| SOUTHWESTERN ENERGY CO ITEM 1A RISK FACTORS In addition to the other information included in this Form 10-K, the following risk factors should be considered in evaluating our business and future prospects |
| The risk factors described below are not necessarily exhaustive and investors are encouraged to perform their own investigation with respect to us and our business |
| Investors should also read the other information included in this Form 10-K, including our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations - - Forward-Looking Information |
| Volatility in natural gas and oil prices can adversely affect our results and the price of our common stock |
| This volatility also makes valuation of natural gas and oil producing properties difficult and can disrupt markets |
| Natural gas and oil prices have historically been, and are likely to continue to be, volatile |
| The prices for natural gas and oil are subject to wide fluctuation in response to a number of factors, including: · relatively minor changes in the supply of and demand for natural gas and oil; · market uncertainty; · worldwide economic conditions; · weather conditions; · import prices; · political conditions in major oil producing regions, especially the Middle East; · actions taken by OPEC; · competition from other sources of energy; and · economic, political and regulatory developments |
| Price volatility makes it difficult to budget and project the return on exploration and development projects involving our natural gas and oil properties and to estimate with precision the value of producing properties that we may own or propose to acquire |
| In addition, unusually volatile prices often disrupt the market for natural gas and oil properties, as buyers and sellers have more difficulty agreeing on the purchase price of properties |
| Our quarterly results of operations may fluctuate significantly as a result of, among other things, variations in natural gas and oil prices and production performance |
| In recent years, natural gas and oil price volatility has become increasingly severe |
| A substantial or extended decline in natural gas and oil prices would have a material adverse affect on us |
| Natural gas and oil prices have recently been at or near their highest historical levels |
| A substantial or extended decline in natural gas and oil prices would have a material adverse effect on our financial position, our results of operations, our access to capital and the quantities of natural gas and oil that may be economically produced by us |
| A significant decrease in price levels for an extended period would negatively affect us in several ways including: · our cash flow would be reduced, decreasing funds available for capital expenditures employed to replace reserves or increase production; · certain reserves would no longer be economic to produce, leading to both lower proved reserves and cash flow; and · access to other sources of capital, such as equity or long-term debt markets, could be severely limited or unavailable |
| Consequently, our revenues and profitability would suffer |
| Lower natural gas and oil prices may cause us to record ceiling test write-downs |
| We use the full cost method of accounting for our natural gas and oil operations |
| Accordingly, we capitalize the cost to acquire, explore for and develop natural gas and oil properties |
| Under the full cost accounting rules of the SEC, the capitalized costs of natural gas and oil properties - net of accumulated depreciation, depletion and amortization, and deferred income taxes - may not exceed a “ceiling limit |
| ” This is equal to the present value of estimated future net cash 24 SWN _________________________________________________________________ [103]Table of Contents flows from proved natural gas and oil reserves, discounted at 10 percent, plus the lower of cost or fair value of unproved properties included in the costs being amortized, net of related tax effects |
| These rules generally require pricing future natural gas and oil production at the unescalated natural gas and oil prices in effect at the end of each fiscal quarter, including the impact of derivatives qualifying as hedges |
| They also require a write-down if the ceiling limit is exceeded, even if prices declined for only a short period of time |
| If natural gas and oil prices fall significantly, a write-down may occur |
| Write-downs required by these rules do not impact cash flow from operating activities but do reduce net income and shareholders &apos equity |
| We may have difficulty financing our planned capital expenditures which could adversely affect our growth |
| We have experienced and expect to continue to experience substantial capital expenditure and working capital needs, particularly as a result of our drilling program |
| Our planned capital expenditures for 2006 are expected to significantly exceed the net cash generated by our operations |
| We expect to borrow under our credit facility to fund capital expenditures that are in excess of our net cash flow and the remaining proceeds of our 2005 equity offering |
| Our ability to borrow under our credit facility is subject to certain conditions |
| At December 31, 2005, we were in compliance with the borrowing conditions of our credit facility |
| If we are not in compliance with the terms of our credit facility in the future, we may not be able to borrow under it to fund our capital expenditures |
| We also cannot be certain that other additional financing will be available to us on acceptable terms or at all |
| In the event additional capital resources are unavailable, we may curtail our drilling, development and other activities or be forced to sell some of our assets on an untimely or unfavorable basis |
| Any such curtailment or sale could have a material adverse effect on our results and future operations |
| Although our estimated natural gas and oil reserve data is independently audited, our estimates may still prove to be inaccurate |
| Our reserve data represents the estimates of our reservoir engineers made under the supervision of our management |
| Our reserve estimates are audited each year by Netherland, Sewell & Associates, Inc, an independent petroleum engineering firm |
| In conducting its audit, the engineers and geologists of Netherland, Sewell & Associates study our major properties in detail and independently develop reserve estimates |
| may differ significantly on an individual property basis from our estimates |
| When, in the aggregate, such differences are within 10prca, Netherland, Sewell & Associates, Inc |
| is generally satisfied that the estimates of proved reserves are reasonable |
| Reserve estimates are prepared for each of our properties annually by the reservoir engineers assigned to the asset management team in the geographic locations in which the property is located |
| These estimates are reviewed by senior engineers who are not part of the asset management teams and by the president of our E&P subsidiaries |
| There are numerous uncertainties and risks that are inherent in estimating quantities of natural gas and oil reserves and projecting future rates of production and timing of development expenditures as many factors are beyond our control |
| We incorporate many factors and assumptions into our estimates including: · expected reservoir characteristics based on geological, geophysical and engineering assessments; · future production rates based on historical performance and expected future operating and investment activities; · future oil and gas prices and quality and locational differentials; and · future development and operating costs |
| Although we believe our assumptions are reasonable based on the information available to us at the time we prepare our estimates, our actual results could vary considerably from estimated quantities of proved natural gas and oil reserves (in the aggregate and for a particular geographic location), production, revenues, taxes and development and operating expenditures |
| In addition, our estimates of reserves may be subject to downward or upward revision based upon production history, results of future exploration and development, prevailing natural gas and oil prices, operating and development costs and other factors |
| In 2003, reserves were revised downward by 15dtta5 Bcfe due to poorer-than-expected well performance related to our South Louisiana properties |
| In 2004, the reserves were also revised downward by 12dtta7 Bcfe due primarily to slightly higher decline rates related to some of the wells in our Overton Field in East Texas |
| In 200 5, our reserves were revised downward by 31dtta7 Bcfe, primarily due to continued unexpected declines associated with our Gulf Coast properties and minor changes to decline rates for our wells at the Overton Field |
| These revisions represented no 25 SWN _________________________________________________________________ [104]Table of Contents greater than 4prca of our total reserve estimates in each of these years, which we believe is indicative of the effectiveness of our internal controls |
| Because we review our reserve projections for every property at the end of every year, any material change in a reserve estimate is included in subsequent reserve reports |
| Finally, recovery of undeveloped reserves generally requires significant capital expenditures and successful drilling operations |
| At December 31, 2005, approximately 27prca of our estimated proved reserves were undeveloped |
| Our reserve data assume that we can and will make these expenditures and conduct these operations successfully, which may not occur |
| Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations - - Forward-Looking Information” in Item 7A of Part II of this Form 10-K for additional information regarding the uncertainty of reserve estimates |
| Our future level of indebtedness may adversely affect operations and limit our growth |
| At December 31, 2005, we had long-term indebtedness of dlra100dtta0 million, excluding our several guarantee of NOARK’s debt obligation, none of which was indebtedness under our revolving credit facility |
| As of February 20, 2006, no bank indebtedness was outstanding under our existing dlra500 million revolving credit facility |
| However, as indicated in the risk factor headed “We may have difficulty financing our planned capital expenditures which could adversely affect our growth” above, we also expect to incur significant additional indebtedness in order to fund a portion of capital expenditures in 2006 |
| The terms of the indenture relating to our outstanding senior notes and our revolving credit facility impose significant restrictions on our ability and, in some cases, the ability of our subsidiaries to take a number of actions that we may otherwise desire to take, including: · incurring additional debt, including guarantees of indebtedness; · redeeming stock or redeeming debt; · making investments; · creating liens on our assets; and · selling assets |
| Our level of indebtedness, and the covenants contained in the agreements governing our debt, could have important consequences for our operations, including: · requiring us to dedicate a substantial portion of our cash flow from operations to required payments on debt, thereby reducing the availability of cash flow for working capital, capital expenditures and other general business activities; · limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions and general corporate and other activities; · limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and · detracting from our ability to successfully withstand a downturn in our business or the economy generally |
| Our ability to comply with the covenants and other restrictions in the agreements governing our debt may be affected by events beyond our control, including prevailing economic and financial conditions |
| If we fail to comply with the covenants and other restrictions, it could lead to an event of default and the acceleration of our repayment of outstanding debt |
| We may not have sufficient funds to make such repayments |
| If we are unable to repay our debt out of cash on hand, we could attempt to refinance such debt, sell assets or repay such debt with the proceeds from an equity offering |
| We cannot assure you that we will be able to generate sufficient cash flow to pay the interest on our debt or that future borrowings, equity financings or proceeds from the sale of assets will be available to pay or refinance such debt |
| The terms of our debt, including our credit facility and our indentures, may also pr ohibit us from taking such actions |
| Factors that will affect our ability to raise cash through an offering of our capital stock, a refinancing of our debt or a sale of assets include financial market conditions and our market value and operating performance at the time of such offering or other financing |
| We cannot assure you that any such proposed offering, refinancing or sale of assets can be successfully completed or, if completed, that the terms will be favorable to us |
| 26 SWN _________________________________________________________________ [105]Table of Contents If we fail to find or acquire additional reserves, our reserves and production will decline materially from their current levels |
| The rate of production from natural gas and oil properties generally declines as reserves are depleted |
| Except to the extent that we acquire additional properties containing proved reserves, conduct successful exploration and development activities, successfully apply new technologies or, through engineering studies, identify additional behind-pipe zones or secondary recovery reserves, our proved reserves will decline materially as reserves are produced |
| Future natural gas and oil production is, therefore, highly dependent upon our level of success in acquiring or finding additional reserves |
| Our drilling plans for the Fayetteville Shale play are subject to change |
| As of December 31, 2005, we have spud 88 wells relating to our Fayetteville Shale play |
| The wells were drilled in areas that represent a very small sample of our large acreage position |
| Our drilling plans with respect to our Fayetteville Shale play are flexible and are dependent upon a number of factors, including the extent to which we can replicate the results of our most successful Fayetteville Shale wells on our other Fayetteville Shale acreage as well as the natural gas and oil commodity price environment |
| The determination as to whether we continue to drill prospects in the Fayetteville Shale may depend on any one or more of the following factors: · our ability to determine the most effective and economic fracture stimulation for the Fayetteville Shale formation; · material changes in natural gas prices; · changes in the estimates of costs to drill or complete wells; · the extent of our success in drilling and completing horizontal wells; · our ability to reduce our exposure to costs and drilling risks; · the costs and availability of drilling equipment; · success or failure of wells drilled in similar formations or which would use the same production facilities; · receipt of additional seismic or other geologic data or reprocessing of existing data; · the extent to which we are able to effectively operate the drillings rigs we acquire; or · availability and cost of capital |
| We continue to gather data about our prospects in the Fayetteville Shale, and it is possible that additional information may cause us to alter our drilling schedule or determine that prospects in some portion of our acreage position should not be pursued at all |
| We may have difficulty drilling all of the wells that are necessary to hold our Fayetteville Shale acreage before the initial lease terms expire, which could result in the loss of certain leasehold rights |
| Approximately 25cmam737 net acres of our Fayetteville Shale acreage will expire in the next three years if we do not drill successful wells to develop the acreage or otherwise take action to extend the leases |
| As discussed above under “Our drilling plans for the Fayetteville Shale play are subject to change,” our ability to drill wells may depend on a number of factors, including certain factors that are beyond our control |
| The number of wells we will be required to drill to retain our leasehold rights will be determined by field rules established by the Arkansas Oil and Gas Commission or the AOGC Through February 20, 2006, the AOGC has approved field rules for five of our fields in the Fayetteville Shale play, establishing drilling units of 640 acres and well spacing requirements within each drilling unit of 560 feet minimum distance between completions in common sources of supply within the Fayetteville Shale formation, up to a maximum of 25 wells per drilling unit |
| There can be no assurance that we will be successful in obtaining the same size drilling unit or the same spacing within each drilling unit in the field rules for our other pilot areas or for our other Fayetteville Shale acreage as a whole |
| To the extent that the field rules for our other pilot areas or our other Fayetteville Shale acreage are less favorable, we may not be able to drill the wells required to maintain our leasehold rights for certain of our Fayetteville Shale acreage |
| If our Fayetteville Shale drilling program fails to produce a significant supply of natural gas, our investments in our gas gathering operations could be lost, which could have an adverse effect on our results of operations, financial condition and cash flows |
| 27 SWN _________________________________________________________________ [106]Table of Contents As of December 31, 2005, we had invested approximately dlra15dtta8 million in our gas gathering operations and we intend to invest approximately dlra37dtta5 million in 2006 |
| Our gas gathering business will largely rely on gas sourced in our Fayetteville Shale play area in Arkansas |
| If our Fayetteville Shale drilling program fails to produce a significant supply of natural gas, our investments in our gas gathering operations could be lost, which could have an adverse effect on our results of operations, financial condition and cash flows |
| Our exploration, development and drilling efforts and our operations of our wells may not be profitable or achieve our targeted returns |
| We require significant amounts of undeveloped leasehold acreage in order to further our development efforts |
| Exploration, development, drilling and production activities are subject to many risks, including the risk that no commercially productive reservoirs will be discovered |
| We invest in property, including undeveloped leasehold acreage that we believe will result in projects that will add value over time |
| However, we cannot assure you that all prospects will result in viable projects or that we will not abandon our initial investments |
| Additionally, there can be no assurance that leasehold acreage acquired by us will be profitably developed, that new wells drilled by us in prospects that we pursue will be productive or that we will recover all or any portion of our investment in such leasehold acreage or wells |
| In addition, wells that are profitable may not achieve our targeted rate of return |
| Our ability to achieve our target PVI results are dependent upon the current and future market prices for natural gas and crude oil, costs associated with producing natural gas and crude oil and our ability to add reserves at an acceptable cost |
| We rely to a significant extent on seismic data and other advanced technologies in identifying leasehold acreage prospects and in conducting our exploration activities |
| The seismic data and other technologies we use do not allow us to know conclusively prior to acquisition of leasehold acreage or drilling a well whether natural gas or oil is present or may be produced economically |
| The use of seismic data and other technologies also requires greater pre-drilling expenditures than traditional drilling strategies |
| In addition, we may not be successful in implementing our business strategy of controlling and reducing our drilling and production costs in order to improve our overall return |
| The cost of drilling, completing and operating a well is often uncertain, and cost factors can adversely affect the economics of a project |
| Further, our drilling operations may be curtailed, delayed or canceled as a result of numerous factors, including unexpected drilling conditions, title problems, pressure or irregularities in formations, equipment failures or accidents, adverse weather conditions, environmental and other governmental requirements and the cost of, or shortages or delays in the availability of, drilling rigs, equipment and services |
| We incur substantial costs to comply with government regulations, especially regulations relating to environmental protection, and could incur even greater costs in the future |
| Our exploration, production, development and gas distribution and marketing operations are regulated extensively at the federal, state and local levels |
| We have made and will continue to make large expenditures in our efforts to comply with these regulations, including environmental regulation |
| The natural gas and oil regulatory environment could change in ways that might substantially increase these costs |
| Hydrocarbon-producing states regulate conservation practices and the protection of correlative rights |
| These regulations affect our operations and limit the quantity of hydrocarbons we may produce and sell |
| In addition, at the US federal level, the Federal Energy Regulatory Commission regulates interstate transportation of natural gas under the Natural Gas Act |
| Other regulated matters include marketing, pricing, transportation and valuation of royalty payments |
| As an owner or lessee and operator of natural gas and oil properties, and an owner of gas gathering, transmission and distribution systems, we are subject to various federal, state and local regulations relating to discharge of materials into, and protection of, the environment |
| These regulations may, among other things, impose liability on us for the cost of pollution clean-up resulting from operations, subject us to liability for pollution damages, and require suspension or cessation of operations in affected areas |
| Changes in or additions to regulations regarding the protection of the environment could significantly increase our costs of compliance, or otherwise adversely affect our business |
| One of the responsibilities of owning and operating natural gas and oil properties is paying for the cost of abandonment |
| Effective January 1, 2003, companies were required to reflect abandonment costs as a liability on their balance sheets |
| We may incur significant abandonment costs in the future which could adversely affect our financial results |
| 28 SWN _________________________________________________________________ [107]Table of Contents Natural gas and oil drilling and producing operations involve various risks |
| Our operations are subject to all the risks normally incident to the operation and development of natural gas and oil properties and the drilling of natural gas and oil wells, including encountering well blowouts, cratering and explosions, pipe failure, fires, formations with abnormal pressures, uncontrollable flows of oil, natural gas, brine or well fluids, release of contaminants into the environment and other environmental hazards and risks |
| We maintain insurance against many potential losses or liabilities arising from our operations in accordance with customary industry practices and in amounts that we believe to be prudent |
| However, our insurance does not protect us against all operational risks |
| For example, we do not maintain business interruption insurance |
| Additionally, pollution and environmental risks generally are not fully insurable |
| These risks could give rise to significant costs not covered by insurance that could have a material adverse effect upon our financial results |
| We cannot control activities on properties we do not operate |
| Failure to fund capital expenditure requirements may result in reduction or forfeiture of our interests in some of our non-operated projects |
| We do not operate some of the properties in which we have an interest and we have limited ability to exercise influence over operations for these properties or their associated costs |
| Approximately 22prca of our gas and oil properties, based on PV10 value, are operated by other companies |
| Our dependence on the operator and other working interest owners for these projects and our limited ability to influence operations and associated costs could materially adversely affect the realization of our targeted returns on capital in drilling or acquisition activities and our targeted production growth rate |
| The success and timing of drilling, development and exploitation activities on properties operated by others depend on a number of factors that are beyond our control, including the operatorapstas expertise and financial resources, approval of other participants for drilling wells and utilization of technology |
| When we are not the majority owner or operator of a particular natural gas or oil project, we may have no control over the timing or amount of capital expenditures associated with such project |
| If we are not willing or able to fund our capital expenditures relating to such projects when required by the majority owner or operator, our interests in these projects may be reduced or forfeited |
| Shortages of oil field equipment, services and qualified personnel could adversely affect our results of operations |
| The demand for qualified and experienced field personnel to drill wells and conduct field operations, geologists, geophysicists, engineers and other professionals in the natural gas and oil industry can fluctuate significantly, often in correlation with natural gas and oil prices, causing periodic shortages |
| There have also been shortages of drilling rigs and other equipment, as demand for rigs and equipment has increased along with the number of wells being drilled |
| These factors also cause significant increases in costs for equipment, services and personnel |
| Higher natural gas and oil prices generally stimulate increased demand and result in increased prices for drilling rigs, crews and associated supplies, equipment and services |
| We cannot be certain when we will experience shortages or price increases, which could adversely affect our profit margin, cash flow and operating results or restrict our ability to drill wells and conduct ordinary operations |
| Our business could be adversely affected by competition with other companies |
| The natural gas and oil industry is highly competitive, and our business could be adversely affected by companies that are in a better competitive position |
| As an independent natural gas and oil company, we frequently compete for reserve acquisitions, exploration leases, licenses, concessions, marketing agreements, equipment and labor against companies with financial and other resources substantially larger than we possess |
| Many of our competitors may be able to pay more for exploratory prospects and productive natural gas and oil properties and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than we can |
| Our ability to explore for natural gas and oil prospects and to acquire additional properties in the future will depend on our ability to conduct operations, to evaluate and select suitable properties and to consummate transactions in this highly competitive envi ronment |
| In addition, many of our competitors have been operating in some of our core areas for a much longer time than we have or have established strategic long-term positions in geographic regions in which we may seek new entry |
| We have recently made significant investments in our drilling rig operations; however, we are still dependent on third party drilling companies |
| We also lack experience in owning and operating drilling rigs |
| We have recently made significant investments in commencing our drilling rig operations, including commitments to purchase ten drilling rigs and hiring, as of December 31, 2005, 45 new employees for our drilling 29 SWN _________________________________________________________________ [108]Table of Contents subsidiary, DeSoto Drilling, Inc, or DDI We expect DDI to have a total of approximately 275 employees by year end 2006 |
| The ten drilling rigs will not be sufficient to meet the needs of our drilling program and we will still be dependent upon third party rig providers in order to execute our drilling program in 2006 and beyond |
| There can be no assurance that the commencement of our drilling rig operations will not have an adverse effect on our relationships with our existing third party rig providers or our ability to secure third party rigs from other providers |
| We may also compete with third party rig providers for qualified personnel, which could adversely affect our relationships with rig providers |
| If our existing third party rig providers discontinue their relationships with us, we may not be able to secure alternative rigs on a timely basis, or at all |
| Even if we are able to secure alternative rigs, there can be no assurance that replacement rigs will be of equivalent quality or that pricing and other terms will be favorable to us |
| If we are unable to secure third party rigs or if the terms are not favorable to us, our financial condition and results of operations could be adversely affected |
| We cannot assure you that we will be able to attract and retain qualified field personnel to operate our drilling rigs or to otherwise effectively conduct our drilling operations |
| If we are unable to retain qualified personnel or to effectively conduct our drilling operations, our financial and operating results may be adversely affected |
| We depend upon our management team and our operations require us to attract and retain experienced technical personnel |
| The successful implementation of our business strategy and handling of other issues integral to the fulfillment of our business strategy depends, in part, on our experienced management team, as well as certain key geoscientists, geologists, engineers and other professionals employed by us |
| The loss of key members of our management team or other highly qualified technical professionals could have a material adverse effect on our business, financial condition and operating results |
| Our hedging activities may prevent us from benefiting from price increases and may expose us to other risks |
| To reduce our exposure to fluctuations in the prices of natural gas and oil, we enter into hedging arrangements with respect to a portion of our expected production |
| As of December 31, 2005, we had hedges on approximately 70prca to 75prca of our targeted 2006 natural gas production and approximately 15prca to 20prca of our targeted 2006 oil production |
| Our price risk management activities reduced revenues by dlra77dtta2 million in 2005, dlra35dtta6 million in 2004 and dlra37dtta4 million in 2003 |
| To the extent that we engage in hedging activities, we may be prevented from realizing the benefits of price increases above the levels of the hedges |
| In addition, such transactions may expose us to the risk of financial loss in certain circumstances, including instances in which: · our production is less than expected; · there is a widening of price differentials between delivery points for our production and the delivery point assumed in the hedge arrangement; · the counterparties to our futures contracts fail to perform the contracts; or · a sudden, unexpected event materially impacts natural gas or oil prices |
| In addition, future market price volatility could create significant changes to the hedge positions recorded on our financial statements |
| We refer you to “Quantitative and Qualitative Disclosures about Market Risk” in Item 7A of Part II of this Form 10-K |