Coterra Energy Inc. (CTRA) Earnings Call Transcript & Summary

Good morning, everyone. Up next, we have a fireside chat with Cabot Oil & Gas. Cabot is a pure-play natural gas operator focused in Northeastern Pennsylvania with 173,000 net acres, an important play, primarily in Susquehanna County. Speaking to the quality of the asset over the past few years, the company's financial results have been among the strongest in the industry despite a challenging period of crisis [ past ]. Presenting today for the company is Scott Schroeder, EVP and CFO.

Maybe just to start, Scott, could you comment on the news we heard out of Pennsylvania earlier this week?

Yes, Michael, and thanks for the opportunity to be here, and I'd be happy to at least share the prepared statement that the company has come together on this. First of all, let me stress, Cabot is and has always been extremely focused on its communities in which we're a part of and the environment, with the goal of mitigating and minimizing all impacts to our operations, and that is unwavering. Secondly, while this proceeding is new, it is a replay of matters, many of which are over a decade old, all of which have been previously disclosed and worked through with the Pennsylvania Department of Environmental Protection. Third, we were prohibited from discussing the investigating grand jury, and we were unaware of its findings. Fourth, we received notice of the charges contemporaneously as they were released to the public. Fifth, with discussions underway between the parties, which, in my opinion, should have occurred before the announcement, I will have no further comment at this time.

Okay. Thank you. Moving on to maybe some more interesting topics, could you give us the house view on gas macro kind of both near term and longer term? And then would love your views on basis as well.

Sure. Obviously, even pre-pandemic or pre-OPEC war -- price war, we were -- the market was setting up to be good. We were very positive in our first part of the year. Our investor deck highlighted that the year was shaping up -- while winter did not materialize, it was shaping up much like the 2016 time period when we saw -- the last time we really saw really low prices and then saw a recovery in the second half of the year. And so that formed early optimism as it related not so much to 2020, we knew it was going to be a challenging year, but for '21. Fast forward to March, April time period, the OPEC war, the pandemic impact and different variables kicking in and different things for obvious reasons, the economy slowing down, those various points, but that same optimism and setup from the shutoff of supply from the Permian, from the curtailments across that space, the impact to associated gas, obviously, on the demand side, what we're seeing currently with the LNG demand being impacted. But at the end of the day, 2020 looks choppy like it was looking at the start of the year. But that same level of optimism, maybe not exactly the same level from 60 days ago on the gas price, but the gas price is still fairly robust for 2021 and setting up very well. Compound that with the idea that the supply impact that we expect to see from exit '19 could be down as much as 8 to 9 Bcf a day. And while LNG demand declines offset some of that, it's going to take a marked effort by industry to replenish that supply. And you're going to -- companies are going to have to be incentivized to -- with higher prices to make those investments. At the end of the day, though, even if they can make those investments, you've got a whole part of the gas market sector that has challenged balance sheets. And the pressure from your side of the ledger is for them to improve their balance sheets long before they start chasing growth again. So there's going to be a dynamic that's going to be interesting to watch it shake out as we get through kind of the trough of 2020 and into 2021. I do think the response by the market or by the companies is going to be different than it was in '16 when there were capital markets transactions that bailed out the effort and allowed them to go forward with growth. I think that's going to be pushed back, further complementing higher gas prices. And in terms of basis, I think, right now, we do see -- with that supply dynamic happening, we see kind of a firming basis. And the best indication is the Leidy's indication for '21 at kind of $0.50 to $0.55.

Got it. And then in terms of pricing, what do you need to see to transition from maintenance CapEx to a growth program?

Yes. Let me stress, we've been on a lot of calls, as Matt highlighted, when we were talking ahead of time that it's funny how fast people are turning back to this growth narrative even with the headline numbers that we're seeing right now still being very low but with the optimism going, and obviously, there's lead time in all of our investment cycles. We think it's way too premature to really look at that growth, but you can rest assure that -- I think that the same dynamic that took place from the opposite direction in late '19 where you had good prices in the start of the year followed by more concern with pricing in the back half of the year, you -- we put out a growth case, remember, in October, along with a maintenance case and said we'd determine which way we went -- would go. And we formalized that early part of the year, early part of February this year and went to the maintenance case. Right now, internally, we've only run a maintenance case into '21 and '22, but I'm sure we'll be doing a lot of sensitivities around what that growth case could look like and what those growth measures were. I would say last year's growth case that we laid out in October had a 5% growth level. That would be the top end, I think, now. I think you look at low to mid-single digits as kind of the fairway for growth going forward, at least from Cabot.

And we've seen a couple of players in the basin defer in trading production in the near term just given the shape of the gas curve, among other reasons, with the goal of enhancing free cash flow. What are your thoughts from that perspective?

I think their pattern worked very well for them. One, in particular, was ahead of its production guidance and curve. So it made a lot of sense for them to make that statement and especially based on balance sheets to improve their cash flow position. I think for us, we're not opposed to that at the right time. Again, referencing back to that '15, '16 kind of trough time period before this one, we did take 0.5 Bcf a day off the market for a period of time back then. We have no plans to do that right now. But it is -- we do model some curtailments that we see but more moderate curtailments as it relates to anticipated line pressures, maintenance projects and things like that. Again, our -- even our cost structure has changed dramatically since that '15, '16 time period. So our variable cost to moving incremental molecules is very low compared to any peer.

And what are your thoughts just on hedging as you look towards 2021?

We like hedging, contrary to the current thought process. Again, we had some questions in the one-on-ones about hedging, and that individual had hung on the fact that we weren't very hedged coming into this year, so he thought that was always our motivation. But bottom line, we target being at least 1/3 hedged going into any year and as high as 2/3 in any 1-year period. Obviously, we thought -- when you go back to 2018 going into '19, there was that great window of opportunity to hedge, and we took full advantage of that. So we were probably 2/3 hedged for most of '19. We underestimated or we guessed wrong, however you want to say, going from '19 into '20. So we were naked coming into the end of the year, and that's not a position we like to have. We won't make that mistake again. We'd like to be 1/3 to 2/3 hedged in with -- we haven't layered anything in for '21 at this point in time as we're kind of watching the dynamic. But we have added, since our first quarter call, more hedges around protecting the summer when we saw some opportunities where the market was positive for us. So we'll call those more defensive hedges. We'd like to be more offensive in our stance as we look at '21. And again, we haven't executed any on '21, but do not look for us to be as uncovered as we were this year -- coming into this year.

Got it. And then Leidy South coming online in the second half of '21. How is that capacity -- or your thoughts on how that capacity will impact differentials?

Keep in mind, that's going to account for less than 10% of our gross volumes. So we're not anticipating it. While it is a better market, so it will have some impact on the weighted average gas pricing, a positive territory, I don't think it's going to be a monumental difference in terms of that. And it's not going to impact our guidance around that incremental volume around our gathering and transport rates either. It will be kind of in the same fairway. It would be a nominal change.

And then on the share repurchase program, you talked about being opportunistic versus programmatic. How do you see that evolving going forward? And how do you think about dividend policy going forward?

Yes. Let me back up and start with we are very committed, as we've been very clear, of returning at least 50% of free cash flow to our shareholders every single year. And this will be our third year of doing that. The last 2 years, we far exceeded the 50% level. And based on the dynamic that's shaking up -- shaping up for this year, we will again exceed the 50% because if you just look at the -- where gas prices are and what we think is going to happen, our common dividend is going to nearly match or be just shy of filling our -- being the use of all of our free cash flow for this year. So with that as a backdrop, as you get into a more robust gas price environment, we're focused on the dividend first from a common perspective. Share buybacks, if you did a look-back on what we did, we bought in about -- between 60 million and 70 million shares over the last 3 years. In hindsight, we wouldn't have done that based on where -- looking where the share price ended up going. Again, it was the right move at the time. Because of that lens, I think you will see more of a propensity to fully vet a variable dividend as probably the second or special dividend after the common dividend. Again, buybacks will still be part of the arrow in the quiver, but we will entertain the idea of the variable or special dividend concept.

And how do you see cash taxes trending as you look to 2021?

First, in 2020, our guidance out there is we're 100% deferred. And -- but we're using all of our NOLs and all of our AMT carryforwards. So as you migrate into 2021 under the maintenance program, which is the only one we've fully vetted at this point in time, you're looking at cash taxes going to about 60% to 66% because of the exhaustion of those tax incentives. That's in the maintenance case. Obviously, if you get into a higher growth case, you will have more pretax income, but you will have the ability, if you invest more money in that environment, for more IDCs. Again, we have not run that case. Now based on the maintenance, it's going to be 60% to 66%.

Got it. Got it. Maybe a couple of questions on the Upper Marcellus. How does that fit into your development plan moving into next year? And how do you compare the capital efficiency and aerial extent of that to the Lower Marcellus?

Sure. The next year -- for 2021, we have 5 Upper Marcellus wells planned. Hold on, Michael, I got something that popped up on this computer.

Sorry, technical difficulty.

Sorry about that. Well, we have 5 wells planned for next year, more continuing the science around the Upper Marcellus. Keep in mind, the most efficient way of our whole development is to do all the lowers first followed by the uppers. And so at this point in time, the upper horizon, from a strategic perspective, ranges anywhere from 130 feet thickness in the west part of the play to nearly 300 feet in the eastern part of the block. So there's a -- and remember, it covers all 173,000 acres. So there's a lot of opportunity there. I would parlay that also with the fact that last year, in December, the Pennsylvania governor signed a new legislation that allows you to drill across units, which is really a game changer because what that's going to allow us to do is reset all of our locations on whatever the optimal spacing is and the optimal lateral length, it's really a brand-new greenfield operation. It's not going to change the rock property. The rock property is still very good, probably 70% of what our lower is, but we're going to be able to drill 10,000 to 12,000 foot laterals and just kind of march across the acreage where we have the infrastructure, minimizing the parent-child effects because once you go and look on a pad, you're going to drill the whole thing up and then -- and move to the next. So I think the efficiency gains, compounded by the longer laterals and the ability to just be very methodical in that process, will -- we expect to close that delta between the absolute return in the lower and the absolute return in the upper.

And what sort of lateral lengths do you think we could see in the Upper Marcellus?

We're working on that. I think we're going to -- we're targeting 10,000 to 12,000 feet as probably the optimal at this point in time. But those 5 wells and things like the handful of wells we're going to do in this interim period, probably each year, we'll test that concept on what the ultimate best lateral length is.

And maybe moving on to A&D. We've seen one recent deal in Appalachia. And it may have been a bit of a unique situation but has the low -- one of the lower valuations we've seen in years. Kind of what are your views on industry consolidation within Appalachia and maybe what role Cabot can play in that context or even outside of the basin?

Yes. I think, first off, from the macro perspective, consolidation has to take place in this industry. Unfortunately, I think the cards are stacked against a great deal of consolidation, simply because if you're sitting in a chair and you're looking at -- and the lens of what we have, and we just talked about the upper in that runway, and I didn't say this, but that runway goes to -- well into the 2040 decade, and then you're going to compare what you have to do with that versus buying something today, that creates a challenge. That challenge is then compounded by what they bring to the table in terms of balance sheet requirements, cost structures and firm transportation agreements. So all of those play into the fact that while Cabot does not need to do anything, Cabot does believe consolidation needs to take place. And those 2 messages, when they combine, makes it very difficult to make that happen. I think over the last few years, we've been asked a lot about, even our brethren in the Marcellus but not adjacent to us, and the challenge hurdle for us is the leverage component. And I think what the pandemic and the OPEC price war highlighted that, that balance sheet constraint is not unique to gas companies, it's fairly widespread across the whole space in all the basins, and we're seeing that kind of play out. So I think it's going to be equally challenging for out-of-basin transactions, even consolidation in other basins, to make things happen because of the fact of just the underlying assets you're getting and the burden that comes with them, can you make it work? And the simple story is always the best. I mean if you got to explain away a lot of stuff, odds are the market is going to sell first and ask questions later.

I do have one question from the audience. Can you maybe talk about the local demand build-out in the Susquehanna area and kind of the potential for that going forward?

Yes. We have -- in the last few years, there's been about 1.5 Bcf a day of local demand, of which we're part of. Obviously, 400 of that is the power plants that we're directly part of. There's some other power plants also that make up the vast majority of that. That market is probably fairly saturated because you don't want to overbuild the power generation side of that business. But you have the New Fortress project with them working with Chesapeake, and we'll see how that all plays out, trucking LNG down to the port in Philadelphia and then putting it on a ship to take to the Caribbean. We sold our CNG station so that we could double the capacity of it with other people's money and serve our rig fleets and serve our truck fleets and then also afford them the ability to service other industries with LNG trucking it to nearby states. So there's a lot of opportunity from that. It's a lot of singles, probably not even a lot of doubles, but that's going to fill a void and continue to be part of the equation as we go forward.

And then another one just on service costs. I mean you're seeing, at least in the oil basins, quite a bit of deflation. Are you seeing any cost reductions in the Appalachian areas?

So let me answer that this way. Keep in mind, we -- you understand our capital efficiency. Right now, we're running 2 rigs. We ran 3 to start the year just because the one was on -- we were always going to 2, one was on a larger pad. And we have 2 crews that we have access to from a completion perspective. We didn't sign up both crews. We've signed up one, and the other one is kind of a spot crew. With that footprint, we -- and we generally sign all these things up in the fourth quarter of the year going in. And which is what we did this year. So while there's not a lot of flexibility as it relates to the 2020 program, we're already having conversations with both of the rig providers and the completion providers about, more on the rig side, bigger declines on the rig side; a little bit less on the completion side because we already have the lowest price we've pretty much ever had in our history up there. So the key thing -- the key lens to look through on that is we don't want to put any of these guys out of business. We've got to have -- so it's a balance of you make money, we make money, we feel good about our efficiencies, it's a partnership. But we do see some room for further economic relief as we go into '21, not so much in 2020.

And then another one that just popped up, with the Henry Hub price, would you look to curtail output?

Well, that's a great question, but I'm never going to answer it. Again, we're not going to telegraph that.

Got it. Well, we appreciate the time, Scott. I think that's basically all the questions I had and all the audience questions. But on behalf of JPMorgan, thanks again for participating in our conference in this situation. But hopefully, we all aren't in the same spot next year.

Thank you very much, Michael, and it was our pleasure to be part of this.

Thank you.