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

Well, good morning, and welcome to day 2 of JPMorgan's 9th Annual Energy Conference. My name is Arun Jayaram. I'm the JPMorgan's E&P and OFS analyst. I'm thrilled to have Coterra to lead off day 2. Thrilled to have President and CEO, Tom Jorden. And we'll host a fireside chat today. We think that Coterra is one of the most unique E&P investment opportunities in the space. Not only do they provide access to a long-lived inventory base in low-cost rocks in the Permian Basin, but they have a lot of leverage to U.S. natural gas with the low-cost position in the Appalachia Basin, which I think could get more airplay as we think we're in a really positive longer-term supply-demand balance for natural gas. Tom, how are you?

Doing very well. Thank you.

Yes. Well, just for some of the generalists in the audience today. I was wondering if you could spend some time, Tom, on your strategy and what you think is unique about Coterra relative to your upstream peers?

We only have 30 minutes for that? Coterra is built to last. I'll just start with the end. Coterra has really premier oil assets in the Permian Basin, great assets in the Anadarko Basin, but also tremendous natural gas assets in Northeast Pennsylvania and the Marcellus Shale. And we built Coterra with the idea that one can never confidently predict commodity swings, and we've certainly seen that over the decades. And so Coterra has low cost of supply in gas and oil and the ability to pivot to changing market conditions and have stable revenue. I mean one of the things in our business that is most destructive are the oscillations in revenue where you start and stop your programs with commodity price swings. And Coterra has a revenue stream that is -- affords stability because of its diversity. And so we're really in a nice position particularly excited about some of the conversations around electricity demand and what that will mean for Coterra.

Great. Tom, one of the things that's differentiated Coterra from your peers is just how technically savvy you are in terms of your subsurface knowledge. You also have a great team full of a bunch of Texas longhorns, which I think has helped, little home cooking. But kidding aside, I was wondering, post the pandemic, the operating performance in the field has been really strong. And I was wondering if you could just talk about what's been the catalyst to drive this strong performance in the field. We've seen a lot of beat and raises from your team. But what do you -- what's the secret sauce? What's happened at Coterra?

The standard answer is people, but I'm going to go a different direction on my answer because everybody in this industry has great people. I mean it's really hard to say that individuals necessarily are the differentiating factor. We -- and Coterra has great people. I mean, I don't misinterpret my answer while I'll pick Coterra second to none in terms of quality of our people, the dedication and experience of our people. But we also have a culture that I think is a competitive advantage. Coterra is a very open company. And when I mean that -- when I say that, what I mean is we really demand a tremendous amount of collaboration across our platform. We want to make sure that the organization chart itself never prevents any 2 people from collaborating and sharing ideas. So we have a tremendous amount of ongoing conversation between our Midland office, our Tulsa office, our Pittsburgh office in terms of best practices. Phones are ringing constantly and people are flying from location to location to collaborate. But I'll also say, we also have an open culture in terms of wanting ideas and challenges. We really encourage and demand people. If they have a data-driven opinion on any issue, we want to hear it. And that is especially true if I'm in the room and somebody is disregarding with me. Yes, we set that example by welcoming challenge and making sure that all ideas are fleshed out. Ultimately, we're in the idea business. And the only way in our opinion to prosecute that effectively is to have an open playing field where everything gets analyzed and then and only then do you form an opinion and choose a course of action. Now we don't vote. We have an executive team that is responsible for higher-level decision-making. But up until the point where we make that decision, it is really an intellectual jump ball. And that has really made us better as an operator. That -- we also -- and that goes all the way down to the field. I mean, from field to C-suite, Coterra is a company that's built on ideas.

Okay. Next topic Tom I want to ask you about this capital allocation. Can you talk about your capital allocation plans in 2024? And I know that you did redirect some capital around your 3 core basins in terms of your 2024 guide?

2024, I think, is reflective of our flexibility. Natural gas prices certainly out of the chute, were incredibly weak, and that's not a surprise to anybody. And we took the opportunity to reallocate capital, to put Marcellus mostly in a maintenance mode that actually Marcellus will -- our gas production will shrink a few percentage points this year, and we reallocated that capital to the Anadarko and the Permian. It's really worked out well. We're seeing very good oil growth, very great profitability. And yet we're staged in the Marcellus to respond very quickly if and when gas prices do spring back. So really, it's, first and foremost, about returns, but we -- as you know, Arun, we do a lot of planning. We have a lot of contingency plans, high, medium and low that allow us to pivot at will. And we drive ourselves crazy with planning. In our call recently, I quoted Dwight Eisenhower, who said that in his experience, plans are worthless, but planning is essential. And I could not underscore that comment more forcefully when it comes to Coterra. Having the forethought of what you would do if really prepares the organization to make very quick responses to changing conditions.

Yes, tom, one of the unique aspects of the company is you're very capital efficient. And your 3-year outlook is one that is targeting over 5% growth CAGR for oil. Why do you think this is the appropriate level of volume growth for the company?

Well, there's no magic formula on that. What we do is we look at our cash flow, and we just make a decision as to what percent of our cash flow we think we want to invest. I would say that with commodity prices at cycle, it's hard to get that right. But we're typically going to land in current conditions -- and I'll come back to what I mean when I say that. In current conditions, we're going to land somewhere between 40% and 60% of our cash flow. And then the remainder is going to be there for our dividend, for our buyback, for other uses. Occasionally, it's going to be debt retirement. But that's kind of a fairway where we think in current conditions, that's prudent. Now I keep saying I'm going to come back to current conditions. If the marketplace were to call on Coterra to grow at a rate faster than that, we have the ability and we're ready to respond to that. I think Coterra is rather unique in that space where we have the organic ability to -- over a reasonable time frame to increase our oil production 50%. And I think there may be a condition where the marketplace calls for that. But in the meantime, we think our capital allocation is right where it needs to be.

And if we look forward, I know you don't have a formal 2025 guide, but what's your thought process around capital allocation between the Permian, Marcellus and Anadarko in 2025 given the contango in the gas strip?

Well, we're watching that carefully. And as I said, we've got lots of optionality there. We would really like to see our gas production get back to growth. We really do. We have very low-cost supply. It's extremely profitable. But we're -- as I say to our organization, we may underwrite our hopes with the strip, but we're not going to underwrite our capital program with the strip. We're -- seeing is believing when it comes to commodity prices. So we'd like to see structural changes in the marketplace in terms of supply and demand of natural gas that would justify increased capital. We think we're seeing that. But in answer to your question, I think you would probably see a healthy capital program overall. I don't think we would shrink our Permian program unless oil significantly fell but we'd really like to see Marcellus back at work.

Okay. Next topic, you just talked a little bit about the cash return on the balance sheet. Could you just talk about your capital kind of returns framework?

Well, we added a shoe, when Coterra was launched, we were paying a variable dividend. We really have 3, maybe 4 avenues of capital return. I mean one is our ordinary dividend. One is the variable dividend. One is the buyback. And then the fourth, I would throw in there is debt reduction. We were paying a heavy variable dividend. And quite frankly, we did a little market research and found that we knew we weren't getting credit for it, but you're always easier to criticize yourself. We thought everybody else was. And when we did some market research, we realized that really the variable dividend payers weren't getting rewarded for. So we took that as a market signal that the marketplace really wasn't rewarding the variable dividend. I mean, they were great for the -- when you get a check, I mean they are great. But next day, your share price didn't move. And that was happening over quite a few quarters. So we rethought that and we reprioritized our buyback. And that was an easy decision to make. I mean we're really interested in growing Coterra. And we really thought that our share price was some of the best opportunity for M&A in the marketplace, quite frankly. And so we prioritized our buyback over variable. We still keep variable in our toolkit. I mean I wouldn't say we would not consider a variable dividend, but we really think moving the buyback ahead was the right move.

Okay. I wanted to talk a little bit about the balance sheet and what this could imply for kind of cash return through some buybacks. You exited 1Q with around $1.5 billion of cash on the balance sheet. I think that at one point in time, you're thinking about using cash on the balance sheet to pay off a September debt maturity of $575 million. Can you talk about what your thoughts -- your plans are today around that? And I think you've maybe extended the maturity on that or...?

No, we went to the marketplace with a series of notes earlier this year. But our intent is to retire that $575 million. So when you say $1.5 billion cash, we would say $925 million because $575 million is really marked aside.

Is earmarked, yes, got it.

Yes, so our full intent is to pay those notes off when they come due.

Okay. And what is the thought about you and Shane around the appropriate level of cash to keep on the balance sheet because we think the share price is kind of pretty attractive for buybacks just given the macro setting and what you're doing in the field?

We have telegraphed softly that we've -- we used to say hard that $1 billion cash on the balance sheet was what we thought was the right answer. We've got great liquidity. And so I think we've relaxed that a little bit. I think you'd probably see us want to have $500 million in cash on our balance sheet, but we just think our buyback is something that we're quite interested in supporting. And if that means our cash dips a little down, that's okay. We've got great liquidity.

Okay. Great to hear, Tom. We're a bank at JPMorgan and we want you to become a bank, I guess you're leaning into our business model. Kidding aside, let's talk a little bit about the Permian. You know where I'm going to start is I wonder if you could give us maybe a fulsome update on the Windham Row project in Culberson County. And maybe describe for the generalist here, what you're doing with this large development project?

Yes, the -- of course, for those of you that are not familiar with Permian, there's probably nobody in the room for whom that applies. But the Permian Basin is multi-targeted basin. So we have thousands of feet of rock column that may have anywhere from 3 to 7 or 8 different target zones stacked vertically. And so how you prosecute those is really a function of your facility design and how you want to stage that because you often -- if you're going to bring on a massive amount of wells at one time, these wells do decline quite quickly, and we produce a lot of water. So you have to have a lot of handling equipment on the surface for that flush production. You don't want that facility when it's 3 months old to be terribly overbuilt because the production has declined so much. So there are a lot of elements involved in how you prosecute that. But you also have to make a decision if you have multiple targets, do they interfere with one another. Or can you drill one and come in years later and drill a second? How do they interact? . Generally, in the Delaware Basin, we found that targets we're prosecuting do not interact meaningfully, at least that was our intention going into the Windham Row. There's a formation called the Wolfcamp, that's our primary target. And the Windham Row was initially configured to be 51 wells side by side in the Wolfcamp. Now we've got a lot of projects that already have established how to drill those wells side by side. So the fact that we're putting 51 side by side, it's really not a stretch technically. A lot of people when you say 51 wells, they run for cover, because there have been some notable failures in our industry where operators got ahead of themselves, drilled too many wells and found out the fact that there was massive well-to-well interference. The Windham Row is not that project. It is well-calibrated 51 wells side by side. There's a zone on top of the Wolfcamp called the Harkey zone that we had initially said, no, we're good. We can come back and get that a year or 2 down the road. But in Culberson County, we had some recent results that showed us that there was a little bit of interference between the Wolfcamp and Harkey, not severe, but enough that we said, all right, let's come get that Harkey early. So we added 3 wells in the Windham Row. So Windham Row is 51 wells in the Wolfcamp and 3 wells in the Harkey. The reason it's only 3 is because we were far along on the project by the time we made that decision. We'll come back and get the rest of those Harkey wells here early next year. But the project is going very well. We're flowing back our first set of wells. I think we have 10 wells that are currently online and producing, and so far so good.

So far, so good. Great to hear. Great to hear. Going back to the Windham Row, I think one of your plans is to run a simul frac crew to run it off grid power. Can you talk about where you're at with that process between using a simul frac versus...?

Yes. There are a couple of elements I want to highlight there. We do have an electric crew running in Culberson County. And in Culberson County, it's 100,000-plus acres. It's one of the most contiguous blocks in the Delaware Basin. We are 50-50 partners with Chevron there and Coterra operates. We own and operate our own electrical distribution grid there. So we have a couple of substations that provide power. We take power off ERCOT through our own substations and then we have an electrical distribution grid. And that gave us tremendous flexibility when it comes to electrification. We're in the midst of a very significant multiyear electrification. Not only have our drilling rigs been running directly off-grid power, but we have compressors, we have a gas gathering system, and we're electrifying our compressors. But it really gave us an opportunity with an electric frac crew. When people say electric frac crew, they're generally towing some fossil fuel-powered power source. It's either a gas turbine or reciprocal diesel engines that provide electrical power to the electrical crew. So although you say it's electric frac crew, if you really isolate everything that drove on location, it's fossil fuel powered. What we're doing in Culberson County is we're actually plugging that crew into the grid. So there's no mechanical generation in the process. And we're finding that, that is giving us smoother power, greater performance out of our delivered horsepower out of electric pumps. And so we took the opportunity in the Windham Row to simul-frac. So we've got additional banks of electric pumps. We are simul-fracking. We're seeing great advantages with simul-fracking, not only on fuel savings, but efficiency and speed of execution. So it's really, really a nice benefit from owning your own infrastructure.

Got it. And then let's talk a little bit about well performance. You had a record year in the Delaware Basin in 2022, still strong, maybe a little bit lower in 2023, but still very strong on a relative basis. How do you expect well productivity in the Delaware Basin to trend this year? And what kind of outlook do you have on the future years?

Yes. We don't expect to see any meaningful change in our capital efficiency. We'd love to get more productive wells. But in terms of -- I think what I hear in your question is, Tom, when are your wells going to start degrading because you're going at the lower quality rock. And we think we've got a really long runway there. So we would expect our capital efficiency to be relatively constant. Now there'll be peaks and valleys around that baseline, just on where we choose our projects. Lea County is probably our most prolific area, not necessarily our most profitable area, but our most prolific area in terms of flush production. And if you're bringing online 100 wells a year and 20 of them are Lea County, you're going to see a peak in that peak and valley cadence.

Yes, of course. Great. Let's talk a little bit about cost deflation, what you're seeing in the field? As you're aware, the U.S. rig count has countercyclically come down this year despite relatively positive oil prices. Gas obviously has been under pressure. I think that your guide is based around 5% kind of cost deflation, but help us think about what you're seeing from a deflationary standpoint?

Yes. I mean, I don't really have anything new to add there, other than you're going to hear different answers from different operators and mostly because it kind of depends on when your equipment comes off contract and is renewed. So when do you do a reset on your price? So we typically have very few annual contracts, I mean for us a long-term contract could be an annual contract with the one exception being our electric crew. And then the rest of our equipment is typically pad to pad. So that 5% guide, I think, is what we'd still hold. I think on a total well cost, if you were like resetting from a year ago to resetting today, if you added price savings and efficiency savings, it's probably closer to a 10%, but 5% is kind of what we've guided.

But guided to. Okay. Great. Final question on the Permian is if you could talk a little bit about your marketing strategy for natural gas. Obviously, we've seen some weakness year-to-date in Waha pricing. Obviously, we have a project in the third quarter, which is going to kick in the Matterhorn project, which may help, but give us some thoughts on marketing gas in the Permian?

Well, when you put 2 companies together, it's always a lot of fun because if you have humility, you learn a lot. And I would say when it comes to marketing from background I came from, we didn't know what good look like. We just didn't. And then we met a new marketing group and thought, wow, this is what good looks like. And our marketing group is fantastic. I mean, it really takes a portfolio approach. They like to show a pie chart with multiple outlets so that you're dampened the volatility in your price file. They really seek to have multiple types of arrangements. Like if you look at our Marcellus project, you're going to see power pricing, you're going to see direct sales to industrial end users, you're going to see long-haul firm and you're going to see them basing in basin. You're going to see some LNG. It's really, really a nice portfolio. And so we're kind of redoing our Permian marketing along those lines. Waha pricing is a problem. And the biggest problem is Waha gas is for the basin, a waste product. And those wells are drilled because of the primary revenue source is oil. And even at negative $2 Waha, you would still drill the oil well. I mean, so it just -- it offers some additional challenges, but it also offers some opportunities. I mean, I think the -- this whole electrification data center discussion is going to realize that the Permian Basin is probably a great place to generate electricity.

Yes. Okay. Let's shift gears, talk a little bit about your gas portfolio. Maybe I'd love to hear your thoughts on just the macro -- or Coterra's macro view of the U.S. natural gas market.

Yes, I don't know how even a casual observer can't be very optimistic about natural gas. Now we're all born optimists, right? I mean, we drill wells for a living and things go wrong. And if we weren't optimists, we have jumped out of the window years ago. But when you look at natural gas markets right now and you look at not only LNG that's opening up significantly in 2025. So within the next 18 to 24 months, United States will be exporting 25 Bcf a day of LNG or maybe a little longer runway than that, but that's certainly the directional runway. And then now superimposed on that is the growing electricity forecast and the needs of this country. Natural gas is really going to need to be a significant part of that. I mean at a JPMorgan's analysis, I mean, we've heard estimates of anywhere between 40% and 80% of that incremental electricity will be natural gas. So look, I don't know there are some rather exorbitant forecasts on what that will mean on Bcf a day. But if it's 2 Bcf a day, that would be really significant for natural gas markets. So we are really optimistic about natural gas. And when we look at where we've positioned Coterra with the quality of our oil assets, the low cost of supply, the basin diversity and the exposure to this looming natural gas situation, we just couldn't be happier with where Coterra sits right now.

Yes. Can you talk about your overall capital efficiency in the Marcellus. I know that you have -- the mix of activity is moving a little bit more Upper Marcellus, but give us a sense of how things are going.

Well, this is one where cross-organizational collaboration is really fast and furious. The challenge in the Marcellus is water handling. And capital efficiency, a big part of that is how do you handle your water. Now you might be surprised to hear me say that. I mean we produce on a gross basis, 600,000 barrels of water per day in the Permian Basin. In the Marcellus, on a steady state, we probably produce 7,000 barrels a day. And I will tell you that the executive team worries about that Marcellus water, probably 10:1 over the Permian water. And that's just unique to Pennsylvania. Water is used in recycling in the Marcellus. So if you look at all the operators, when you're fracking and you have a lot of activity, you're reusing almost 100% of your water. But if you stop that, you don't have anywhere to put your water. And so we're -- our team has really done a nice job of finding solutions to that. And by the end of this year, I think we have solutions identified that will give us complete flexibility in our capital program. But it's a big part of capital efficiency is how do you handle your water, how do you provide yourself the opportunity to accelerate or decelerate without arbitrary concerns, and I would say water can be an arbitrary concern with what we're doing.

Got it. One of the things we've highlighted in our work is that you have an acreage position in Dimock township in Southeast PA that we think has some core to the core kind of capabilities. So give us a sense of your development plan in that part of your portfolio?

Well, yes, you know the history there. It's an area of the field that we were precluded from drilling, and we 1.5 years ago, settled that with the Department of Environmental Protection, the Attorney General's office in Pennsylvania, and I really want to credit our team for really putting their shoulder to the wheel and getting that done. So we're back drilling there. We'll be bringing on our first production in December. We're currently going to be completing there. We've drilled the wells. We'll be completing here in July, and staging it in, so we'll have first production there. Depending on how we do it, I'll say this fall, we'll be bringing wells online. So we're really pleased to be doing that. The community is pleased to be doing that. A lot of the people live in that area have not participated in the royalty that some of their neighbors have. So we're really, really pleased to be doing that.

Sounds good. And is it going to be Lower Marcellus or is it...?

Yes, Lower Marcellus.

Got it. Last question, Tom, I'd be remiss if I didn't ask you about M&A, obviously, Cimarex merged with Cabot a couple -- a few years ago. You haven't done much since that time, but give us a sense of how you evaluate deals and just maybe the current landscape around that...

I'm going to start by I'm a little worried about you, I'm you're 29 minutes in before you've asked me the M&A question. We -- I'd love to see Coterra be bigger. I'll just say that. I'd love to see Coterra be better. And I think that a lot of the attributes I talked about, the virtue of what makes us such a good operator, in my opinion, what makes us such a premier company, I think that's scalable. So I think if we had more assets brought into Coterra, we would do well with that under the right set of circumstances. But with M&A, it's about being better pound for pound. It's not about being bigger. It's not about, hey, I can bring in these assets, just are you better pound for pound. And that's a high bar for us. We have deep inventory. We have very low cost of supply. We are geographically focused on where we are focused, we have critical mass. But we look at everything. I mean there's not a significant transaction that's come through that we haven't taken a look at. We've been close on a couple of deals, I'll say that. But we just haven't found the right one. And then I'll finish by saying a lot of buyers have a problem to solve. And yes, don't take this statement as arrogance because it's not. But we don't start with, oh, my goodness, we have this problem to solve. If it truly doesn't make us better pound for pound, it's not a good deal for the Coterra shareholder.

Great. Tom, we're out of time. Thank you so much. I appreciate it.

Yes, thank you, Arun. Yes.