2008 was an extraordinary year for oil and gas producers, including Berry Petroleum Company. The first half of the year saw a rapid increase in commodity prices with crude oil rising to over $140 per barrel and natural gas increasing to over $13 per thousand cubic feet. In the second half of 2008, we saw prices fall faster than they had increased in the first half with both oil and gas prices dropping by 65%.
Through this tumultuous period Berry achieved significant growth in production, cash flow and reserves. Production averaged 32,000 barrels of oil equivalent per day (BOE/D) with increases from developments in our diatomite and Poso Creek assets in California and our Piceance assets in Colorado, as well as our East Texas acquisition. Operating cash flow for 2008 increased by 71% to $410 million due to the Company's 19% production growth and was supported by realized commodity prices which averaged $59.81 per BOE after hedging.
Proved reserves at year-end 2008 increased 45% to 246 million BOE and we replaced over seven times the 11.7 million BOE produced last year. The "all-in" finding and development (F&D) cost, including the East Texas acquisition, was $12.30 per BOE, one of the best among independents.
Despite an overall strong performance in 2008, we also experienced challenges. In addition to the pronounced declines in commodity prices, the United States grappled with economic turbulence in the banking and financial services industries coincident with the Company's acquisition of assets in East Texas. In late December 2008, a local refinery owned by Flying J, to which we had sold our heavy oil production since 2006, declared bankruptcy that forced a shut-in of our California production.
While these events impacted our business and stock price, our focus for the last six months has been to address those issues that we can proactively influence in order to maintain the Company on a firm financial and operational footing.
We point to seven initiatives we have undertaken to reinforce confidence in Berry Petroleum Company and to prepare us for the years to come.
- Reduced Costs
We reduced our development activity sharply late last year as commodity prices declined. We also focused proactively on cost reductions because of the impact that the higher 2008 operating cost structure could have on year-end reserves calculations. For 2009 we are targeting a 20% to 25% reduction in operating, capital and general and administrative costs compared to 2008.
- Secured Refining Contracts
We successfully returned our California operations to full production in early 2009 and marketed our heavy California crude in January, February and March under short-term agreements with a variety of refiners in California. During this time, the price difference between the light oil benchmark (WTI) and California heavy oil decreased to less than $6 per barrel from $14 per barrel. We expect in the near-term to enter into multi-month contracts with several refineries for our California heavy crude sales which we expect will pay a premium to this heavy oil differential.
- Increased Oil Hedges
We increased hedging levels to 90% of our crude production for 2009 such that if WTI crude prices average $40 per barrel, the Company will realize approximately $65.50 per BOE, less differentials. These hedging levels, combined with our crude contracts, make the recent decline in the heavy oil differential even more important to our operating cash flow projections which now approach $200 million for 2009.
- Amended Credit Facility
We quickly took steps to amend our credit facility to ensure that we would remain in compliance with the covenants under the terms of that facility as a result of the $38 million write-off of accounts receivable attributable to the Flying J bankruptcy. This action resulted in a modification of the covenants which improves our financial flexibility to raise capital under the terms of our bank facility including, but not limited to, second lien financing, unsecured debt and other junior debt.
- Hedged Interest Rates
We minimized the effects of increases in interest rates on the rate we pay on our bank debt by locking in LIBOR rates through 2012 in the 2% range using interest rate hedges and swaps.
- Sold DJ Asset
We agreed in the first quarter of 2009 to sell our Denver-Julesburg natural gas assets in Northeastern Colorado for $154 million and upon closing will use the proceeds to pay down bank debt. This move alone will reduce outstanding debt by 12%. We plan to continue to reduce debt in 2009 through payments from operational cash flow.
- Balanced Capital Program
We, with the oversight of the Board, also developed a 2009 capital program that invests in our higher return projects, balances expenditures to be within operating cash flow and produces a projected average of over 30,000 BOE/D
in 2009.
Commodity-based businesses are cyclical by their very nature. Oil and gas prices are at the bottom of the current cycle primarily due to a reduction in demand caused by the deep recession seen around the globe. During such times, we believe the prudent, near-term strategy for Berry Petroleum is to focus on cost reductions, improve our balance sheet, maximize the value of our oil and gas production through marketing and hedging and seek opportunities to optimize our portfolio of assets. We are pleased with the progress being made on all these fronts.
We welcome David Wolf in his role as Executive Vice President and Chief Financial Officer. He brings an intimate knowledge of the credit and capital markets to Berry which is vital in the current environment.
Financial Highlights
The Company earned net income of $134 million or $2.94 per share in 2008 or a 3% increase from last year's net income of $130 million or $2.89 per share.
The full-year results for 2008 include a $12 million loss from the fourth quarter due to a $38 million write-off of receivables from the bankruptcy of Flying J. We also wrote-off certain rig related charges and dry hole expenses in the fourth quarter. For the full-year 2008 these write-offs reduced our net income by approximately $25 million or $0.56 per share. The Flying J bankruptcy accounted for about 85% of this reduction.
Full-year 2008 oil and gas revenues were $698 million with oil revenues contributing $519 million and gas revenues $179 million. Total operating costs for 2008 averaged $38.44 per BOE and our oil and gas operating costs were $17.10 per BOE.
Operational Highlights
Year-end proved reserves totaled 246 million BOE. These reserve additions were driven by $398 million of development capital and $668 million of acquisition capital. The 88 million BOE of proved reserve additions replaced 756% of the Company's 2008 production with 43% of the total being replaced from our development capital for an organic replacement rate of 392%. The quality of our reserves was highlighted by the fact that we had no write-downs from ceiling tests at year-end 2008. The reserve-to-production ratio increased to 19 years.
Diatomite production increased 86% over 2007 to over 1,800 BOE/D, and diatomite proved reserves increased by 160% to over 30 million BOE as a result of drilling 85 development wells, along with additional production history demonstrating ultimate recoveries. Poso Creek production increased 59% to 3,100 BOE/D from a 28-well program and we were able to hold our S. Midway proved reserves flat after production, offsetting a low base decline with improved recovery from deeper zones and the flanks of the field.
Our Piceance production increased 103% to 20,750 Mcf/D and proved reserves increased 80% to 42 million BOE from drilling 72 gross wells and from the active development of the offset operators on our property.
The Company made a significant acquisition of two properties in Limestone and Harrison Counties of East Texas for $668 million, which closed in July 2008, establishing a new core area for Berry.
The assets include over 100 producing natural gas wells on 4,500 acres, and we have identified over 100 additional drilling locations targeting multi-zone stacked-pay opportunities. This is an excellent entry point into a price-favored basin with strong cash margins and excellent potential to grow production with upside exposure to a prolific shale play. The East Texas acquisition added 50 million BOE of proved reserves to our year-end total at an average cost of $13.36 per BOE.
2009 Plans
Our capital budget for 2009 is $100 million and because we operate substantially all of our production, we can manage our spending within cash flows, which we expect to range between $170 million to $200 million. We will invest in our highest return projects and keep operating costs in line with commodity prices as we weather this challenging environment.
Our capital spending in 2009 will be directed largely at our N. Midway diatomite oil development and our East Texas natural gas development. In total the budget division is $51 million in California, $35 million in East Texas and $14 million in the Rockies.
We expect California production to grow, with the diatomite production growth offsetting other heavy oil natural declines. Without significant capital investment in the Piceance we expect production declines in our Rockies natural gas assets.
East Texas production will remain flat with a one rig drilling program. We have completed vertical Haynesville tests in 2008 that demonstrated the productivity of the shale on our properties. We expect to drill our first horizontal Haynesville well by midyear. We are also actively evaluating a Bossier shale horizontal well at our Freestone property.
Summary
Your management and Board are being proactive to ensure that Berry remains well situated to return to growth as the economy and commodity prices begin to recover. We continue to look for reductions in expenses and are striving to realize operating margins better than $25 per BOE as we did in 2004 and 2005 when crude prices were also around $40 to $50 per barrel.
We believe our near-term strategy combined with long-lived assets, a tightening California differential, a solid hedging program and a plan to continue to reduce debt will allow us to negotiate through 2009 successfully and capitalize on the Company's fundamental strengths.
Sincerely,
Martin H. Young Jr.
Chairman of the Board
Robert F. Heinemann
President and CEO
March 18, 2009