Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

Good morning. Thank you for joining us today. My name is Jeff Robertson, I'm the Managing Director for Natural Resources at Water Tower Research. I'm pleased to be joined today with -- by Kelly Loyd, who is the CEO of Evolution Petroleum; and Mark Bunch, who's the COO of Evolution Petroleum for a fireside chat. Before we begin, I would like to mention that today's discussion could include forward-looking statements as of today, October 24, 2023. Evolution's disclosures regarding such statements can be found on the company's latest investor presentation under the Investor Relations tab of the company's website. So a little bit of housekeeping out of the way, Kelly and Mark, thanks for joining us today.

Thank you, Jeff. Really appreciate the opportunity to come and tell our story a little bit.

Jeff [indiscernible]. Thanks so much.

Evolution is a company whose asset base was built through acquisitions. Clearly, M&A or consolidation in energy has been top of mind recently with both the Exxon and Pioneer acquisition and then yesterday's announcement of Chevron's proposed acquisition of Hess. Kelly, does the corporate consolidation -- even though that's much more orders of magnitude larger than Evolution, but if you think even to the Permian Resources, Earthstone pending transaction, does corporate consolidation have a trickle-down impact on the market for the types of assets that Evolution has typically pursued?

I think it certainly can both directly and indirectly. Looking at the deals you talked about, I think it's fair to say that Exxon's cheap reason for its Pioneer purchase is mostly going to be their oily Permian Basin assets. And I think most would speculate that Chevron really wanted Hess largely for its Guyana exposure. Does that mean that everything not oily at Pioneers for sale? Everything not Guyana at Hess for sales? I don't know but it certainly could be, which in turn, that could lead to additional assets coming to sale. And then other folks wanted to high-grade their asset-based selling stuff. They have to go get into those and so on down the line. So it for sure can have that trickle-down effect.

Can you talk about -- can you share your thoughts on the opportunity set in the non-operated asset market where Evolution has spent most of its efforts?

Sure. I think and Mark can confirm this but we're certainly getting more inbound calls, folks contacting us, wanting to do negotiated transactions. I also think you're starting to see more deals hit sort of the marketed deal front. So the market is -- there's starting to be more supply, whereas there was a real dearth of supply last year, we're starting to see more stuff hit the market this year.

On valuation, oil and gas prices have been on a roller coaster this year, weak in the first half of the year, some strength in the summer and now a little bit of weakness maybe around uncertainty with the global political situation but also the resurgence of maybe some recession fears for 2024. How does that volatility impact valuations? And are people looking it and [ really ] expectations between buyers and sellers?

Well, yes. And it all comes down to truly supply and demand. So when there's very little supply, the sellers are going to want to take either the greater of spot or the curve. Now that we're starting to see a few more deals hit the tape, I think the buyers are going to be in a much better position than they had been. I think the curve will start to take precedence rather than, hey, it was really high 3 months ago, so it's going to be high forever. I think the curve is starting to take precedents because buyers and -- sellers understand that buyers in large part, they may want to hedge, they want to have a reasonable expectation for a return that doesn't include massive price appreciation to get there.

Am I right that the curve for oil is quite backwardated at the moment?

Oil is backwardated, absolutely and net gas is still contango. So...

Mark, you talked about Exxon. Exxon is also buying Denbury Resource or Denbury Inc. now, which is the operator of the Delhi Field that you all own a non-operated interest in. That acquisition, I think, is expected to close next week, pending shareholder approval. Do you have much of a feel yet for how Exxon is taking over that asset will impact Evolution?

Well, we talk monthly with the team at Denbury about Delhi. And I mean, we don't get any negative issues from them about what's going to be happening. And so we think that Exxon is going to probably be interested in doing the right thing in order to optimize value Delhi. And I guess we kind of look at this, why wouldn't they? So we're optimistic that things are going to continue on and not be a problem.

And one of the reasons why we wanted to set this fireside chat, and one of the things we really wanted to highlight was the announcement that Evolution made on its fiscal year-end earnings call or in conjunction with that of a strategic partnership to develop the Chevron oilfield in the Permian Basin with PEDEVCO, another independent. That development program envisions drilling horizontal wells in the San Andres formation, which is a conventional reservoir in a field on the Northwest shelf and New Mexico portion of the Permian. Kelly, before we jump into actual details on the asset, how does the strategic partnership concept fit into Evolution's overall capital allocation model?

That's a great question. The way I'd like to -- think about it, it's sort of like all other corporate actions that we have at our disposal. The wells that the partnership drill will compete for capital. These wells then carry with them an expectation of excellent returns from an IRR perspective that has newly drilled wells, they're going to decline at a higher rate than the rest of our portfolio. We and our partner, PEDEVCO, are excited about moving forward with this together. We also want to do so at a measured pace. It wouldn't meet our corporate profile, our goals to ramp up and drill every one of these wells as fast as humanly possible. What we want to do, and I think you know this but I just want to reiterate, we want to provide solid incremental growth through a program that's designed to increase or extend our dividend life. And we think it fits in very nicely for that.

Is part of the goal with the Permian partnership to add an element of not necessarily direct control but more of an influence that Evolution can have on capital activity on the assets and augment what you see in the nonoperating M&A market?

Absolutely. Yes. We thought this was a key piece for us. I think one good way to look at it is, every well we drill that's successful, it's like making a highly accretive acquisition. So it's definitely a key piece of the puzzle that we're very happy to have now.

Mark let's talk about the strategic partnership itself. Can you just lay out maybe some of the basic terms and why you believe these assets are attractive for Evolution?

Sure. Yes. Like the real basic term that we have here is that it's really a drill as we go type scenario. We've broken the Chevron field up into development blocks. And we elect on a development block at a time. Initially, we elected on 2 but after that, we'll have to just select on one at a time. And so actually, the money that we spend right now is essentially going into the ground, we don't have a lot of stranded capital. So that's probably a major part of the deal terms. And then the other thing that's really exciting about it is, this is not an unconventional play. It's a conventional reservoir. It was a field that was developed with 330 vertical wells. And all we're doing is going back in into a field that has about 800 million barrels of oil in place, and we're just going to improve recovery with horizontal drilling.

I know the San Andres has been developed in various parts of the Permian Basin since the early 1920s and in many areas developed very tight spacing because of low permeability even though it's not a -- what people think it was an unconventional shale-type formation. Does the vertical development activity at Chevron, is that really the guide for all the subcircuit control as to where you want to put laterals within the formation?

Yes. This is a case where we really don't need 3D seismic to know what the structure looks like. We know exactly where it is because those wells, we know where every member of the San Andres is. And so it makes it really easy. All we have to do is make sure we don't -- we try not hit individual wells that are -- the vertical wells. But on a 40-acre spacing, that's actually fairly easy to do.

Mark, are there any infrastructure needs, whether saltwater disposal or gathering or facilities that Evolution will need to invest in as you go forward with these development blocks?

There is. I mean we are actually jumping into this after PEDEVCO drilled 10 wells. And so they also have a saltwater disposal well out there, that's permitted for 20,000 barrels a day. So they have some infrastructure started. And so in certain cases, we'll just be either using that or pay for the usage of that initially on the facilities, you -- on the current wells we're drilling right now. Those will go into an existing facility that they already put together. We won't be using the old vertical facilities because they're old and really too small for what we're looking at. So we will have to put in facilities but that was all factored in, and the evaluation we did upfront because that's just -- all that cost plus drilling additional saltwater disposal wells is -- that's just one of the things you have to do that here. But we're not going to have to drill 10 saltwater disposables. It's going to be probably more like 2 to 4.

Under the terms of the agreement, I think Evolution pays $450 per acre for the acreage and the development blocks as you move forward. So the partnership covers, I think, roughly 16,000 gross acres, so as one of the key features of this from an Evolution's perspective is that you don't have to essentially warehouse acreage for future development, you can pay for the acreage you want in the blocks, and that's all based on success of the drilling you've already done.

Yes. What we do is after the first 2 developmental blocks, which I said we paid upfront as part of the deal. After that, every time we drill wells, we have roughly 90 to 100 days to evaluate production and determine whether we to go on to develop a Block 3 or 4 or 5, whatever the next one is. And so -- and at that point, that's when we put money up to the acreage is like essentially right before we're ready to drill the wells.

Jeff, just to piggyback a little bit on what Mark said earlier, one of the things that I think both parties were really attracted about this structure is, the money we put in largely goes into the ground, right? It's not a whole bunch of dead money sitting there prepaying for stuff. They want to develop this field and so do we. So we get into it as we put money in the ground, and I think that's important. A lot of times, you'll see capital get tied up and prepayments and going for a bunch of stuff upfront, whereas in this deal, the money goes into the ground.

And just one other thing, John (sic) [ Jeff ], that too, I mean because we talked about this a lot. It allows us to be very aligned with PEDEVCO. All of this stuff works together to help it so that we actually are on the same page, and it makes the partnership work better, we think.

I think there are 3 developed wells planned for the fourth quarter, at least to start drilling in the fourth quarter of '23. Mark, can you just talk about the plans for those 3 wells and your expectations of when they might be completed and placed on the production?