SM Energy (SM) set its 2011 capital budget and provided the production guidance, which is 20% higher than 2010’s level.

The company’s board of directors approved an initial total capital budget of $1.04 billion for 2011, with drilling capital budget of $830 million, which is about 80% of the annual capital budget. Of the drilling budget, 60% or $500 million will be used in Eagle Ford shale and 20% or $170 million in the Bakken and Three Forks intervals in the Williston Basin.

The drilling budget also includes $60 million for Granite Wash, $40 million for Permian Basin Oil, $35 million for Haynesville shale and $25 million for Niobrara/Other Oil.

The non-drilling capital outlay is expected to be $210 million, with $80 million for exploration, $65 million for facilities, $30 million for land and seismic, and $35 million for overheads.

The company expects to support its next year’s capital program with cash flow from operations, proceeds from planned divestiture activities, as well as borrowings under its existing credit facility, if required. The capital program mainly aims at major hydrocarbon ventures that are expected to generate significant returns to shareholders. Additionally, the company will likely invest prudently in natural gas and exploration projects for future inventory.

Importantly, SM Energy also provided its next year’s production guidance in the range of 128–132 billion cubic feet equivalent (Bcfe), up 20% from this year’s target of 106.5–109 Bcfe.

In the Eagle Ford shale, the company’s partner Anadarko Petroleum Co. (APC) will operate ten rigs for 2011, instead of seven rigs that it currently operates in the region. Recently, SM Energy increased its takeaway capacity from 80 million cubic feet per day (MMcf/d) to 100 MMcf/d, and is expected to increase again to 150 MMcf/d, by mid-2011. The company also planned to divest or go for joint venture for a portion of its Eagle Ford shale acreage in the first half of 2011.

SM Energy is increasing its focus in its Eagle Ford, Bakken and Granite Wash plays. Development of the Eagle Ford Shale is an important part of the company’s goal to increase stockholder value. We believe that the company’s emerging core portfolio is a positive catalyst for visible organic growth over the next several years. The company holds a Zacks #1 Rank, which is equivalent to our short-term Strong Buy rating.

With better-than-expected third-quarter 2010 results and an improved guidance for 2011 based on increased spending in the Eagle Ford, we view SM Energy as one of the most attractive players in the E&P space. However, our long-term Neutral recommendation is due to the company’s natural gas-weighted reserves. The company derives a significant portion of its operating revenues from natural gas. Consequently, it may face headwinds in this sector in the near term on the back of struggling commodity prices.

 
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