Devon Energy Corporation (DVN) Earnings Call Transcript & Summary

Well, good afternoon, everyone. Thank you for joining us for our next fireside session of this 2020 Virtual Energy Conference. Again, I hope everyone is doing well out there. And I just want to remind everyone that we have a Veracast system set up. And if you have any questions, please just type them in there, and it will come directly through to us. And we can read those questions on the call. So with that, I am truly delighted to be joined this afternoon by Devon Energy and Chairman and CEO, David Hager, who, I guess, will become Executive Chairman of the new combined Devon, WPX sometime in 2021. So Dave, I hope you'll still come and do our conference, but -- in your new role.

Well, if you do it in Miami, I will, yes.

I'll hold you to that because we hope to be there in person again next year.

So folks, I have a bunch of questions I'd like to answer. And again, please do make your questions known, and we'll get to them. But Dave, I've asked this question of a lot of companies. You're in a rather unique position, given -- we'll talk about your business model here in a second. But from your perspective, how is this oil cycle different? And particularly, in the context of U.S. shale production going forward, how do you see those 2 things playing out over, let's say, the next 5 years?

Well, I think to really fully understand the context of the -- where we are, again, it may be my age, but I like to go back and just talk about where we have been as an industry for probably the first 30 years of my career and how it has transitioned the last 10 years of my career. And I'd say, overall, that the first 30 years was an era of scarcity, and the great reward that you got was when you made a significant discovery and you would be confident that the economics of this significant discovery that you made would more than make up for the dry holes you drilled to get to that point. But there's certainly just an overall feeling in the industry that it was -- success was defined by the discovery of incremental hydrocarbons. And kind of a proxy for that success is if you could grow your production that indicated that you're having success with your E&P model. And so there's a great emphasis on growth, which was believed would translate into NAV growth. And the unconventional world really put -- totally changed that model. But it's, frankly, taken the industry to come around some period where we're now generating such -- the efficiencies that we can really take advantage of the unconventional model. So when the unconventional horizontal drilling and hydraulic fracture really started coming into vogue, it was new. We're still, as an industry, trying to figure out what areas throughout the world or the U.S. or whatever work for hydrocarbon -- unconventional hydrocarbons, what zones in those areas were. And so there was a huge amount of appraisal work that was taking place as well. Some areas work, some areas didn't. And so you didn't have near the capital efficiency that you have now in the industry. And there was still this feeling that growth in production was a proxy for success in the industry. And so what we did was a great thing for the country overall with producing hydrocarbons at much lower prices and energy independence and all the benefits that come from that, but we didn't do good for our industry. So I think there's finally an understanding in our industry that we have to have a financial model that makes sense for everybody. And because of that -- and that production growth is not a proxy for success of our companies and that we have to moderate the production growth that we see. And so now also, we're in a much more mature state where we don't know totally but we know to a much greater degree what areas are good for prospectivity, what zones and what areas are good. We know when we should drill the Wolfcamp, when we should drill the Leonard, what areas of the country work, et cetera, et cetera. So we're in a place where we can deliver much greater capital efficiency as an industry and when we -- and if we combine that with moderating the production growth, that we can really generate returns that are going to be attractive to the investor. And so that's where I think we are in the cycle now; finally, this realization that we have a model that can work. And I -- but it's fundamentally different than what, frankly, myself and many other people in the industry were brought up to believe represented success for many, many years in this industry.

Well, I think -- I mean you and I have had the opportunity to talk about this before, and I'm not going to beat that horse to death today. But you've clearly led the industry in this idea and you talked about sub-5% or up to 5% growth for stand-alone Devon. But when you take a step back, before we talk about WPX and consolidation, when you look forward, from the discussions you've had with investors, what do you think they're looking for? And let me elaborate just a wee bit. So energy is 2% of the S&P. If you take out the majors and the refineries and the service companies, it's even -- it's less than 1%. And then you've got a handful of E&Ps. And no disrespect to you guys, but one of your peers said a couple of weeks ago, Pioneer, that coming out the other side of this, there's going to be a handful of investable E&Ps. But they didn't have Devon as one of them, which we have a buy rating on you, so I would challenge that. But the point is that there is obviously a question of relevance and a question of materiality. So when you talk to investors and when you think about what you want to represent as an investment opportunity, what does that look like? How do you differentiate in such a -- given the backdrop I just laid out?

Well, I think there are several elements you have to have as a company to really be successful. You have to have top-tier assets. And we certainly feel, particularly with the combined WPX, that we're going to have that. You did have to execute extremely well on those assets. So drilling -- capital efficiency, for instance, drilling and completion cost, minimize those while getting top-tier results from the wells that you drill. And we're confident we can deliver on that also. You have to have financial strength, a third element. Because we don't control the commodity price, and so we have to have that financial strength to withstand what has become, now 3 times in 11 years, significant price collapses so you can maintain some continuity in your operations because, overall, that will enhance returns versus having an up and down cycle in your operations. Fourth, I think ESG excellence is a new element that is extremely important and certainly something we're very focused on as a company. And then fifth, I think, does go to what you're talking about, a disciplined returns-driven strategy that incorporates all the elements that I just talked about. So we think we have all those elements. We think that's what the shareholders are looking for. Frankly, I think companies historically have had probably some of those elements but not put all of them together. And we feel good that we're really one of the companies that's leading the industry, if not the company that's leading the industry, in emphasizing all of those elements.

Okay. Well, I think, I mean, the cash return story we're going to talk about here in a minute in terms of the cycle. But one other major event has happened, Dave, since the earnings, which, of course, is the election. And now we have -- to be confirmed, but we may have a Democratic administration. You guys had laid out, I think, that you had enough visibility to manage through any risk to federal drilling or leasing. What is the current situation today? Have you had any discussions with the state? And what kind of visibility for the combined company do you see in terms of your ability to execute on your federal lands program?

Well, we think we're going to be able to execute extremely well on our federal lands program. And first off, and I've gone through these elements before, I think the most important thing is we -- just -- if you just take New Mexico, New Mexico is fundamentally an oil and gas state. 40% of the revenue of the state comes from oil and gas, and it is extremely important to their economy. Their governor, Michelle Lujan Grisham, who's helping lead the Biden transition team, I've personally been on Zoom calls with Rick and I -- Rick Muncrief and I have been on Zoom calls with her as recently as 2 or 3 weeks ago, where we talked about this for 2 or 3 weeks. And she's a big supporter of our industry and understands the importance of federal acreage and the ability to execute on that. And so I'd anticipate a moderate policy to come out of a potential Biden administration. It does appear that on the Senate side, we're -- as of today, it looks like now, with Alaska being called, we're at 50-48 on the Republican side with 2 more elections to come up in Georgia. We'll see how those turn out. But again, I think it's unlikely, regardless of how those turn out, that we see significant new legislation that's going to impact our ability to do things. It is important for us to perform our operations in a very environmentally responsible manner. And that's something that Devon has always paid attention to. They're working on new methane rules in New Mexico. We've worked closely with all the appropriate people, including the state on what may be appropriate regulations for that, and we've done it in very constructive manner. The governor has acknowledged that. And so we think we're the type of company that -- whether it be at the state or federal level, that you'd want to operate on federal acreage. And we're very confident -- not to mention our permit backlog that we have of over 500 permits in the Delaware Basin alone on federal acreage live by the end of the year. We're very confident on being able to continue operations.

And then just to be clear, the current -- at the combined company level, what does that represent in terms of a drilling inventory? So I don't know if you want to describe it as years of drilling backlog or how you want to characterize it. What does it look like for the combined company?

More than 4 years.

Okay. So you're covered through an election cycle. I assume that includes the renewal.

Well, the federal permits, just to be clear, they are good for 2 years, and then they have -- then there is a -- they have to be renewed for an additional 2 years. So there would -- it would require renewal of those permits. That has never been denied in the past. It's a sundry notice type process, and we believe that will continue to be the case.

Okay. We'll get to the deal here in a second. But I want to -- I mean, obviously, the S-4 was filed. I want to take a slightly different approach and ask the question on consolidation, Dave, from Devon's standpoint. So clearly, WPX went through a process. But Devon, as a willing buyer, can you characterize what your position has been? Have you been looking for -- where are you looking for a deal? Were you specifically interested in this deal? Were you open to other opportunities? So what -- how is Devon positioned from -- in terms of its role in consolidation?

Well, we -- we've communicated pretty consistently, Doug, I think that we're very confident that we could have executed very well as a stand-alone company, that we had a portfolio that we could be competitive with. But we do recognize, at the same time, that there are other factors at play here. You can realize synergies through the appropriate transaction. And it has -- G&A synergies are always reasonable assume you can achieve. But in addition to that, you want to get one where you can to achieve operating synergies, if at all possible, and we certainly saw that possibility with the WPX transaction. We also do recognize that scale matters in this business. And so incremental scale to be of such a size that you are recognized by the potential shareholders was another element. So we were -- as always, have an internal evaluation and strategic planning process where we think about whether we should be a consolidator, whether we should look to be consolidated, every possible outcome. And we believe that there were -- and there is a very small list of potential companies that might be interesting in this type transaction. And I think what makes this probably still a little bit unique is that we wanted to take the approach of really a merger of equals on this. And there's been a lot of transactions, and we've all been involved in them, where at 80% or 90% of the assets come from one side. And so you take the assets, but you really don't focus on learning much from it. You just, frankly, don't -- say you don't need many of the people from the company you're acquiring, and you just continue to do things the way that you've always done them and just take the asset base. And we think we've done well at Devon, but we're also very open-minded that we don't have a corridor on every best idea out there. And when we looked at WPX, we saw a company that was executing very well on its own. And Rick Muncrief and I have a great deal of trust in each other, and we started talking about, "Let's try to create -- see if we could create a company here that's better than either one of us could easily achieve by itself." And certainly, it helps to have synergies, but there's also intangibles that go into it, just taking the best processes, the best way of doing a lot of different things in the business. And so that's what we're doing with this. And that's why we've taken the approach to have a -- at the Board level, at the senior management level to use that approach. We're currently working on with transition teams around that whole -- that entire same philosophy. And so we're very confident we're creating something here that's going to really be an outstanding company and is a step above what either one of us could have easily achieved independently. And that's the type transaction that was interesting to us, frankly, is where can we do this type thing that really can create some unique incremental value that other type transactions wouldn't do.

Well, the combined company, Dave, puts you in a pretty strong position. Obviously, you're a little bit more diversified versus stand-alone Devon. So I guess a couple of questions come out of that. And it's always -- I don't want this to sound either silly or petulant jam tomorrow or whatever idiom you want to use, but the question that comes up a lot is materiality. Are you still big enough? Does consolidation got further to run either generically in your opinion or specifically for Devon, WPX? Is there more to do in terms of consolidating the business?

Well, generically, yes, I would say there is. I think there's still -- this business, if you were going to take a blank sheet of paper and say how would you design this industry to most efficiently develop the resources that are present, we're nowhere near being there from an operating standpoint or from a G&A standpoint. There are too many companies with too much overhead. And given where most likely commodity prices are going to be, it's important to drive your breakevens as low as you possibly can so that you can generate free cash flow at a lower price point and then, obviously, even stronger free cash flow as prices improve. And there's still a ways to go for the industry. So I think generically, the industry needs to continue to look for consolidation opportunities. Now are the combined Devon, WPX going to participate in that? Obviously, our first priority is to very successfully manage this transition into one company that's rowing the boat together and really achieving everything that we think we possibly can achieve. And so far, I can tell you I think we're well on the path to doing that, but that's our #1 priority. Could there be additional opportunities in the future? Yes, there could be possibly opportunities. But I can tell you, just as you can see how Devon was incredibly disciplined on this transaction, that same approach would continue in the future. And so it gets to be a pretty small universe when you start putting all the criteria on that may possibly make sense. And then we're going to be -- well, I don't know if any of those will really work out or not, but that's our duty to think about possibilities and check out to see if things potentially could work. But I can tell you, if we do, it's going to be incredibly disciplined.

Well, that's good to know because, I guess, the mantra I'm pushing for is good assets in the hands of great management. And to your point, you were quite disciplined here. But I think the follow-on question, which is, again, going back to the S-4, it looks like everything from a Devon standpoint happened fairly quickly. So when you look at the synergies that you've laid out, the capital high-grading, the portfolio structure, the potential maybe even for asset sales, how well scrubbed is that? And what -- I'm talking about more upside to the synergy number, for example, because -- as you get further into the weeds. So maybe you could characterize for us the extent to which there may be some different outcomes when you get fully done with the consolidation.

Well, to cut to the chase, we think there is upside to the -- we've said $575 million total in synergies, $300 million of that coming from the legacy Devon and $275 million from the combination of Devon, WPX. But we think there is upside to that number, and we've tried to put a number out there that we're very confident that we can achieve. I'd say, Doug, this -- the merger may have happened -- in a way, it happened very quickly. In a way, it happened very slowly. And the way I'd say it happened very slowly is that the 2 primary assets that WPX has in the Delaware Basin, Devon had actually done a very deep technical analysis of both of those assets at the time -- or during [Audio Gap] acquired those. So we know those assets extremely well already so we have a sense of what those are all about. And so frankly, when it came to the actual due diligence, all we had to do is update our existing models that we had internally on those assets with just the very latest well results. But we feel confident that the synergies that we've laid out, as I said, we're going to achieve them. I think we'll get more. It's still early days. We still have not done all of the due diligence, I guess, you would say, to confidently raise the number at this point. We need to get technical teams talking to each other even more to get even greater granularity than we provided. But I can tell you we're extremely comfortable with what we have said, and I'm very optimistic those numbers will increase in the future as we get the technical teams to even -- do even more detailed look at the asset base.

So when -- as a follow-on, and maybe it's a little bit too premature to ask about this, but if I could characterize -- and maybe wrongly, but I'll try and characterize your asset base. So the Eagle Ford one, originally, you were operating with -- I guess now with BP. There was always some debate over the longevity of that asset. On the other hand, you have an early end -- or an early gestation asset in the Powder River. And then, of course, you've got the maturity in WPX' Bakken and your maturity in your own sector, leading Delaware position. So how would you rank those assets in terms of are any of them -- are all of them competing for capital in the combined portfolio? Or is there a high-grading opportunity ultimately and potentially even disposal?

Well, I would say that the bulk of the capital is going to be spent in the Delaware Basin. But each of the Eagle Ford, Anadarko Basin and Bakken are competing for capital. They just have lower levels of inventory than you have in the Delaware Basin. But as far as -- we don't fund things just because we're trying to throw a little money around everybody. That's not the approach we take. The approach we take is they have to compete on a returns basis, and each of those are competing for capital. And the one that may seem a little surprising to some people is when I say that's true in the Anadarko Basin. But when we look at the terms of the deal that we have with Dow there, coupled with $3 gas, those are competing very well with what we see in the Delaware Basin right now. The terms of the Dow deal where we pay 1/3 of the capital, roughly half of our interest and they pay 2/3 of the capital, that really -- that promote really helps out those along with the higher gas prices. The one that's a little more challenged at current commodity price environment would be the Powder River Basin. And so there, we have long-term leases. We've drilled some wells where we know we have a lot of hydrocarbons present, particularly in the Niobrara formation and is present over an extensive portion of our acreage position, probably in the order of 200,000 acres. We think we understand what spacing we -- is appropriate from a horizontal standpoint. We're still working on completion designs to really optimize the completion from a vertical sense in the Niobrara. And then we will have to get into full development mode, which really drive the cost down, much as we are -- continue to do in the Delaware Basin. So we're confident we can drive the cost down. Having said that, it's probably more of something that is going to compete for capital at scale more with $45 to $50 oil. And so that's the one that's a step behind the others, I'd say, right now, for competing for capital, but a large resource there and it is very leveraged to oil prices because it's about 80% oil. And so there, once you get above $50, it makes a huge amount of difference in the reality of economics.

Those are federal ones, Dave?

Yes, that's right. 10 years -- so we have that acreage for some period of time. So we have the luxury of doing good technical work, optimizing the results and then being patient both on the technical work and on pricing to go -- before we attempt to go at scale with a program out there.