Contango Oil & Gas Company
Q1 2021 Earnings Call Transcript

Published: 14 May 2021

[Operator:]

Good day, and welcome to the Contango First Quarter 2021 Results Conference Call. Today's conference is being recorded. And now at this time, I would like to turn the conference over to Mr. Wilkie Colyer. Please go ahead, sir.

[Wilkie Colyer:]

Thank you, Jay. Good morning, and thank you for joining us for our first quarter 2021 earnings conference call. My name is Wilkie Colyer, and I'm the Chief Executive Officer of Contango. Joining me this morning on the call are Farley Dakan, the company's President; Chad Roller, the company's Chief Operating Officer; Joe Grady, the company's Chief Financial Officer; and Chad McLawhorn, the company's General Counsel.

[Operator:]

And we will start Q&A with Gail Nicholson with Stephens.

[Gail Nicholson:]

You guys have upped the drilling budget this year and then there is West Texas drilling. Can you just talk about the timing of this activity and what you guys are targeting?

[Wilkie Colyer:]

Sure, Gail, and thanks for the question. So yes, look, we have modestly increased our drilling budget this year roughly on the order of $10 million or $11 million, and it will be to drill 3 gross 1.5 net wells out in our Northeast Bolsa area. The timing of that is, I would say, Q2 and Q3. And that was really driven by a couple of things. One and obviously, the most important thing is that given the recent increase in oil prices and the continued weakness in service cost, the returns on capital, the return on investment, the math all checks out in terms of just the capital investment that will be generated from drilling those wells.

[Gail Nicholson:]

Great. And then do you think from a standpoint of bull's eye, when you look at that piece in your portfolio, it's more unconventional, higher decline rate assets. Is that potential being be divestiture candidate for you guys later down the road?

[Wilkie Colyer:]

Yes, Gail, it's a good point. I mean we -- that's not really our -- necessarily our cup of tea. I mean we do think that it's an interesting asset that's got good inventory it's just might not be -- we might not be the best-suited company to execute on that development plan. So it's everything in the portfolio is for sale at a price. But that certainly, I think, is one that if we can get decent value for, we feel like we can be more impactful in other areas of the energy industry and the upstream industry than perhaps unconventional developments. So I would agree with that.

[Gail Nicholson:]

Great. And then just one last question on the operating expense side, now that you've digested Silvertip and Mid-Con. Looking at the further potential reductions on OpEx, where are you guys in that process? And what kind of are you guys looking for potential reductions on the LOE side on those assets as we move through '21.

[Wilkie Colyer:]

Yes, I'm going to kick that question over to Chad Roller, our Chief Operating Officer; and let him answer. Chad?

[Chad Roller:]

Yes. So as we look into 2021 on the OpEx side, we really look at 2 things. We are in the process of restoring a significant amount of production in the assets that we acquired. The net effect is total operating expenses may go up as we bring more production online. But we do expect a pretty significant reduction in the unit cost or the cost to lift a variable oil. So we do think the efficiencies will go up as well as production. Does that help answer the question?

[Gail Nicholson:]

When you look at that reduction on the per -- daily basis, do you have any idea in the magnitude of like $0.25, $0.50, $1, any thoughts there?

[Wilkie Colyer:]

We haven't released that yet and still in the process of digesting, but we do feel like it will be a material number.

[Operator:]

We'll now hear from Jeff Robertson with Water Tower Research.

[Jeffrey Robertson:]

Wilkie, I'm wondering if you can talk a little bit about how the return to production program and some of what Gail asked about, will it have an impact on your free cash flow generation from the assets you recently acquired over the balance of 2021?

[Wilkie Colyer:]

Yes. It's a great question, and I'm going to kick that one over to Chad Roller as well because I think Chad's really framing this nicely internally in terms of how we think about it.

[Chad Roller:]

Jeff, just so I understand, could you repeat the question for me?

[Jeffrey Robertson:]

Yes. Your return to production program that you talked about, which sounds like it's worked over heavy. I'm just curious if you can talk about how that will impact Contango's free cash flow generation over the course of this year?

[Chad Roller:]

Yes. So if oil prices stay high, it will have an impact on free cash flow this year because we are -- on average, the payout for this work is on the order of 3 to 4 months. And we are accelerating that work in the first half of this year. Essentially, we're really hitting that program hard in the second quarter. Depending on those results, we will either expand the program in the third quarter or revisit it, but we do expect it to have an impact on free cash flow this year with even a greater impact on free cash flow into 2022.

[Wilkie Colyer:]

Yes. And Jeff, just to hop in there. I mean the way we've thought about it is, like Chad said, 3 to 4 month payouts on most of these things. So if you start that in Q2, our view is that it will be net neutral to free cash flow to slightly positive yet at the same time, also adding a lot of reserves. So it's not impacting our free cash flow in a negative way that it is adding reserves. So that's kind of how we thought about it. Like Chad said, depending on the results of the program early on, we may amend that, but that's how we thought about. It was kind of front-loading that to Q2 and making sure we're adding reserves without impacting our free cash flow in a negative way.

[Jeffrey Robertson:]

And a follow-up. Wilkie, you talked about with the expanded credit facility that you have and stronger liquidity. As you think about funding future acquisitions, can you just -- can you talk about the equity mix or the equity debt mix in those and where you're wanting to keep the balance sheet?

[Wilkie Colyer:]

Yes. It's a good question. I mean I certainly think we're in a position right now where we're very much under-levered or overcapitalized, whichever you want to call it. We're still thinking we'll be debt-free based on our existing projects and scope of work by later next year. So that puts us in a really good position. I mean I would say, if we're going to pick a bogey that, I would say, moves a lot depending on the types of assets you have, whether they're high decline or low decline, we think we'd like to stay no more than 1.5x levered. That being said, we're going to be half a turn or thereabouts by the end of this year. So I think that should tell you that we've got a decent amount of room in there. And so that, coupled with the free cash flow we're generating plus the liquidity we have, I think we would feel comfortable with some pretty -- with utilizing our credit facility for something, let's say, on the order of a Grizzly size transaction, obviously -- excuse me, Silvertip transaction. Now obviously, we're looking at some things that are well in excess of our existing liquidity. And so those would require external financing sources. So we always just got to make sure whether we're using debt or we're using equity to acquire something. We've just got to make sure that we're staying prudent and that what we're giving up in terms of dilution or incremental leverage, we're more than getting that back in return in terms of the cash flow profile of the asset.

[Operator:]

We'll hear from Matt Watson, .

[Unidentified Analyst:]

I'd just like to understand a little bit more about the hedging and how you guys are hedged in the remaining of the year and then into 2022 or just anything you can talk about with respect to hedging on the pricing right now?

[Wilkie Colyer:]

Yes. So we are, I would say, very well hedged for the balance of this year. And just talking about oil, I think we're somewhere in the order of a little north of 70% for the balance of this year. Next year, it's a little bit less than that. It's, I believe, about 60%. But our view is that we're going to continue to hedge opportunistically. I mean we obviously want a baseline of hedges, and we think about it kind of in 24-month increments. I mean I think 24-month increments gives us a lot of visibility into the capital we'll have available to deploy into other opportunities. So that feels like kind of the window that we look at typically, given the shape of the curve. The shape of the curve, we're in Contango right now, I'd tell you that we would be more aggressively hedging next year. But right now, given our leverage profile, we're comfortable with the hedge book that we have right now, but that's subject to change, and again, pretty dependent on the shape of the curve, although we always want to have kind of a baseline. And I think we have minimum hedging requirements of about 70% and 50% for 12 months and 24 months out.

[Operator:]

There's no additional question in the queue. I will turn the call back over to your host for any additional or closing remarks.

[Wilkie Colyer:]

Thanks, Jay, and really appreciate everybody joining us this morning to review our first quarter earnings. We're really, really excited about where we are as a company and what we're building here. So look forward to continuing our work, and look forward to coming back and reporting back with you all after we finish up Q2. Thanks again for everybody's time and interest in Contango.

[Operator:]

Ladies and gentlemen, this will conclude your conference for today. We do thank you for your participation, and you may now disconnect.