Expand Energy Corporation (EXE) Earnings Call Transcript & Summary

Okay. Great. Thank you so much for joining us. We are here with 2 of the leading gas companies in the U.S., Chesapeake Energy and EQT. Mohit, thank you so much -- thank you so much for joining us. And we also have Sam here with us, who is our Head of Gas Research, who will be co-moderating the panel with me, Umang Choudhary. So thank you so much again for doing this. I'm sure gas is so much topical right now, especially in the macro, so we'll get a lot out of this from a discussion perspective over the next 30 minutes. So with that, Sam, maybe you want to kick us off with the macro questions?

Yes. And I have to start with production. I don't know if you guys were here when we had our first panel at that ungodly early hour. But one thing that we discussed is we sort of have an idea of what's going to happen with demand, not a lot of demand growth in the U.S. for gas this year, and a decent amount of demand growth in '25. So everybody is thinking about how we transition. And even from a price perspective, if we think, well, if there's no demand growth, weak prices this year, a lot of demand growth in '25, stronger prices that year. How do we get from here to there? And our view is this is a timing issue, and in particular, a production timing issue. At the end of the day, if production rises ahead of that demand growth, why do you need the rally in the first place, right? So production levels have been extraordinarily high. I want to ask both of you, what is your view on these high levels of production? And how do you think that evolves over the course of this year? And based on that, what is your outlook for the market for '24 and '25, and how we transition that?

Maybe I'll go first. Well, thanks for having us here. It's good to be here, first week of January, and hear everybody's thoughts and share our thoughts as well. On to your question. So yes, when you start looking at the production numbers, around 105, 106 Bcf a day. It is -- it has surprised a lot of people to the upside. But when you start looking at the constituents, so Permian, it had some new pipelines come on. And what happens in the Permian, associated gas immediately, those pipelines get filled. Up in the Northeast in the Marcellus, we did this within our portfolio where we had back-end loaded, a lot of the TILs and deferred a lot of production into 4Q just because that's when you traditionally find that the pricing is stronger once you get off the shoulder season. So we had quite a few TILs that we brought on. So there's a lot of flush production that has come on in the Northeast. But as you'd expect, within the next few months, that should start to taper off. And then the third thing I would say is Haynesville has been fairly resilient as well. When you look at the production from Haynesville, even though the rig counts have come down, the production quite hasn't rolled over. Now if you ask why, because it traditionally takes about 6 to 9 months cycle time before when you start doing the reduction in activity before it shows up in the production. We kind of had the cusp of that beginning to show up. So our expectation is that Haynesville should [ trough ] in Q1 this year. It should be happening in real time as we sit here and talk about it. So when you roll all those things up together, the production has to come down. The market is clearly oversupplied. When we think about it from the demand side, with the Exxon announcement, perhaps Golden Pass getting delayed into 2025. So that obviously has a demand impact. Then storage is full, close to full. And then the winter hasn't quite shown up. So when you put all this together, yes, it makes it for a setup where oversupply demand hasn't quite shown up and/or gotten delayed. So it will make for 2024 that could begin to look a little bit how 2023 did. And I'm sure we'll dive into that, but maybe I'll...

Yes, I think we're generally pretty aligned and just like structurally how we think about it. I think importantly, as you think about forecasting supply and where inventories go, we don't like to take Appalachia specifically. We don't see a structural change. I think if you look at what happened in Q3, where you had very weak pricing and e-storage pretty full, TILs were delayed. Some of them pushed off into 2024. And when you couple that with already what you just said, Mohit, where there's a seasonal kind of ramp, it's not the first year that's happened. But you see a lot of production hit all at once. If you were to just extrapolate that forward and hold it flat, that paints a very different picture than I think the reality that we expect, which is that it returns more to like a structural level of 34.5, 35 Bs a day in basin. You probably see that happen kind of late Q1, where you really kind of come back to those levels. That's what we've seen in the past. But again, I think to your point, when you couple that with what's happening in the Haynesville, you're kind of at that point where you've been flat for a couple of months. Rig productivity has improved in the Haynesville in the last couple of years. I think that's probably what skewed assumptions a little bit in terms of where rigs were, where they fell to and where they sit today, the ability to hold some of that flat relative to what you might have seen a couple of years ago. But I think by the end of Q1, if you see Appalachia back to historic levels, if you see the Haynesville rolling, certainly constructive weather in the -- for the rest of the winter would help. But I think that paints a very different picture as you look towards like October balances in '24 than what you have seen. But I think what's really interesting about what's happening this year, though, too, is I think that if gas were $4 in 2024, you see a lot more activity. And so the 2025 story that you talked about, Sam, would probably be a lot more muted. I think the longer prices stay lower, it just pulled back activity. And to your point, because of the delay time of whether it's 6 months, 12 months, where you see like real production response to higher prices. I think it actually sets up an environment in 2025 that probably increasingly gets tighter, the longer you hold at really low levels. I think whether it's a private or public, you're going to be more delayed and more disciplined, especially after what happened 12 months ago to adding back activity. So if that activity at is not mid-2024, maybe it's end of 2024, '25, you just have a bigger air gap and imbalance in supply and demand as you get into 2025. So I think we remain really constructive. I think to Sam's point, it's really a timing question and when that imbalance shows up. But is it -- I guess, as we were talking about before we walked up here, what's interesting when it comes to modeling gas inventories and supply and demand, call it 100 Bs a day in the market. If you're off 2% in your model, which is kind of a rounding error in the grand scheme of things, given all the uncertainty, 2%, 2 Bs a day over a year, that's almost 700 Bcf a day, without any other price movement that kind of helps rebalance. That's the difference between a very bullish market, a very bearish market or vice versa. So we've talked about our view that like volatility will be increasing. I know you guys have talked about that, too. I know a lot of other operators kind of share that view. I think it's going to be increasingly hard to predict when this is going to happen because of the timing mismatch, what happens with weather and these different things that either rapidly tighten or rapidly loosen the market. But we remain pretty constructive. Though, I think '24, at least through most of the summer is probably pretty loose.

So forward 2025 year now, what, between 350, 360 or so, are you bullish relative to that?

From our perspective, when you start looking at the breakeven, there will be a lot of production that gets brought on at those kind of prices. If those prices hold, the strategy for us is to be LNG-ready. And what that means is when you start looking at Golden Pass, you look at Corpus Christi Stage 3, you look at [indiscernible]. So where we are exporting about 14 Bs a day today, there's about 7 Bcf a day of LNG demand that's coming by 2025, right? So that thesis stays intact. The timing might slip a little bit because projects -- but once they are going in the ground, that steel is going in the ground, we know that project will come online. We know that, that demand will show up. And structurally, what it does is to go from 14 to 21 Bcf a day, that's a pretty marked improvement in a new source of demand. And then when you start adding up the other projects, which are in the queue as well, I mean there are some estimates, which get it up to almost 30 Bcf a day. So in the midterm, I would say the thesis is still intact. What has kind of derailed it in the near term is that winter just hasn't shown up. But we knew that, that should happen. And that's why we ran our business in a way where leverage levels are low. We are fairly well-hedged. We have managed our portfolio to be robust with low cost structure where we can withstand all of this. The intent is to create long-term value. And the way you do it is, well, yes, as these ebbs and flows happen, you make sure you keep a pristine balance sheet, make sure you keep a good hedge book and be committed to returns to shareholders, which if I can talk a little bit about that. I mean, we have a base dividend that we pay $2.30 per share every year, which we have been growing over time. That's sacrosanct for us. Then we have a procyclical variable dividend. So as we make more money in an up cycle, we pay a variable dividend. And then opportunistically, when we are in the down cycle, we are doing buybacks. So the intent is when you look at those 3 different levers and you average through them from a shareholder perspective, when you -- irrespective of which part of the cycle, whether it's in the up cycle or in the down cycle, there is quite a bit of return that's coming to the investors, which traditionally, if you think about E&Ps, we just haven't done a very good job providing that return back to the shareholders, and that's a lesson that's been learned, and we are committed to our shareholder return program. Again, through the cycles, just managing all of this. So despite what's happening in the macro conditions, having a portfolio and a company, which is set up to deliver returns to the shareholders.

I mean, I guess, Sam, to answer your, I guess, original question on just like where does gas need to be in 2025. I guess, one, I would expect it to overshoot to the downside and to the upside as the market tries to rebalance and find equilibrium. When we think about our base business and really stepping back and saying like if we're competing as an industry for dollars from other industries, where -- like take real estate for an example. Like if I pay $1 billion for like this hotel, I need to make $100 million a year to get a 10% unlevered return, right? So if you're -- if you're paying that for one of our businesses, there's a certain level of free cash flow you need as a yield every single year. And that's totally disconnected to like what's a single well IRR. So like for EQT, we start producing cash flow -- free cash flow like [ $2.50 ] gas. And for each one of our all of our businesses, when we do the math, you need about $1 of margin to really generate like a 10% WACC. So call it, $3.50 is embedded, at least, as we look at our stock today, assuming kind of unlimited inventory. If you look at -- in our view, like the marginal cost of supply in the Haynesville, you need like $3.25, $3.50 gas in maintenance mode in that box to just hold it flat and be free cash flow-neutral. So you add one dollar on top of that, I think you're well into the $4 range to really justify consistent like returns on shareholder capital. So to accelerate development of an asset like that, I think in our view, you need gas well above that. And so -- and I think if you look at Haynesville-specific assets as we looked at it from an M&A perspective, if you look at some of the publicly traded Haynesville assets, you see that borne out. You need nearly $4 gas for some of those just to start producing cash flow. So if I'm an investor and saying, "I'm going to put money into this box and I need to get my money back before the asset is depleted," is 10% even high enough, I think, is a fair question. That's 10 years to get my money back. and then I start earning real return after that. So I think in our view, I mean, I think you need well into the $4 gas price range. I think a single well IRR, even when we look at ourselves and say if we need it [indiscernible] hit almost 100% IRR at the wellhead. So we don't run our business based on like wellhead IRRs. We think increasingly, that's irrelevant because investors are holding companies to account for like earn me a cost of capital on my shareholder base, not on your wellhead return, but 2 totally different things. So I think we have probably a higher view of where gas needs to be, certainly to see a production response that's really sustainable.

A lot to unpack there, to be honest. Maybe let's -- starting with 2024, right? Last year in '23, one of the concerns which investors had was like, hey, gas prices have fallen off a lot, but supply response hasn't been that quick, right? It took 9 months to 12 months when the supply [indiscernible] Show up. And we effectively are looking for a supply response based on activity reductions in the middle of last year. So as you think about your expectations from industry activity for '24, given where we are on gas prices, where do you think that lies, one? And then two, how do you think about your own capital investments, right, within this more tepid gas price outlook in '24 in theory? Maybe Jeremy, do you want to start first?

Yes. I'll go first this time. So when you think about our business, we're running 3 rigs to hold almost 6.5 Bs a day flat. So it's over 2 Bs a day per rig. So incredibly efficient. If we were to drop activity as a business, we're dropping 1/3 of our rigs. So we're not going to do that. And when you step back and think about just gas supply in the U.S., you have the Permian, which is free supply. You have Appalachia, which is cheap baseload supply, then you have -- think about the Haynesville as being like a peaker plant. It can ramp quickly, it can decline quickly. You saw that play out last year in terms of where rig activity shifted. I think for EQT, running a business where we're drilling 300,000, 400,000 lateral feet kind of per development run, that takes long-term planning. You don't start to stop that. So we're running the business kind of like you see some of the large Permian operations. You commit to it, you have a very low cost structure, and you can do that consistently through the cycle. So I think you should expect us to run at just consistent, predictable, repeatable program, kind of as we've messaged publicly so far. I would expect that as we think about it and as you saw last year, the Haynesville probably [indiscernible] so I think in this gas and price environment [indiscernible] further, I probably look at a moment and probably more to answer that. But I would expect capital investments into more marginal plays to be pushed off, at least, another year at this point.

Mohit?

Yes. From our perspective, the overarching theme is we want to keep the pace of activity somewhat steady because every time you hit the start, stop; start, stop, it's inefficient, right? Because every time you're demobilizing rigs, there's an efficiency and value leakage that begins to happen. Same thing with frac spreads. I mean, you don't want to bring them on and then have them 2 months later on that they're releasing them. So the end goal is to try and keep as steady as you can. So we are running about 5 rigs. We are running 5 rigs in the Haynesville. We are running 4 rigs up in the Marcellus. You should expect us to continue to run the same. The other -- the lever that we have in the equation is what do you do with the frac counts? And if you can reduce the number of frac spreads that you're running, what it does is immediately it increases your cycle time, right? Because it takes you a little bit longer to bring those wells online. And when you think of the capital spend between drilling and completions, if you delay the completion spend, that has a bigger impact because that is the bigger [indiscernible] fee as well. So if you're trying to reduce your in-year capital expense playing with the frac spreads, and that's -- those are some of the iterations that we are working through for our 2024 plan. We'll issue the guidance come February at earnings for what the plan is for 2024. But we'll play with the cycle times, how long it takes to build -- to bring those wells online and what the cycle times are and how much is the working inventory are the wells that we are working through. So that's one part of the answer. The second part, I would say, you don't want to compromise your ability to -- because we as we discussed earlier -- and Sam asked this question, that we think from a macro perspective, the demand is coming. What you don't want to do is compromise too much of our productive ability to grow into that demand when it shows up. Because if you start hitting the brakes too hard, then you can go into a trough, which when the demand shows up, you're still trying to climb back out of that trough, and you want to avoid that as well. So it's a little bit of a push and pull trying to manage that, yes, the market is oversupplied, we need to reduce. We are doing that. Others are doing -- you're doing that, and other companies are trying to do that too. It needs to happen. The market is clearly sending us that signal. But at the same time, try not to compromise your ability to grow into that demand, which will show up.

Now I want to turn a little bit into risk management, and then Umang will follow up with balance sheet goals. But you both have mentioned in the past, and Jeremy just mentioned now how volatility is here to stay. So I want to hear from you how you think about your hedging strategies.

I guess I'll go first again. So as you think about hedging, I mean, the purpose of hedging is obviously just risk mitigation. And so the question is like what is the risk in your particular business you're trying to protect against? I think historically, when so much of the market was hot, was really high yield, it was really trying to protect the balance sheet. And as you look at our businesses today, back at investment grade. You guys have little to no debt at this point. There's not really a need to hedge for sort of like financial protection in the same way. So it's more of hedging to probably reduce volatility and increase certainty. But the other piece that comes into that is just what's your cost structure. And for us, again, it just comes down to like on an unhedged basis. Before you add that, what's that gas price where you start producing cash flow or start bleeding out? We're -- if you step back and look at the last couple of years, like 2020 or in COVID, you had gas settle at about $2. Like, I think, Sam, you know better than I would probably. But that's one of the lowest settles probably in recent decades for just a whole year. So when we think about our base business producing cash flow at $2.50 or above, and every dollar above that, so that's about $2 billion kind of free cash flow after tax. We just want to make sure that really in any environment we can produce free cash flow. So when we look at our business and say, "Okay, if you just ran a $2 case, how much do we have to hedge?" Call it, between $3.50 and $4 as a floor to make sure they're down to $2, we can produce free cash flow or be free cash flow positive. For us, let's call it, 25%, 30% of our total production. Hedging beyond that, in our view, doesn't really seem to have a great purpose because in effect, what you're doing is if you say -- a lot of people like to talk about what's my view on price. And they talk in averages. I think we look at it in a world of high volatility, and we say, "Well, gas falls to 2," and that's kind of your low point. But this is very asymmetric to the upside and also increasingly unpredictable. Why would we hedge more than we have to and cap [asymmetric] upside, right? And so what we're trying to do is keep as much of that exposed while making sure that in any environment, we can consistently produce durable cash flow, which is why it ultimately comes back to like having the lowest cost structure possible is what really allows us to do that. If our cost structure has been sort of being at $2.50, we're at $3, we might have to hedge twice as much, right? And so having a high cost structure in theory, that gives you more operational, like leverage and exposure to gas prices. In reality, it makes you hedge more, which means you actually have less upside. And I think you realize on average below strip in the future. So we want to hedge as little as possible. And if we saw our cost structure come down, which is what we expect, we think it goes from like $2.50, $2.60, down to $2.30, just as we have gathering rates contractually to clients, some other agreements we signed recently come in and improve our margins. We probably hedge even less than that. And so it allows us to have a business that down to $2, we're producing cash flow. And if gas is $6, we're realizing almost all that upside. So we're trying to sort of evolve our hedging strategy based on how we've scoped our business, the profile of our balance sheet, our credit ratings and really provide what we think is the best risk-adjusted exposure to the commodity. There's different ways to go about doing that. A lot of it comes down to the assets, contract structures. But that's, at least, the way we look at it, at least kind of through the end of the decade.