California Resources Corporation (CRC) Earnings Call Transcript & Summary

Hi, good morning, everyone. Thanks so much for joining us. We are very pleased this morning to have with us Mr. Mac McFarland, President and CEO of CRC Resources; Francisco Leon, EVP and CFO; as well as Chris Gould, EVP and Chief Sustainability Officer. CRC's story, for those of you who are less familiar, it has rapidly evolved since emerging from bankruptcy about 6 months ago. The company has done a few transactions to refocus on to the core areas, and it's also announced a new direction with the company's decarbonization initiatives, which are super exciting. So Mac, Francisco and Chris, I'll turn it over to you and then perhaps we can get into some Q&A.

That sounds great, Jeanine. Thank you. We're pleased to be here, excited to present at the 2021 Barclays CEO Energy Power Conference. Perhaps first, I'd start with a few comments on California. As we, in California, continue to adapt to COVID and the Delta variant like the rest of the country, I think it's important to note that California's economy remains strong. California is not only the highest contributor to GDP in the country, but it has also registered the highest GDP growth over the last 5 years, according to Bloomberg, at 21%, ahead of New York at 14% and Texas at 12%. At the end of August, there were 44 cargo container ships anchored outside of the ports of L.A. and Long Beach. That's setting a new record. These ports serve as the entry point for about 1/3 of all imports to the U.S. Additionally, LAX remains one of the 15 busiest airports in the world and total vehicle miles driven have returned to pre-COVID levels. Said simply, California is open for business and the macroeconomic indicators remain strong. At the same time, California is leading the nation in low-carbon initiatives and energy transition. And I'm happy to say that CRC is at the intersection of this energy transition. We supply safe, stable, local production for all those miles driven today, and we are positioning ourselves with important CCS and renewable energy solutions to help California achieve its emission reduction goals in the future. On our base business. Our base business is characterized by conventional, low decline, low carbon intensity production. In fact, a recent study by the Clean Air Task Force showed that CRC has the lowest carbon intensity of the top 100 producers in the U.S., and we estimate that our production in California is lower than the average CI of any barrel coming into California. Our core business is built on solid financials and a strategy that delivers returns to shareholders. CRC's recent financial results demonstrate our ability to execute on this strategy and generate meaningful cash flow. In the first half of this year, we delivered $200 million of free cash flow and we are projecting $400 million to $500 million for the full year 2021. We did this while maintaining production using less than 50% of our discretionary cash flow. And in fact, in 2021, it's more like 35% to 40%. We think our core business alone is a compelling investment due to the mid-teens free cash flow yield and extremely low leverage. By the end of the year, we'll be less than 0.5 turn levered. And we have attractive valuation metrics, and that's independent of which metric you choose. And because of this relative undervaluation and our strong commitment to return cash to shareholders, we currently have in place a $250 million share repurchase program that runs through the first quarter of 2022. That's our core business. In addition to that, we basically offer a free option on carbon management activities. And that's because our assets are well suited and uniquely positioned to aid California towards a lower carbon intensity future. We believe that's an opportunity that is not available to most other independent companies. It's a very exciting time for our company and for the state of California. And we believe CRC's year-to-date stock performance is only just the beginning to reflect the value and potential we see ahead. We've identified -- and you mentioned this, we've identified carbon management and a 1 billion metric tons of permanent CO2 storage capability. We're focused on that first 20%, 200 million tons. And we've recently announced our first project, which is Carbon TerraVault I. We filed a Class 6 injection permit with the EPA for 10 million tons, and we're following that up with a second reservoir that will add an additional 30 million tons. The combination of those 2, 40 million metric tons of storage capability is Carbon TerraVault I. We've also begun to prepare 45Q and LCFS certification permits for this project, and those should be in place shortly. Because of California's aggressive carbon goals and progressive policies, we believe these projects will be able to take advantage of LCFS, Low Carbon Fuel Standard credits and the framework that's available in the state. These credits are an important differentiator versus other projects in the U.S. It's a California-only thing. And they are critical to the success in scaling the CCS technology, which we believe, ultimately, as California tries to get to net 0 by 2045 and provide 15% of the overall solution. We are targeting injection at Carbon TerraVault I by 2025 and planning to permit an additional cumulative 200 million tons of CO2 projects by 2027 and at that time, be injecting 5 million tons per year. Those are our carbon goals. They are aggressive, but we are committed. In addition to storage opportunities, we continue to pursue the CCUS opportunity called CalCapture at Elk Hills. This carbon capture and EOR project continues to advance and we'll provide additional information on that project later this fall. We are pleased with our results and optimistic for the road ahead. We'll have more details on these activities at our upcoming carbon storage update on October 6. It's for these reasons, it's our strong free cash flow yield from our core business and the carbon management opportunities that we have that we continue to believe that CRC is one of the best positioned companies in the energy sector. So with that, I'll turn it back to you, Jeanine, and Chris, Francisco and I will be happy to answer some questions. Jeanine, I think that you are muted.

That's the fifth time now that I've done that. It's the last day, it's been long. Okay. So as I was saying, I definitely want to get to the carbon capture opportunities, obviously. But maybe we can just start with the free cash flow and the base business there. So you recently increased your free cash flow guidance. You upped the share repurchase by $100 million. And so can you just talk a little bit about how you plan on executing your share buyback? Is it going to be more ratable? Or is it going to be more opportunistic?

It's more opportunistic. You're right. We started with $150 million at the end of the first quarter. And as we got more comfortable with our full year free cash flow, we increased to $250 million. We've been doing it through open market purchases and other forms. But we continue to stay in the market, and we'll be there through the first quarter. As we said, we've got the ability to go through the first quarter of next year provided we don't exhaust the full $250 million. Anything you want to add, Francisco?

No. I mean, to us, there was a fantastic opportunity to buy back our reserves effectively, by $5 per BOE. And as we look at ways to deploy that excess cash flow, we want to be opportunistic but thoughtful about where the best returns are. And clearly, it's been in the share repurchase program.

Okay. So you're authorized through the first quarter of next year. And so I guess my question is kind of what happens after that? Does the optimal or right way if there's such a thing to return cash to CRC shareholders, how does that change over time?

Yes. So I think the way, Jeanine, we think about it is we look at it on a portfolio management rather than a prescriptive, how are we going to return cash to shareholders. So obviously, we embarked on the share repurchase program. We're always considering whether or not we'll do a dividend. But from a portfolio management standpoint, we look at how do we return cash to shareholders, how do we reinvest in the business, how do we deploy capital to invest in our carbon management activities, how do we put it back through the drill bit? And in fact, if you saw the slides today, which I'm sure you have, and for those, we've announced that we're going to go ahead and put a fourth rig on this -- in the fourth quarter of the year. And so it will change over time. Obviously, we thought that it was the best investment at the time to do the share repurchase program, but it's all things around the table, as long as we can maintain some financial metrics that kind of is our story, which is the low leverage liquidity. You want to go through that for a bit?

Yes, absolutely. So the key objectives for us are maintaining our strong balance sheet to what we said is we're going to be below 1.5x net leverage. We want to invest in the business to maintain flat and recycle no more than 50% of free cash flow. As Mac indicated, we're way below that this year, but we're going to stay within those parameters. But we want to continue to invest in the business. So as you do all that, you saw it this year, we were able to do the basic objectives and still generate $400 million to $500 million of cash flow. We don't have any prepayable debt until 2024. So all these options are available to us plus in -- and we have to look at where the best returns are. It's a balancing of all the options. We're considering a fixed dividend as part of the -- what comes next. But it's -- right now, it's been share repurchase program. We bought back one of our drilling JVs. So more of an A&D, and we're adding that fourth rig. We're right now in our third rig in Long Beach, and we're adding to a fourth rig to exit the year. So we feel we have a pretty good range of options that are -- and we just -- we want to make sure we go after where the best returns are.

And so maybe if I could just push a little bit on that fixed dividend. One of the things that I think has been a game changer for energy stocks in our space is just that now investors are getting paid to sit in these stocks they're getting through fixed dividends and now variable dividends as well. Whereas before, you didn't have that much of it, and they need to be compensated for volatility in oil prices, et cetera, et cetera. So for some people, a fixed dividend is table stakes. So what do you really need to see in order to institute some level of fixed?

Well, so I think the answer to that is, it depends on where we are. So when we exited bankruptcy, we had a fairly concentrated shareholder base. That base has been deconcentrating over time, and it has gotten what I'll -- it has become more regular way investors as opposed to those that came out of the restructuring, if you will. We're happy with all of our investors, but it has become less concentrated. And there has been an increased call as you move to more regular-way or right-way-type investors in the sector these days, you're right, dividends become an additional tool that helps attract people to the stock. So we are to the company. And so we have been considering it, but we thought the first step with this share repurchase program, we're building effectively even after the share repurchase program, we'll have 100 -- closer to $200 million of cash on the balance sheet if it was fully exercised by the end of the year, a little bit of a war chest. But we have investments coming up. And we think we have opportunities to reinvest. We're going to be careful about getting over our skis with respect to reinvestment through the drill bit and what we're doing there. But as Francisco said, we'll do the right A&D work, we'll do the right deployment through the drill bit, and we'll also think about how do we shift some capital into carbon management.

Yes. One more thing to add. We have -- as we talked about, we have a lot of options, fixed dividend is one, but it has to compete against -- every dollar has to compete. And we're seeing a phenomenal opportunity with our carbon management business to grow that. So we are -- as we create the foundation of that business we have to be very thoughtful about where that next dollar goes. And we're well hedged. We have a good support in terms of our cash flow generation, but we do think about where the best use for that dollar is, and it could be a fixed dividend, but the carbon management business looks attractive as well.

And in terms of the capital allocation to the carbon management business, where is that now? Where do you see that going over the next call it, 1 to 3 years?

Well, I think it's -- if you look at -- take Carbon TerraVault I, okay, just as an example, and we hope to have many of those projects. But if you look at that specific project, we don't hope, we plan on it, we're going to do it. But the -- if you look at that project, right now, we're spending early-stage development, right? We are getting the field ready. We've done all of the simulation work. We filed the permit. We're working our way through all of the different permitting requirements. We're working with a number of counterparties, if you will, our partners thinking about coming into the project with respect to either providing a source or investment, et cetera. But the capital -- the large capital investment is going to be come after the final investment decision, which is down the road a couple of years. So you have these early stage. And so to answer your question specifically, we're spending between $5 million and $10 million a year right now in cash, whether that be capital or CapEx for us. We talk about it in cash. We look at the bottom line. And so it's OpEx, G&A, limited capital deployment on the carbon management activities. But we enjoy the flexibility that we have because we've set these financial parameters. We've built up a substantial unlevered cash on the balance sheet. And we feel as though we can deploy that as necessary. Now we're only going to deploy it, obviously, if we see the returns. But like you said, every dollar has got to compete. But that's what we're doing. We're spending $5 million to $10 million early-stage development, but there will be a time when capital is required to make these projects get to first injection.

Okay. And we're going hit on that in a little bit because we definitely want to hear about that. But in terms of like sources of cash to fund the future carbon management business. So clearly, you have a very strong free cash flow story. You recently announced a complete exit from the Ventura Basin, that was for gross proceeds of over $100 million. Are there other areas in the portfolio where maybe you can prune to maybe lower cost, increase margins and just more cash on the balance sheet to fund future carbon management opportunities?

You want to take that?

Yes, absolutely, Jeanine. We have a big portfolio of assets, the largest producer in the state, largest gas producer, oil producer. And we have feels that they are probably going to be better owned by other operators, higher cost fields that are not going to compete for capital in our portfolio going forward. So we'll continue to be active on the E&D side. We did -- the last announcement was the Ventura exit, and we took some of that money to buy back PDD from our DrillCos and also simplifies our business. So it's a portfolio management year towards high-grading, not necessarily to raise proceeds or not exclusively to raise process, but there will be more opportunities to further consolidate and core up our main business, our core business, and we'll will continue to look for those opportunities.

Yes. It's interesting, Jeanine, because -- I don't know, 6, 9 months ago, the question we got asked, is there really an A&D market in California? And we don't want to give away the commercial activities we are undertaking. But I think there are other opportunities that we're going to pursue.

Okay. On the divestiture side, what about on the acquisition side?

Yes. And I think on the acquisition side as well, as we -- as you see our activities concentrated in Kern County in the San Joaquin Basin. We also have activity in the L.A. Basin. So if we have an opportunity to pick up more assets, bolt-ons to our current for -- of CRC, we will definitely do that. So I would expect us to be on both sides on the acquisition and the divestiture.

Okay. Maybe if we can move to the carbon management part of the business, you talked about the 1 billion net tons of permanent CO2 storage. And I think I heard you said you're going after 20%, the Carbon TerraVault I is about 40 net tons. So maybe you can just talk about what you meant by that 20%. And does that just reflect what you see as the near-term opportunities?

I think it's just a prioritization. I mean, we're working on more than that. But I guess the point being is that this first 20%, we have line of sight towards. And so we're focused on getting permits filed, doing the work that's necessary to get them to commercial availability to accept CO2. And that takes time. So for example, the permit that we filed at Carbon TerraVault I is on a 2-year time line. That's where we're -- I think it's Page 14, we show sort of a time frame of when we might be able to get to certain dates of FID and injection. But there's a lot of leg work that goes into it. One of the things that I think people may not understand is that in order to file a permit, we just didn't do that in 3 months, right? We have been working on that. And quite frankly, because of our seismic, because of our understanding of the subsurface at Elk Hills, because of the work we had done at CalCapture, it kind of gave us a jump start. And because we own Elk Hills in fee simple, we were able to do that. Now in addition to that, we're working the next 160 million of that 200 million but we have lines of site to the next after the 200 million, but it's just a prioritization. I mean when you start with 1 billion tons, it's a great number, but it can be overwhelming and you've got to prioritize. And we've set up a dedicated organization. Chris Gould, our Chief Sustainability Officer, joined us a couple of months ago. We're building an organization around him, engineers, geologists, commercial people to go after these opportunities and to get them on the table and make them real. I think that's the biggest thing, is that we're focused on real solutions and what we can do with our assets.

Okay. And then the fun part here, economics. So what we've noticed is until investors can get a better feel for some of the economics and the total addressable market for things, it is a little difficult to embed the carbon opportunities into valuations and to stock prices, et cetera, et cetera. So can you -- you have Carbon TerraVault. Can you talk about how you make this project viable? Like anything you can say on the economics of it?

Sure. Well, I think, first, it starts with that we're in California and LCFS. So that's, call it, $200 a ton. You have 45Q for another $50 a ton. There's talk -- the governor floated an energy policy bill last week that talks about expanding the scope of GHG emission reductions in the state to include carbon capture on industrial sources as well as off of power plants. And so there may be additional revenue line incentives, if you will, if you consider 45Q a revenue line. Even though it's a tax credit, there's a lot of talk about it being direct pay. So when you put those things together, that's the revenue opportunity. Now obviously, the capital that has to go in are either capture systems on brownfield sites or greenfield sites that build the capture system into their current development opportunities. And then there's pipe, if you will, the connective tissue between the source and the sync. And all of that is going to share in that $250-plus a ton. I will tell you, I agree with you, it's tough for investors to value that into the stock because it's a little bit of a first of a kind. We talked about being a little bit of the leading edge in creating a commercial scale storage project. It's really a bit of bleeding edge, quite frankly. Because when we're working with the EPA, we're doing things -- the last Class VI Permit, it was filed, took 6 years to get there, now we're working with them to get it done within 2 years. And there's a lot of uncertainty and permitting activity that we're undertaking that is sort of -- I wouldn't call it trailblazing, but it's doing it for the first time or doing it for the first time on this accelerated scale. And so we're working through those issues. I only give that as an example because that's the same with respect to the commercial activities and the economics associated with this. But the one thing that I would say is that at the end of the second quarter, when we announced Carbon TerraVault I, and that we're going after this first $200 million. We had a significant amount of inbound at that point in time because we have the natural resource, which is the storage tanks. So it's a little bit of the chicken or the egg, who's going to build a capture system if they don't know where they have a place to put it. And so we went ahead and filed for the permit in order to create -- to get rid of the chicken or the egg story. So now we're open for business if we get the permit, and we've had a number of inbounds. In fact, the number of inbounds just on that particular project, if we signed everybody up, it would be oversubscribed, we couldn't sign everyone up. So a significant amount of interest, and that's from the source standpoint and a significant amount of interest to help fund. Obviously, investors in the -- would like to come in at the project. And there's a lot of money chasing, I'll call it, low carbon initiatives. And we're excited about it.

Yes. I mean California got it right. Ultimately, the ability to stack credits allows for projects that will require from capital and risk capital to be put to work and offer participation in the economics in a way that makes these projects ultimately a success. So, yes, excited about that.

And then maybe on the returns. You mentioned a few times before that when you look at capital allocation, every dollar needs to compete. And what we found in some E&Ps that are doing the base business plus carbon capture or lower carbon businesses is that it needs to -- the lower carbon businesses need to have a return but there are other extenuating factors that say that it doesn't have to compete with drilling a well in the Permian or something like that. So like how do you think about that? And can you just expand on your comments on that every dollar needs to compete and how that relates to the carbon capture opportunities?

Well, I think that's a fair assessment. I mean let's go back to what I called early-stage development dollars, right? Those dollars don't necessarily have a current economic return, but we're making the investment there because we believe that once we get to commercial and first injection, we will have projects that meet or exceed our financial hurdles, and they will compete for those dollars. So we're making some investments up front here. you can call it R&D, but it's not research and development because we actually filed a permit. And so we're making those investments. We're perfecting the next Carbon TerraVault II through whatever. And as they proceed, we're going to make those investments. So you're right, when I said every -- or when Francisco said every dollar compete, we think about it that way, but we also know that we have a significant opportunity here that we want...

Okay. And then maybe if we can turn to just CRC's competitive advantages. I think as you said, there's a lot of folks chasing lower carbon solutions these days for obvious reasons. CRC is well positioned in CCS. So can you just kind of walk us through why you're so confident that you can execute on the current project? And what are your competitive advantages that allow you to perhaps execute on these types of projects better than anyone else?

Well, sure. And Francisco and Chris can jump in here. But we -- it starts with we have the asset positions across the state. I mean one of the things that started this year out when we were doing a high-yield offering is we said we were in too many fields because we're in 129 fields, and it will change after Ventura, but we were in 129 fields in California. And it -- at that point in time, a lot of people thought that was an anchor. I'll be honest, I thought it was a bit of an anchor. But then when you look at it and you think about what are the opportunities to use those mineral positions or carbon storage, it actually becomes a unique asset, okay? And because we've been in these fields for a long time, we have a lot of seismic in the state, 3D seismic. We have the ability. We understand how to do the injection simulations in order to permit these projects. And we've got a lot of people that have been working on CalCapture, who have experience with CO2 from past experiences. Obviously, there's no CO2 flood in California or EOR through CO2 in California, but we've had people that have managed it. And so when you put all of that together with the natural resource of the asset and the willingness to put some capital at work to perfect this carbon management option, I feel fairly confident we'll be able to get it done.

And Chris, jump in as well if you have anything. But no, that's absolutely right. We have conventional assets we have multiple -- it's a stack reservoir, have a really good understanding of the reservoirs. We are one of the few operators in California that drills wells below 5,000 feet. So between seismic, well control and ownership, we have a really good head start on that resource that's in the right positions within the state where you want to be for both oil and gas and carbon management.

Right. I think the other thing, Jeanine, if I may, just in venturing off into the regulatory and political world of California, which has often been seen -- investors say, oil and gas company in California. Well, now it's an oil and gas company with a carbon management story in California. And let me just talk about that. I mean when we've gone through and had premeetings associated with -- and I want to keep those undisclosed, but when we had premeetings with government officials, regulatory agencies, politicians in the state, they were very excited to support Carbon TerraVault because they understand that CCS can be part of it. So it's changing the dynamic of the oil and gas company, of CRC into both an oil and gas company and a carbon management company, and there's a lot of momentum behind that. As Francisco said, his quote was California is leading the nation. And this carbon philosophy and these goals to carbon -- and a lot of times, those headlines of banning internal combustion engines or banning fracking or what make it out of California, but it's also -- the regulatory construct, we're still drilling. We're still producing 100,000 BOE a day. We're still getting our permits. We're doing all of that work, but we're now -- we have a different side to us too, which is just carbon management. And so we're committed to working with the state and through this energy transition, and that's been a plus.

We are -- we're actually out of time. If I could just sneak 1 question in. How are you thinking about exploring partnerships with your CCUS initiatives?

Give us a call. We're open for business.

Okay. All right. I like that, open for business. Well, this has been really exciting. I think your story has just evolved so rapidly, and we've always said that the business models and E&Ps are converging now that everybody is going to a low-growth kind of free cash flow type model. But I think CRC offers a really unique value proposition with your carbon capture management aspect of it. So we are excited to see how it's going to progress. And so Mac, Francisco, Chris, thank you so much for your time. This has been a real pleasure.

Jeanine, thank you, and thanks for everybody in attendance. Appreciate it.

Okay. Take care.

Take care.