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Southwestern roars back to drilling with 5-rig restart; shares shoot up

After idling nearly 40% of its workforce and laying down allits drilling rigs in January, shale gas driller dramaticallyannounced its return to the E&P game.

The news came as Southwestern reported an adjustedsecond-quarter EPS loss of 9 cents, a penny better than S&P Capital IQ'sconsensus expectation. Investors liked what theyheard, and shares in the independent producer soared as high as 12%, to $14.82,on July 22. The shares closed at $14.47, up 9.5% on the day.

Southwestern decided to double its 2016 drilling budget to$750 million and stand up five rigs: two in the southwest Marcellus Shale, twoin the northeast Marcellus and one in Arkansas' Fayetteville Shale.Southwestern said the move would allow it to capture the $3/MMBtu-plus gasprices predicted for 2017.

"These achievements position the company to capture thebenefits of a strengthening commodity price of that appears to be in process,"CEO William Way told analysts on Southwestern's earnings conference call July22. "Based on this strong operational performance and our high-qualityassets, improved commodity prices, a stronger balance sheet — including thepreservation of our strong liquidity position and funds earmarked from ourequity offering — we are re-initiating economic drilling and completionactivities in each of our operating areas."

Way promised that Southwestern would not chase unprofitablewells and had locked in enough takeaway capacity in the Marcellus to get gas tomarket.

"We will not chase uneconomic production growth,"Way said. "In line with our intent to invest within cash flow and drivecontinued improvement in the balance sheet, we will remain flexible and adjustactivities accordingly as prices move."

Jefferies LLC analyst Jonathan Wolff was quick to praise thenews. "Recent steps toimprove [Southwestern]'s balance sheet and liquidity have includeda West Virginia acreage sale, the restructuring of its bank lending arrangement(to secured) and a large equityoffering," he said after the earnings release late on July 21."Tough times remain, but we agree with tonight's decision to significantlyincrease investment (from 0 to 5 rigs) in order to maintain its long-termvalue."

Analysts at Tudor Pickering Holt & Co. saidSouthwestern's move is a precursor for similar ones by , which for themost part have spent the first half of the year spending little while waitingfor commodity prices to improve.

"Positive to see a top gas beta pick accelerating intoimproving commodity prices, a sign of things to come from northeastpeers," Tudor Pickering Holt said July 22. "Given (i) FY'16 strip hasimproved nearly 20% since the initial budget was set and (ii) the now-consensusview that [Henry Hub prices] will spike considerably entering 2017, returningto the drill bit is the right move in our view and is the first of manynortheast E&P guidance raises to come this earnings season."

On a GAAP basis, Southwestern lost $620 million, or $1.61per diluted share, in the second quarter, an improvement over the $815 million,or $2.13 per share, loss from the same period a year ago. After charges thatincluded a $470 million write-down in the value of its reserves, Southwestern'sadjusted losses were $34 million, compared to adjusted losses of $9 million, or2 cents per share, a year ago.

Production dropped 8% year over year in the second quarter,to 225 Bcfe, with 96 Bcf from the Fayetteville Shale, 90 Bcf from the northeastMarcellus and 38 Bcfe from southwest Appalachia.

The company's average realized price for natural gas was$1.32/Mcf, including hedges, a 41% drop from the $2.23/Mcf realized in thesecond quarter of 2015. Southwestern reported costs of $1.52/Mcf in the secondquarter of 2016, a slight improvement over the year prior.