Diversified Energy Company (DEC) Earnings Call Transcript & Summary

Greetings, and welcome to the Diversified Gas & Oil 2020 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to CEO, Rusty Hutson. Please go ahead, sir.

Good morning for U.S. participants, and good afternoon for London participants. We're going to go through a prepared presentation. We'll start here on the executive summary of the presentation for those who have it in front of them. And we'll -- just to go over a few highlights of 2020, to get into some operational highlights in the presentation and then move on to some financial highlights. But I would like to start out with some executive summaries of just really 2020 in general and really a very challenging year from a lot of different perspectives. Obviously, we had the pandemic and all of the challenges that it brought. But it was also a year full of extreme volatility in the commodity price environment, which made managing very difficult. I'm very proud of the year that we had in terms of the overall performance, both from an operational perspective and also from a financial perspective, and we'll get into a lot of that during this call. On Page 5, I'll really just talk about a few things here as it relates to the milestones in the business. It was a good year for us financially, but really a lot of milestones hit this year. We released our inaugural sustainability report, which will be releasing version 2 this year. But our first inaugural sustainability report, and I thought we did a fantastic job for the first time of preparing that report. We also completed our premium main market listing back in May of 2020, which was a big milestone for the company. And then also in September, we were admitted to the FTSE 250 Index. So a lot of maturation in the business this year. We also announced in October, a partnership with Oaktree Capital, really for bigger transactions for us -- for them to co-invest alongside of us in those transactions. Anything over $250 million of purchase price, they have the ability to invest with us. I think for a couple of reasons, that is as big for us as a company. First and foremost, I think it gave us credibility in what we were trying to accomplish as it relates to the PDP focused acquisition strategy and the fact that Oaktree was looking to do the same thing. And so for them to JV with us was a big milestone for us as a company. As we look at the year, when you look at the daily net production, over 100,000 BOE per day on average for the year, up 18%. We exited 2020 adjusted for some temporary curtailments that we were seeing at about 105,000 BOE per day, $628 million of natural gas production per day. And then the big thing that we've been bringing up on every call and every quarter is our Smarter Asset Management program continues to hold our conventional type production in our portfolio, relatively flat. At 69,000 BOE per day. And that has been very, very important in the operations, but also in the production profile of the company and the cash flows of the company. Cash margins continue to be extremely strong, 54%. You'll see a slide later that shows how that has been maintained over the last 3 years. Operating expenses, we continue to manage those down on a per Mcf basis. Total cash expenses, including the G&A cost in the business now at $1.15 per Mcf equivalency or $6.92 a barrel, extremely low. And we're doing that without risking any growth in any maintenance capital in the business. We continue to spend to keep production, but at the same time, maintain our cost structure in a very low place. Hedges continue to be very important. 2020 provided $145 million of cash flow. That -- the thing that makes that extremely important to us is that we talk about how we are insulating ourselves from that commodity price volatility that we -- like we saw in 2020. Now is 20 -- and this just proves that the strategy is playing out the way we expected it to. We talk about the hedges. We got 90% of our production hedged for this year and we feel really good about that. 65% in -- for the first half of next year, we continue to layer on in 2022. I've talked to our investors over and over again about how -- if I'm sitting here talking about near-term gas prices affecting our business, then we haven't done our job. We should be talking about 1 and 2 years down the road as it relates to hedging, and that's where we are as we sit here today. So we will continue to be opportunistic in the way that we approach, our future hedge positions and how to layer on to get the best and the most cash flow into the business as possible to continue to maintain that dividend strategy that we talk about. The balance sheet continues to be strong, $213 million of liquidity at year-end. We have over $220 million as we sit here today. Hedge protected cash flows. We paid down principal last year of $82 million. As I've said over and over again, if you're going to lever the business to grow it, you need to pay it back. Most of the E&P companies have kind of forgotten that concept. But we continue to pay down our debt with the excess cash flows that we have in the business, and that includes after paying the dividend. So a very strong cash position. Leverage continues to stay between the 2 and 2.5x that we've stated as our primary goal, and now we're at 2.2x. And then we've optimized the capital structure to use the cash flows of the business to pay down the debt, like we were talking about, as 70% of our debt structure or our debt is now in principal and interest amortizing notes with fixed coupons and hedged for the duration of the notes to protect the cash flows. So all in all, a very strong 2020. Moving to Page 6. This is very important because we -- what we said we would do when we came in and we did the IPO back in 2017, we continue to show that is -- that resolve is still there. We have a very low-decline asset base with very stable production, probably 1 of the lowest decline rates in the industry. And so we've grown production at a pretty fast pace even through the acquisition strategy, but we've been able to maintain the existing production so that there's not a great level of decline in the portfolio that we have to offset on an annual basis. The cash costs continue to be very low. And you can see since 2017, we brought that down 45% on a per Mcf basis to $1.15. That's extremely low when you factor in that, that includes our G&A structure. And we don't have a high capital expenditure outlay to go on top of that. The hedge strategy has been so, so important and 1 thing that we have really hung our hat on in terms of being able to maintain a very reliable cash flow and a very reliable dividend strategy. So as we have grown the business through acquisition, you can see here that the compounded annual dividend growth rate has been very, very strong. And so we -- as we enter 2021, our first quarter payout of $0.04 we annualized about $0.16. So you can see that, that continues to go up as we've acquired new assets. The cash margins over the last 3 years have been over 50%. And that's with gas and oil prices being all over the board. Therefore, again, the cash -- the hedge strategy that we're employing is insulating us from all the volatility and giving us the ability to continue to pay that annual dividend on a reliable basis. Leverage continues to stay low. Our liquidity is strong. You keep your balance sheet in a good place, and it gives you company the ability not only to perform, but also to be in place for opportunities as they present themselves. On Page 7. Really, the strategy, again, doesn't change. It's been the same for the last 4 years. We talked about it. We keep driving home the strategy every time we have investor meetings and speak with our analysts. We talk about how we hedge to limit our downside risk. We want to make sure that we're taking care of our cash flows and protecting those in commodity price cycles. We're generating a strong free cash flow. Our free cash flow yield is 25% and we don't have a large amount of capital expenditures that has to be utilized on the back end of that. Distribute shareholder returns, we continue to pay our dividends, as we've stated since day 1. And not just pay them but pay them in a very safe manner with a lot of free cash flow left over to safeguard the balance sheet by paying down our debt and making sure that we have liquidity to take advantage of the opportunities when they present themselves. You can see on this chart, which I think is very telling. If you go all the way back to 2017 when we did the IPO and you look at our total shareholder return of 174% that's pretty high. And when you compare it to the NASDAQ and you compare it to the -- to our Appalachian peers and you compare it to the FTSE 250, we've outperformed and definitely over the Henry Hub price. We've outperformed them all. But what's even more telling is since the pandemic, the growth rate that's been in the business over the last 12 months has been truly amazing at 116% total shareholder return, way outperforming the to FTSE 250 over that period of time. So we obviously are doing what we said we would do and delivering for our shareholders. On Page 8, we talk about ESG and how our culture and strategy really fits with ESG. And our whole business model, it really is a positive as it relates to what the ESG requires of -- from companies. We acquire assets, we don't drill, we don't frac. We don't have completions crews out there, which means that we're focused on low-cost, low-decline assets with complementary midstream assets at accretive valuations. And what that means is that we are focused on all of the different aspects of the ESG movement. I mean, as it relates to environmental emissions, social considerations over our acquisition targets, we look at all those things when we're assessing acquisitions. We look to optimize and produce by deploying the Smarter Asset Management to improve production, lower unit costs, we're maintaining production wells that may otherwise be forgotten or nonproductive. And as a result of that, it's making less demand for new wells to meet the energy demands that the country needs. So we're -- -- we are -- we considered a stewardship of existing wells to reduce the demand of new wells. We're also transporting gas through our midstream assets and we're working actively to reduce emissions of those assets that otherwise other parties that own those assets may not be focused on. So it's all kind of built within the culture and strategy of the company. On Page 9, we believe good ESG is good business. And really, it's good business for DGO. We know that our Smarter Asset Management and optimizing our operations result in improved production and expense efficiencies, reduce fugitive emissions because we're taking care of wells that may otherwise not be taken care of by the previous owners. We're hedging, protecting cash flows, paying our employees competitive wages in the communities in which we operate, stay in compliance with our debt covenants. And then we have a safe and systematic well retirement. We're responsibly retiring wells at the end of their economic lives, maintaining regulatory compliance and engagement, safe and thorough process of what -- as we retire those wells and efficient use of capital. So it's a good business for us. Good ESG is just good business for Diversified. You can see some of the recent corporate governance initiatives that we've recently rolled out the enterprise risk management, which is focusing on our internal controls around all these risk -- different risk areas. The TCFD, we've completed the scenario analysis and are currently developing the road map for further integration disclosure under that framework for disclosures. And then we've -- the ESG, EHS compensation metrics served within our executive bonus plan, has been beefed up to represent more than 20 -- represent 25% of our payouts in 2021. So all of these things are moving us in the right direction. And in our second year sustainability report, we'll have more details around a lot of these different options and different initiatives. With that, I will then now turn it over to Brad Gray, our Chief Operating Officer, to discuss some of our operational highlights.

Thank you, Rusty. First, I'd like to say a big thank you to our employees for delivering great results during a very challenging year. Our employees stayed committed to our strategy, to our daily priorities and more importantly, to each other. And it was great to see that their efforts were rewarded with terrific results. We were able to diligence 3 transactions, closed 3 transactions and integrate 3 transactions, all while operating our company and taking care of our families during some very difficult and challenging times. As Rusty's quote earlier in the presentation stated, "our relentless focus on operational excellence serves as the bedrock of our performance", and every one of our teams stayed committed and stayed focused on operational excellence in 2020. Now I'll proceed with our presentation here with some highlights on our ESG activities during the year. I'll first start with the perspective that we've had, since we went public back in 2017. The foundation of our strategy and our business model is sustainability. Rusty reemphasized this point earlier when he said that good ESG is good business, and our foundations are good ESG. So I'll highlight a sample of our metrics under each ESG category now. First, environmental. And before sharing a few metrics, I do want to reiterate that because we acquire existing assets, which are comprised of wells, pipelines and compressors, our business model focuses on making them safer and more productive. We naturally have a strong E for the environmental category of ESG. The metrics we are sharing for our environmental category are focused on emissions. We first reported emissions information in our Inaugural 2019 sustainability report. In this first report, we stated 2 items regarding our reported emissions. First, that our reported emissions were very conservative, and we knew that. And second, we also stated that on the hills of our system consolidation project in 2019, which we call Project Delta, we were focused on improving the operational information for our emissions generating equipment. As a result of our team's efforts and the effective consolidation of sizable data sets, we were able to make progress with our inventories and we were able to make appropriate adjustments to our missions generating equipment from our 2019 report. Additionally, through our Smarter Asset Management programs, we were successful in repairing determined leaks, eliminating duplicative compression as well as implementing more efficient production techniques. These are all driving favorable results with our lower calculated admissions. And as a result of our field efforts and our improved data, our reported CO2e emissions declined by 27%. Additionally, our GHG emissions intensity ratio also declined by 37% due to lower reported admissions and due to the addition of production volumes from our acquisitions of assets from Carbon Energy and EQT. Our business strategy is very much aligned with the S or the social category of ESG. When we acquire assets, we also strive to incorporate the appropriate number of employees from the seller and bring the -- these employees into our DGO family. Our strategy, along with our practices, saves jobs in local communities. Our business model allows us to provide competitive, the top wages in the areas that we operate, while also providing our new employees and their families with excellent benefits and retirement saving programs. Finally, we empower our new employees to run their businesses, to improve their businesses and to make their businesses more profitable. And then we celebrate their successes. In order to solidify this positive environment, we must start with our #1 daily priority, which is safety. Without our total commitment to safety, we are not able to achieve our goals or achieve the financial and production goals that we established. During 2020, we were able to improve our total recordable incident rate by 34%, while also maintaining a consistent ratio from 2019 of 1 preventable motor vehicle accident for every 1 million miles driven. Although our goal is to achieve 0 incidences, we were pleased with our improvement. Additionally, we were pleased to implement numerous safety programs that we believe will continue to drive an excellent safety culture for the future. From a governance perspective, we also made great progress on numerous fronts. We formalized numerous corporate policies that were already a part of our culture in our programs, but were necessary to be formalized for our listing to the main market of the London Stock Exchange. From a Board governance perspective, the percent of female representation has increased from 0% in 2018 to 29% at the end of 2020. Additionally, our Board through its Nominations Committee is targeting to further increase its percentage by the end of 2021. From an executive director and senior leadership compensation perspective, Rusty mentioned this earlier, we are increasing the percentage of variable compensation that's tied to ESG performance from 10% up to 25% for 2021. Rusty also mentioned that we have implemented the TCFD disclosure framework. These -- this framework and disclosures will be represented in our annual report, which will be released soon. Also, another significant governance item during 2020 was the formalization of a robust and thorough Enterprise Risk Management program, our Board, our Board committees and numerous members of senior leadership are highly engaged in our ERM processes. And then finally, for 2021 and our ESG activities, we've always been significantly engaged and supportive to our communities. Not only do we work in numerous communities across the Appalachian basin, but we also live in these communities. And during 2021, we are increasing the number of intentional engagements we have with our communities, and we're excited about the positive impacts that our employees can make. As we move on to the next slide, I will turn our attention to operational -- our operational philosophy of Smarter Asset Management. We talk about Smarter Asset Management a lot. And as many as our investors know, we originally described our practical, profit focused operating philosophy of Smarter Well Management, with the growth and diversification of our asset types, it just made sense to rebrand Smarter Well Management to Smarter Asset Management. But the same concepts they apply. We make good business decisions at the asset level, good business decisions to be safe to improve production, to improve efficiency and to celebrate our daily gains, and we celebrate with our teams. And so our new brand for our operating philosophy is now firmly Smarter Asset Management. Smarter Asset Management truly starts with the empowerment of our employees to help create value for their businesses and for their company. And by being successful in creating value for their business and their company, our employees are also creating significant shareholder value and for all of our stakeholders. Our success in driving effectively flat production for the past 10 quarters from our legacy assets has generated additional cash flow of approximately $58 million when comparing against our forecasted engineered declines. And this $58 million is just 1 of the ways that small gains on a daily basis truly add up to big wins. Moving forward, it's 1 thing to talk about programs and brands and priorities. But it's much better to actually show real-world tangible examples of our smarter well -- Smarter Asset Management practices. So we provided 3 examples of production improvements and 1 example of a creative well treatment that's also very environmentally friendly. The first example we have named Pennsylvania Pipeline, and this was an opportunity we identified from 25 acquired wells that were shut in and not producing. We checked the integrity of the wells, which were all fine. And thus, we determined that the wells were shut in due to a pipeline being taken out of service by another operator. Due to our extensive relationship with other operators in our areas, we work a deal to use our equipment and our employees to simply reconnect a new piece of pipe, and we immediately gain production from these new wells -- from these wells. Similar situation on example, 2, except these acquired wells, were oil-producing wells, although they were not producing due to neglect and lack of capital maintenance from the previous operator. Our production engineers and our field teams identify the opportunity, which we actually did identify during our diligence reviews, and our teams developed and executed a production improvement plan, but the same result. There's a small investment, bringing incremental production and value to our stakeholders. Our last production example involved the evaluation of a well through our monthly well review process, which includes reviewing historical production levels. Through this review process, our team identified that this well was not utilizing the right lift equipment and technique for the formation of well. We made the adjustment, made a small investment, and we increased production tenfold on that well. The last example that we have here on Smarter Asset Management is truly a win-win-win. We have a very experienced operating team and we also cultivate a culture of driving for efficiency through cost-effective and practical solutions. So our field employees decided to utilize an everyday white Vinegar, to help dislodge some salt buildup in a wellbore. It wasn't the expensive balsamic vinegar for sure, but just your basic white vinegar. So that was a very creative. Yet, it was an effective solution that was inexpensive and environmentally friendly. Moving on to Page 14. We're providing a visual just showing the increases in production that Rusty mentioned earlier that we've both achieved on an annual basis and an exit rate basis. For December, our adjusted exit rate increased 10% to 105,000 BOE per day. And as noted in the bar charts, our production increases were driven by increases in both our conventional production and our unconventional production. Rusty also mentioned earlier our 7% decline, our corporate decline rate that's a factor that we work very hard on. We're very proud of it. And our Smarter Asset Management programs, working with our teams on a daily basis, it truly does impact that corporate decline. A few additional statistics to highlight on this slide. Our production mix continues to be 99% natural gas and natural gas liquids. Our year-end reserves increased 7.8% up to 607 MMBoe and our PV10 value for only our PDP reserves ended the year at $1.9 billion. One additional item of note related to our reserves, we did transition our third-party audit relationship to Netherland Sewell & Associates for our year-end 2020 reserves. This transition to NSAI was successful and our internal reserve engineering team did a great job managing this process. Moving forward to our next slide, we're really highlighting the scale that we have built with our integration processes and how we view this scale as extremely beneficial to our growth strategy. Over the last 4 years, we've integrated $1.7 billion of acquisitions, 11 transactions, added over 1,000 employees, installed numerous systems, and we've literally loaded millions of rows of data. We have and we continue to invest in skilled resources, while we're constantly driving to improve our processes and our systems, we are a 100% cloud-based company, and that really provides us a significant advantage and ability to quickly scale our systems as well as the ability to standardize our processes and our data. On the hills of our 2019 Project Delta, where we converted 3 ERP platforms into a single ERP platform, and we expanded and standardized all of our supporting applications. Our teams really made great progress during 2020 to reap the efficiency benefits of having senior application platforms. We're constantly driving for improvement. We will not accept the status quo, but we are excited about our ability to scale and integrate future acquisitions. Additionally, as a result of our decision in 2018 to be 100% cloud-based, we were very successful and efficient in our systems and our connectivity response to the need to work remotely due to COVID. Our systems and our employees did not miss a beat. Moving on to Page 16. We're further highlighting the importance of our systems and the power of all the data we are aggregating and processing. The amount of data we process is significant. And thus, it does require powerful and efficient tools. I previously discussed the power of our 100% cloud-based architecture and our efforts to consolidate our systems. I'd also like to highlight the importance of our data, warehouse technologies and the significance of the analytical tools we're using with our data. From a cloud perspective, we primarily use Microsoft Azure, while we also have applications in both AWS and Oracle. Our big data warehouse, where we aggregate all of our information runs on a Snowflake platform. In our data warehouse, we drive consistency of data attributes, data usage from numerous applications and our data warehouse and analytical and reporting tools allow for a much higher speed of analysis than our transactional applications. Our entire network application layer requires robust security and business continuity processes, and we continue to enhance all of our processes related to security and controls. And we're really -- we're pleased with the progress our teams made during 2020 on this important part of our business. Finally, I'll wrap up my comments by discussing another very successful year from our asset retirement and plugging programs. Through our consent agreements that we proactively completed with our 4 states where we operate the most wells, we are required to plug 80 wells per year. During 2020, which, again, was an extremely challenging year to navigate around the areas that we operate due to COVID, our teams exceeded this requirement and successfully plugged 92 wells. Our average plugging costs continued to be approximately $25,000 per well, and we spent approximately $2.4 million in 2020, which represents less than 1% of our EBITDA. We are continually actively engaged with state legislatures and regulators to drive for improved plugging processes and policies. One other item of note for 2021 for our plugging program, we established an internal plugging team that will be focused initially in our West Virginia operating area. We're excited about this new plugging team. We're confident that they'll do great work, completing safe plug jobs, but they're also going to provide us the opportunity to control our cost for years to come. Finally, I do want to say again how much I appreciate the hard work, the dedication and the great results delivered by our teams during 2020. Now I'm going to turn it over to Eric Williams to walk us through some detailed results.

All right. Thanks, Brad. Before I get into the slides, I do want to step back and do a little bit of housekeeping. As you're well aware, we did release an RNS this morning with our full year 2020 results and the accompanying financial statements and footnotes. So I'll be referencing some of the numbers that were included therein, but would certainly refer you to those, not only for our full IFRS financial statements, but also the accompanying alternative performance measures that we'll discuss, and the reconciliations that we include therein. We also include those reconciliations in the appendix to our investor slides. And so with that, I'll walk through a few numbers that you may have seen and help explain those within the context of the business. And 1 of the items that we'll continue to discuss, just as Rusty alluded to earlier, is how hedging is an integral part of our business. It's been an important part of protecting our downside and providing stable cash flow through a really challenging price environment that you'll see on the graph later. But to do that and to underpin our low-cost, long-term fully amortizing financing, we do have long-term hedge portfolios in place. So well we're 90% hedged in '21 and 60% hedged from '22, you see that hedge protection push forward all the way out to nearly 2030, with around anywhere from 45% to 35% of our long-term production protected from downside of risk. But with price volatility will come, the noncash mark-to-market valuation adjustments on that portfolio. And because we do not elect to designate our derivative contracts as hedges for accounting purposes, those changes in values will roll through our reported results and create a bit of volatility. That I'll help -- hopefully will help to distill as we walk through a few numbers. We've spoken earlier about adjusted EBITDA of $326 million, which is up 10% or $27 million over $273.3 million in 2019. But as we look at the composition of those numbers, we'll start with revenue on an IFRS basis. We had just about $409 million of revenue, which was down a little bit from last year's GAAP revenue of $462 million. But when you add back those significant hedge related cash flows, which Rusty mentioned earlier, were $145 million in 2020 and about $50 million in 2019, that's nearly 3x more hedge contribution this year. Our adjusted revenue was actually up 8% year-over-year to $553 million or about $41 million higher. Again, that hedge mark-to-market loss did result in an operating loss versus income last year. So we had a $78.6 million to our operating loss versus $180 million of income last year. But importantly, $238 million of that was the noncash mark-to-market adjustment. So interestingly, when you adjust both years for that item, operating income was $160.2 million. Moving down to pretax loss and income. The hedge mark-to-market noncash charge did result in a pretax loss of $136.7 million versus income of $131.5 million, but importantly, not only when we tax effect the mark-to-market loss and recognize that deferred tax benefit, but importantly, you've heard us talk about the margin of all tax credits and the significant value that those afford us in future periods. So adjusting for the tax credits and the mark-to-market tax benefit, the net loss on an IFRS basis is $23.5 million versus $100 million of income last year. But when you tax effect the noncash charge, operated -- I'm sorry, adjusted net income is actually up 83% year-over-year to $175 million versus $96 million last year. So really strong results. You do have to cut through the hedge related noise to ultimately distill that. But I do want to spend just 1 more moment on the tax credits. You'll recall at the half year, this was a point we discussed, but we realized over $70 million of margin wealth tax benefit. And that's very much aligned with the E or the social aspect of our ESG story. Because we do operate in areas of the country where we provide high-paying jobs, strong benefits, and we pay significant production in operating-related taxes into many local communities. Many of those communities are actually -- do not benefit from the Marcellus and the Utica production. So there are communities where we maintain our legacy wells, and therefore, very important to those local areas. The federal government does provide a tax benefit for continuing to operate in low price environments. And so that $70 million of tax credit, if you divided it by the effective tax rate, will allow us to offset over $430 million of future taxable income. So significant value to the company, and ultimately, will go a long way to protect our cash flow as we move forward. I'll pick up on Page 19 of the presentation. And we did talk a lot about the exceptional environment in which we operated. The first graph is intended to show that the price environment that we've seen over the last couple of years, it's unlike any we've seen since the early '90s. In fact, you have to go all the way back to 1998 to see a realized price or a Henry Hub price, like we've just seen this year. And yet in spite of that, you see the efficiencies and the scale that we've built. Brad talked about all of those transactions that we integrated over time to emerge as a very efficient business, which allows us to deliver 54% margins even in that really challenging price environment. And hedging has been a strong part of that in order to shore up the price protection, to allow us to bridge to more constructive price periods, which we see nicely on the horizon and we'll talk about momentarily. But strong cash flow with one thing. It's also important to have a low-intensity capital business, which 7% corporate declines that we've talked about, affords us the ability to take the cash flow that we generate from our assets and provide tangible returns to shareholders. In the graph, you see, we've distributed just in 2020 alone $197 million in the form of share buybacks, dividends and debt repayments. We fill that on you in a bit in more detail on Page 20. And you can see, not only do we highlight 2020's activity where you can see the numbers I just described. But importantly, going all the way back to IPO, and we do that to, as we said, really reinforce the commitment to the strategy and the consistent results that the strategy has delivered. You see that the payouts have been nearly -- are actually exceeding $0.5 billion with $287 million of that going back to shareholders in the form of dividends and share repurchases and nearly as much, just under $250 million being repaid on our borrowings throughout time. So really strong results. Moving to 21. This is a graph you've seen a few different times. But we constantly remind, and Brad did a great job of articulating how we deliver this. But our relentless focus on cost. We recognize that hedging will bridge you between periods of price volatility. But underneath that, you need to run a really good business. And so driving cost out of the system, leveraging the scale that we built is incredibly important. And you see the results. Base LOE, which is the lowest part of the orange structure that we show, is the portion of our operating expense that we directly control. That's our wages and benefits, it's our Smarter Asset Management activities. And you see that was down 30% 2018 to 2019, but it's further 24% from 2019 to 2020, as we leveraged our skilled workforce across to more geographically dense assets and ultimately drive more production from those wellbores. You see -- I'll talk a little bit more about the gathering and compression expense, a line item that you see stable year-over-year from $1.42 million to $1.45 million. The slight increase was due to the acquisition of Carbon Energy's midstream assets. But ultimately, those afford us some significant benefits that we'll talk about and how those deliver value and ultimately continue to enhance margins. And then a stable G&A structure, you do see year-over-year a slight increase in this line item. As we have made investments, many of those that Brad just articulated in our technology area that ultimately will allow us to drive a much more efficient business. They also positioned us for the move to the main market and the investments that we needed to make as a premium list and strong corporate governance. But meaningfully, they position us for additional growth and scale, as we do, not only add on assets in Appalachia, but certainly look to beyond. And just as we built a very scalable operation, I believe we now have a very scalable administrative support function as well. But you add it all together. And in spite of those investments, you still see year-over-year compounding 10% declines in total cash operating costs, which is a remarkable outcome in this environment. Moving to 22. The point here is just to talk about how that cost structure relative to our hedged pricing strategy, deliver strong margins. And so you can see that despite a 30% decrease in NYMEX prices over the last 3 years or 2 years really, we've been able to maintain margins north of 50%, 53% in 2018 and 2019 and slightly widening that in 2020 to 54%. And we've done that through cost efficiencies and hedge protection. But importantly, as we look out, we're obviously very encouraged to see the forward price curve, reflecting the optimism that broadly underpins the sector with the remainder of '21 and '22's pricing outlook, 31% and 10%, respectively, better than they were just 1 year ago. And that's important because particularly, as we're focused on 2022, it allows us to capture those higher prices within our hedge portfolio as we continue to focus on margin delivery over time. Moving to 23. This is a new slide, and this is -- we've gotten a lot of questions around what the midstream operation does to us or does for us. And so we try to distill this down in a way that will hopefully take a qualitative conversation that we've had several times and distill it to something a bit more quantitative so that you can see just how this is a strategic asset for us. Ultimately, if you were to take our asset more than 50% of our natural gas volumes flow across the 17,000 miles of midstream that we own. So we are the largest producer into that asset, which makes it very strategic. And 1 of the reasons why that control premium and having control of the asset is so vital. From the qualitative, you've heard us discuss the various elements that it affords us from revenue diversification. So we charge third parties that do move on our system a tariff, in exchange for the right to transport their gas. So we had very stable third-party midstream revenues that you see in our P&L. We also received pricing optimization. That comes in a couple of different ways. Not only are we able to move gas from one market to another in order to realize better end pricing, but we're able to move our own volumes as we enlarge the system and have additional connectivity in the system, we can move our own volumes into the system and allow that production to also access better markets. The system also affords a flow assurance. So throughout the basin, as you can appreciate, there are various times when midstream systems will go into scheduled maintenance and at times unscheduled maintenance, whether for compression or other issues. So our ability to pivot real-time and move production from one sales meter to another to keep our production moving, it's certainly very strategic. And lastly, expense optimization. Not only does owning the asset, as we'll talk about quantitatively, afford us a lower cost, but as we're able to move more of our own production on to the system, we not only eliminate the third-party cost that we were incurring, but we also eliminated the third-party inefficiencies. And as you well know by now, that a big part of the diversified story is that we very much focus on operating efficiencies and maintaining asset uptime, both on the upside and the midstream side. So owning the midstream affords us the ability to make sure that we keep the asset in a -- as pristine a condition as it can be. But quantitatively, if you take the values that we reported in our income statement, you'll see that we had just about $53 million of operating cost. And we also realized about $25.4 million of third-party revenue and $4.4 million of revenue uplift from the volumetric redirects into better markets. So the net operating cost is about $23 million. And when you unitize that, you look at how much volume we're transporting on the system. We're able to move that gas for $0.23 per M as opposed to with third parties on our system or if we were to move gas on another system are paying anywhere from $0.75 to $0.90 an M. So the 51% lower cost is reflective of the lowest end of that range. But importantly, we didn't just stop at the cash operating cost because we recognized that the system does require additional capital. So we have fully burdened this for the $14 million of CapEx that we spent last year, which adds an additional $0.14 of cash cost to the system, ultimately bringing our fully burdened cost to just $0.37. So relative to that $0.75 market rate, you can see that we're able to deliver that same service for half the cost. But importantly, as we continue to operate the assets more efficiently as we continue to layer in additional assets that we would acquire, you can see that these benefits will only continue to grow. Moving on to 24. It's another new slide, and it addresses another question that we'll get from time to time. And that's production replacement or EBITDA replacement over time and how we can support the business within cash flow. Obviously, we've been acquisitive, and so we've been active in the equity markets over time. But we would never ask our investors to write a check for an asset that didn't ultimately transform the business. If we're treading water and ultimately maintaining. Then we'd expect to live within cash flow, and you've seen us do that many times with the bolt-on acquisitions that we fund within cash flow. But what we wanted to do was take our actual production and our actual production decline and illustrate exactly how our production replacement could work. So if you take our exit rate from the first half of the year, which includes the contribution of the carbon energy and the EQT assets that we acquired, and you roll it forward to the adjusted 2020 exit rate, that's where you see that 7% decline. I -- you'd get that same number if you took our 2019 exit, the 2020 exit and adjust it for carbon. So that number is -- you can calculate a couple of different ways. But ultimately, that 7% decline equates to about 15 Bcf of gas that we need to replace. And when you look at the margin that we're earning on that gas or that production, you can see it's about $20 million of EBITDA that we need to replace on an annual basis. One of the huge benefits of having that low corporate decline rate that we talked about. You'll recall that when we do acquire assets, we generally play -- pay anywhere from 2 to 4x. So for the purposes of this illustration, I've used the 4x multiple. So to acquire $20 million of EBITDA, we would pay around $80 million to do that. But importantly, everything we acquire is producing. So you'll recall, we don't purchase PUDs or undeveloped resource. We purchased cash flowing assets. And because of that, we're able to lever those assets responsibly. So that the cash contribution is ultimately less. And so we talked about a 2.5x or less leverage profile. And then we delever on the back of that. So while we'll introduce leverage at the introduction or the purchase of the assets, you see us today living with 70% of our debt in declining -- or amortizing structures. So the debt that we ultimately draw, we would repay, but in this scenario, we would borrow $50 million, and therefore, just need $30 million to fund our production replacement. And when you look at the composition of our cash flow, of course, we're fully committed to the 40% of dividends. If you take our amortizing debt, that requires about 20%, which leaves 40% of our cash flow for debt service, CapEx and growth, which you can see here, it's just 10% of our EBITDA is necessary to fund the growth. Fits very comfortably within the free cash flow that we generate after dividends and debt service. Transitioning to Page 25, it's a slide you've seen, but it differentiates us in the market, and it's one that I think is important to reinforce. We've said several times that if you look at our capital structure, it's simple, we have RBL, our revolving credit facility, and then we have permanent long-term financings that are fully amortizing. And 70% of our debt sits in those fixed rate, fully amortizing structures, insulated from redetermination risk and other market volatility because all of that is underpinned by the long-term hedging that I talked about earlier. If you -- it -- what that's done is it's afforded us a very low borrowing cost. So across all of those structures, our weighted average borrowing cost is just 4.7%. And ultimately, because most of our leverage sits within the fixed rate debt, our revolving credit facility is actually levered less than 1x. And so not only do we have a healthy 17 bank syndicate, but you could appreciate in this market to have less than 1x leverage, results in a very supportive bank group, which is strategically important as we look at significant opportunity for growth in 2021 that Rusty will speak to in just a few moments. But we also provide line of sight to how that amortization will roll off. And so you can see the scheduled principal amortization over the next several years. And understand that ultimately, that net 2.2x leverage on a 7% decline asset is a very healthy place to be. So when we say we'll never compromise the balance sheet for the sake of growth, I think this slide really bears that out. And I'll conclude on 26 talking about hedging. This is part of the diversified DNA as much as ESG is that Rusty described earlier. And it's something that we'll always focus on protecting our downside. And at times, that means you give up some upside. But when you're able to deliver margins north of 50% and pay dividend yields like we've paid, and very healthy dividends, we certainly think the trade-off is worth it. We sit in an exceptional position for the remainder of '21 with approximately 90% of our production hedged, at an average core price of $2.94 on an Mcfe basis. You'll recall that many times, we talked about that price in terms of MMBtu, but we do sell high BTU gas. And so when you convert that MMBTu price, you ultimately see that $2.94, which is more reflective and more comparable to the cost structure that we talk about at $1.15 per Mcfe. And then looking out to next year, you can see that 60% average price of $2.81 that we are opportunistically increasing as we enjoy improving a forward curve and outlook for natural gas. I believe over the last 12 months, you've seen the natural gas overall curve rise 48%. So very nice tailwinds for a change. And importantly, while we had those noncash mark-to-market losses in the P&L that at the aggregation of 10 years of valuing, importantly, not only will we realize the healthy margins that we fixed with that, but every unhedged margin, whether it be from our -- or unhedged Mcfe, whether it's from Smarter Asset Management or from an acquisitions. We'll receive higher market pricing as opposed to market -- lower market prices like we've endured the last couple of years. So all in all, a very, very positive outlook as we move the ball down the field. With that, I will hand the call back to Rusty for some closing remarks.

Thank you, guys. Just a couple of ending remarks here. Turning to Page 28 or Slide 28. Everybody is fully aware of our partnering with Oaktree. We get the questions from time to time is when are you going to spend that money. I can assure you, we will spend it -- don't become impatient. But there's a lot of activity in the market. The market is ripe for acquisitions. There's a lot of noncore asset sales going on, very strategic assets. We're going to be opportunistic, we're going to take advantage of different distressed situations. We're going to take advantage of big companies divesting non-core type assets. We'll take advantage of bankruptcy situations when they present themselves and try to get extreme discounted value through those avenues. Partnering with Oaktree gives us a lot of credibility with sellers, gives us a lot of funds that we can put to work alongside our own and really give us a -- what the biggest aspect to me is the inventory of assets that they would acquire alongside of us that we can acquire back from them at some point in the future. So it represents a strategic pipeline of assets to acquire that we already operate. So we'll be -- we'll continue to push hard and work with them on those opportunities. Strategically, it's going to be more of the same for us. We're going to progress our sustainability initiatives, continue to improve there. We're going to maintain our disciplined growth strategy and keep our balance sheet strong while we grow the company. And we're going to protect our future cash flows because at the end of the day, our dividend strategy is nonnegotiable, and we will always do what's necessary to protect that over the long haul. And then finally, on Page 30. This slide is always here because it never changes also. We'll be -- we'll continue to provide stable cash flows to support the dividend. We'll integrate our operations to continue to drive down low-cost -- or to continue to drive down our costs to maintain our low-cost structure. We'll keep our balance sheet strong and we won't put it at risk for any kind of growth. Our decline rates are very important. We'll continue to -- and that will be attacked from 2 sides. It will be attacked from the type of assets that we acquire and the maturity of those assets, but also from our operations and continue to employ our Smarter Asset Management program. And we will always maintain our emphasis on assets that don't take a significant amount of capital intensity to maintain production or to -- to have to drill wells. So that is our -- the end of our prepared comments, and I will turn it back over to the moderator for any questions.

[Operator Instructions] Our first question today is coming from Alex Smith from Investec.

Just a quick 1 for me following on the conversation on the M&A activity. It could be good to get a sense of how competitive the market is at the moment. You see a bit of an uptick in activity in the past couple of quarters of the ETT Chevron deal and a few other listed peers have stated intention to kind of look at the market. So I guess the question is, are the tender processes more competitive today compared to previous periods? And maybe just touch on how many packages are coming to the market? How does it compare to previous periods as well?

Yes, that's a great question. I think the answer is it depends. I think there are some areas where there is more competition. I think the EQT Chevron deal, for example, that asset really belongs with EQT. I mean it was a -- EQT had a nonoperated position with Chevron. The asset was highly developed. There have been a lot of capital deployed on that asset in the first half of the year. And there is going to have to be a lot more deployed to complete some DUCs and some in process wells. I think that -- so depending on the package, there could be more competition. A lot of the stuff we've been seeing over the last several months has a lot of development attached to it. Those are not assets that we're interested in we're more interested in the assets that are more mature, that don't have high decline rates. We are in a very good position when it comes to those kind of assets to be competitive and to be probably the bidder of choice, simply because we can execute -- in oak -- the Oaktree agreement adds additional credibility from that perspective. We will be acquiring assets this year. We're just making sure that the ones that we do fit the profile, are valued properly and give us the ability to -- give our investors long-term value that we have promised them.

That's great. Just a follow-up on that. I guess, have you been approached more since the Oaktree partnership? Like has there been a change in maybe the style that the company has approached you?

I wouldn't say that we've been approached more. I just think that when we enter processes, we have a lot more credibility. We'd -- there's always a chance that if you're not the highest bidder in a process that you don't make the second round. We always make the second round whether we're a higher bidder or not because they know we can execute. And sometimes you get people bidding that they can't execute. And so what we like to do, we may not always be the high bidder, but I'll guarantee we'll be into the second round because they know whatever bid we put on the table we can execute on. And so I think it if -- we probably haven't seen a significant amount of calls coming in. But definitely, we've seen the credibility of our offers have a lot more weight.

Yes. I'd probably share that the reason we haven't seen a significant uptick per se is that we've been active for the past 4 years. And so there's been no shortage of banks and other parties who have had a consistent flow of opportunities rolling in front of us. I'd say the size of the opportunities is increasing, given there's an awareness that not only do we have the ability to raise our own capital, but to have Oaktree behind us. So the quantum of things we're looking at is not necessarily changing, but certainly, the nature of the acquisitions is certainly larger.

The next question today is coming from Chris Wheaton from Stifel.

A couple of questions on your OpEx, please, which is -- the control of which I think has been excellent in the last year. Could you perhaps outline -- you talked about letting local employees run their local businesses. Could you talk about how you think about incentivizing those guys and empowering them to not just maximize production. But really get up to costs as well because it's the cost control in the last 12 months to me, it's really stood out. And also then, I'm interested in the ERP Enterprise Risk Management system. What -- how is that helping you to look at risks holistically across the business? And actually maybe start to identify areas where you can spend -- you can target spend more effectively to drive both risk and better return to the business.

Chris, this is Brad Gray. I'll start with your first question in regards to efficiency. We've stated in numerous publications and in presentations our 4 daily operating priorities. Safety is number one. Number two, is production, every unit counts. We spend a lot of time talking about that. But the third is efficiency, every dollar counts. And so this is part of the culture that we have built and continue to build. And it's -- that -- it's part of communicating and teaching our employees what the income statement looks like. What the net check is at the end of the day, what the take-home pay is. And so that is just an additional daily focus that we have to look at our cost, look at the assets that we have, we are constantly striving for elimination of duplicative assets, for assets where we have excess capacity, pipelines that are no longer needed. And so those are the opportunities that we look at. We do have some ability to consolidate, purchasing power and things of that nature. But because our business is relatively decentralized from a local market perspective. We just -- we work on developing and maintaining solid relationships with our vendors. They understand the business. They understand where the industry is, where the pricing environments are. And so they work with us on opportunities to reduce cost. From an ERM perspective, probably let Eric speak more to that. It is, what I would say though, is that it's a -- it's been a good process for us to not only, one, formally identify, but to also sit around the table and talk about the different risks in the business and how we mitigate those, how we improve on those. And we've really included numerous levels of management in the process to ensure that we're covering the different risk and the -- at the appropriate levels.

Yes. It has been a really important initiative. We've talked a lot about our growth over the last 4 years. And the transition to the premium list, it was really important that we take a step back and make sure that the platform that supports all of this growth was really shored up. So certainly, as we've expanded the Board and enhanced governance, one of the things that from the top-down has asked us to do was to take a step back and look at risk holistically. And not just -- we talk about Diversified being a financial model, and we focus very much on the finances. As Brad articulated, it's part of our culture, all the way down to the well tenders. I'll anecdotally share, and some of you may remember the story, but when we took the rating agencies out to tour the assets during our inaugural asset-backed securitization work. One of the members of the team commented to our well tender that it sounded to him like he ran his own P&L. And I wondered if my well tender knew what a P&L was. And to my pleasure he responded back and he said, "I do. He said I know what natural gas costs and I know what I'm asking to spend. And so you do see that culture underpinned, but it's not just financial risk. There's also operational. And so we've done a very robust analysis and inventory of our risks. We cared them for Tier 1 and Tier 2 at the strategic level. We're implementing testing programs and monitoring programs, and we'll do reporting back to the Board. But those risks, kind of the things you expect. And you're going to see this in the full annual report that we'll publish later on this month or the first of April in advance of our general meeting. But one of the enhancements we made to the way that we present our annual results is that we really link our strategic objectives to the underlying risk and the key performance indicators to our ESG initiatives, et cetera. And so you'll see us talking about things like corporate strategy and acquisition risk, information technology and security, health, environmental and safety, the regulatory and political outlook as we see administration is changing, ESG in general and climate change, commodity price volatility, which we obviously talked significantly about with hedging. And then just liquidity and access to capital. Those are things that we're very focused on, that we'll be reporting to the Board. And then there's another layer underpinning that, that will be a big part of the program. But I appreciate the question because it's not just about delivering the production that you see, but it's really about making sure that we shore up the organization so that we can be providing long-term rewards to our shareholders over time.

[Operator Instructions] Our next question is coming from Simon Scholes from First Berlin.

Congratulations on some very robust results. I've just got 2 questions. Firstly, on the carbon and EQT acquisition that you made in the middle of last year. I mean, would it be fair to say that you expected the eventual bargain purchase gain reported to be higher back in May, June last year than the 1 you have reported? And secondly, on basis hedging. I mean, as far as I can see, I mean, base -- the volume in the gas market that you've got basis hedged is about 70% of what you've got volume hedged, sorry, price hedged. I mean should we expect that ratio to be roughly the same going forward? And can you also comment on how you see basis differentials developing going forward?

I'll deal with the basis first, and then I'll let Eric speak to the bargain purchase gains. But yes, I think we -- we're comfortable in the 70% to 80% range on the basis hedges really just to take the -- again, taking the volatility out of the commodity prices. We try to be as opportunistic there as possible because really, what we have seen in the past is that bases diffs move in the direct opposite with natural gas Henry Hub prices. So normally, what happens is we're locking in basis differentials when we're not locking in Henry Hub. So it's a direct opposite to each other. And so we -- when prices are lower and basis starts to squeeze, we lock it in. And then when Henry Hub moves up, we lock Henry Hub. So it's a delicate balance because it is very difficult. But the the long-term ability to lock basis diffs too far out are restricted simply from liquidity. It's a very illiquid market when you get past 12, 15 months. And so you really have to be more watching it on a daily basis and looking for opportunities there because you get out 12 to 18 months on basis differentials, and there's just not a lot of liquidity there to take advantage of. And if you go out and try to lock anything in the past 12 to 18 months, you can move the market pretty significantly with any kind of basis dip order. So it's delicate, we like to be in about that 70% to 80% range. There's multiple different paces differentials. I mean, it's very -- it's not just as easy as saying, well, here's 1 differential. We've got 3 or 4 different ones that we have to manage. But yes, I would say 70% to 80%, and then it's -- we're going to try to stay 12 to 24 months out in front of us.

Yes. And then I'll complement or follow-up on the bargain purchase gain. It's a good question. I hadn't bought to productively address just because, as you'll appreciate, we've always excluded bargain purchase gains from our adjusted EBITDA, they're noncash, they're nonrecurring. But optically, it may appear that, that was a smaller number than you had expected. But importantly, you have to think about the composition of our acquisitions. EQT, the assets we acquired from EQT were -- was an asset acquisition, and therefore, it's not eligible for bargain purchase gains. You simply allocate the excess value, if you will, across the assets you acquired rather than having a stand-alone gain. Carbon Energy was a corporate acquisition under accounting rules. And so therefore, it either could have a bargain purchase gain or goodwill. And as you'd expect, given the nature of our acquisition strategy, we did have a 17 -- a little over $17 million, $17.2 million gain on just carbon, which is a percentage of the purchase price is around 13%, 14%. And that's been pretty consistent. It might be a tad bit lower, but part of that is you're purchasing in a better price environment. And so that will certainly play through. But net-net, the numbers are quite consistent with what you've seen in previous periods. And as we've done in previous periods, we hired a third-party firm, a large accounting firm, to help us do a very robust analysis of that valuation. And then TWC took a hard look at that during the year audit. But I think we landed at a really good spot.

We reach end of our question-and-answer session. I'd like to turn the floor back over for any further closing comments.

We have no further comments. We appreciate everybody's time today. And obviously, if you have any further questions that you would like answered, you can forward them to our Investor Relations group, Teresa and Rand, and we will answer them accordingly. Thank you very much for your time today.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.