The following discussion is intended to provide information relevant to an understanding of our financial condition, changes in our financial condition and our results of operations and cash flows and should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and in our Form 10-K for the year ended December 31, 2008. Unless the context otherwise requires, references to "CWEI" mean Clayton Williams Energy, Inc., the parent company, and references to the "Company", "we", "us" or "our" mean Clayton Williams Energy, Inc. and its consolidated subsidiaries.

Forward-Looking Statements

The information in this Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical or current facts, that address activities, events, outcomes and other matters that we plan, expect, intend, assume, believe, budget, predict, forecast, project, estimate or anticipate (and other similar expressions) will, should or may occur in the future are forward-looking statements. These forward-looking statements are based on management's current belief, based on currently available information, as to the outcome and timing of future events. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in our Form 10-K for the year ended December 31, 2008, in our Form 10-Qs for the quarterly periods ended March 31, 2009 and June 30, 2009 and in this Form 10-Q.

Forward-looking statements appear in a number of places and include statements with respect to, among other things:

• estimates of our oil and gas reserves;

• estimates of our future oil and gas production, including estimates of any increases or decreases in production;

• planned capital expenditures and the availability of capital resources to fund those expenditures;

• our outlook on oil and gas prices;

• our outlook on domestic and worldwide economic conditions;

• our access to capital and our anticipated liquidity;

• our future business strategy and other plans and objectives for future operations;

• the impact of political and regulatory developments;

• our assessment of counterparty risks and the ability of our counterparties to perform their future obligations;

• estimates of the impact of new accounting pronouncements on earnings in future periods; and

• our future financial condition or results of operations and our future revenues and expenses.

We caution you that these forward-looking statements are subject to all of the risks and uncertainties, many of which are beyond our control, incident to the exploration for and development, production and marketing of oil and gas. These risks include, but are not limited to:

• the possibility of unsuccessful exploration and development drilling activities;

• our ability to replace and sustain production;

• commodity price volatility;

• domestic and worldwide economic conditions;

• the availability of capital on economic terms to fund our capital expenditures and acquisitions;

• our level of indebtedness;

• the impact of the current economic recession on our business operations, financial condition and ability to raise capital;

• declines in the value of our oil and gas properties resulting in a decrease in our borrowing base under our credit facility and impairments;

• the ability of financial counterparties to perform or fulfill their obligations under existing agreements;

• the uncertainty inherent in estimating proved oil and gas reserves and in projecting future rates of production and timing of development expenditures;

• drilling and other operating risks;

• hurricanes and other weather conditions;

• lack of availability of goods and services;

• regulatory and environmental risks associated with drilling and production activities;

• the adverse effects of changes in applicable tax, environmental and other regulatory legislation; and

• the other risks described in our Form 10-K for the year ended December 31, 2008, in our Form 10-Qs for the quarterly periods ended March 31, 2009 and June 30, 2009 and in this Form 10-Q.

Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way. The accuracy of any reserve estimate depends on the quality of available data and the interpretation of that data by geological engineers. In addition, the results of drilling, testing and production activities may justify revisions of estimates that were made previously. If significant, these revisions would change the schedule of any further production and development drilling. Accordingly, reserve estimates are generally different from the quantities of oil and gas that are ultimately recovered.

Should one or more of the risks or uncertainties described above or elsewhere in our Form 10-K for the year ended December 31, 2008, in our Form 10-Qs for the quarterly periods ended March 31, 2009 and June 30, 2009 or in this Form 10-Q occur, or should underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We specifically disclaim all responsibility to publicly update or revise any information contained in a forward-looking statement or any forward-looking statement in its entirety.

All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.

Overview

We are an independent oil and natural gas exploration, development, acquisition, and production company. Our basic business model is to increase shareholder value by finding and developing oil and gas reserves through exploration and development activities, and selling the production from those reserves at a profit. To be successful, we must, over time, be able to find oil and gas reserves and then sell the resulting production at a price that is sufficient to cover our finding costs, operating expenses, administrative costs and interest expense, plus offer us a return on our capital investment. From time to time, we may also acquire producing properties if we believe the acquired assets offer us the potential for reserve growth through additional developmental or exploratory drilling activities.

For most of 2008, the economic climate in the domestic oil and gas industry was suitable for our business model. Until the second half of 2008, oil and gas prices were favorable and provided us with the economic incentives necessary to assume the risks we face in our search for oil and gas reserves despite higher drilling, completion and operating expenses.

During the second half of 2008, global economies began to experience a significant slowdown sparked by a near-collapse in worldwide financial markets. This slowdown continued to intensify into 2009 and is currently being viewed by many economists as the most severe recession in United States history, second only to the Great Depression. The United States government has taken significant steps to support the financial markets and stimulate the economy in an effort to slow or reverse the downward spiral of economic indicators, but the success of these measures and the duration of the current recession cannot be predicted.

Reduced demand for energy caused by the current recession has resulted in a significant deterioration in oil and gas prices, which in turn has led to a significant reduction in drilling activity throughout the oil and gas industry. The prices of field services during the last half of 2008 and the first quarter of 2009 remained relatively high despite declines in oil and gas prices. As a result, we experienced reductions in operating margins during the last half of 2008 and into the first quarter of 2009. The effects of lower operating margins on our business are significant since they reduce our cash flow from operations and diminish the present value of our oil and gas reserves. These factors have an adverse effect on our ability to access the capital resources we need to grow our reserve base. Lower operating margins also offer us less incentive to assume the drilling risks that are inherent in our business.

During the second quarter of 2009, operating margins on oil-prone properties improved somewhat due to a combination of higher oil prices and lower rates for field services caused by decreased demand for those services. Since most of our developmental drilling locations are oil-prone, we have elected to resume drilling developmental oil wells in the Permian Basin and the Austin Chalk (Trend) during the remainder of 2009. As a result, we now plan to spend approximately $131.1 million on exploration and development activities in fiscal 2009, an increase of $17.3 million over our previous estimate. By comparison, we spent $372.7 million in fiscal 2008 on exploration and development activities.

We continue to monitor the impact of the recession on our business, including the extent to which changes in commodity prices could affect our financial liquidity. While we believe we are taking appropriate actions to preserve our short-term liquidity, a prolonged recession of this magnitude could negatively impact our long-term liquidity, financial position and results of operations.

Key Factors to Consider

The following summarizes the key factors considered by management in the review of our financial condition and operating performance for the third quarter of 2009 and the outlook for the remainder of 2009.

· Our oil and gas sales for the third quarter decreased $68.9 million, or 54%, from 2008 due substantially to decreases in prices for both oil and gas.

· Our oil and gas production for the third quarter of 2009 was 5% lower on a barrel of oil equivalent ("BOE") basis than in the comparable period in 2008. Our oil production was 12% lower than the third quarter of 2008, and gas production remained relatively constant compared to the 2008 period.

· We recorded a $4.7 million net gain on derivatives in the third quarter of 2009, consisting of a $10.6 million non-cash gain for changes in mark-to-market valuations and a $5.9 million realized loss on settled contracts. For the same period in 2008, we reported a $132.7 million net gain on derivatives, consisting of a $169.5 million non-cash gain due to changes in mark-to-market valuations and a $36.8 million realized loss on settled contracts. Since we do not presently designate our derivatives as cash flow hedges under applicable accounting standards, we recognize the full effect of changing prices on mark-to-market valuations as a current charge or credit to our results of operations.

· During the third quarter of 2009, we increased borrowings under our revolving credit facility by $50.7 million from $119.3 million at June 30, 2009 to $170 million at September 30, 2009. In August 2009, werepaid in full all amounts outstanding under the secured term loan of Desta Drilling, LP "Desta Drilling" with borrowings of approximately $27.2 million under the revolving credit facility (see Liquidity and Capital Resources).

· At September 30, 2009, our capitalized unproved oil and gas properties totaled $63.5 million, of which approximately $33 million was attributable to unproved acreage. Therefore, our results of operations in future periods may be adversely affected by abandonments and impairments related to unproved oil and gas properties.

Recent Exploration and Development Activities

Overview
Due to recent improvements in operating margins attributable to higher oil prices and lower costs for field services, we elected to resume drilling developmental oil wells in the Permian Basin and the Austin Chalk (Trend) during the second quarter of 2009. Approximately 46% of the $89.9 million spent on exploration and development activities during the first nine months of 2009 was applicable to developmental prospects. We currently plan to spend approximately $131.1 million on exploration and development activities during fiscal 2009, of which approximately 60% is expected to be spent on developmental drilling. We may increase or decrease our planned activities, depending upon drilling results, operating margins, the availability of capital resources, and other factors affecting the economic viability of such activities.

Permian Basin
The Permian Basin is a sedimentary basin in West Texas and Southeastern New Mexico known for its large oil and gas deposits from the Permian geologic period. Although many fields in the Permian Basin have been heavily exploited in the past, higher product prices and improved technology (including deep horizontal drilling) encouraged high levels of current drilling and recompletion activities. We gained a significant position in the Permian Basin in 2004 when we acquired Southwest Royalties, Inc. This acquisition provided us with an inventory of potential drilling and recompletion activities.

We spent $32.7 million in the Permian Basin during the first nine months of 2009 on drilling and completion activities and $1.2 million was spent on seismic and leasing activities. We drilled 23 gross (21.68 net) operated wells in the Permian Basin and conducted various remedial operations on other wells in 2009. In response to recent improvements in operating margins, we began a drilling program in Andrews County targeting the Wolfcamp/Spraberry formations and currently have three of our drilling rigs employed in this program. We currently plan to spend approximately $62.3 million on drilling and completion activities in the Permian Basin in fiscal 2009.

Austin Chalk (Trend)
Prior to 1998, we concentrated our drilling activities in an oil-prone area we refer to as the Austin Chalk (Trend) in Robertson, Burleson, Brazos, Milam and Leon Counties, Texas. Most of our wells in this area were drilled as horizontal wells, many with multiple laterals in different producing horizons, including the Austin Chalk, Buda and Georgetown formations. We believe that the existing spacing between some of our wells in this area affords us the opportunity to tap additional oil and gas reserves by drilling new wells between existing wells, a technique referred to as in-fill drilling. These in-fill wells are considered lower risk as compared to exploratory wells and until recently, offered more attractive rates of return.

We spent $4.6 million in the Austin Chalk (Trend) area during the first nine months of 2009. In response to recent improvements in operating margins, we have resumed our in-fill drilling program in the Austin Chalk (Trend) and currently have two of our drilling rigs employed in this program and plan to add another rig in early 2010. We currently plan to spend approximately $13.3 million on drilling and completion activities in the Austin Chalk (Trend) in fiscal 2009.

South Louisiana
We participated in the drilling of the State Lease 18669 #1, an exploratory well in Plaquemines Parish (West Lake Washington prospect) in 2008. The well was completed as a producer in June 2009. We own a 50% non-operated working interest in this well.

We have abandoned the drilling of the Miami Corp #1, an exploratory well in Bayou Sale field on our Liger prospect in St. Mary Parish, due to down hole mechanical problems. We moved the drilling rig approximately 20 feet north of the current location and drilled the Miami Corp #2 as a replacement well. We also abandoned the Miami Corp #2 well and recorded a pre-tax charge of $17.5 million in connection with these wells during the third quarter of 2009.

We spent $24.5 million in South Louisiana during the first nine months of 2009 on exploration and development activities, of which $22 million was spent on drilling and completion activities and $2.5 million was spent on seismic and leasing activities. We currently plan to spend $25.4 million for fiscal 2009, of which $22.3 million relates to drilling and completion activities and the remaining $3.1 million relates to seismic and leasing activities.

North Louisiana
In 2005, we began a drilling program in North Louisiana targeting the Cotton Valley/Gray and Bossier formations. In this area, the Cotton Valley/Gray formations are encountered at depths ranging from 8,000 to 12,000 feet, and the Bossier formation is encountered at depths ranging from 11,000 to 15,500 feet.

To date, we have drilled 18 wells on our Terryville prospect and have completed 16 wells as producers. On our Ruston prospect, we have completed four wells as producers. We spent $4.4 million in North Louisiana during the first nine months of 2009 on exploration and development activities, of which $3.9 million was spent on drilling and completion activities and $500,000 was spent on seismic and leasing activities. We currently plan to spend $5.1 million for fiscal 2009 in this area.

East Texas Bossier
We have an extensive acreage position in East Texas targeting the prolific deep Bossier sands which are encountered at depths ranging from 14,000 to 22,000 feet in this area. Exploration for deep Bossier gas sands in this area is in its early stages and involves a high degree of risk. The geological structures are complex, and limited drilling activity offers minimal subsurface control. Deep Bossier wells are expensive to drill, with completed wells costing approximately $18 million each. Although seismic data is helpful in identifying possible sand accumulations, the only way to determine whether the deep Bossier sand will be commercially productive is to drill wells to the targeted structures.

We have drilled the Sunny Unit #1, a 17,300-foot exploratory well in Burleson County, Texas to the deep Bossier formation, and have completed the well in the middle Bossier sands. The well tested at a rate of 5,400 Mcf per day at 5,500 psi on a 13/64-inch choke, but due to the absence of a suitable gas market in the area, the well is currently shut-in while we determine which, if any, of the various marketing alternatives are economically viable.

We spent $15 million in the East Texas Bossier area during the first nine months of 2009 on exploration and development activities, of which $6 million was spent on drilling and completion activities and $9 million was spent on seismic and leasing activities. We currently plan to spend approximately $15.4 million for fiscal 2009, of which $6.2 million relates to drilling and completion activities and the remaining $9.2 million relates to seismic and leasing activities.

Utah
In 2008, we participated in the drilling of the Ron Lamb 31A-4-1, a 12,670-foot exploratory well in which we own a 33% non-operated working interest. The well was drilled in the central Overthrust area in Sanpete County, Utah targeting the oil-prone Navajo sandstone formation. We abandoned this well in the first quarter of 2009 and recorded a pre-tax charge of approximately $1.7 million for drilling and leasehold impairments related to this well in the first nine months of 2009. Plans to participate in the drilling of a third exploratory well in this area have been deferred until 2010.

Supplemental Information

  The following unaudited information is intended to supplement the consolidated
financial statements included in this Form 10-Q with data that is not readily
available from those statements.

                                                                  Three Months Ended
                                                                    September 30,
                                                                  2009          2008
Oil and Gas Production Data:
Gas (MMcf)                                                          3,900         3,920
Oil (MBbls)                                                           662           755
Natural gas liquids
(MBbls)                                                                63            39
Total (MBOE)                                                        1,375         1,447

Average Realized Prices (a):
Gas ($/Mcf)                                                    $     3.79     $    9.88
Oil ($/Bbl)                                                    $    64.60     $  116.01
Natural gas liquids
($/Bbl)                                                        $    31.89     $   69.90

Gain (Loss) on Settled Derivative Contracts (a):
($ in thousands, except per unit)
Gas: Net realized gain
(loss)                                                         $    2,992     $  (7,190 )
Per unit produced
($/Mcf)                                                        $      .77     $   (1.83 )
Oil:   Net realized
loss                                                           $   (8,861 )   $ (29,324 )
Per unit produced
($/Bbl)                                                        $   (13.39 )   $  (38.84 )

Average Daily Production:
Gas (Mcf):
Permian Basin                                                      14,374        13,536
North Louisiana                                                    10,076        16,273
South Louisiana                                                    10,755         4,320
Austin Chalk (Trend)                                                2,306         2,271
Cotton Valley Reef
Complex                                                             3,916         5,832
Other                                                                 964           377
Total                                                              42,391        42,609

Oil (Bbls):
Permian Basin                                                       3,526         3,983
North Louisiana                                                       230           392
South Louisiana                                                       773            90
Austin Chalk (Trend)                                                2,585         3,659
Other                                                                  82            83
Total                                                               7,196         8,207

Natural Gas Liquids (Bbls):
Permian Basin                                                         246           174
North Louisiana                                                        26             3
South Louisiana                                                       116             6
Austin Chalk (Trend)                                                  288           233
Other                                                                   9             8
Total                                                                 685           424

                                                                    Three Months Ended
                                                                      September 30,
                                                             2009                2008
Exploration Costs (in thousands):
Abandonment and impairment costs:
Permian Basin                                              $      4     $    716
North Louisiana                                               3,172            -
South Louisiana                                              18,955            -
East Texas
Bossier                                                         958       40,063
Utah                                                            750            -
Other                                                           310        2,257
Total                                                        24,149       43,036

Seismic and
other                                                           898        5,993
Total exploration
costs                                                      $ 25,047     $ 49,029

Depreciation, Depletion and Amortization (in thousands):
Oil and gas
depletion                                                  $ 29,481     $ 24,881
Contract drilling
depreciation                                                    392        2,134
Other
depreciation                                                    180          211
Total DD&A                                                 $ 30,053     $ 27,226

Oil and Gas Costs ($/BOE Produced):
Production
costs                                                      $  14.01     $  15.80
Oil and gas
depletion                                                  $  21.44     $  17.19

Net Wells Drilled (b):
Exploratory
Wells                                                           1.1            -
Developmental
Wells                                                          16.6         21.6



                                                                  Nine Months Ended
                                                                    September 30,
                                                                 2009          2008
Oil and Gas Production Data:
Gas (MMcf)                                                        12,369        13,645
Oil (MBbls)                                                        2,129         2,142
Natural gas liquids
(MBbls)                                                              175           138
Total (MBOE)                                                       4,366         4,554

Average Realized Prices (a):
Gas ($/Mcf)                                                    $    4.11     $    9.83
Oil ($/Bbl)                                                    $   52.10     $  111.48
Natural gas liquids
($/Bbl)                                                        $   26.70     $   61.70

Gain (Loss) on Settled Derivative Contracts (a):
($ in thousands, except per unit)
Gas: Net realized gain (loss)                                  $   7,478     $ (18,361 )
Per unit produced
($/Mcf)                                                        $     .60     $   (1.35 )
Oil:  Net realized
loss                                                           $ (13,701 )   $ (65,578 )
Per unit produced
($/Bbl)                                                        $   (6.44 )   $  (30.62 )

                                                                           Nine Months Ended
                                                                             September 30,
                                                                2009                       2008
Average Daily Production:
Natural Gas (Mcf):
Permian Basin                                                    15,157             14,287
North Louisiana                                                  12,007             15,169
South Louisiana                                                  10,342             11,682
Austin Chalk
(Trend)                                                           2,580              2,313
Cotton Valley Reef
Complex                                                           3,989              5,848
Other                                                             1,233                500
Total                                                            45,308             49,799

Oil (Bbls):
Permian Basin                                                     4,010              3,683
North Louisiana                                                     257                363
South Louisiana                                                     624                393
. . .