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Southwestern's Fayetteville Shale exit goes over poorly in the stock market

Southwestern Energy Co.'s $1.87 billion sale of its Fayetteville Shale operations did not go down well with investors, who want to see more debt reduction from oil and gas drillers instead of outspending cash flow for production growth.

In a Sept. 4 announcement, Southwestern said it is exiting the Fayetteville Shale in Arkansas and Oklahoma, a play it pioneered more than a decade ago, with an agreement to sell its exploration and production and associated midstream gathering assets in the area to a private equity-backed company. The buyer, Flywheel Energy LLC, is backed through Kayne Anderson Capital Advisors LP's Kayne Private Energy Income Fund LP.

The sale is part of the company's repositioning to focus on "higher margin" Appalachian assets, Southwestern President and CEO Bill Way said in a Sept. 4 news release. An increased investment in liquids-rich areas would help Southwestern achieve self-funded production growth, the company said.

Southwestern's shares fell 5% in heavier-than-normal trading, to $5.34, on the day of the announcement. The stock then fell much of the rest of the week, and was trading at $4.86 per share late in the afternoon on Sept. 7. While the purchase price came close to analysts' expectations, Southwestern's plans to use $600 million of the proceeds to expand gas and liquids production might have disappointed some.

"Proceeds will be used to reduce debt ($900 million), repurchase shares ($200 million), and accelerate activity in SW Appalachia ($600 million)," Jefferies LLC oil and gas analyst Zach Parham wrote as he outlined the deal for his clients. "While getting a sale completed in a tough market for gas assets will likely be viewed positively, we believe investors may have wanted more debt reduction/cash return versus utilizing proceeds to outspend cash flow to drive additional growth."

B. Riley FBR Inc. oil and gas analyst Rehan Rashid said the purchase price was a little light, but paying off $900 million in debt gives Southwestern a lot more flexibility for its future in Appalachia. "We believe that this is still a very good outcome for corporate capital structure and should allow for stronger enterprise and investor focus on growth/value maximization of Appalachian assets and equity valuation," Rashid said.

With Southwestern's northeast and southwest Pennsylvania shale operations at neutral cash flows, Rashid argued, the company can grow production cheaply and direct that cash to further buybacks or debt reduction.

Other Appalachian producers are also growing their production, with Utica Shale gas from three counties and five producers leading Ohio's 50% year-over-year increase in production to 6.4 Bcf/d in the second quarter. The state's top five producers, led by Ascent Resources, accounted for 75% of the state's shale gas production.

Jefferson County wells, which tripled production compared to the 2017 second quarter, are split almost exactly in half between two drillers, Ascent and Chesapeake Energy Corp. Ascent more than doubled production in a year and continued to widen its lead over rival Gulfport Energy Corp. as Ohio's top Utica Shale producer by volume.