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

Moving on to our next conversation. I'm really delighted to have Tom Jorden, Chairman, CEO of Coterra Energy, to be here for our next fireside chat. Tom, thank you for being here.

You're welcome.

It's always great to -- it's always a treat.

Well, from my lens, it really feels like operations are doing really well. Coterra, it's -- you guys have been beating the numbers left and right, by our count 7 out of 8 quarters, been beating oil numbers. Has that surprised you to the upside? Have you -- are you surprised by how well just operations are for me?

Well, I'm surprised by some elements. I'm not surprised by others. We have a great operational team. We have a culture that invites and demands open collaboration. We share best practices. We want good ideas to spread like wildfire. But we have an organization that's really actioned -- embraced that in an actionable way. We have seen some capital efficiencies though that have surprised us. We've seen well performance that exceeded our expectations. But we've also seen product -- project acceleration that's exceeded our acceleration. As we've gone to simul-frac on our largest project, we've really seen our time line accelerated, and a lot of those volumes that have led to outperformance were because of increased timing. And we're still in the business where things go wrong. I mean we've been fortunate to have a great string of just excellent operational cadence. But we don't sandbag. We really do try to update our guidance with what we think the midpoint is almost likely. So there will be future quarters where that's where we land. I hope we don't fall materially below our midpoint, but it's been rewarding to have that cadence. And if anything, Betty, I'm quite hopeful that Coterra is building a brand of operational excellence, of results orientation, of not overpromising but delivering solidly on what we say. And then finally, being plainspoken, telling people, describing the business as we see it, and having a lot of credibility in the marketplace.

That's great. The -- maybe how that -- I can come back to it. Maybe -- so there's the one question that comes a lot when it comes to the Coterra story is the diversified business model, less so on the geographic front, but more on the gas and oil diversification that it's -- and as a result, almost like despite the really great operations, Coterra still trades at a discount to the gas companies and still trades at a discount relative to some of the large-cap E&Ps. So do you think you're getting the full benefit of the diversified business model? The -- like what are the metrics that you look at to define it? And how you think about the success of this type of diversification?

Well, we're competitive. I'm competitive. I look at a lot of things. I mean you can look at a chart of multiple against a lot of different x-axis, market cap, it can be cash flow, it can be enterprise value. And I would say our multiple is middle of the pack. But there's nothing that we want to be ordinary about Coterra. I mean we want Coterra to be a cut above on assets, we want a cut above on performance, a cut above on cost of supply and a cut above on performance among metrics, including our share price. And so I think as we establish that brand, and quite frankly, as we see some cycles in our business, I think you're going to see the value of having our diversified revenue stream. Although a big challenge is people don't know where to comp us because we're an oil company or a gas company. And although we're a little over 70% gas by volume, we also have a huge oil and NGL revenue. So this year, oil and NGLs are going to be in the 60s as a percent of our total revenue. If you go back 6 quarters ago, natural gas was the majority of our revenue. So that's exactly the way we want it because we like that consistency of cash flow. Between first and second quarter this year, prices swung wildly and yet our cash flow only changed by about 12%. And that allows us to have consistency of operations, long-term plans and deliver the kind of performance that you referenced in your first question.

That's great. And then -- so another question that comes up more frequently is the -- I would say the perception of the accretive nature of the company. You often say that Coterra doesn't have a problem to solve. So how do you think about the value of M&A versus organically buying back your shares?

Well, I love the way you frame that question because you said the value of M&A. I mean ultimately, our job is to create value, not to grow, not to be bigger, create value. I think because of our operational capability that if we were to bring more assets in the organization, we would prosecute them well. In fact, I think when companies think about M&A, I think that the first question they should ask themselves is what are their strengths and how do you play to your strengths? And we are a capital allocator among a diverse portfolio, and I think a greater set of assets would be prosecuted well by our organization. But we're not -- that in and of itself is not justification. It's got to be something that is accretive to your shareholders and adds value to your owners. And that eliminates a lot of transactions that we've seen in our space. I'm not going to comment on any one, but we have been in that market. We've had shots on goal, and we don't carry forward any regrets based on what we've seen in transaction prices. You asked about comparing it to our own buyback. Look, we think one of the best M&A opportunities that we see right now is in our own shares. And we always -- we do -- we're very pleased to have a consistent and a buyback that we lean into. But that -- it's not either/or. There's -- you have to be good at a lot of things simultaneously in this business. If I sat here and told you that the best thing we had to do is buy our own shares back, that would be -- I'd be really disappointed in myself if I said that. We have lots of other things to do, and we're always in the hunt for value-added opportunities.

Value-added opportunity. So what criteria do you look at when you evaluate these type of opportunities? Like how do you narrow down the opportunity set?

Well, quality rocks is for your first screen. It's really hard to beat the rocks. So you want to have high-quality rocks. We also like multi-target basins. We, all else being equal, if we were to -- all else being equal now because returns are paramount, we'd probably choose to balance our oil and natural gas liquids a little further up, all else being equal. And then we'd really like to see if we were entering a new arena, we'd like to see a runway sufficient to justify the tuition price that one always pays. We have a lot of humility. We look at a lot of our competitors and have a lot of respect for our competitors. But we'd never be so arrogant as to say, "Well, we're going to parachute into a new play and immediately be the leading-edge company." I'd love to see that become true, but it takes time. And you always find things that -- or obstacles that were unforeseen. So size and scale, duration, quality of rocks. And then the big-ticket item is to acquire it at a value that gives you the chance to make money, what -- some of these transactions are being priced for perfection. I mean you just don't have a lot of room for failure. Now look, a lot of things can bail you out. You can have commodity pricing bail you out, you can have technology bail you out, you can have geology bail you out. All of those things happen, but the opposite happens, too. And it's just how risky this company want to be. We've seen a lot of bankruptcies from people that got on the wrong end of that.

Makes sense. Do you find duration being a more difficult aspect to meet in value...

No. We have the luxury of a long inventory coming into it. So inventory length is not really a thing we're trying to solve. If we had a short-duration asset that was -- fairly firm the line in terms of our overall inventory, we would be interested in that.

Back to buyback. You have returned over 100% of your free cash flow in the first half of the year and also having one of the best balance sheets in the sector. Is there any reason to stockpile cash? Or is that more -- that free cash flow is more likely to come to the shareholders?

Well, look, we love returning cash to our shareholders. We -- our first call is our dividend. We have one of the largest ordinary dividends from a yield perspective in our sector. It's front in line ahead of our capital program. And that we instituted a dividend many years ago, and one of our long-time owners asked for it and told us that a dividend reminds a management team of who they work for. And we -- our experience is that's absolutely true. When you have that dividend and you're making an annual capital program, the fact that, that has first call on your capital is good. It's appropriate because you are owned by your public shareholders. We haven't made any lofty promises on higher percentages of cash flow return just because we just don't see any virtue in that. I mean it paints you into a corner because then you're reacting to what you promised. We've just seen -- show by our results, who we are. We're just -- we're not going to get into an arms race of cash return.

And I show by action instead in -- it's so far been so good.

So far, so good.

So far, so good. Sort of on the capital allocation question. I think you've also talked about Coterra as being more capital constrained rather than opportunity constrained. As you look out in the current macro price environment, how do you balance growth versus CapEx? And that's especially related to some of the efficiency gains that you were seeing, sort of tying that to that 3-year outlook that assumes some level of modest growth. So how do you think about [ outputting ] that, putting capital into the...

Yes. No, that's a great question. We think about growth solely in the context of growth of financial performance. We don't manage the company by production growth. We just don't. We look at a given year. So soon, we'll be looking ahead into '25, and we'll do a first pass estimation of what our cash flow will look like. And of course, that involves a guess of capital program, and that generates cash flow. So there's a little bit of iteration there. But one of the biggest overprints is commodity pricing, and so you can generally get close. And then we'll make a first cut and say how much of our cash flow do we want to invest? And once -- and we typically, in this environment, are between 50% and 70% of our cash flow that we would invest. And so from that point forward, it's just a race on what are the highest-quality investments, what generates the best return over time, what's ready to go? Are there partner considerations, other lease considerations? Are there any other kinds of commitments, marketing, vendor commitments, all of which we have very few, but those are just things you have to consider in capital allocation. But by and large, our capital allocation is around the quality of the investment and what we can stage in a given arena. No business unit has any call on capital. It really is zero-based budgeting. If we have taken a business unit to 0 because there's better opportunities, that's the right answer. So that's kind of how we think about it. We like to be very nimble in that. And so we typically don't enter into a lot of long-term vendor commitments. We think that those are -- there are great ideas when prices are going up, there are horrible ideas when prices are going down. And we've seen both of those. And so I'll say -- I'll tell you exactly how we decide how many rigs or frac fleets to enter into any kind of long-term contract on. We run a downside on our cash flow, and we'll run $40 oil and $2 gas typically. And we say, "If prices were to fall to that level and sustain that level, how many of those services can we keep deployed?" And we've lived through a couple of cycles where we have exactly gotten that right, where in 2016, the price fell where we had 3 rigs in the contract. In 2020, we dropped -- we had nothing under contract, and we dropped just about everything except for 1 rig. These downcycles happen more swiftly and more severely than you'd ever predict. And so our experience tells us, don't enter into long-term contracts if you can avoid it. Today, as we said, we have 4 rigs under any type of term agreement looking into '25. And all 4 of those will roll off contract by August, 2 go away in April and then 1 in, I think, June and then the fourth 1 by August. We have 1 frac crew under a long-term contract. It's our electric crew. There we entered into a 4-year contract for that single crew. And we're in year 3 of that, and it's been a fantastic arrangement. It's been continuously deployed in our Culberson County asset. It's a full-electric crew. It runs off-grid power. A lot of electric crews come equipped with some kind of external power generation [ either do ] solar or natural gas, but this truly is running off-grid power. We plug it into our own grid. And it's been just a fantastic operation.

Got it. As you look out in the current macro environment, a lot of uncertainty today. Is there any reason for you to -- and you talked about your nimble asset allocation process. Any reason to deviate change much from, I guess, what you saw earlier in the year?

Well, we've already changed significantly. From our first pass, we've continued to decrease our gas activity. We're very constructive on gas. I mean we can get into that. But right now, we have a short-term disconnect. We've had a couple of meetings on this. It never ceases to amaze me how as an industry we can turn the glimmer of a good idea and massively overcapitalize it. We tend to do that quite well. So right now, there's just an oversupply, and it will work its way out. I think given the conversations around LNG and the role that has in global energy conversation around electricity in the United States, we're also in the developing world. It's as you study that, it's really hard not to be very constructive about natural gas. But you know what, we will pin our hopes and dreams on that kind of future, but our capital program is grounded in today's reality. So as we sit here today, we've really -- we have no rigs running in the Marcellus. We've released our last rig in the Marcellus, where we still have a frac crew working. And when that finishes, we may go to no completions. And we've got lots of plans for on-ramping when the price recovers and they're ready to roll. But for now, that's the right answer for us or the luxury of having other places to deploy our capital.

Yes. You have talked about $2 in-basin pricing as a threshold to bring some of the deferred TILs in the Marcellus online. Why even grow? Why even at that level, like given the -- like would there -- would you want to wait for even better pricing before you will put capital back?

Well, yes. Now turning TILs on and putting capital back are two different things, and I'm going to answer your question directly. We'd like to see a netback price north of $1 before I think you'd see us put a lot of our deferred production to production. We currently have a little under 300 million cubic feet a day shut in, and then we're going to -- we're completing now but we may delay those TILs if we choose to. We're laying down all drilling completion activity going forward. And that's the answer that we would seek. Operators shutting production in, that is an appropriate response but we don't like it. I don't like it because there's shut-in production that will come back online at the lowest incremental marginal price. And over the long run, what we need is to balance the market with the full-cycle drilling completion cost against the full-cycle return of the commodity price. Until that balance is found, you're still going to see a little bit of disconnect. And so that's our approach. Now we have the luxury of saying that because within our portfolio, we can reallocate. It's not a choice between investing in our gas assets or not investing at all. We have Permian deep inventory, we quote 15 years plus in Permian inventory with lots of opportunities set in front of us. We also have the Anadarko. Although the Anadarko generates a lot of natural gas production, it also has a lot of natural gas liquids production. So for a typical Anadarko well, the dominant revenue phase is a combination of oil and natural gas liquids. So we're really pleased with where Coterra is in this problem set because we do have the flexibility to pivot and be patient with great built-in upside exposure to natural gas.

No, makes sense. Makes sense. Pivoting into the Permian that we're watching the Windham Row closely. So it's been tracking ahead from a timing perspective. How is it performing? Just -- and based on what you're seeing from the performance of Windham Row, how is that informing how you want to develop the next row development in Culberson?

Yes. Well, we're seeing -- yes, so far, so good is the answer to your question. As of the end of the second quarter, we had 21 of the Wolfcamp wells online. We continue to complete and bring wells online. As we discussed in our earnings call, we have pivoted a little bit on how we think about the Wolfcamp-Harkey interaction and whether they should be codeveloped or you can do one and come back later. We don't know that we have the final answer on that. But in Culberson County, with one project test that we did, where we had two side-by-sides where we codeveloped and then the other one we drilled Wolfcamp and came back later and overfilled the Harkey, we saw a little better performance on the codeveloped. Still great Harkey economics across the board. But what we've said is, "Look, let's make our default option, codevelop while we continue to study this." So we added 6 wells to the core Windham project, but we're now overfilling the rest of that row. So really, it's become a 73-well project with all the Harkey wells. But seeing very good results thus far. We've had a couple of small operational hiccups as one always does with a 50-well project, and nothing to really delay the results or give us too big a concern. As far as informing future projects, this Windham project was already well calibrated. We've done this a lot of different times throughout the basin and certainly in Culberson County. And putting this many wells side by side let us take advantage of efficiencies of simul-fracking, efficiencies of infrastructure, efficiencies of just project staging and what that does, saltwater disposed on, all those kind of come together and are managed most effectively with large project size. But I wouldn't say other than the Harkey-Wolfcamp interaction, that we've had necessary learnings that we would because of the material changes other than we've been surprised at the performance of simul-fracking. We'll probably seek to simul-frac wherever we can. And we have many years of these kind of projects. If not 73-well projects, projects that are half that size, we'll probably have something like that every year in Culberson County for quite a few years yet to come.

With the simul-frac, is it -- what percentage of Windham Row did it account for? And...

Yes. I'm going to guess on that. I think it's 60% or 70%, yes.

And then going forward, more likely to get through.

Yes. We initially thought we'd have less than that, and our team kind of scrambled and kind of adapt on the fly and reconfigured some pads, but it's really been excellent. And a lot of it is because we own all the infrastructure and control our destiny there. So in terms of delivering water to location, in terms of disposing of water, having the source of electrical supply, it's all come together really nicely. We have a great partner in Halliburton there, and they really performed well, and it's been just a terrific project thus far.

That's great. Maybe moving to Anadarko. It's very few -- it's not a basin that we get a lot of operating -- operator talking about the performance in Anadarko and -- but Coterra has seen some strong results. And you've talked about the learnings that you have made over the past few years to get more consistent results. So how do Anadarko Basin compete now in the portfolio? And how do you think about capital allocation in that basin?

Yes. The Anadarko is really highly competitive. Many of our projects there if you think in terms of PVI space or PVI 2.0 or better, it's -- in terms -- it depends what your oil and gas price is. Oil and gas prices, we've never had a good time predicting that. So that's why we like to have both in our portfolio because the situation ebbs and flows. Under current conditions, it's slightly behind the Permian but only slightly. And there are some great projects that we're really pleased to be prosecuting. But it won't take much of a change in gas prices for that to swing the other way.

Do you think you have enough scale there to fully optimize your operations and do what you think you could get out of that asset?

Yes. We have good scale there. We've got, as we talked about, probably about $2 billion of additional drilling opportunity in many, if not almost all of which are long laterals. Our team has done a great job kind of swapping and trading assets around, so we have long laterals. We're looking for additional opportunity. We're looking for additional opportunity everywhere. I mean the fact that the basin is out of favor with public companies is not -- we're not disappointed in that. I'll just leave it there. Now not all public companies, Clay was just up here and Devon certainly, a great Anadarko operator. We've partnered with them in the past and have great respect for Gavin and the team. And they're certainly fully appreciative of the Anadarko. Of course, Continental is not -- no longer a public company, but they're always an aggressive Anadarko operator and they do a nice job there. They're tough competitors. And then there's a whole bunch of private companies that are really quite active. So I'll just say this. You asked me about value, there's a lot of value in the Anadarko Basin.

Got it. Got it, and the value. This is an open-ended question, and I look forward to asking you this question. But if you -- open ended, looking out 3 to 5 years, where do you think -- what assets or aspects that makes you most excited about the Coterra story?

Oh, boy, I love what our organization does when they have challenges, when we take their shackles off and point them in the right direction. We -- one of the things that we don't talk about very much is the way that machine learning has completely transformed our business. And at some point, we'd love to talk about that because we didn't make it look easy. We had some false starts, but I'll say we did some fundamental things where we got it right. And machine learning has contributed to that operational cadence fully and completely. At Coterra, there's an operational meeting. I don't care how many salty completion engineers and drilling engineers are in the room. They've all been humbled by the power and what we've all learned about machine learning, and they won't have that meeting unless the machine learning team is at the table commenting on what best practices should be. We're also highly adaptive. And inventories are great. We all love to talk about them, but I've never in my career seen inventories play out the way people said they would. You go back a decade, you go back 5 years and inventories evolve. And as long as you are learning evolving organization, 5 years from now, we're going to have things that we didn't anticipate, and I'm excited about that. I'm also really proud of where Coterra stands in terms of the environmental challenges. And look, we have an election coming up, and I'm not political. And regardless of the outcome, we're going to have challenges. But it could be that given one outcome, there could be a resurgence in the ESG movement because people may be frustrated with what's happening in Washington, therefore, they come out of some different angles. And Coterra is second to none in our focus on environmental excellence. All of our new facilities when we talk about Culberson are tankless. Those are truly emissions-free facilities. We've done that through inspections and overflights. They are emission-free. We are at the forefront of, I think, the discussion on methane detection, and we're serious about it. It's our top engineering challenge. We're serious about it. And I think Coterra is really nicely positioned for the kind of scrutiny our industry will become -- would be under.

I appreciate you bringing that up, and it is very important, and thank you for doing the right things.

Yes.

So thank you very much, Tom, for this conversation.

Thank you, Betty. Yes. Thank you.

That was great. Thanks.

Yes. Thank you.