Summary of CONCHO RESOURCES INC

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is intended to assist in understanding our business and results of operations together with our present financial condition. This section should be read in conjunction with our historical consolidated financial statements and notes, as well as the selected historical consolidated financial data included in our Annual Report on Form 10-K for the year ended December 31, 2008.
During the third quarter of 2008, we closed a significant acquisition as discussed below. As a result of the acquisition many comparisons between periods will be difficult or impossible.
Statements in this discussion may be forward-looking statements. These forward-looking statements involve risks and uncertainties. We caution that a number of factors could cause future production, revenue and expenses to differ materially from our expectations. See "Cautionary Statement Regarding Forward-Looking Statements."
Overview
We are an independent oil and natural gas company engaged in the acquisition, development, exploitation and exploration of producing oil and natural gas properties. Our operations are primarily focused in the Permian Basin of Southeast New Mexico and West Texas. We have also acquired significant acreage positions in and are actively involved in drilling or participating in drilling in emerging plays located in the Permian Basin of Southeast New Mexico and the Williston Basin in North Dakota, where we are applying horizontal drilling and advanced fracture stimulation techniques. Oil comprised 62.9 percent of our
137.3 MMBoe of estimated net proved reserves at December 31, 2008, and 66.9 percent of our 8.1 MMBoe of production during the nine months ended September 30, 2009. We generally seek to operate the wells in which we own an interest, and we operated wells that accounted for 93.1 percent of our proved developed producing PV-10 at December 31, 2008 and 65.6 percent of our 3,831 gross wells at September 30, 2009. By controlling operations, we believe that we are able to more effectively manage the cost and timing of exploration and development of our properties, including the drilling, completion and stimulation methods used. Commodity prices Factors that may impact future commodity prices, including the price of oil and natural gas, include:
• developments generally impacting the Middle East, including Iraq and Iran;

• the extent to which members of the Organization of Petroleum Exporting Countries and other oil exporting nations are able to continue to manage oil supply through export quotas;

• the overall global demand for oil; and

• overall North American natural gas supply and demand fundamentals, including:

† the impact of the decline of the United States economy,

† weather conditions, and

† liquefied natural gas deliveries to the United States.

Although we cannot predict the occurrence of events that may affect future commodity prices or the degree to which these prices will be affected, the prices for any commodity that we produce will generally approximate current market prices in the geographic region of the production. From time to time, we expect that we may hedge a portion of our commodity price risk to mitigate the impact of price volatility on our business. See Note I of the Condensed Notes to Consolidated Financial Statements included in "Item 1. Consolidated Financial Statements (Unaudited)" for additional information regarding our commodity hedge positions at September 30, 2009.

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Oil prices in 2008 were high and particularly volatile compared to historical prices. In addition, natural gas prices have been subject to significant fluctuations during the past several years. In general, oil and natural gas prices were substantially lower during the comparable periods of 2009 measured against 2008. The following table sets forth the average NYMEX oil and natural gas prices for the three and nine months ended September 30, 2009 and 2008, as well as the high and low NYMEX price for the same periods:

                                                   Three Months Ended September 30,              Nine Months Ended September 30,
                                                     2009                   2008                   2009                   2008

Average NYMEX prices:
Oil (Bbl)                                       $      68.24          $       118.67          $      57.22          $       113.59
Natural gas (MMBtu)                             $       3.42          $         9.02          $       3.90          $         9.74

High / Low NYMEX prices:
Oil (Bbl):
High                                            $      74.37          $       145.29          $      74.37          $       145.29
Low                                             $      59.52          $        91.15          $      33.98          $        86.99

Natural gas (MMBtu):
High                                            $       4.88          $        13.58          $       6.07          $        13.58
Low                                             $       2.51          $         7.22          $       2.51          $         7.22

Further demonstrating the continuing volatility, the NYMEX oil price and NYMEX natural gas price reached highs and lows of $81.37 and $69.57 per Bbl and $5.16 and $4.29 per MMBtu, respectively, during the period from October 1, 2009 to November 2, 2009. At November 2, 2009, the NYMEX oil price and NYMEX natural gas price were $78.13 per Bbl and $4.82 per MMBtu, respectively. 2010 capital budget
On November 5, 2009, our board of directors approved a capital budget for 2010 of approximately $506 million. The capital budget is predicated on us funding it substantially within our cash flow. If commodity prices decline, below those at the time of the capital budget approval, and considering other factors that may change, we expect we would adjust our spending such that we spend substantially within our cash flow. The following is a summary of our 2010 capital budget:

(in millions)                                                                2010 Budget

Drilling and recompletion opportunities in our core operating area          $         383
Projects operated by third parties                                                      8
Emerging plays, acquisition of leasehold acreage and other property
interests, and geological and geophysical                                              82
Maintenance capital in our core operating areas                                        33

Total 2010 capital budget                                                   $         506

Senior Notes Issuance
On September 18, 2009, we issued $300 million in principal amount of 8.625% senior notes due 2017 at 98.578% of par. The 8.625% senior notes will mature on October 1, 2017 and interest is paid in arrears semi-annually on April 1 and October 1 beginning April 1, 2010. We used the net proceeds of $288.2 million (net of related estimated offering costs) to repay a portion of the borrowings under our credit facility. The senior notes are senior unsecured obligations of ours and rank equally in right of payment with all of our other existing and future senior unsecured indebtedness.
We issued the senior notes to (i) extend the maturities of our debt to better match the long-lived nature of our assets, (ii) increase liquidity under our credit facility and (iii) reduce our dependency on bank debt.

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Borrowing base
Pursuant to the terms of our credit facility, our borrowing base was to be reduced by $0.30 for every dollar of new indebtedness evidenced by unsecured senior notes or unsecured senior subordinated notes that we issue. As a result of this provision, the borrowing base under our credit facility would have been reduced by $90 million due to our issuance and sale of the senior notes. However, we received waivers of this provision from lenders representing approximately 95.4% of our borrowing base, resulting in an actual reduction of approximately $4.1 million in our borrowing base, which reduced our borrowing base to $955.9 million.
On October 23, 2009, our borrowing base of $955.9 million was reaffirmed by our lenders under our credit facility. At September 30, 2009, we have $605.9 million of availability under our credit facility based on the reaffirmed borrowing base.
2009 capital budget
On November 6, 2008, our board of directors approved the following capital budget for 2009, predicated on us funding it substantially within our cash flow:

                                                                                           Current 2009
                                                                   Original 2009          Planned Capital
(in millions)                                                         Budget               Expenditures

Drilling and recompletion opportunities in our core
operating area                                                    $           398        $             316
Projects operated by third parties                                              8                        5
Emerging plays, acquisition of leasehold acreage and other
property interests, and geological and geophysical                             72                       60
Maintenance capital in our core operating areas                                22                       19

Total 2009 capital budget                                         $           500        $             400

In January 2009, in light of the significant drop in commodity prices during the fourth quarter of 2008, we took actions to reduce our activities to a level that would allow us to fund our capital expenditures substantially within our cash flow, which at the time resulted in estimated annual capital expenditures of approximately $300 million for 2009. As a result of improved commodity prices, in particular oil prices, we recently increased our estimated capital expenditures for 2009 to approximately $400 million, which we believe we can substantially fund within our cash flow. We will continue to monitor our capital expenditures, at least on a quarterly basis, in relation to our cash flow and expect to adjust our activity and capital spending level based on changes in commodity prices and the cost of goods and services and other considerations. For clarity purposes we view "our" cash flow as our cash flow from operations before changes in working capital, and we include the cash payments/receipts on our derivatives that are included in our investing activities.
During the first nine months of 2009, we incurred approximately $305.5 million of capital expenditures (excluding the effects of asset retirement obligations and adjustments to the acquisition of the Henry Properties). These costs were in line with our cash flows (as described in the previous paragraph) during the period. For the balance of 2009, we expect to use the remaining approximately $94.5 million of our planned capital expenditures to pursue increased opportunities in our core operating areas along with targeted opportunities in our emerging plays.
Henry Entities acquisition
On July 31, 2008, we closed the acquisition of Henry Petroleum LP and certain entities affiliated with Henry Petroleum LP (the "Henry Entities") and additional non-operated interests in oil and natural gas properties from persons affiliated with the Henry Entities. In August 2008 and September 2008, we acquired additional non-operated interests in oil and natural gas properties from persons affiliated with the Henry Entities. The assets acquired in the Henry Entities acquisition, including the additional non-operated interests, are referred to as the "Henry Properties." We paid $583.7 million in cash for the Henry Properties acquisition, which was funded with borrowings under our credit facility, which was amended and restated on July 31, 2008, and net proceeds of approximately $242.4 million from our private placement of 8,302,894 shares of our common stock.
Derivative financial instrument exposure At September 30, 2009, the fair value of our financial derivatives was a net asset of $0.4 million. All of our counterparties to these financial derivatives are parties to our credit facility and have their outstanding debt commitments and derivative exposures collateralized pursuant to our credit facility. Pursuant to the terms of our financial derivative instruments and their collateralization under our credit facility, we do not have exposure to potential "margin calls" on our financial derivative instruments.

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We currently have no reason to believe that our counterparties to these commodity derivative contracts are not financially viable. Our credit facility does not allow us to offset amounts we may owe a lender under our credit facility against amounts we may be owed related to our derivative financial instruments with such party.
New commodity derivative contracts. During the nine months ended September 30, 2009, we entered into additional commodity derivative contracts to economically hedge a portion of our estimated future production. The following table summarizes information about these additional commodity derivative contracts. When aggregating multiple contracts, the weighted average contract price is disclosed.

                                       Aggregate                Index                  Contract
                                        Volume                  Price                   Period

Oil (volumes in Bbls):
Price collar                             600,000        $ 45.00 - $49.00   (a)     3/1/09 - 5/31/09

Price swap                               960,000        $          59.44   (a)    7/1/09 - 12/31/09
Price swap                               273,000        $          67.50   (a)    8/1/09 - 12/31/09
Price swap                             3,307,000        $          63.44   (a)    1/1/10 - 12/31/10
Price swap                             2,601,000        $          71.66   (a)    1/1/11 - 12/31/11

Natural gas (volumes in MMBtus):
Price collar                           1,500,000        $   5.00 - $5.81   (b)    10/1/09 - 12/31/09
Price collar                           1,500,000        $   5.00 - $5.81   (b)     1/1/10 - 3/31/10
Price collar                           3,000,000        $   5.25 - $5.75   (b)     4/1/10 - 9/30/10
Price collar                           1,500,000        $   6.00 - $6.80   (b)    10/1/10 - 12/31/10
Price collar                           1,500,000        $   6.00 - $6.80   (b)     1/1/11 - 3/31/11

Price swap                             3,000,000        $           4.31   (b)     4/1/09 - 9/30/09
Price swap                             1,050,000        $           4.66   (b)    7/1/09 - 12/31/09
Price swap                             6,810,000        $           6.13   (b)    1/1/10 - 12/31/10
Price swap                               300,000        $           7.29   (b)     1/1/11 - 3/31/11
Price swap                             5,400,000        $           6.96   (b)    4/1/11 - 12/31/11

Basis swap                               600,000        $           0.79   (c)     7/1/09 - 9/30/09
Basis swap                               450,000        $           0.89   (c)    10/1/09 - 12/31/09
Basis swap                             8,400,000        $           0.85   (c)    1/1/10 - 12/31/10
Basis swap                             1,800,000        $           0.87   (c)     1/1/11 - 3/31/11
Basis swap                             5,400,000        $           0.76   (c)    4/1/11 - 12/31/11

(a) The index prices for the oil price swaps and collars are based on the NYMEX-West Texas Intermediate monthly average futures price.

(b) The index prices for the natural gas price swaps and collars are based on the NYMEX-Henry Hub last trading day futures price.

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In October 2009, we entered into the following oil and natural gas price swaps to hedge an additional portion of our estimated future production:

                                        Aggregate         Index           Contract
                                         Volume           Price            Period

   Oil (volumes in Bbls):
   Price swap                             540,000     $ 80.33   (a)   1/1/10 - 12/31/10

   Natural gas (volumes in MMBtus):
   Price swap                           1,504,000     $  6.11   (b)   1/1/10 - 12/31/10

(a) The index price for the oil price swap is based on the NYMEX-West Texas Intermediate monthly average futures price.

(b) The index prices for the natural gas price swaps and collars are based on the NYMEX-Henry Hub last trading day futures price.

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Results of Operations
   The following table presents selected volume and price information for the
three and nine months ended September 30, 2009 and 2008:

                                                    Three Months Ended September 30,               Nine Months Ended September 30,
                                                      2009                    2008                   2009                   2008

Net production volumes:
Oil (MBbl)                                               1,912                   1,247                  5,430                  3,033
Natural gas (MMcf)                                       5,753                   3,944                 16,122                 10,395
Total (MBoe)                                             2,871                   1,904                  8,117                  4,766

Average daily production volumes:
Oil (Bbl)                                               20,783                  13,554                 19,890                 11,069
Natural gas (Mcf)                                       62,533                  42,870                 59,055                 37,938
Total (Boe)                                             31,205                  20,699                 29,733                 17,392

Average prices:
Oil, without hedges (Bbl)                       $        63.44          $       114.44          $       53.00          $      110.29
Oil, with hedges(a) (Bbl)                       $        63.44          $       104.73          $       53.00          $       99.51
Natural gas, without hedges (Mcf)               $         5.60          $        10.12          $        4.90          $       10.87
Natural gas, with hedges(a) (Mcf)               $         5.60          $        10.11          $        4.90          $       10.84
Total, without hedges (Boe)                     $        53.46          $        95.91          $       45.19          $       93.89
Total, with hedges(a) (Boe)                     $        53.46          $        89.53          $       45.19          $       86.98

(a) These prices do not reflect the cash receipts/payments related to the oil and natural gas derivatives that were not designated as hedges and are reflected in
(gain) loss on derivatives not designated as hedges in our statements of operations. If the cash receipts/payments related to the oil and natural gas derivatives that were not designated as hedges were included in our oil and natural gas sales our oil and natural gas prices would be as follows:

                                                    Three Months Ended September 30,                  Nine Months Ended September 30,
                                                      2009                     2008                    2009                     2008

Oil (Bbl)                                        $       70.75            $       95.24           $       65.96            $       90.35
Natural gas (Mcf)                                $        6.19            $        9.87           $        5.48            $       10.71
Total (Boe)                                      $       59.51            $       82.81           $       55.00            $       80.86

The presentation above provides the full effect of our oil and natural gas derivatives program without consideration for the financial presentation of the cash receipts/payments from the oil and natural gas derivatives.

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Three months ended September 30, 2009, compared to three months ended September 30, 2008
Oil and natural gas revenues. Revenue from oil and natural gas operations was $153.5 million for the three months ended September 30, 2009, a decrease of $17.0 million (10 percent) from $170.5 million for the three months ended September 30, 2008. This decrease was primarily due to substantial decreases in realized oil and natural gas prices, offset by increased production (i) as a result of the acquisition of the Henry Properties on July 31, 2008 and (ii) due to successful drilling efforts during 2008 and 2009. Specifically, the:
• average realized oil price (after giving effect to hedging activities) was $63.44 per Bbl during the three months ended September 30, 2009, a decrease of 39 percent from $104.73 per Bbl during the three months ended September 30, 2008;
• total oil production was 1,912 MBbl for the three months ended September 30, 2009, an increase of 665 MBbl (53 percent) from 1,247 MBbl for the three months ended September 30, 2008;
• average realized natural gas price (after giving effect to hedging activities) was $5.60 per Mcf during the three months ended September 30, 2009, a decrease of 45 percent from $10.11 per Mcf during the three months ended September 30, 2008; and
• total natural gas production was 5,753 MMcf for the three months ended September 30, 2009, an increase of 1,809 MMcf (46 percent) from 3,944 MMcf for the three months ended September 30, 2008. Hedging activities. The oil and natural gas prices that we report are based on the market price received for the commodities adjusted to give effect to the results of our cash flow hedging activities. We utilize commodity derivative instruments in order to (i) reduce the effect of the volatility of price changes on the commodities we produce and sell, (ii) support our capital budget and expenditure plans and (iii) support the economics associated with acquisitions. Currently, we do not designate our derivative instruments to qualify for hedge accounting. Accordingly, we reflect the changes in the fair value of our derivative instruments in the statements of operations as (gain) loss on derivatives not designated as hedges. All of our remaining hedges that historically qualified or were dedesignated from hedge accounting were settled in 2008. The following is a summary of the effects of commodity hedges that qualify for hedge accounting treatment for the three months ended September 30, 2008:

                                                                       Oil Hedges             Natural Gas Hedges
                                                                   Three Months Ended         Three Months Ended
(dollars in thousands)                                             September 30, 2008         September 30, 2008
Hedging revenue decrease                                             $       (12,111 )        $             (38 )
Hedged volumes (Bbls and MMBtus, respectively)                               239,000                  1,242,000

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Production expenses. The following tables provide the components of our total oil and natural gas production costs for the three months ended September 30, 2009 and 2008:

                                                   Three Months Ended September 30,
                                                     2009                     2008
                                                            Per                      Per
   (in thousands, except per unit amounts)    Amount        Boe        Amount        Boe

   Lease operating expenses                  $  13,573     $ 4.73     $ 12,338     $  6.48
   Taxes:
   Ad valorem                                      954       0.33          792        0.42
   Production                                   10,682       3.72       13,734        7.21
   Workover costs                                  230       0.08          177        0.09

   Total oil and gas production expenses     $  25,439     $ 8.86     $ 27,041     $ 14.20

Among the cost components of production expenses, in general, we have some control over lease operating expenses and workover costs on properties we operate, but production and ad valorem taxes are directly related to commodity price changes.
The lease operating expenses during the third quarter of 2009 include the benefit of approximately $2.3 million ($.79 per Boe) related to overestimate of costs in the prior periods.
Lease operating expenses were $13.6 million ($4.73 per Boe) for the three months ended September 30, 2009, an increase of $1.3 million (11 percent) from $12.3 million ($6.48 per Boe) for the three months ended September 30, 2008. The total increase in absolute amounts, taking into consideration details in the preceding paragraph, in lease operating expenses is due to (i) the wells acquired in the Henry Properties acquisition and (ii) our wells successfully drilled and completed in 2008 and 2009. The decrease in lease operating expenses on a per unit basis, taking into consideration details in the preceding paragraph, is due to (i) increased volumes from our successful drilling program in 2008 and 2009 that has allowed economies of scale in our cost structure and
(ii) cost reductions in the services and supplies primarily as a result of the recently lower commodity prices, offset by the wells acquired in the Henry Properties acquisition, which have a higher per unit cost as compared to our historical per unit cost. Ad valorem taxes have increased primarily as a result of the Henry Properties acquisition, which were highly concentrated in Texas, a state which has a higher ad valorem tax rate than New Mexico, where substantially all of our properties prior to the acquisition were located. Production taxes per unit of production were $3.72 per Boe during the three months ended September 30, 2009, a decrease of 48 percent from $7.21 per Boe during the three months ended September 30, 2008. The decrease is directly related to the decrease in commodity prices offset by the increase in oil and natural gas revenues related to increased production volumes. Over the same period, our Boe prices (before the effects of hedging) decreased 44 percent. Workover expenses were approximately $0.2 million for the three months ended September 30, 2009 and 2008. The 2008 and 2009 amounts related primarily to workovers in our Texas Permian area. Exploration and abandonments expense. The following table provides a . . .