Southwestern Energy Company (SWN) Q3 2022 Earnings Call Transcript

Operator

Thank you very much. At this time, we will begin our question-and-answer session. [Operator Instructions] And the first question will be from Doug Leggate with Bank of America. Please go ahead.

Doug Leggate

Thanks. Good morning everybody. Guys, I wonder if I could start off with a question on the takeaway of the new takeaway agreements that you have. Bill, as I recollect, the acquisitions were predicated on ensuring that you had adequate takeaway.

So, can you walk us through the nuance of what the incremental takeaway means? Is this a different allocation of where you expect your weighted basis to move or higher destination realizations? I’m just trying to understand what the implications of that are? And then I’ve got a follow-up, please.

Bill Way

Sure. As you well know — good morning Doug. As you well know, we take a very integrated approach to E&P and marketing and transportation and do so, whether we’re in acquisition mode or whether we’re drilling wells in a particular part of the basin. And so as you look at the — when we did the acquisition and completed it, we had all of the transportation and capacity that we require to be able to move the gas that we were attempting to move. And that was a condition precedent of doing all of those deals.

But as you move forward in time, we continuously optimize our marketing and our transportation if we can — if we find an opportunity to add a bit of transportation and lay off some somewhere else, we’ll do that. If we look to find a new marketplace that we’ve become very interested in and we want to pursue that. We can add transportation.

So net, we’re in a maintenance capital mode. We are — this capacity reinforces our long-term flow assurance and our access to the markets that it serves. We’re not signaling a growth in production or growth in drilling beyond maintenance capital through our plan. And we found the opportunity to optimize further. and one other comment I’ll make about optimization.

When we build transport capacity, it’s not a one and done. If we’re going to take on $300 million a day, it doesn’t necessarily come in $100 million, $300 million a day on we like to layer it in, we like to build optionality so that we can really optimize the economics of the program.

Doug Leggate

Bill, would give me for the follow-up on this, but does this put you in a position where you can market excess capacity? Because obviously, a number of your peers don’t have the same luxury that you do or having to take away in place?

Bill Way

Yes. Obviously, that opportunity is present, but we don’t we don’t acquire transportation to then turn around and resell it. We acquired transportation to optimize our plan, maximize its value. We have sold transportation capacity or laid it off temporarily to others in the past, and it’s more of an outcome when you’re finished doing your planning than a core objective.

If we can make a little bit of that on the side, we do that. We also buy gas and move gas through our — through any part of our transport where there’s available capacity and make a little margin there as well. It’s all about…

Doug Leggate

My follow-up, hopefully, a quick one for Carl is – Carl, obviously, there’s upward pressure on CapEx. I think we’re all aware of what’s happening there. But last quarter, — you talked about the free cash flow capacity as strip has come down pretty meaningfully since then. I’m wondering if you could share any update on how you see at strip today with CapEx pressures and any changes in cash taxes, for example, what you see your free cash flow outlook in 2023 at this point?

Carl Giesler

Doug, thank you for the question. Obviously, with continued inflation and at least the near-term softening in commodity prices, we expect our cash flow to come in lower than levels that we had discussed in August. That said, we believe we still have a line of sight actually a pretty clear line of sight to achieving our debt targets while continuing to progress our repurchase program next year.

Doug Leggate

On the slide deck. Thanks, Carl.

Carl Giesler

Thank you.

Operator

Thank you. And the next question will come from Charles Meade from Johnson Rice. Please go ahead.

Charles Meade

Yes, good morning, Bill and Clay and Carl to the rest of the team there.

Carl Giesler

Bill

Charles Meade

Bill, I wanted to ask about your trajectory going into 2023. And more specifically, you guys had a nice beat in 3Q, but it makes the – it makes spread a little bit steeper decline in going into 4Q, even though you guys are still on track in a larger sense, but that decline we’re seeing in 4Q is — what are the implications that are going to carry over into 2023 from there?

Clay Carrell

Yes, Charles, I’ll start. It’s all consistent with what we talked about in the second quarter where when we elevated the capital guidance due to inflation, it was so that we could keep activity levels on track with our originally planned activity levels and that fourth quarter activity sets us up for 2023 to start the year off in the right way.

And as we all know, the timing of completions has clearly a quarterly impact on production levels. And so what we’re doing in the fourth quarter is going to be the production that comes online in 2023 in the beginning. And then we will have a similar somewhat front-end loaded program as we come into 2023. So we should have a similar profile to that production as we move into 2023.

Charles Meade

Got it. That’s helpful detail, Clay. And then perhaps the follow-up, you referenced the efficiency gains you expect to see in the Haynesville, now that you guys have put a couple of quarters under your belt there. Can you give us a sense of the — I guess, the kind of the qualitative and the quantitative. What is the scale of these — of the efficiencies you think you can — you have line of sight on? And where are they coming?

Clay Carrell

Yes. It’s a continuation of the conversations that we’ve been touching on as we started operating in the Haynesville. We’re clearly got a year of learnings that is helping us as we forecast 2023. We’ve had completion design improvements that have helped with the well performance of these wells when we brought them online. We’ve seen cycle time improvements as the program has moved through the year that we feel like as we get into 2023 will be more consistent across the program. We’ve done facility modifications to help us optimize production levels and reduce the impact of downtime as we move through the year. So we think, all of the key categories around efficiency improvement that we focus on are set up for us to continue to make progress as we move into 2023, and especially with the one year of learning’s behind us.

Charles Meade

Got it. That’s helpful. Thanks, Clay.

Clay Carrell

Yep.

Operator

And the next question will come from Scott Hanold with RBC. Please go ahead.

Bill Way

Hey, Scott.

Scott Hanold

Hey, how you are doing? Can I ask on as you look into 2023 and beyond. And I would say, first and foremost, you all did a really good job of generating a lot of free cash flow in 3Q and you not only reduce debt fast, but also did – you had a pretty strong share buyback quarter as well. As you kind of look into next year and sort of the point Doug made about having the lower strip prices out there, how do you think about stock buybacks balance between that and that debt reduction target, because it looks like you bought back at about 7.40 in the third quarter. Obviously, your stock is now below $7. So it seems like it’s a good opportunity to really lean into buybacks here.

Carl Giesler

Scott, it’s a great question. And the reality is our approach really has not changed. Our priority remains to reduce debt. We believe that has various benefits, not only for debt or equity reduced volatility and other benefits. That said, as we progress towards our debt objectives, we’ll continue to repurchase shares. And we believe that with what we think is a significant disconnect between our share price and net asset value, the opportunity for those buybacks should be accretive for a while. It certainly were in Q3, and future commodity prices and our corresponding cash flow will dictate the pace of our progress on that front.

Scott Hanold

Got it. Thanks. And as my follow-up, kind of going back to the contract you did adding 500 today on the LNG corridor. Can you give us a sense of what are some of the pricing dynamics you all will get out of that? How does that differ from just selling it in market? And how are those discussions going with also those counterparties on negotiating what kind of price uplift or exposure to international markets right now? How is that – how are those conversations going?

Bill Way

So the added capacity gives us better netbacks versus Perryville, for example. And so we took the opportunity to get the capacity. Now, there’s nothing wrong with Perryville either. It’s quite strong, but this gives us a bit of an added advantage.

On LNG, let me comment that today we moved $1.5 billion of gas to the LNG sector in multiple agreements. Our strategy has moved forward to have us pursue take 1.5 BCF per day and make it 2 Bcf a day. And of that, 0.5 Bcf today would be focused on the LNG market and specifically international pricing, where we believe that there is an opportunity for us to understand it better and potentially access higher margins. We will do so with a risk-based approach to that.

We’re in conversations with all of the appropriate LNG projects that we can reach and that dialogue will continue. I would expect that we’re quite a ways away from having an agreement in place or even deciding to go pursue that, given the risk nature of the global gas market and the volatility that’s there.

But the — may be real clear that 0.5 Bcf a day I mentioned is — our target is up to that. We’re not at a point right now where we want to go any further than 0.5 Bcf a day, which is still a robust pursuit, but again, global gas volatility and all of the learning and discussions that need to go on, we’re going to take a measured approach to that.

Scott Hanold

Okay. Are the counterparties a little bit more open to providing you access to those markets and say they might have been two, three months ago when international prices were a lot more robust, or is — it kind of — are they kind of looking at more of a balanced approach to it as well?

Bill Way

Yes. I think you need to think about them in terms of two sets, existing LNG exporters less likely to probably let anyone into new agreements that relate to existing marketing opportunities. There’s always exceptions and there’s always opportunities. But in the main, I would go there.

The new entrants to the game are more interested in looking for ways to create some kind of an enabling event, whether it’s a very healthy in-basin producer that’s got the financial strength and the reserves to back up an agreement and negotiate something going forward that has increased pricing, or as you’ve seen in some of the press where somebody comes in and builds a pipeline to the facility to enable it to happen or something like that.

And there’s all kinds of options in that space. But, in the main, we’re having some good discussions with those different — next — the next wave to come on and — but even with that, it takes time to work through all of the nuances that are about international marketing of gas.

Scott Hanold

Got it. Thanks, Bill. That’s exactly what I was looking for.

Operator

And our next question is from Paul Diamond with Citi. Please, go ahead.

Paul Diamond

Good morning, all. Thank you for taking my call. I was just hoping to kind of circle back a bit on the Haynesville productivity and efficiency gains. You noted that you’re moving from 7,000 to call it, 9,000-foot laterals. Has there been any surprises as far as location? I know you guys are at a point where you kind of poke holes in the entire basin. Is there any areas that you’re more enthused about than others, or is everything kind of coming up roses?

Clay Carrell

Well, I would say that, it is performing across the position as we had expected when we did our original evaluation and in a lot of ways, even better performance than what we had expected.

The Southeast part of the play in DeSoto and Red River Parish and the Natchitoches Fault zone is where we’ve had the best performance. We figured that, that would be the case based on the greater reservoir pressure and the deliverability and EURs that those wells have, and we’ve continued to see that throughout the development, but across the play and our acreage position, the performance has been where we thought. I think the proof points of that are how we’ve delivered the program over the year, all the drill wells, turn in lines. All the activities are on track with our program and then we’re getting the performance that we expected, if not a little bit more. And in this service environment, I think that’s a big positive and it points to the quality of the integration of the asset that occurred and then the execution that the team has delivered.

Paul Diamond

Okay. Understood. Thank you. And just one quick follow-up on that. How do those well results play into your approach of splitting your capital expenditures between Appalachia and Haynesville. I know you’ve talked more about like 55/45 previously, does that still hold, or is there in any leakage one way or the other?

Bill Way

This is Bill. When we prepare our budget for a given year, we take all of the opportunities that we have across the enterprise and effectively rack and stack them by economic return. You have these large Haynesville wells. We have wells in Appalachia with high volumes of gas as well. We have wells with natural gas liquids and condensate. So we put them all down economically, we then pick a slate of wells to be drilled and then optimize around that. So we’re not over capitalizing midstream in place or we’re not under utilizing capacity somewhere. And so it’s a choreographed approach to laying out an inventory of wells.

Certainly, right now, we’re at 55/45. It will probably be somewhere in the same neighborhood given the strength of the economics across the enterprise. And the fact that we really are advantaged in that we have complementary investment opportunities in every part of our business. Could it change? Probably it could, but it will be in the decimal points versus some wholesale changes at this point.

Paul Diamond

Understood. Thank you for the clarity.

Operator

The next question will be from Nick Pope from Seaport. Please go ahead.

Nick Pope

Good morning, everyone.

Bill Way

Morning.

Nick Pope

I was hoping that you guys could provide a little more clarity on operating costs. Looking at full year guidance, you guys are trending well below where that full year unit guidance is on operating cost. So trying to make sure I understand if that’s you guys just operating ahead of schedule, or if fourth quarter, we should expect some uptick in operating costs, or is there anything unusual going on there?

Clay Carrell

Yeah. I would say that from an inflationary standpoint, we have seen the impact on the expense side as well as the capital side in the main categories of water disposal, water hauling, compression. But our team is very focused on how we can offset some of those costs. And provide some efficiencies that don’t take us — have us take the full brunt of those. But we have seen increases. And as we move into the fourth quarter, I don’t see a big change to what we’ve seen year-to-date.

Bill Way

Yeah, I agree with that. And I’ll tell you, why I don’t have Brittany reach out to you, and look at that can give you some further color.

Nick Pope

Got it. I appreciate that. On the kind of back to that efficiency question, I know we’re all – there’s been several questions on it so far. If you look at the Haynesville kind of, it seems like the lateral lengths last two quarters have kind of been in a similar ballpark 9,300, 9,400-foot. Do you feel like you are reaching kind of like the optimal link there? Is there limitations on geometry, or do you think you might – you might push that further? I guess, where do you think you are on kind of being able to push the limits on kind of how big wells you’re putting down there?

Clay Carrell

Sure. So, like we talked about this first year, a lot of learning has occurred. As it relates to lateral links, we’re going to be very methodical about it just like we did in Appalachia. And each area of the field has some specifics that maybe limit how long we can go. We want to make sure that we stay efficient in the program. And so that’s a potential lever. It’s not the same opportunity like we had in Appalachia to go 15,000 feet laterals there given the geometry, there’s some faulting there in that Net acres fault zone. So I think around the 9,000 foot right now is where we’re finding some optimized efficiency, and we’ll continue to take a very methodical approach to that going forward.

Bill Way

And by way of a further example, we can do 24,000 foot laterals in Pennsylvania. All of our wells aren’t 24,000 they’re optimized. So that’s one data point. The other data point is in Louisiana, you’re restricted to 15,000-foot laterals in most part. And so – but we’re not going to put all of our wells bumping up against that limit. All at once, as Clay said, we’ll take our time to learn and then advance that average forward.

Nick Pope

Got it. That is very helpful. Appreciate it. Thank you.

Operator

The next question is from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann

Good morning, all. Thanks for the time. Carl an easy one first. Just could you just talk obviously balance sheet suggest today quickly improving. Can you talk about you and the teams not for hedging going forward?

Carl Giesler

Neal, thanks for the question. Look, with the strengthening balance sheet, as Bill described, what we believe is a structurally strong long-term outlook, particularly for natural gas, we anticipate being able to lower our hedge levels, certainly below where they’ve been for 2022 and 2023 going forward. That said, hedging does remain a core part of our enterprise risk management. So while we’ll moderate, we’ll continue to protect our financial strength.

Neal Dingmann

Glad to hear that. And then just a follow-up on Bill, maybe for you and team, on M&A. Again, I’m just more curious is there – you guys did obviously two outstanding deals a bit ago. One, are there still a number of deals floating around in the Haynesville; and two, would you entertain any of these as long as they sort of satisfy your criteria that you’ve had in the past?

Bill Way

So, thanks for that. And I’ll make a comment – I want to make one more comment on the hedging before I get to that. We’ve actually – where we have these three rolling periods, and we used to be in the first year, 58%. We’ve lowered the low end by 10 percentage points on the first rolling period and the second rolling period. So — and we had already done the third. So again, stronger financial strength, capability of the company that keeping enterprise risk management in line.

On the strategy around M&A, certainly capturing the tangible benefits of scale is what we’re all about, not just growing to be bigger. And so you heard on this call, you hear, see in our book, you understand as well. Those benefits are coming in optionality, greater capability to expand our marketing into areas where we haven’t been before. But we’re going to continue to look at M&A opportunities that show up, and let me define what that means.

We believe it’s important for us to understand what’s going on in our basins where we choose to be. That doesn’t mean we’re going to buy everything. It’s just we need to understand that. And occasionally, opportunities come up for us to look at. But if you look at our recent deals, you look at the importance of the corporate objectives that we continue to talk about around repaying debt, returning capital to shareholders and meeting the criteria of our framework work for acquisitions, which has become more challenging given the assets that we purchased and given the improvement that we’ve made in our asset base. I think our priority right now is paying down debt, returning capital to shareholders. Again, we look at some things and evaluate them, but we’re sticking to that focus of continuously improving the strength of the company.

Operator

Thank you. And the next question will come from Umang Choudhary with Goldman Sachs. Please go ahead.

Umang Choudhary

Hi. Good morning. Umang Choudhary from Goldman Sachs. Hope you can hear me okay. My first question is on inflation. You talked about 15% to 20% inflation next year. Are you seeing any signs of any regional bifurcation in terms of how much inflation you’re seeing between Appalachia and Haynesville?

Clay Carrell

Yes. So as we went through 2022, we realized higher inflation in the Haynesville than in Appalachia. And as we’ve started our contracting process for 2023 that trend is considering is continuing, maybe moderating a little bit, but Haynesville a little higher than Appalachia. We’ve used the same approach that we used in 2022 around contracting the major spend categories early well in advance of the coming year, and that served us well in 2022, especially from a quality of the goods and services where in Haynesville and in Appalachia, we did not have any of the execution issues that some of the operators have seen around supply chain and around timely getting all their goods and services done. So that’s the approach we’re using as we move into 2023.

Umang Choudhary

That’s helpful. Thank you. And for my next question, I wanted to talk about your credit rating. How are the discussions going with credit agencies on the path to investment grade is a $3.5 billion debt number, is that the boggy which they’re looking for or are they comfortable given the macro environment, are they comfortable with probably a higher number?

Carl Giesler

Great question. Thank you for that. I’m going to make a couple of comments. To answer your question directly, our target debt range of $3.5 billion to $3 billion is exactly that. Our target debt range, while the agencies expect us to progress and openly meet that, that is not a requirement that they said that, we need to meet to achieve investment grade. Referring from that, that we could potentially become investment grade before achieving that level of debt.

So I wanted to make that clear. I guess, our second point is, we believe that from both a financial risk profile and a business risk profile, we are already either at or at least very close to investment grade. And that leads to my third point, it’s really just a matter of time, a, for us to continue delivering on what we’ve said we’d do with the agencies in the market more broadly. And two for – rather be, I guess, for the agencies to make the decisions when they do because it’s ultimately their decision to make.

Bill Way

We go into quite a bit of detail, and I’ve had the opportunity to meet them as well. And I think the – Carl is right, it’s not an absolute number, but the credibility of our path to get there is what they are banking on. And we talk a lot about that. We share a lot of detail on that path. We have built a credible path a wholesale change in that changes the game and they’re very clear about that. But right now, the confidence that they have shared with us around the pathway that we’re pursuing gives us the confidence of our dialogue and belief.

Umang Choudhary

Okay. Thank you. Thank you for the answer.

Operator

The next question will be from Subash Chandra from The Benchmark. Please go ahead.

Subash Chandra

Well, thanks. Bill, a question for you on maybe not now, perhaps longer term. Any interest in sort of getting involved in some of these other sustainable type things that whether it’s carbon sequestration or hydrogen, you guys have been certainly when it comes to sustainable development have been, I think, pretty early. So curious what you think there?

Bill Way

Yes. I think that, we continue to evaluate some of those options and carbon sequestration is one of them that we are thinking about We’ve been in a leading position for a long time doing whether it’s water or air. And as you think about water and air and you think about opportunities to make a difference that are backed up by real changes to the business or backed up by reductions that are actual in nature versus more indirect. We take that approach, and we’ll study those, and if they make sense to us, we’ll dig into them a bit more. But sequestration is one that we are looking at, along with, obviously, continuous improvement in the achievements and metrics that we have.

Clay Carrell

The momentum in G3 deal that we talked about in the press release has a CCUS component tied to it that is in the early stages, but was part of our attraction to that deal.

Bill Way

Exactly.

Subash Chandra

Okay. Interesting. And Clay, I guess, when you say a traction of that deal, that is where Southwestern plays an active role in the sequestration aspect of NG3?

Clay Carrell

So we’re partnering with them, and we’re improving the emissions from a reduction of CO2 that happens in that Haynesville basin area.

Subash Chandra

Okay. Got it. Thanks. And just a follow-up, I think you mentioned that you’re well on your way, something like that towards securing your 2023 services. Can you give a context of like how much of that has sort of price visibility, how much of that is still going to be floating through the course of next year?

Clay Carrell

Sure. It has all the traditional service company contracting components to it with some have quarterly openers, some have twice a year openers in them. Drilling rigs, for example, are typically fixed for either a six-month contract or a 12-month contract. We’re dealing with a lot of the same service providers we’ve worked with in the past. So we’re not breaking new ground as we continue to work together to position the company to get the best cost we can in this environment, but also the quality of services and continuing to update the way we structure those agreements to provide the best opportunity for the company as we go forward, and that’s well underway.

Bill Way

And I think one other aspect of it that I put on the table is continuity of talent and being able to count on very capable people to execute the plans we have. Seven of the rigs that we use — we will use and 2023 of the frac fleets we use in 2023 are staffed by Southwestern Energy employees as we own that equipment and that business and their capability capabilities are incredible, and they stand very strongly with the contractor counterparts, but they are also a high degree of continuity in the fact that they’re part of our team and direct employees, and we’re thrilled to have them and that risk then moves off the table, and we can focus on other aspects of the risk profile.

Subash Chandra

Okay. Thank you, gentlemen.

Operator

Thank you. And the next question is from Noel Parks from Tuohy Brothers. Please go ahead.

Noel Parks

Hi. Good morning.

Bill Way

Good morning.

Carl Giesler

Good morning.

Noel Parks

Talking about your company-owned rigs, and I’m thinking of some of the things I’ve seen from the rig companies as far as their own risk/reward and caution. And I was wondering if we’re in a long-term, say, $5 or better gas world and maybe we’ve hit the peak of the growth in inflation. Would you consider another company-owned rig and I’m thinking in terms of the long time frame for lead time for a new build. So is that something that would be on the table for you, you think?

Bill Way

I think you’ve got to look at that kind of an opportunity in a couple of different ways. One, capital allocation priorities, paying down debt, returning cash flow to shareholders is our two priorities in the use of cash.

Second thing is being able to operate and maintenance capital to keep the business in a place where it doesn’t roll backwards, you got to keep the investment opportunities consistent on the plan.

And then the other part is just studying the environment and understanding the utilization rates and just how certain are we that that base load needs to increase. As you’ll note, we don’t have seven frac fleets and seven rigs. We have fewer frac fleets partly for utilization, partly for availability from third parties and having that mix so we can learn. So I would say that, that has to go into that discussion. And right now, we’re focused on the great teams we have and the capital allocation strategy that we put out in the market.

Noel Parks

Great. Fair enough. And sorry, if you touched on this already, but thinking about your hedging strategy and obviously, with less debt, there’s less pressure to lock in cash flows. As you look ahead to next year 2023 and into 2024, is there a point where you think it’s likely you might need to turn back more towards thinking in terms of downside protection. It certainly seems that the Nat gas fundamentals globally are kind of on a one-way ride up. But I think we just get beyond the next year, is it time to start thinking about some caution there, or do you think erring on the side of leaving the upside exposure just still outweighs the need for downside protection.

Bill Way

Thank you for the question. So let me start by saying, we’ve not left managing the downside risk. We’re able to moderate hedges in the current environment, but do understand that on balance as part of our enterprise risk management practice, hedging is a major piece of that, and we will – we remain in that place where we’re going to be watching from the defensive perspective and defense and protection perspective, what’s happening.

When you strengthen, the company’s strengthened the balance sheet is stronger, all of that, the market is stronger, you get to have a bit more optionality. But hedge minimums remain. I think the key point is that, we’ve got a lot of capital and a lot of costs, just like everybody else does. And one of the priorities for us is to protect that and get your money back at least. And so the hedging ranges that we are hedging targets that we set take that into account and take into account the forward gas strip or liquid strip, depending on what you’re doing and making sure that at the given strip pricing, we are managing that risk. We have the opportunity to use swaps and collars and other things such that you can give yourself a bit more upside exposure.

And as we’ve already said, our hedges, we’re hedged. Our upper limit in the current year is 80%. We don’t need to be at that place. But at a given strip, but as it moves around, we move around with it and monitor those and link them together. So I think – I know we have a lot of investors who want to be certain that we’re not walking away from that defensive risk management side, and it’s integral to our enterprise risk management, so we are not.

Noel Parks

Great. Thanks a lot.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Bill Way for any closing remarks.

End of Q&A

Bill Way

Well, thank you all for joining us on the call. Thank you very much for the questions. Any further clarification on our plans, please reach out to us, especially our IR team, they’re very happy to – to talk.

And with that, have a great weekend, go Astros, and we’ll talk to you soon.

Operator

Thank you, sir. This concludes Southwestern Energy’s Third Quarter 2022 Earnings Call. You may now disconnect.