Swift Energy Company (SFY)

TOP CONTRIBUTORS

Geoffrey Jordan

Swift Energy (NYSE: SFY) develops and operates oil and natural gas properties, with a focus on oil and natural gas reserves onshore and in the inland waters of Louisiana and Texas. The company hires independent contractors to extract crude oil and natural gas from its properties, and then it sells these commodities on the open market to oil companies such as Royal Dutch Shell (RDS'A), Chevron Corporation (CVX), and Exxon Mobil (XOM). In 2009, Swift Energy's total proved reserves were comprised of approximately 39% crude oil, 43% natural gas, and 18% natural gas liquids (NGLs).^[1] At the end of 2009, Swift Energy had proved reserves of 112.9 million barrels of oil equivalent (MMBoe) with 50% of proved reserves developed.^[1]

Swift Energy is the largest producer of crude oil in the state of Louisiana. The company has become predominantly an oil producer, with oil constituting 48% of its 2009 domestic production, natural gas constituting 39% of production, and natural gas liquids (NGLs) constituting 13%.^[2] Like many operators of oil and natural gas properties in the U.S., Swift Energy reported a large loss in 2008 and in the first quarter of 2009, totaling $260.49 million and $59.1 million, respectively. The unprofitability of Swift Energy's business was caused by the sharp declines in energy prices in 2008; the aggregate average price of energy (including both oil and natural gas) decreased 58% from $77.80 per barrel of oil equivalent in the first quarter of 2008 to $32.29 in the first quarter of 2009. Swift Energy earns higher revenue on oil and natural gas sold when energy prices are high, so the sharp decline in prices in 2008 and into 2009 substantially reduced the company's revenue. The company also decreased its production volume by 5% in 2008 to 10 MMBoe (million barrels of oil equivalent) due to lower oil and natural gas demand.^[2]

The fall in demand for crude oil is tied to the 2007 Credit Crunch, the 2008 Financial Crisis, and the ensuing recession. When the demand for crude oil fell in the second half of 2008, oil prices fell from a record high of about $147 per barrel to around $50 a barrel in the first quarter of 2009.^[3] However, NYMEX crude oil has stabilized around the $70-80 range, up from its February low of about $42.^[4] Rising oil prices are caused by a variety of factors, including a weak U.S. Dollar (USD), OPEC production quotas, and the rising demand for energy in emerging markets such as China and India.

While oil and gas dominate the world's supply of energy, alternative energies such as wind energy, solar energy, and geothermal energy pose a long-term threat to the oil industry and to Swift Energy's business. At the same time, fossil fuels are estimated to account for 70% to 80% of global energy supply in 2100,^[5] and the comparatively low price of crude oil does not favor the economics of renewable energy, though government subsidies are helping to spur the adoption of alternative energy.

Company Overview

Swift Energy manages the development of its oil wells and supervises well operations and maintenance. The company does not own drilling rigs; instead, independent contractors are hired to provide drilling equipment and personnel. Swift Energy employs drilling, production, and reservoir engineers, geologists, and other specialists who work to improve production rates, increase reserves, and lower the cost of operating oil and natural gas properties.^[6]

Swift Energy does not refine oil or process natural gas.^[6] Once oil and natural gas are extracted from Swift Energy's wells, the company sells these commodities to other energy companies on the open market.^[6] The vast majority of Swift Energy's sales are to two oil majors: Royal Dutch Shell (RDS'A) and Chevron Corporation (CVX). Shell accounted for approximately 48% of Swift Energy's gross oil and gas sales in 2009, while Chevron accounted for 25%.^[1] No other oil company accounted for more than 10% of oil and gas sales for the past two years. Oil produced by Swift Energy is moved from drilling sites via crude oil pipelines, barges, and trucks.^[6] Natural gas is usually delivered to El Paso’s Tennessee Gas Pipeline system and then sold on the spot market.^[6]

Business and Financial Metrics

First Quarter 2010 Performance

Swift Energy announced earnings for the first quarter of $14.2 million compared to a net loss of $59.0 million in the year-ago quarter.^[7] Swift Energy produced 2.04 million barrels of oil equivalent during the first quarter of 2010, a 14% decrease compared to first quarter 2009 production.^[7] First quarter production decreased as a result of limited new drilling activity, freezing problems due to unusually colder temperatures in Louisiana, and unplanned equipment repairs at Lake Washington. Total revenues for the first quarter increased 44% to $109.8 million due to higher commodity prices.^[7]

Effect of the Global Recession and Credit Crisis
Rapidly falling prices for oil and natural gas beginning in the third quarter of 2008 had a significant impact on Swift Energy's cash flows, capital expenditures, and liquidity. Oil and natural gas prices continued to decline during the fourth quarter of 2008, leading to a 49% decline in average prices when compared to average prices received in the third quarter of 2008.^[2] Swift Energy has taken the following steps to mitigate the effects of the recession:

• 2009 capital expenditures were budgeted at $125 million, down from $674.8 million in 2008^[2]
• The company reduced its workforce by 11% (40 employees) to lower general and administrative costs^[8]
• The company adjusted its operations and facility usage levels to reduce lease operating expenses^[2]

Discontinued New Zealand Operations

In June 2008, Swift Energy closed the sale of all of its New Zealand assets for $82.7 million.^[2] As a result of the sale, a third party brought a lawsuit against Swift Energy for breach of a contract related to obtaining their consent to transfer the permit. Pending the outcome of the litigation, Swift Energy deferred the potential gain on the permit sale.^[2]

Key Trends and Forces

Weak demand for oil and natural gas and falling energy prices limit Swift Energy's revenues and profitability

The U.S. Energy Information Administration (EIA) reported that consumption in 2008 of refined products in the United States declined by nearly 6 percent from the 2007 average, representing the largest annual decline since 1980.^[12] This decline, following record-high retail gas prices and crude oil prices during the first half of the year, was prompted by the severe economic downturn in the second half of the year.

However, the EIA now projects that the world oil consumption will grow by 1.6 million barrels per day (bbl/d) in 2010, which would lead to an increase of about $2 per barrel in EIA's projections for West Texas Intermediate (WTI) crude oil spot prices.^[13] EIA expects WTI prices to average about $84 per barrel during the second half of this year, rising to $87 by the end of next year. To date, energy production, shipments, and prices have not been significantly affected by the oil spill following the April 20 explosion aboard the Deepwater Horizon drilling rig and its subsequent loss in the Gulf of Mexico, 50 miles off the Louisiana coast.^[13]

The rise of renewable energy threatens Swift Energy's business model in the long run

Alternative energy has not been widely adopted because it is not yet economically feasible when compared to cheap, plentiful fossil fuels. However, if energy sources such as solar or wind become more economically sound, the negative impact on the oil and gas industry will be immense. Specifically, Swift Energy's revenue is driven by the demand for oil and natural gas by oil companies such as Chevron Corporation (CVX). If the demand for fossil fuels is eventually replaced by the demand for alternative energy, Swift Energy's revenue will decline substantially.

Although infrastructure is being installed for renewable energy and solar power and wind energy are advancing on the technological front, the fall in oil prices after July 2008 has put the economics of renewable energy into question. With energy once again cheap and plentiful, the imperative to develop renewable energy has weakened. On the other hand, concern over global climate change has continued to rise, increasing government support for renewable energy grants and subsidies. For example, President Obama called for the U.S. to double its use of renewable energy by 2012 as part of his plan to stimulate the economy and pull the country out of recession. His plan, which includes up to $800 billion over two years in subsidies and tax cuts for renewable energy, energy efficiency, and electric grid modernization projects, has the potential to pull the industry out of the slump caused by the 2008 Financial Crisis.^[14] Moreover, Obama pushed through a stimulus plan that earmarks $80 billion for green projects, including $7.6 billion in renewable energy loan guarantees and bonds, as well as grants of up to 30% for business/homeowner investments in renewables.^[15] A further $10 billion has been earmarked for energy efficiency, $11 bn for efficient power grid expansion, $6 billion for clean energy research, and $2 billion for hybrid cars.^[16]

While oil and gas dominate the world's supply of energy, alternative energies such as wind energy, solar energy, and geothermal energy pose a long-term threat to the oil industry. On the other hand, some research institutes forecast that fossil fuels will account for 70% to 80% of global energy supply in 2100.^[5] It is clear that fossil fuels are essential to the functioning of the global economy, suggesting the intermediate-term viability of Swift Energy's business model, but the prospect of a transition to alternative energy threatens it in the long-run.

Adverse weather conditions such as hurricanes can potentially devastate Swift Energy's Louisiana and Texas operations

Approximately 49% of Swift Energy's 2008 reserves and 61% of its 2008 production are located in its South Louisiana and Southeast Louisiana core areas.^[2] These areas are vulnerable to hurricanes during the Atlantic hurricane season, which runs from June 1 to November 30.^[17] Increased hurricane activity between 2005 and 2008 resulted in lower production and physical damage to Swift Energy's operations. For example, a significant percentage of the company's production was shut down by Hurricanes Katrina and Rita in 2005, and by Hurricanes Gustav and Ike in 2008.^[18]

In 2008, production decreased 5% to 10.0 MMBoe as a result of production shut-ins necessitated by Hurricanes Gustav and then Ike. Additionally, the effects of the hurricanes were felt through the third and fourth quarters as the drilling and completion of several wells were delayed as the company moved drilling rigs into safe harbor before the hurricanes and then had to return them to the field. Hurricane Ike in mid-September caused damage to several fields in the company's South Louisiana core area and its High Island field due to high water levels.^[2] Swift Energy estimates that the total cost for the replacement of assets, repairs, and clean-up costs related to Hurricanes Gustav and Ike, primarily in the Bay de Chene field, were approximately $25 million.^[2]

Competition

Although the oil industry is dominated by the oil majors, including Chevron Corporation (CVX), CONOCOPHILLIPS (COP), and Exxon Mobil (XOM), 56% of US natural gas and 59% of U.S. oil is produced from companies with under 20 employees, according to the Independent Petroleum Association of America.^[8] Swift Energy's primary competition comes from other small, independent oil and gas companies that develop and operate properties throughout the U.S.

• Rosetta Resources (ROSE) is an independent oil and gas company that develops oil and gas properties in North America. The company’s operations are concentrated in the areas of the Sacramento Basin of California, the Rockies, and South Texas.^[19]
• Delta Petroleum (DPTR) is an independent oil and gas company that develops natural gas and crude oil properties. The company’s core areas of operation are the Rocky Mountain and onshore Gulf Coast regions.^[20]
• Carrizo Oil & Gas (CRZO) is an independent energy company that develops natural gas and oil reserves. The company’s operations are focused on producing natural gas in the Barnett Shale area in North Texas.^[21] It also operates onshore in the Gulf Coast areas of Texas, Louisiana and Alabama. The company also owns property in the United Kingdom and in the North Sea.^[21]
• APCO Argentina (APAGF) is an international oil and gas exploration and production company. Apco has interests in seven oil and gas producing concessions and one exploration permit in Argentina.^[22]

References

1. ↑ ^{1.0 1.1 1.2} Swift Energy 10-K 2009: [Item 1. Business" p. 4
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9} SFY 10-k 2009 "Management's Discussion and Analysis of Financial Condition and Results of Operations" Item 7, p. 30
3. ↑ BBC News: Oil price goes below $50 a barrel
4. ↑ Wikinvest: Oil Prices
5. ↑ ^{5.0 5.1} Peak oil, peak coal, peak gas and projected fossil fuel use
6. ↑ ^{6.0 6.1 6.2 6.3 6.4} SFY 10-k 2009 "Operations" p. 14
7. ↑ ^{7.0 7.1 7.2} Swift Energy: SWIFT ENERGY ANNOUNCES FIRST QUARTER 2010 EARNINGS OF $14.2 MILLION. May 6, 2010
8. ↑ ^{8.0 8.1} Financial Times: Producers run low to beat recession
9. ↑ SFY 10-k 2009 "Estimated Proved Oil and Natural Gas Reserves" p.11
10. ↑ SFY 10-k 2009 "Marketing of Production" p. 16
11. ↑ Swift Energy 2009 Annual Report, p. 8
12. ↑ Chevron Supplement to the 2008 Annual Report, p. 45
13. ↑ ^{13.0 13.1} U.S. Energy Information Administration: "Short-Term Energy Outlook"
14. ↑ SeekingAlpha: "Obama Calls for Doubling Renewable Energy in Three Years"
15. ↑ FT: Fiscal sun shines on renewables groups
16. ↑ FT: Fiscal sun shines on renewables groups
17. ↑ About.com: When is hurricane season?
18. ↑ SFY 10-k 2009 "Risk Factors"
19. ↑ Google Finance: ROSE
20. ↑ ^{20.0 20.1} Google Finance: DPTR
21. ↑ ^{21.0 21.1} Reuters: Carrizo Oil & Gas
22. ↑ Google Finance: APAGF
23. ↑ Google Finance: SFY
24. ↑ ROSE 10-k 2009 "Results of Operations" p. 32
25. ↑ CRZO 10-k 2009 "Oil and Natural Gas Reserves" p. 13
26. ↑ Google Finance: APAGF
27. ↑ APAGF 10-k 2009