre footprint has been de-risked for the Cline Shale. And, approximately 60,000 acres of our 140,000 acre position has been de-risked for the Upper Wolfcamp. That doesn't mean to say the rest of the acreage is not productive, we just don't have enough production history yet. Many of the other zones on this acreage have been producing – just not long enough yet.

And, we're not done. The prize keeps getting bigger. We have a tremendous proprietary library of hole cores and now we have meaningful horizontal wells themselves. We think there's reason to believe that the Cline is prospective over most of our acreage, if not all of it. And, we're seeing the same thing with most of the Wolfcamp zones.

OGFJ: Laredo was the first company to drill a successful/economic horizontal well in the Cline, recognizing its potential. How did you identify this opportunity and what are your development plans for the Cline?

FOUTCH: The Cline Shale drove us to buy an acreage block in a very narrow band about 20 miles wide and 70 to 90 miles long. We believed that this acreage had Cline Shale potential and an opportunity for potential in other zones. There was one well and one drilling rig running in the entire county. We brought in the second rig to start drilling horizontal wells. Our first well in 2009 hit the target we were looking for in the early part of 2010, but it wasn't particularly successful. We did however see tremendous shows in the Cline. So we cored it and decided to drill an additional Cline horizontal well.

Today in that county, there are 35 or 40 drilling rigs drilling.

OGFJ: Is there anything else you'd like to add?

FOUTCH: Don, I've spent most of my career trying to find a repeatable play where I had several thousand locations to drill that had a high teens, low twenties rate of return. We have that today in our vertical program. But what's really tremendous, is that I'm trying not to drill any more of those vertical wells than we need to because our horizontal program looks like it has much better economics. As I said before, the prize keeps getting bigger at Laredo.

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

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