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Switch to natural gas a winner for Callon

One-fifth of production to come from onshore drilling by year’s end

Callon Petroleum’s plan to reinvest revenue generated by its offshore drilling operations into onshore drilling operations has proven to be wise decision.

Fred Callon, Callon’s chairman and CEO, said in a third quarter earnings conference call with analysts last week that onshore drilling represented 16 percent of the company’s overall production at the end of September.

“Production from onshore plays at this time last year was zero (percent),” Callon said. “At the end of the third quarter we were producing 500 barrels of oil equivalent per day from the Permian Basin. We had no shale gas production this time last year. By the end of the third quarter our first Haynesville well was connected and producing approximately 10.5 million cubic feet of natural gas per day on a restricted flow rate.”

Year to date, Natchez-based Callon has drilled 15 wells at its Wolfberry site in the Permian Basin, which straddles West Texas and Southeast New Mexico.

Callon said the wells were drilled to a 100 percent success rate, and nine of them are producing.

“As a result of our successful drilling program, we’ve converted approximately 4.4 million barrels of oil equivalent from probable to proven reserve category, which increased our reserves by 34 percent from year end to 13 million barrels of oil equivalent on Sept. 30,” Callon said on the call. “We are well-positioned to continue funding our 2010 drilling program, internally generate cash flow, as well as look for additional acquisition opportunities in our core onshore areas of operation.”

The wells in the Permian Basin are currently producing 500 barrels of oil equivalent per day. Gary Newberry, Callon’s senior vice president for operations, told analysts on the call that by year’s end, the company hopes that number is up to 750 barrels of oil equivalent per day.

Callon completed its first well in the Haynesville Shale in the Ark-La-Tex region Aug. 30. Production started Sept. 3. The well currently produces 9.6 million cubic feet of natural gas equivalent per day.

“We have no ongoing drilling obligations on our Haynesville lease, which allows the flexibility to divert capital to the Permian Basin until gas prices improve,” Newberry said. Newberry said he would like to see prices reach at least $5 per million British Thermal Units. Natural gas hit that mark late last year and in early 2010. It closed last Tuesday at $3.81 per million BTUs.

On the oil side, Callon has two drilling rigs contracted for the next year — with a strong possibility of that being extended — in the Permian Basin. The second rig was added in mid-October.

With the addition of the second rig, Newberry said Callon’s drilling capacity has risen from three wells every two months to four wells per month.

Adding a third rig is a possibility, but the pumping services industry has been overwhelmed by the explosion in drilling in the Permian Basin, and has not yet caught up to demand.

“If we can see that the service industry is going to expand options to get our wells completed, we will be very aggressively growing in the Permian in 2011,” Newberry said.

For 2010, Callon expects to drill a total between 22 and 23 wells by the end of the year, and a total of 48 wells in 2011.

For the first nine months of 2009, Callon’s average production was 5,220 barrels of oil equivalent per day. For the same period in 2010, that number has dropped to 4,420 barrels, but that loss, Newberry said, has been offset by Callon’s onshore drilling operations.

For all of 2010, Newberry said Callon will produce an average of between 4,500 and 4,800 barrels of oil equivalent per day. By the fourth quarter, more than 20 percent of production is expected to come from onshore drilling.

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