Expand Energy Corporation (EXE) Earnings Call Transcript & Summary

Well, good morning. Welcome to day 2 of the 37th Annual Barclays' CEO Energy-Power Conference. My name is Betty Jiang, and I'm the new integrated E&P Analyst. Thank you again for joining us. I hope you have your beverage of choice ready because we have an amazing lineup of conversations planned for the day, and I'm really excited to get it started. For our first session today, I'm pleased to welcome Nick Dell'Osso, President and CEO of Chesapeake Energy. Chesapeake has really undergone significant portfolio transformation, emerging out of bankruptcy in 2021, made a major acquisition in Haynesville and just recently fully exited the Eagle Ford. Now it's a 2-base [indiscernible] to apply gas E&P with a strategic focus in LNG. So clearly, Chesapeake is not what it was 2, 3 years ago. So that's very good. Nick, thank you for being here.

Thank you. Thanks for having us.

Of course. I want to start our conversation first with gas and the volatility. I think I was amazed to see how front month gas price last year was doubled, triple where it is today and then just the volatility in the space has been tremendous. Given the volatility, how do you even run your budget and operational plans with that? How do you -- what's the flexibility in plant? And talk to me about how you manage around volatility in the space.

Sure. It's a great question. And volatility has obviously been the most important theme of the last couple of years for gas and maybe always and maybe always will. And so one of the things that we think is super important is to be flexible in your capital plan and to be prepared for that volatility in cash flow that comes with the volatility in price. One of the things that you balance against that volatility is that consistent operations results in better capital performance for your drilling program. So you don't really like to take your rig count from 0 to 6 back to 0 every couple of quarters. You need to try to aim for something that has a bit more stability to it. What we've done this year is we've dropped a couple of rigs across the portfolio to pull back some activity. But we did that with a lot of planning. At the beginning of the year, we thought the prices would be weak throughout the year. We plan for rig drops to occur as they finished pads as it made sense in the operational lineup to have that capital go away. We pulled out rigs. We pulled out some frac crews. And so that's worked out really well. So we didn't create any sort of unnatural friction to change that capital program. The way we're incrementally managing it from there is to then adjust our turn-in-line schedule. So if you think about the fact that it will be volatile, we know there will be a lot of up and down to price. We know that there will be some unpredictability on how that works. We're happy to continue to drill wells with the rigs that we have running, but not always turn those wells in line immediately and manage the flow of production accordingly. So that's working out really well for us and it gives us a lot of flexibility. Flexibility, again, is something that I think you have to have the right asset base for, you have to have the right balance sheet, you have to have the right financial condition in order to execute on a plan that has a lot of flexibility in it. It's something that we haven't always had and we're very happy to have today, and so we're trying to use as well as we can.

Got it. And so along that line with the service operators that you're working with. Does that mean that you're just not signing longer-term contracts and it's always a bit fairly flexible for you to move that crews around or delay the turn-in-line schedule?

We think of that as needing a mix and the diversity of how we contract, just like everything else in our portfolio that we manage. So some of the rigs and frac crews that we use have longer-term contracts, more set pricing and some are much shorter term so that we can dial up and down our activity levels.

And you mentioned for several calls now, the ability to maintain, how does the productive capacity for a higher price environment. How do you think about that? What is that productive capacity? What is that flexibility? Like what are you solving for, the ability to ramp up to X amount of volume?

We don't think about it as having a volume target. We think about it as being able to respond to the market's needs. So the market right now is oversupplied. There is more supply than there is demand. You can see that in all of the research notes that look at the macro. We want to be positioned for the point in time at which that flips. When the market needs more supply, we want to be ready to deliver it. We think we have one of the lowest cost sources of supply in the industry, so we should be one of the first calls. When that happens, we're excited that we have a portfolio that is connected to markets. We have 2 assets that can deliver into that supply picture when needed, where the Marcellus stays pretty constant with Haynesville growth lever. So we can respond to those changing conditions in a way that we think is exactly what the market needs and should drive an outsized profit for us relative to companies that might have a higher breakeven.

So when we talk about the completion side of -- I guess, the CapEx that's more flexible. Can you put a magnitude around what that level is? Like how much can you defer and how much CapEx do you save by flexing the schedule of those wells?

Sure. So what's interesting about the market is that while the market is oversupplied, it's not oversupplied by a massive amount. When you think about us being a 100 to 102 Bcf a day market for natural gas in the U.S., we're probably around 1 to 1.5 Bcf a day oversupplied. So when you think about how to impact that, it doesn't take a whole lot of activity. We've dropped 2 rigs and 2 frac crews effectively. That will bounce around a little bit through the year. It doesn't take a whole lot. And when we talk about deferring turn-in-lines, we might defer a pad here or there. We're not building a large amount of DUCs. We're not having to change our capital program with really large material swings. These are at the margin changes that do have a pretty nice impact on the supply/demand balance over time and it is having, we think, the desired effect for the market. The lag effects -- one of the questions we get often -- I was just talking to -- one of the attendees about this just a second ago, the lag effect of these changes in capital takes a while to show up. So the activity that's been dropped this year, it really doesn't show up into -- as reduced production until sometime in '24. We think that will happen and we think the market will come into balance during '24.

Great. So then longer term, talk to me about your -- the framework around how you think about what's the optimal activity level? You're not necessarily solving for growth. So what's the metrics that you think about on the -- governing activity?

It's not really a metric that we think about like that. I mean, again, I'm going to look back to the fundamentals, where supply and demand. When supply falls below demand, which we think it will, at some point, we'll be ready to drive our production higher and capture that need in the market. Until then, we're happy to continue to run the capital program that we're running. If the supply/demand picture begins to look worse than it is today, we'll be happy to drop activity back lower. We know we can make money throughout the cycle, but we would like to see supply and demand in a more constructive place to bring activity back. We think that probably happens sometime in '24, but until it does happen, we can be patient and continue to do what we're doing. And again, if we saw something that change to the negative, we could pull back activity further. We really expect that at this point. We think the market feels like it's headed in the right direction, but the gas market will continue to rise and we have a business that's flexible enough and assets that are resilient enough that, that will be something that we can handle without a challenge.

On your asset base, your 2-basin asset with Haynesville and Marcellus. You talked about briefly that running Marcellus more for flattening it. Haynesville for [ flex ]. I guess, more bigger picture, how do you think about the value proposition of having 2 basins E&P? And how you differ from other gas E&P that might be a single basin?

Yes. It's exactly that. We have the combination of assets where the Marcellus is a constrained basin, but has just tremendous economics. So we can run a constant capital program there. We can deliver consistent volumes into the market and earn a great rate of return on our activities in the Marcellus. In the Haynesville, we are in a position where we can dial that asset up or down depending on market conditions. And we are in proximate location to the LNG export facilities, which gives us a completely different opportunity for pricing. We really are excited to have the combination of both. We think they work really well together, and it's all part of our strategy to be LNG-ready. As we see the export capacity coming on over the next couple of years, we know we have an asset that can grow into that as the market pulls that gas and we think it will. So we're ready to respond to that as it happens. We think the combination of the two is really powerful and is differentiated relative to the rest of the industry to have two such high-quality assets in both of those basins.

And despite volatility, you're still returning cash to shareholders and maintaining that. Talk to me about your return framework and I think something with the cyclical nature and how you think about variable dividend and share buyback. It's quite interesting.

Yes, thanks. We're happy with our return program in that it is designed to have some flexibility around how it works and to work well through cycles. So this year -- so our program, just to summarize it is, we have a base dividend. We have a variable dividend, which is 50% of free cash flow after the base dividend and then we have an active buyback program. The way we think about all of those is the base dividend will be delivered always in every year, and that's our plan. It's been designed to be resilient through cycles and to stand up and hold up to our cash flows even at low prices. We're seeing that play out this year. We feel good about our base dividend. In fact, we just raised our base dividend to $2.30 with our Q2 earnings. Our variable dividend this year, given that free cash flow has been reduced with lower prices has gone down. And then our buyback program has remained pretty active. And so we like that dynamic and that what it drives is a return model that we think matches the way cycles should work. So this year, with gas prices relatively low, our variable dividend program declines and yet we can continue to buy back shares during a time when low prices would suggest that it's a good time to be buying back your stock. If you roll forward to some point in the future when we have export capacity online and supply is below demand and we see gas prices rising significantly, our variable dividend program will come back in. And depending on how the market conditions play out for our equity, we would still be active as a buyback program, but maybe not as active when we have a much more robust equity market. And so we like the ability to be countercyclical with our buyback program. Procyclical with our dividend. And we think that discipline that's instituted by having those features automatically run as the market conditions change is pretty aligned with how the market would like to see capital return to shareholders.

And does that mean you are willing to also lean a bit into your balance sheet? Or are -- especially now the cash position opportunistically to do buyback or to return cash in a way that is -- that fits the environment because you do have a $800 million cash balance today effective and you have proceeds coming in from the Eagle Ford. So the question is, what do you do with that?

Right. So that's a great position for us to be in, right? We like to have a lot of liquidity. We like to have the financial flexibility that comes with that liquidity. And it does give us an opportunity to be opportunistic, and we will look for those opportunities when it makes sense for us to lean harder into a buyback, we can do that.

Great. The -- all right, let's talk about your be ready LNG strategy. What does it mean? Yes, what does it mean for Chesapeake?

When we think about our Haynesville asset, it sits right next to the pipelines that all will feed into the LNG export capacity. We have an asset base that has really long running room, very high rate of return development ahead of us for 15 years in Haynesville. We can drill great wells and be ready to grow as that export capacity comes online. We get asked all the time. Is there a gas price at which you want to raise rigs? Is there a signal from the forward curve that would cause you to add capital or reduce capital? The forward curve is a good proxy for how the market is perceiving supply and demand, but we watch those fundamentals a lot more closely than we do just some magic number in the forward curve. The forward curve can become a -- it can get separated from those underlying fundamentals. And so what we really like about our Haynesville position that as we see demand go above supply, our assets in the Haynesville are best positioned to answer that call and to deliver growth volumes into the LNG export market. There will be a growth on U.S. gas over the next several years as export capacity goes up by -- at least over the next couple of years, about 10 Bcf a day. These are all projects that are under construction. That's 10% growth in demand for the U.S. market. The kind of growth is something that is a little bit hard to fathom when we think about how slowly the market moves over time. That growth in demand will change the underlying fundamentals of our industry pretty significantly. And the growth will be met, first, by the Haynesville; second, probably by the associated gas coming out of the Permian. And then after that, it's going to pull harder to find gas in other places. We don't really have pipeline projects that are going to deliver large amounts of incremental volumes out of the Marcellus directly to feed that increased demand. And so it will have to come from the Haynesville and other places that are connected to the infrastructure in the U.S. to be able to meet that growth in demand. Our Haynesville, again, geographically is positioned advantageously to other areas that can grow. So we really like that dynamic. We know that ultimately, the associated gas in the Permian probably ends up being exactly the capacity of the pipes that are built. So if you always -- if you want to think about how much of that growth in demand will be met by the Permian, just go look and see the pipes that are under construction. That's the cap. There can really not be any more than that. And you know you will need a lot of growth from the Haynesville at that point.

Are there pipeline constraints with Haynesville? Or what's the infrastructure situation there?

So there's a lot of pipes being built in the Haynesville right now. You can build intrastate pipes in Louisiana to get from Haynesville directly to the LNG export facilities. That facilitates the growth in infrastructure, again, in an advantaged way over a lot of other basins. There's a number of different significant projects underway right now. We are an equity investor in one that we're very pleased with. It's called the NG3 pipe. It's being built and operated by a company that does business under the name of Momentum. We own about 1/3 of the equity in that project. And that's a great project for us. We're really excited about. It is underway and expected to be on time and on budget. And we're really excited to be in that project. That's a project that will take gas from the heart of the Haynesville field directly to Gillis, which Gillis is becoming not a true hub but a point at which a lot of other pipes that feed directly into each individual facility will come and collect gas. So Gillis will evolve into something that feels like a hub in and of itself and that's where we will deliver our gas.

Why did -- one, I do think that pipeline is really interesting and the fact that it can get built and then there are some environmental attributes in line with that pipe as well. But just curious why did you think you need an equity investment to be part of that pipeline versus just signing up as a supplier?

We did the rate of return to the developer was pretty significant, and we wanted to make a pretty sizable commitment. We wanted to move a lot of our gas down to Gillis. So our commitment to that pipe created a lot of equity value. So we felt it was a really good opportunity for us to participate with capital alongside the developer under the same economic conditions that they have to participate in that equity value creation. And give an offset ultimately to the cost of the delivery of the product through the pipe. When you think about the rate on the pipe, it's very competitive. It's a very competitive market. You have multiple pipes being planned for and constructed at once. So we were able to work with all of the different developers of those pipes to determine which project was best for us, which project had the best economics on rate alone. And then from there, we were able to participate in the equity to further reduce our ultimate economic exposure to that project in a way that's really positive. And again, our commitment created that equity value in and of itself. So we thought it was a good offset.

What's the volume? Is there a volume commitment?

There is a volume commitment. We're about 700 million a day on that pipe.

That's a lot.

Yes, that's a lot. But we produce over 2 Bcf a day gross, out of the field, and that's how to think about the ratio of that volume. So it's well within what we need to plan for in order to have proper market access and advantaged pricing.

Great. Let's unpack the -- some of the agreements that you signed on the LNG side with Gunvor and Lake Charles. What's interesting is that you saw the offtake agreement before signing the liquefaction deal. Is there any strategic reason why you did one before the other?

Yes, the offtake agreement tells you the price that you're ultimately going to receive for your gas and gives you the economic relationship you need with the market you're ultimately selling to. We thought it was really important to -- and a good opportunity to define that ahead of then being able to negotiate with a liquefier for what is essentially just another midstream contract. It's a large one, but it's a midstream contract to deliver gas to a certain point. In this case, it's the point at the tailgate of the liquefaction facility, but that is a pure infrastructure-related transaction. The real value comes from how you sell that gas. And we wanted to have that defined, we thought we had an opportunity to get that defined. And it actually gave us a better ability to negotiate with the liquefiers to have an economic deal baked with a buyer so that we and the buyer could present to the liquefier exactly who their customer was going to be on both sides. And make sure that they understood who they were really dealing with and the committed nature that we were looking for from that contract. There's a little bit of a chicken and egg problem when you go to do these deals. And when you approach a liquefier and say, "I really want to do a deal. I think I'm going to sell my gas somewhere in the world, and I think I'm going to get some money for it." There's a little bit of a -- that sounds good, but let -- tell me more. And so for us to go ahead and define what that offtake agreement looked like, who was going to take it, how the economics would work and what our relationship was to each other as well as how we would be positioned relative to liquefier, we think helped us to move forward in that discussion pretty well.

In that case, who pays for the liquefaction cost?

So we do. We will have a contract directly with the liquefier. And we'll have the ability with that contract to always decide not to send our gas through that liquefaction facility and instead sell it domestically. In that case, we will owe a charge to the liquefier when we choose not to send gas through, but we will offset that by selling the gas in the local market. And therefore, you have sort of a floor to your economics.

In that case, what happens to the other side with Gunvor if you're not -- deciding to not go through the...

It's part of our deal with them, that we have the ability to choose not to send it.

So you have the flexibility?

We do.

Is it full flexibility on the volumes or...

There's a notice period. But yes, we have flexibility to not send it.

No, that's great. So how did that -- what's the background on the Gunvor deal? It's fairly -- you don't see these deals quite a bit. Just how that came about? And is there opportunity to do more?

There's absolutely opportunity to do more. We have a great team that has been working, the ability to contract for LNG for quite a while. We've added to that team. We've brought in a part of our team that's very experienced and have a lot of relationships around the world through LNG. And we've been able to really open some doors and put in place this deal and working on several others. So ultimately, we would love for 15% to 20% of our gas to be priced internationally. We think that will take us a few years to get there. We kind of want it to take us a few years. We'd like to see this market evolve a little bit more. We think that it probably gets better over time. And so we're trying to participate as efficiently as we can in what is relatively early for an independent producer like us. And be ready to continue to grow our exposure to LNG markets as that export capacity out of the U.S. grows.

When you have these conversations, does it include direct conversation with the end user, like whether that's a European utility or APAC utility? Like how -- is that a different type of conversation than the conversation that you had with Gunvor?

That's a great distinction. It is a little bit of a different conversation. And we've had a lot of conversations with those trading organizations like Gunvor, who can optimize the delivery of that cargo as well as what I would consider a point-to-point end user purchase of the product. The point-to-point end user purchase of the product in some ways can be a little bit more complicated. You are taking away the ability for someone in between to optimize the value of the delivery of the gas. And so the risk sharing of how you price that gas becomes more acute between an end user and a supplier and ultimately, feels a bit more complicated than selling to a trader who's managing an entire book of business and can price more efficiently how they're going to pay for supply relative to a lot of different outlets, which they can sell it. They're a market maker at the end of the day, which we all know can add efficiency to a market. And when you take that out and you do point-to-point deals, there have been -- we've come close in some conversations that we thought would be really attractive. I think that there's a chance we could do something with an end user at some point in the future, but I'm also happy that we've done the deal we've done and would continue to do those if the economics prove better.

You said earlier that you have volume flexibility with Gunvor. It feels like that flexibility will be more difficult to get if you're signing that contract with the end user. Is that fair?

That's fair. That's fair. Again, it is about that risk sharing of a point-to-point versus selling into a more liquid buying pool.

Got it. And then this is where I tie in the certified gas and environmental attributes. I think it's a growing space, and it's -- Chesapeake is really leading in that. But I think there's still not enough recognition internationally to say like what is the right benchmark and metrics. And more importantly, are people willing to pay for a premium for better produce and lower carbon intensity gas. Hopefully, that is something that will evolve over time. But the Chesapeake's environmental attributes and what you have done on that front, does it make a difference in your conversation with whether that's trader, whether that's end user? And are you seeing some willingness for them to pay some premiums for that gas?

The -- it makes a big difference. It makes a big difference that we can present to the market who we are from an environmental standpoint that we have really strict environmental standards in our company and that we have a very minimal carbon footprint associated with our production. As far as a premium around lower carbon intensity production, that is still evolving. I would say we get a very modest premium today in some of our discussions. But for the most part, what it does is it puts you at the front of the discussion to be engaged with those consumers. And that's very important to us. It's very important to those consumers. It's very important to the buyers of gas to know that they are able to then market a product back to other buyers if it's through a trader that they can certify as being responsibly sourced. We have all of our production out of the Marcellus and the Haynesville certified is responsibly sourced out of both. We were intentional about doing that certification through the MiQ/EO100 standard. MiQ is part of the Rocky Mountain Institute. EO100 is a European-based organization. And so we think that will have better traction internationally in recognition of what that means for responsibly sourced gas. And that market is very early to evolve. We'd like to see that market continue to evolve. Ultimately, I would love for all gas produced out of the U.S. to be viewed by the rest of the world as responsibly sourced because I think that will cause the U.S. to continue to be that supplier of choice for international growth and demand for gas. And that growth in demand for gas internationally is massive. And it will be massive for decades, we think. The overall just short nature of the energy market for the foreseeable future is undeniable. And we know that gas is such an important part of fulfilling that demand. We think it needs to come from the lowest possible carbon footprint. It needs to come with the best possible economics and we think U.S. Natural Gas is the right answer. And we think our responsibly sourced gas, which is only going to get better, by the way, will be an even better answer within that pool. We talked about our NG3 project a few minutes ago, and you referenced environmental attributes. But what we didn't specifically talk about is that we have the ability to do a carbon capture project associated with that pipe. Something that we're pursuing. Whereby the CO2 that gets extracted from the pipe before it's delivered to market, rather than venting that CO2, which is the traditional way that it's handled throughout the Haynesville. We will do that at the terminus of that pipe at Gillis, capture it there and then be able to either sequester it or sell it into a CO2 market there. Really, really powerful addition to the environmental attributes of our gas and potentially really powerful from an economic standpoint as well when you consider the tax credits associated with either selling that CO2 or sequestering it.

And my understanding is MiQ is also looking into orders of growth around gas certification beyond the upstream, the full value chain. So that there's a better understanding of across upstream all the way to the delivery point.

I think this is super important. I do think this is where the market will head and trying to understand the environmental footprint of the hydrocarbons that we use. We need to be partnered with our end users. It's something that I've talked about with a number of the larger utilities in the U.S., and it's something that certainly the international consumers of gas think about quite a bit. Everybody wants to be able to see all the way from wellhead to burner tip, what the environmental footprint is and know that it's minimized and know that it's done in a prudent way.

Great. Very important topic, and thank you so much for leading the charge on that. So with that, we're out of time. But thank you so much, Nick, for being with us and join me in thanking him.

Thanks, Betty. Appreciate it.