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

All right. Well, welcome to our 9 a.m. Eastern Time session. We're thrilled to have a fireside discussion here with Coterra. Tom Jorden, thank you for being with us, Daniel as well. Thank you for spending some time with us.

Good morning.

Well, I'll ask you guys to make some opening comments, Tom. But one of the -- last year was certainly an important year of transition for Cimarex and Cabot forming this new combined company. Talk us through how integration is going so far. What do you view as the business rationale at the time of merging the 2 businesses? And how that ultimately creates a more sustainable E&P business model going forward?

Yes. Well, thank you, Neil. The integration, I would say, is going more slowly than I'd like, and I'm always going to say that because I'm deeply impatient, and I've got some really great people taking it in an order that needs to happen, particularly on the financial integration and some of our system integration. I think there's prudence, but I'm in a hurry. And -- but I would say, overall, I would -- the technical integration, social integration, the business plan integration is going extremely well. And we're behaving like 1 team more and more every day. We've recently had a number of our new team relocated over the holidays. So I was pulled from a hallway conversation with 1 of our business leaders to come in here for this, and that's exactly what I like. And in a perfect world, we'll hear some shouting in the hallway while we're on the line. And it's just terrific. I mean it's just terrific that there's an energy and a passion around building this company and really finding best-in-class approaches to every one of our problems. And the core thesis to your question of why we form Coterra, we feel more strongly about today than we ever did. And I hope we'll have a little bit of time to talk about the macro situation and what's evolving, what we're seeing out of Europe in the energy transition. But we are very convinced that Coterra will provide one of, if not the most stable business model in the energy transition space. As we look ahead, we're going to be low 50s gas revenue and mid- to high 40s oil and natural gas liquids revenues. We think that's a terrific balance going forward. We think it will provide stability of financial return to our owners. And we're here to compete, and I really feel good about how we're lining up.

Umang, I know you want to ask a question on the commodity element.

Yes, absolutely. You have a -- like you mentioned, Tom, you have a diversified commodity and asset mix. How do you see the macro environment shaping up for oil and gas in the near term as well as in the medium term? And how does that influence your activity plans between Permian, Appalachia and Anadarko?

Well, we certainly produce a lot of gas across our portfolio and then our oil assets are in the Permian and Anadarko, and that's where we're gearing natural gas liquids as well. So when I talk about commodity, there is a geographic overprint as well, but we'll put that aside for now. We are really bullish on energy right now. I think the market is bullish on energy. And oil kind of has had its own momentum as the post COVID, if I can say, post-COVID, we've been saying post-COVID for way too long, but I'm going to continue to say post-COVID, that there seems to be a lot of construction -- constructive talk in the oil markets. You've seen oil move up significantly and the supply-demand fundamentals seem to be supporting it. And that's one of the things we've always said we would look for is not necessarily worried about a meeting in Vienna to set the price, but that supply/demand fundamentals would take hold, and we see that happening. When it comes to natural gas, this has been an important week. The discussion out of Europe about rehabilitating natural gas and nuclear as a green energy source is, I think, can't be underappreciated or you can't be over-appreciated. What you're seeing there, in a larger context, is reason breaking through the wall of ideology and that there are -- we have problems to solve, and we have a lot of anti-fossil fuel talk that is wanting to sacrifice natural gas on the altar of purity. And that is just a terrible approach for problem-solving. And so what you see happening out of Europe is they're realizing, "Oh my goodness, if we don't really advance natural gas, we are screwed." I mean that -- and that's exactly the case to any rational observer of the problem. And so that -- if that talk gains traction, and I'm optimistic it will, because a crack has opened, I think it could also rebound into Washington and cause some really constructive worldwide discussion around the world of natural gas. So we are really bullish on natural gas right now. And the conversation this week is heartening to me, not only from a business perspective, but just from a service of humanity perspective, because natural gas is the only way we're going to be able to lift people out of energy poverty and I think people are waking up to that.

Tom, some of the critiques of the deal, the Cimarex-Cabot transaction was that if we were going into a structurally more bullish oil environment, did you dilute down some of that exposure to the upside on the oil side by moving into natural gas? But what you're saying here is you're equally constructive on the gas outlook versus oil, and so you don't feel like you diluted that energy upside optionality?

Well, yes. And that -- I mean, the outcome is yes. But looking at building Coterra, we said we can't predict the future. I cannot tell you, with certainty, 2 years from now, where oil will be, where natural gas will be and where they will be relative to one another. So yes, if oil is $120 and gas is $2, you can come back to me and criticize me all day long for Coterra, but I can't predict. And the history, as we looked at it, and we looked at it hard in analyzing Coterra, the history is that both of them cycle, and they don't always cycle in tandem with one another. And when we looked at the historical cycles of oil and natural gas, we saw the most stable long-term platform to have that balance of revenue mix. Because we can do long-term planning, we can fulfill a pledge to our shareholders to return capital over the cycles. And we can also not be buffeted by the destructive fluctuations in cash flow that really undermine everything we need to do. So look, you can pick an outcome, you can pick an endpoint where you say, well, that Coterra doesn't make sense, but you can do that with any commodity company. But this is the strategy that we think is the winnable one.

Tom, the demand side of natural gas, the point that you're making is a very compelling one. The counter to that or where folks will often push back as the supply side in saying, "Well, the U.S. producer is making relative record highs in terms of natural gas production." What's your confidence level in production discipline to support the gas backdrop?

Well, production discipline is a question you can ask oil and natural gas. But I do think operators are going to be disciplined. Like, for example, right now, as we've reviewed the Appalachian market, there is some excess capacity. I mean if we wanted to grow, we have the capacity to bring further volumes onto the market. But we don't think that's the prudent choice right now. We want to watch the situation. There is, I think, across our space, across the energy space generally, a discipline in the public operators. And I think it's real, I don't think it's a fad. And could it erode? Yes, of course, it could. But I don't see signs of it in '22.

Tom, let's pivot over to capital returns because when we think about -- and we're talking right before this, the underperformance of Coterra over the last year, of course, some of that was natural around the integration of the businesses and uncertainty. But I think investors are looking for a little bit more clarity around capital returns, not just how much of the free cash flow is coming back but in what form. Talk to us about the conversations you're having internally and with your Board and your own philosophy around return of capital.

Well, our capital return, its overall approach, we laid out when we communicated around Coterra. Our base intent, our base intent is within any but the most draconian commodity cycle to return 30% of our cash flow from operations in the form of an ordinary dividend and a variable dividend. Now that's a baseline pledge. And could we go above that? Of course, we could. We would like to get a little operating rhythm under our belts. We -- in terms of capital allocation, I think one of the real powers of Coterra is our ability to allocate capital because we don't have long-term commitments. We don't have marketing or lease commitments that are inordinate. And so we will have the ability to pivot and try to maximize our overall corporate returns. Now it's going to take us a little time because, as you know, with pad drilling and the lead time of these projects, certainly, any decision we would make wouldn't have any material operational impact until second half '22 because these projects were already well underway prior to closing Coterra, October 1. But we'll certainly look at debt reduction, and we're pretty much there. But the question that we always get asked is buybacks. And that's another option that we're very carefully looking at. We're not opposed to buybacks whatsoever. And we're looking at it from an analytical standpoint, as I hope doesn't surprise you. We're just not going to wave our arms and say, "Oh, yes, it's a good thing to do," and we feel emotionally good about it. We're going to tear it apart on -- and we are tearing the part on what does it look like from a per-share metric. And there's an interesting overprint to that. As we increase our return of cash to shareholders, then the yield itself is an element of consideration that we wouldn't have had 5 years ago. So we're very open to any and all meaningful ways to benefit our owners. And ordinary dividend, variable dividend and buyback are certainly 3 that are on the table right now, and we're having great conversations with our Board on it. And I think you're going to see us be very constructive.

And Tom, I don't want to pin you down to a date, but do you have a sense of when you would like to give the market more clarity around the form of our return for current capital?

Well, I think as we get clarity, we're going to communicate it. I would anticipate that we'll have more granularity to discuss on our next call. I don't know that we'll have any action to talk about. But as we do our analysis, we'll certainly telegraph our leanings.

Okay. Very good. Umang, I know you had the asset-level questions that you want to proceed with Tom.

Thanks, Neil. So one of the key focus for investors in terms of durability of free cash flow has been inventory life. As you integrate the 2 companies, where do you see you stand on the core inventory across the 3 basins? And which are the opportunities which actually stand out to you within the Permian or within Appalachia?

Well, the inventory life is -- that question seems to never die through the cycles. And it kind of -- I was thinking about it as I was anticipating that question, I was thinking about it this morning that -- it's really a question of are you a dynamic learning organization? And I think really good companies have made that less of an issue by how they performed. I think really good learning organizations have not let themselves go static and let inventory life become an existential problem, which I think is kind of what your question suggests. At Coterra, we have a very deep inventory and, really, in all 3 of our basins. Anadarko is probably the one that's got the widest inventory. But even there, at our current investment rate, you're talking decades. Now we need to increase the investment rate. But we have a terrific inventory in the Anadarko Basin, very deep inventory in the Permian, as you know. And the conversation always wants to pivot to the Lower Marcellus. We've got a number of years in the Lower Marcellus. So then we will move it to the Upper Marcellus and we're very constructive on the Upper Marcellus and it's not an uncalibrated construction. Now is the Upper Marcellus as good as the Lower? No, it's not. But it's shades of excellent. I mean the Upper Marcellus will compete with everything in our portfolio, heads up and we're terribly optimistic. And so inventory life is -- there are lots of things I worry about. Inventory life is not a core concern. There are a lot of ways that I want to increase the capital efficiency of our existing inventory, but I don't think, at Coterra, inventory life is something that's going to trip us up. Because we -- I'll finish where I started with this question. We're a learning organization. We're a dynamic organization, and we're going to be opportunistic, both through organic opportunities and we're not going to -- inventory will not be a problem for Coterra go forward.

That's great. So that would mean that consolidation is not really high up in your list of things to do with the free cash flow you're generating?

Well, it's not a strategic priority. One of the things that we, I think, attempted to communicate, maybe we're clumsy in it, is the thing I love about Coterra is flexibility. And anybody that's listened to me over the years knows that's one of the things I value most from my seat is just having flexibility. I don't like to get boxed in through marketing commitments through lease obligations through PUD bookings that steer capital. I like flexibility so that we can wake up every day and make decisions around return on investment and that, that's the only thing we have to worry about, and there are overarching concerns. And look, if something dropped in our lap that had a great entry price that were good for the Coterra's shareholder, and we could do it without impairing our balance sheet and honor all of the pledges we've made to our owners, we would look at it and look at it hard. But those are celestial events, I mean, quite frankly. I think many of the acquisitions people make, they get themselves in a position where they have to do something, and that's a really bad place to be. And we don't have to do anything. We have the luxury of choice, and that's, that -- if we had the right opportunity and the bar is high and the criteria are steep, we would look at it.

Great. I wanted to follow up on your comments about Appalachia and productivity there. It's been one of the key concerns when we talk to investors who have looked at that asset. And we have seen trends where productivity has declined over the years. As you integrate the 2 companies, what are the steps you're taking to kind of improve the infill performance of the Lower Marcellus? And what makes you optimistic about improving the performance of Upper Marcellus over time?

Well, we've had some great interplay between our Coterra new technical team, both people in Tulsa, people in Midland, people in Pittsburgh and people here in Houston. And we've got some great ideas floating around. We'll be looking at well spacing hard. And I think that has -- I'm deeply interested in that. We're looking at completion styles hard. We're looking at how you manage offset interference. We're looking at that hard. And I think there are some really good ideas floating around. And they go every which way. I mean I'm deeply impressed with the operating and technical people in all 3 of our business units. So I think you're going to see some progress there. Now that said, as you look ahead, one of the drivers of capital efficiency in the Lower Marcellus is that it is well linked. You -- we're at a point in that although we have multiple years of remaining inventory, a lot of it is kind of sliding in things that don't offer 2-mile wells. And so that has a natural imprint and that's hard to overcome. When we pivot to the Upper Marcellus, one of the things we love about the Upper Marcellus is it's relatively wide open. And so we really can approach that with no consideration other than capital efficiency and best technical approach. So we're pretty optimistic about what will come out of that free flow of ideas that's going on at Coterra.

That's awesome. And then talking about Delaware, right? You've seen strong capital efficiency in 2021. Relaxed spacing has helped productivity. As you look towards 2022, what are the things which you believe you can -- the organization can do, which can improve the cost positioning of Delaware further, that can reduce the cost for the company?

Well, we're pushing hard on that. We've had a lot of discussions here just over the last week or so, because as we're setting 2022 goals for ourselves, cost is always one of the metrics that we said. And we're holding the line. We think we can look at 2022 with the same cost structure we were anticipating. We are seeing some inflation. And of course, you're hearing a lot of operators talk about that. But we think we can push back on that. And there are a couple of things that we have in our toolkit. We currently have what we think is the largest 3-mile development in the Delaware Basin underway. It's certainly the largest in the Upper Wolfcamp. It's in Culberson County. And the cost per foot of that is remarkably attractive because with the 3-mile lateral, you gain that advantage. And so we're excited about that. We also bring on our first all-electric tractor this year. And we ought to have it operational sometime in May, may slip into June. But that's one that's running off our grid. It's being powered with grid power, and that offers some remarkable efficiencies. We tested that over the last year in a small scale, taking these electric pumps and operating them off the grid, and we observed tremendous engine efficiency over these portable power sources because we had a wider operating range. And so we're working with Halliburton on that, and we're very excited about bringing that grid in -- or bringing that crew in on-grid power as is our partner Halliburton there. And that, we think, is going to lead to some efficiencies that -- it's very difficult to model, but we think we're moving in the right direction there.

Great. And does that lend to your discussion last quarter when you said that you are seeing some inflationary pressures, but you can offset it through operational efficiencies? You used to maintain that view that in 2022, we'll be able to offset any inflationary impact through efficiency gains.

Well, I don't think it'll be -- look, I'd love to say we'll offset all of it. But we have talked about net-net. We're modeling single-digit cost inflation, so I wouldn't say we're at zero cost inflation. But that after we model in what we think are operational efficiencies, we're still seeing mid- to high single digit is what we're modeling in. A lot of that is fuel, it's steel, it's labor. It's a lot of little things, very hard to push back on those. So we're modeling some inflation.

Tom, staying on the Delaware. It's amazing how federal lands went from an issue which was top of mind to something that we don't get asked about very much anymore as the administration has taken a different tact on U.S. energy policy. But as you thought about developing Coterra, that was one of the things that you also talked about, which was mitigating policy risk depending on whether there is a change in administration or a shift in these. Just talk about your conversation as it relates to permitting. Are you worried about U.S. policy out on federal lands at any time over the course of the next 5 to 10 years? And how should investors be thinking about risking that piece of fit?

Well, look, yes, I think anybody that's paying attention has to worry about public policy. And that's why I was -- one of the many reasons I'm very interested in this conversation out of Europe, and I chose my words carefully. You've got reason cracking the wall of ideology. I think any -- when we're talking about -- the energy transition is an engineering and technical problem. And if anybody walked in my office with ideology-based solutions and was unable to support it with data, analysis and logic, it'd be a very short meeting. And yes, we have -- I think we perhaps glanced off the risk of a large public policy set through ideology. And we're still in that risk space. And I think that reality has intervened with -- when you see what's happening in the energy prices in Europe and much of the world. And it's not only -- it didn't fall out of the sky and hit them on the head. These were consequence of really bad public policy decisions. And so I think the U.S. is always in that risk. And I think as leaders in our industry, we have to calmly discuss this, have a data-driven discussion and not deny that, look, there is an energy transition underway, but our industry can be a very constructive partner in that energy transition. And you can't start first with an ideology that says we are anti-fossil fuel. That is just illogical, and I think that the opening salvos out of our administration were perhaps a little thick with that thinking and reality crept in. So do I worry about it? Yes, I think anybody that's prudent has to wake up every morning and worry about it. But we are seeing a flow of permits on federal land. I think we're seeing a reasonable approach. We're also facing really tough requirements coming out of the EPA. I think that we have to live in this space. And this is a high priority for us to address the emissions challenges of our time. But we're hoping that we'll have a counterparty in state and federal governments we can work with.

Tom, what would it take for you to shift from the free cash flow-oriented approach that you talked about on this call to one of more of a growth orientation, whether it's the Delaware or in Appalachia? And one of the key kind of themes of this conference is the continuation of that discipline in running the shale model for cash, but at Cimarex, you weren't afraid to talk about the importance of growth as well.

Well, we don't operate -- we don't live in a vacuum. We -- the Shale 3.0 model was adopted because of external investor pressure. None of us woke up one morning and had an epiphany and said, "Oh, my didn't, we need to revise our business model." It was investor pressure, and I credit a number of really good thought leaders that challenged us. There were some pain involved, and it was a good process. But you know what, we don't live in a vacuum. So if you and Umang will take the pledge right now that you will never ever write a report calling for industry growth, I'll follow on there, but I don't think you will because you don't -- you can't predict the future. And we -- look, if we had a future where there was a serious supply shortage, it's the irony of the White House calling for OPEC Plus to increase production, the deep irony of that. So look, we -- Shale 3.0 is real. We mean it. We're all in. But we didn't get here because of our own epiphany. We got here because of external environment. And I can't tell you that external environment won't change. I can just tell you that I hope to behave logically. I hope to have good conversations with our owners and I hope to respond well to the world as it unfolds.

Tom to that point, what are the markers that you're looking for to indicate that there truly is a call on U.S. Shale? Because we agree with this viewpoint that as we work down to OPEC's fair capacity, in '23, there will be a need for more of your barrels. Hopefully, it can be brought on in a way that doesn't oversupply the market. But what are the indicators you're watching to say, "We need to grow again?"

Well, I'll say this. If I had an hour in the White House to just sit on the couch and talk, I would discuss the long-term strategic advantage the U.S. would have through LNG that whether it be Europe or China, I think that when you look at Russia and China, the energy security is -- we've been lulled into not worrying about energy security, just fundamental energy security. And if you get a modern economy that doesn't have energy security, it will imprint every geopolitical decision that's made. And the United States has a remarkable resource in natural gas. I think any geoscientist that works U.S. shale basins will tell you that there is an untapped resource that is -- the USGS has done a fair estimate of it, and it's multiple trillions of TCF. I think that could be used to the geopolitical advantage for the United States. And so when you ask, "What are the things that could change?" I think we could wake up to that. And we ought to be streaming LNG tankers around the world and offering energy security, which will follow with supporting the very democracies that we want to see thrive.

And on the oil side.

Well, oil is certainly, I think, going to be a function of a growing world economy. The world still lives on oil, and we will for a long, long time. So I think that depending on the transportation requirements, I'm fairly constructive on oil as well. I don't see oil as having, necessarily, the long-term geopolitical factors that natural gas does. But we don't want to see our transportation fuel to an unstable region in the world. So I think oil is also something that United States can be very constructive on.

Thanks, Tom. Umang?

You mentioned there's greater appreciation of natural gas as a lower carbon intensity fuel, and it's good to see some traction on that front. As you look at Appalachia, are you seeing more engagement with authorities, regulators, your counterparts on the midstream utilities, portfolio takeaway buildout to unlock that potential?

Well, we're -- I'll say this. At Coterra, we've had a very creative marketing department. I'm very pleased at the Coterra Marketing Department. And they've done a really nice job finding in-basin outlets into the fact that as we've recently reviewed it, we've had the opportunity to take additional firm transport out of basin that we've turned down because we think there are in-basin opportunities, and we think there are a fairly robust set of future opportunities as we look at future coal to gas switching. So yes, I think there are lots to do in Appalachia. I also think we ought to build some pipelines in Appalachia. I mean, you're not going to find an Appalachian operator who doesn't say that. And I'll credit Toby Rice. I think Toby's letter to Senator Warren was brilliant. And I think everything in there is spot on. So hopefully, we can have that conversation in a rational way and talk more about natural gas as a fuel of the future.

Tom, can you talk a little bit about your view around hedging? You've left yourself relatively unhedged on the gas side, which has been the right decision in the near term. The curve on the oil side is in backwardation. What is the right strategy for a company that is diversified with a good balance sheet around its hedging position?

Well, hedging is insurance. It's a question of what it is you want to ensure. And as I look ahead, these are remarkable times in our business. I don't know that I've ever seen the fundamentals as good as they are right now. As I look into '22 and beyond, it's remarkable how low our capital is as a percent of our cash flow. And so classically, we've looked at hedging as ensuring our cash flow so our capital program doesn't get interrupted. And now when you look at the productivity of our assets and our current cost structure, our capital as a percent of our cash flow is the lowest I've ever seen it as we go forward. So you've questioned, what is it you want to insure? And I think now we'll be arguing about, all right, we've made this dividend promise, are we interested in insuring some baseline variable dividend? I'm very confident that our ordinary dividend is in the books. But do we want to ensure some baseline variable? And that's a conversation that we're having. I had some debates on this subject yesterday. And then there's also just a part that says, "Wait a minute." When you look at what you could hedge for right now, whether it strips the backwardation or not, if you could teleport me back to April of 2020 and tell me I'm even having this conversation about should we hedge or not, I would want to dope slap myself. So I think you'll see Coterra layer some hedges on. I don't know -- we've historically talked about a 50% hedge level. I don't know that, that'll be the landing point. But I think you'll see us come out with a hedge approach.

Yes. That's more ratable.

Yes, yes. And you can't have an approach that's -- you can wake up every morning and say, "Hey, is it high or low?" You just got to take the emotion out of it and just say, you know what, we're just going to have this target and layer them on.

Well, Tom, on behalf of Umang and myself and Goldman Sachs and our clients, thank you for this conversation. Wish you well at the conference, and it's an incredibly important year for your organization, and we wish you well.

Well, thank you very much. We're fired up, ready to roll and we're going to show the world why we're here. So thank you so much, and happy New Year.

Happy New Year. Thanks, Daniel.