Concho Resources Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.21.13 | About: Concho Resources (CXO)

Concho Resources (NYSE:CXO)

Q4 2012 Earnings Call

February 21, 2013 10:00 am ET

Executives

L. Price Moncrief - Vice President of Capital Markets & Strategy and Director of Corporate Development

Timothy A. Leach - Chairman, Chief Executive Officer, President, Chairman of Concho Equity Holdings Corp and Chief Executive Officer of Concho Equity Holdings Corp

E. Joseph Wright - Chief Operating Officer and Senior Vice President

Analysts

John Freeman - Raymond James & Associates, Inc., Research Division

Ryan Oatman - SunTrust Robinson Humphrey, Inc., Research Division

Pearce W. Hammond - Simmons & Company International, Research Division

Arun Jayaram - Crédit Suisse AG, Research Division

Ryan Todd - Deutsche Bank AG, Research Division

Mario Barraza - Tuohy Brothers Investment Research, Inc.

David R. Tameron - Wells Fargo Securities, LLC, Research Division

Irene O. Haas - Wunderlich Securities Inc., Research Division

Brian Singer - Goldman Sachs Group Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 Concho Resources Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Price Moncrief, Vice President of Capital Markets and Strategy. Please proceed.

L. Price Moncrief

Good morning. We're glad you could join us today for Concho's Fourth Quarter 2012 Conference Call. Before we get started, I'd like to direct your attention to the forward-looking statement disclosure contained in the press release.

In summary, it says that statements in last night’s press release and on this conference call that state the company’s or management’s expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provisions under federal securities laws. There are many factors that could cause actual results to differ materially from our expectations, including those we've described in the press release, our 10-K and our other filings with the SEC.

In addition, we will reference certain non-GAAP measures, so be sure to see the reconciliations in our earnings release or our most recent investor presentation. Both the earnings release and the investor presentation can be found on our website.

On today's call, I am joined by Tim Leach, our Chairman and CEO; as well as other members of our management team who will be available to take questions later in the call.

With that, I'd like to turn it over to Tim.

Timothy A. Leach

Good morning. Thanks for joining us today as we review our results for the fourth quarter and year, as well as our outlook for 2013. The fourth quarter was a good one for Concho. We produced over 89,000 Boes per day and generated nearly $400 million in EBITDAX, both all-time records for the company. Fourth quarter production grew 5% over the third quarter, driven in large part by our oil growth, which was 7% over the third quarter. Full year '12 production came in at 29.8 million Boes as at the top end of our annual production guidance and is 26% higher than the previous year. Adjusting for acquisitions during the year, organic production in '12 was 28.5 million Boes, a 21% increase over '11. As notable, when you consider we deliver organic production growth in excess of 20% every year as a public company, but more importantly, we've delivered profitable growth over those 5.5 years.

2012 was an important year for Concho in terms of strategically positioning the company to keep that track record of profitable high return growth. While we greatly expanded our drilling inventory during the year, we also enhanced returns across our portfolio through a combination of the Three Rivers acquisition and our efforts over the second half of the year to accelerate horizontal activity in the northern Delaware Basin. The $1 billion Three Rivers acquisition was funded entirely with borrowings and a $500 million non-core asset divestiture. Since closing the acquisition in July, our team has identified nearly 2,400 drilling locations on Three Rivers assets, which represents about 20% of our total drilling inventory at year end. That's a material increase in inventory for a deal that didn't require any equity. And about half of those Three Rivers locations are located in the Delaware Basin where the returns are among the best in our portfolio.

Taking a look at our updated rate of return models in the latest investor presentation, you'll see the pretax returns across our Bone Spring inventory are between 50% and 60% at current commodity prices. That's an improvement over our last update and reflects the strength of our drilling results in '12.

As I've done over the previous quarters, I'd like to update you on our most recent progress in the northern Delaware, and I'm pleased to say that our results in the fourth quarter are the best to date. Since our last earnings call, we've added 25 northern Delaware Basin horizontal wells that have 30 days of production data, bringing our total horizontal wells in this area completed by Concho to 131, targeting 7 unique zones. The average 30-day production rate for those 25 new wells was in excess of 800 Boes a day from single zone completions and averaged 70% crude oil. 17 of those 25 wells were Bone Spring completions, with an average 30-day rate over 850 Boes and over 75% crude oil. Three of those Bone Spring wells averaged over 1,100 barrels a day of crude oil, not liquids, not equivalents, for the first 30 days.

Our efforts in the Delaware are paying off, as it's now a meaningful source of production growth. Net production from the horizontal Delaware Basin averaged over 21,000 equivalent barrels per day during the fourth quarter, a 32% increase over the third quarter. After just 2 years, the Delaware Basin represents about 30% of total net production, and we barely tapped the vast resource opportunity that it has to offer.

As you've probably read in our operations release 2 weeks ago, we added substantially to our northern Delaware Basin drilling inventory. It increased 125% over year-end '11 to over 4,200 locations. Only 250 of those locations are currently identified in the proven category, so we're clearly in the very early stages of increasing proved reserves and production growth from that region.

In 2013, we will spend nearly half of our capital budget or about $750 million there drilling 160 wells. At that pace, it would take us over 2 decades to process our entire inventory. But at current return levels, we should be able to grow and reinvest our cash flow annually to accelerate that pace of development just as we've done with our other core areas. It's a proven strategy that's created significant value for our shareholders over 5 years, and I'm excited about the prospect of extending that track record for years to come.

Concho is more opportunity rich today than it's ever been in its history thanks to the Delaware Basin and horizontal technology. Horizontal drilling has not only created an abundance of opportunities across the Permian, it's also shifted the playing field in favor of those capable of executing large capital and drilling programs. I expect that this will continue to drive consolidation in the Permian, and I expect Concho will be right in the mix as 1 of the largest operators in the Permian with over 30 operated rigs and the capability of running 40 to 50 rigs. However, I believe '13 will largely be an execution year for Concho given the depth of our high-return, high-growth inventory. We have lots of momentum behind us, and I'm confident that we have a great strategy in place to consistently deliver profitable growth.

Before we move to Q&A, let me get in the weeds on a few topics. The first topic is the Midland-to-Cushing basis differential and the expected impact on our oil realizations. During the fourth quarter, the average realized basis differential was $3.57 per barrel. While pricing for the first quarter is not quite complete, it appears the average Mid-Cush differential will be in the range of $7.50 to $8 a barrel. As a result, our expected unhedged realization in the first quarter as a percentage of NYMEX crude is likely to be in the low 80s.

Given the volatility in the differential and the impact it can have on our oil-weighted cash flows, we began to layer on basis hedges during the first quarter to protect a substantial portion of our oil volumes beginning in April and going through the end of '13. The average blended basis hedge is roughly $1.23 per barrel. Taking this into account and assuming the current strip, I believe that we will be able to deliver full year unhedged oil realizations there within our guidance.

Finally, I'd like to point out 2 things related to '13 production. First, on December 20, we closed our non-core asset divestiture, which contributed approximately 5,000 Boes per day of production during the fourth quarter. Secondly, we increased our full year '13 production guidance in our operations release a couple of weeks ago without changing our '13 capital budget. The new range is 33.4 million to 34.8 million Boes and excludes volumes associated with the recent divestitures. It also represents 15% to 20% organic production growth consistent with our track record.

So with that, I look forward to taking your questions, and let me turn the call now back over to the moderator.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will be coming from the line of John Freeman, Raymond James.

John Freeman - Raymond James & Associates, Inc., Research Division

First question I had, Tim, you sort of alluded to it in terms of the sizable increase in that rate of return slide that you've got in your presentation for the Bone Spring and then also the Avalon, and I'm just wondering if we could get maybe a little bit more specifics on what changed from the prior guidance? Just kind of going through the slides, it didn't jump out at me in terms of the EUR or completed well costs. Sort of what changed?

Timothy A. Leach

Okay. You want to take that, Joe?

E. Joseph Wright

John, this is Joe. I think the biggest changes you see over the quarters is our initial rates in those Delaware Basin wells. Those have been increasing each quarter and I guess, driving a lot of that rate of return growth, as you think about the Bone Springs part. The Avalon, when you look at it, certainly as we moved east this year in '12, we have become more oily with that model, and that's a reflection -- the rates of return there are reflection of that.

John Freeman - Raymond James & Associates, Inc., Research Division

Okay. And then if I shift gears to the southern Delaware where...

Timothy A. Leach

John, let me add one thing on that rate of return. Those rate of returns were calculated using capital costs that were used in our capital budget we prepared last November. So the costs have come down since we prepared that, and we believe they'll continue to come down. So I think those rates of return will continue to go up just due to capital costs.

John Freeman - Raymond James & Associates, Inc., Research Division

And then for the southern Delaware, you've drilled 9 horizontals there. You had 4 that looked pretty strong wells, but we're still not including any of those in our identified drilling locations. Maybe if you could just sort of elaborate, is it just a timing issue? It's too early? Anything you could sort of elaborate on that?

Timothy A. Leach

Yes, I think that we're still very high on that area. I still think it's early to do the end zone dance. We have plenty to talk about in the northern Delaware Basin, and I just think it's very early for such a large acreage position to go out and for us to start flapping our arms over a number of locations and what the EURs are going to be. I'll tell you quite frankly, with that much land and the wells we've drilled there, I don't know yet what the final EURs of those wells are going to be. But we still are pretty optimistic about it.

Operator

Your next question is coming from the line of Ryan Oatman, SunTrust.

Ryan Oatman - SunTrust Robinson Humphrey, Inc., Research Division

It looks like the company's replaced some vertical Yeso locations with horizontal ones. Can you talk about whether you're seeing greater success across the New Mexico Shelf with the Yeso? And what type of cost recovery and spacing assumptions we should be thinking about for horizontal Yeso development?

E. Joseph Wright

When you compare the rates of return on those verticals and those horizontals, I think in our new -- investor presentation on Page 11, you'll see the rates of return there. The horizontal Yeso have a very nice rate of returns, better than our vertical Yeso. When you think about spacing, we're drilling those basically on 40s at the moment. We will downspace that at some point. Cost wise, it's running between $3 million and $4 million. That cost is dropping. Though I think we'll be between $3 million, $3.5 million as we progress through the year.

Ryan Oatman - SunTrust Robinson Humphrey, Inc., Research Division

And what kind of recovery should we expect there?

E. Joseph Wright

You know our general model is somewhere between 300,000 and 350,000.

Operator

Your next question is coming from the line of Pearce Hammond, Simmons & Company.

Pearce W. Hammond - Simmons & Company International, Research Division

Tim, we've heard that the A&D market in the Permian right now is a little bit saturated. Is that your experience or your view of it right now? And are there still plenty of privately -- the potential for private negotiated deals in the Permian?

Timothy A. Leach

Right. I mean, let me say that since we're solely focused in the Permian, we feel like we ought to be familiar with every deal that's out there. There are a lot of opportunities in the Permian right now. There's a lot of interest in the Permian. Yes, there are a lot of the same kind of opportunities that we've had that -- where we've traditionally built our company around. There's still some of those out there. I would only add that because of our large drilling inventory of high rate of return projects, that this is more of a year of execution for us. The bar has been raised pretty high on what a acquisition brings to us to make it attractive.

Pearce W. Hammond - Simmons & Company International, Research Division

And then can you provide any color on the horizontal Wolfcamp and Upton County on any of the wells that you've drilled there?

Timothy A. Leach

Yes. Well, we're not -- we are on -- we're drilling our third I think, and we haven't talked about individual wells yet. I think we talked about having success and it being a strategy that we're pursuing to convert maybe some of the downspaced increased density wells to capture those reserves more through horizontals at a higher rate of return. That appears to be on track.

Operator

Your next question is coming from the line of Arun Jayaram, Credit Suisse.

Arun Jayaram - Crédit Suisse AG, Research Division

Impressive results on the Delaware given those 30-day rates. Were those well results -- you show 3 different areas in your presentation on 14. Were those concentrated in any 1 of those 3 areas? Or are they throughout the acreage position, the 800 Boe per day 30-day rate?

E. Joseph Wright

Yes, this is Joe. I was just checking at Slide 14. When you think about what they did and where we drilled in 2012, we did most of our activity down in the southern Lea County area and then over in the Lea County, kind of the middle part of that county. So when you think about really kind of as we move the ball in 2012 with additional locations, that's really where a lot of that add came from.

Timothy A. Leach

But he's asking about the 25 new ones we just reported. They're pretty well spread around...

E. Joseph Wright

Yes, and they would be spread out through those areas.

Arun Jayaram - Crédit Suisse AG, Research Division

Fair enough. And just one question from the buy side I've gotten a little bit of is just looking at the PV-10. You guys did announce the Three Rivers acquisition last year, and I guess one of the questions that are on buy side is that the PV-10 went down, a little bit of a surprise there. So I was wondering if you could comment about overall value creation through the drillbit in 2012. Obviously, there are some limitations thinking about the SEC rules. I just wanted to -- Tim, if you could comment on that?

Timothy A. Leach

Yes. Well, the PV-10 reflects mostly the proven reserves. Gas prices were down. The differential on the liquids prices on the gas were down. That was the biggest effect on the PV-10. And then the PV-10 also reflects a fairly substantial divestiture of PDP properties.

E. Joseph Wright

And even if -- and I'd like to add, too, on that. If you ran that -- look at that PV at last year's pricing, it would be $9.3 billion. So it would be up substantially.

Operator

Your next question is from the line of Ryan Todd, Deutsche Bank.

Ryan Todd - Deutsche Bank AG, Research Division

A question for you on inventory and rig activity in the Bone Springs. You meaningfully increased your inventory in the northern Delaware and in particular in the Bone Springs. Can you talk to maybe a little bit what were some of the assumptions that you're using around the inventory in the Bone Springs? Maybe how much acreage is applicable if there's a spacing assumption or if they're all engineered locations? And then, finally, you've got a massive inventory life there. How do you view potential for acceleration going forward?

Timothy A. Leach

Sure, let me start with that, and I may call on Price to help me with some of those questions. But I think we handle our inventory maybe different than other companies, so when we talk about a well count in inventory, it's an engineered location that we know that we can go drill. So we're not doing acreage math. The pace with which we're drilling, we have started the process of taking every available dollar and moving it into the Delaware Basin. So we've underspent in the Yeso and the Wolfberry in order to move that cash flow over to the Delaware. And I think as you see the quarters roll along, you will see us continue to increase our activity and accelerate our pace in the Delaware, not only because that's the highest rate of return thing on the -- on our portfolio right now, but that's the newest area of discovery. So we're in -- and I would say that the economics ought to be improving because we're still just beginning to get the manufacturing process of getting these wells drilled. So I think you'll see the pace pick up there.

Ryan Todd - Deutsche Bank AG, Research Division

And in terms of the determining factor in the pace, is -- I mean, when you look at this year, is it effectively commodity price/cash flow that's going to dictate?

Timothy A. Leach

That gives me a great opportunity to give the grow within cash flow commercial. So we start out with our estimated cash flow, and our attempt this year is going to be to show this growth by staying within cash flow. We're executing $1.6 billion capital budget. So yes, it's based on an oil price assumption. I mean, there's really 2 big factors. It's oil and gas prices and then the capital cost and the direction those things are heading. So right now it seems like we have a little -- the oil price is running a little bit better than what we budgeted around, and also, I think capital costs are a little bit lower than we entered the year with. So things are looking pretty good.

Operator

Your next question is coming from the line of Mario Barraza, Tuohy Brothers.

Mario Barraza - Tuohy Brothers Investment Research, Inc.

Just wanted to follow up a bit on the Midland Basin side. I'd -- when will we get an update on the horizontal performance and on the Wolfcamp? Is it still -- are you still thinking the back half of this year when we could hear potential inventory numbers?

Timothy A. Leach

Yes. I mean, we've got a lot of our drilling in the Midland Basin. It's going to be moving the horizontal. So the back half of the year is a more reasonable time to think an update from us, but you're good to get plenty of information on the Midland Basin from other operators if that's their main activity level. But we've got great acreage over there. We picked up some more good acreage from Three Rivers. We've got horizontal wells drilling in all parts of our acreage over there, so the Delaware is our primary focus.

Mario Barraza - Tuohy Brothers Investment Research, Inc.

Okay. And with the ramp-up in the Delaware, have you secured the midstream infrastructure if you were to further accelerate drilling activity there?

Timothy A. Leach

No. I mean, generally, I think the answer to your question is we're not a midstream operator. Now we will build out gathering facilities, especially in frontier areas where those kind of infrastructure things don't exist. We will participate more than we've had in the past in building, gathering and roads and electrical, those kind of things.

Operator

Your next question is coming from the line of David Tameron, Wells Fargo.

David R. Tameron - Wells Fargo Securities, LLC, Research Division

Tim, can you talk about -- we've heard -- I know Rich Kinder was out there talking about oil potentially going west out of Texas to California longer term. Can you just talk about -- do you guys have any plans for rail capacity? Or how you look at that bigger picture down the road 3 to 5 years? Any comment on that?

Timothy A. Leach

Yes, I'll comment. I'll let Joe jump in. But in general, I think that our strategy is to provide as many outlets for our crude coming out of the Permian as possible. And I think as you look out for the time frame that you're talking about, I think there's going to be ample capacity to go in many different directions, which I think will help our pricing out here. You want to talk any specifics around that?

E. Joseph Wright

Yes. Let me -- just so you know, in that same line is that we do move some of our crude by rail today. That's just trying to establish that link to that kind of service. And as Tim said, we're looking for options, many different options out of the basin.

Operator

Your next question is coming from the line of Irene Haas, Wunderlich Securities.

Irene O. Haas - Wunderlich Securities Inc., Research Division

A question on southern Delaware Basin. You guys have been probably one of the first movers down there, and my question for you is are you testing most of those zones one at a time and how many zones have you tested? And the Reeves County play, does it extend into Pecos County? And specifically, is this an area that has some challenges in terms of drilling? Is it a difficult area to drill? And also, when could we reasonably expect first production?

Timothy A. Leach

I couldn't could understand what you were saying, Irene. You're breaking up on the telephone a little bit.

Irene O. Haas - Wunderlich Securities Inc., Research Division

Okay. Can you hold for a second? Let me try something else. Can you hear me better?

Timothy A. Leach

Yes, I think so. Okay, try again.

L. Price Moncrief

Maybe one question at a time.

Irene O. Haas - Wunderlich Securities Inc., Research Division

The question is in southern Delaware Basin, how many zones have you tested? And does the play in Reeves County connect into Pecos County? Is it a difficult area? Any sort of technical challenges in drilling these wells because due probably to overpressure? And then when could we reasonably expect first production in such case?

Timothy A. Leach

Okay. Primarily the zones that we're drilling in the southern Delaware is the Wolfcamp zone. Although, we are beginning to test the Bone Spring section and it had good shows in that as well -- but that's -- right now it's a Wolfcamp exercise for us. We are drilling over in the Pecos County. We have plans for about 2 rigs running around the clock or throughout the year, both in Reeves and Pecos County in that section of our acreage. As we move into Pecos County, that has historically been a less drilled area with more -- when you say technical problems, it's a little bit tougher drilling in Pecos probably than it is in Reeves, not necessarily pressures, but there's other rig problems in that area. So I mean we're kind of -- that kind of dictates our pace a little bit to make sure that we -- the first well that we drill out there, we're proceeding with caution.

Irene O. Haas - Wunderlich Securities Inc., Research Division

And what was the reasonable time frame in such case and actually see first production from this part of the basin?

Timothy A. Leach

Well, I mean, we're already making a well out of this part of the basin, but as far as seeing some to start moving the needle for Concho, with the amount of capital we're putting in, the number of rigs we have running down there, it'd probably be the end of this year.

Operator

Your next question is a follow-up from the line of Arun Jayaram, Credit Suisse.

Arun Jayaram - Crédit Suisse AG, Research Division

Tim, there's been some concern or talk about the Longhorn Pipeline reversal, a slight delay there. I was just wondering if you could -- Devon talked a little bit about this on their call. Can you give us an update on what you're hearing on Longhorn?

Timothy A. Leach

Okay. I'll turn that over to Joe.

E. Joseph Wright

Yes, we're not hearing of any delays on our end. We've already -- have had some crude move into that line. Certainly, there's a fill-up period, so that's going to take a while. But that's moving pretty well. And what we're seeing kind of generally with crude is things are moving a whole lot better out of the basin right now.

Arun Jayaram - Crédit Suisse AG, Research Division

Okay, that's helpful. And second question for Tim, EOG Resources had an interesting update on the Delaware Basin, and I was just wondering, Tim, if -- I don't know if you listen to them but if you could maybe comment on potential read-throughs to your acreage position?

Timothy A. Leach

Oh, I mean, I don't like reading through anybody else's business, but I would just tell you it doesn't surprise me that a good operator like EOG likes the Delaware. I mean that -- there's plenty of opportunity out there. It's a great fit for a company that can run a drilling machine, and there are so many zones to drill, too. It's not surprising, and our acreage is in and around all the stuff they're doing. So we're glad other companies agree with us. It is a great place to be.

Operator

Your next question is coming from the line of Brian Singer, Goldman Sachs.

Brian Singer - Goldman Sachs Group Inc., Research Division

A couple of questions and I apologize for joining late. But first, in the southern Delaware Basin, can you just talk about production mix there, how oily that is and whether you see variability around that and whether you expect that to change as wells go through their life?

Timothy A. Leach

You want to talk about that or answer that?

E. Joseph Wright

Yes. Brian, this is Joe. Really our oil mix down there is real high. We're looking at 75% plus. The -- and I think that's going to probably hold true to the Wolfcamp and the Bone Springs down in that area. You had a second part to the question.

Brian Singer - Goldman Sachs Group Inc., Research Division

Well, the second part was whether it changes over time or whether it stays -- it should stay constant as the well goes through its life.

E. Joseph Wright

That's certainly dependent on the interval. Maybe within the Wolfcamp, it might change, but we don't think it's going to change. We're pretty oily.

Timothy A. Leach

But I would remind you, for the total area, Brian, that there are areas that we think are gassier. And it's early, but when we were acquiring our acreage down there, we were trying to use our best judgment to stay in those oily areas.

Brian Singer - Goldman Sachs Group Inc., Research Division

And then in the Midland Basin, just between the wells that -- well or wells that you may have drilled that there's not necessarily a lot of granularity onto the public, and then the wells that others have drilled on the northern and central Midland Basin that were -- that they are obvious to the public. Can you just talk about whether you have any greater or less confidence in the potential horizontal expansion up in that direction?

Timothy A. Leach

Let's see. We've had success drilling horizontally on our acreage in the Wolfberry. As we said early on, where our acreage is positioned, we think the Wolfcamp is better reservoir rock on that edge of the basin than it is in the center of the basin. So there's a lot of oil in place. We have had some of the results as what you're reading from the rest of industry.

Operator

Your next question is a follow-up from the line of Pearce Hammond, Simmons & Company.

Pearce W. Hammond - Simmons & Company International, Research Division

Yes, Tim, just a quick follow-up. I'm just curious about what you're seeing on service cost and service availability in the Permian right now in general as you look out in 2013.

Timothy A. Leach

I like the direction it's going. And since that's Joe's business, I'll turn it over to him.

E. Joseph Wright

Yes, Pearce, trending down, I think we're pretty pleased with where service costs are going today. A lot of the very big rigs, those rates are coming down on a day basis. High prices are coming down. When we think about all the extra frac fleets out here, those costs, the trend is down. The big thing right now, I'd say, is we're not waiting on services at all. Everybody is meeting demand currently.

Pearce W. Hammond - Simmons & Company International, Research Division

All right. Do you have a preference to enter long-term contracts like on pressure pumping or more short term?

E. Joseph Wright

I like short term.

Operator

At this time, I'm showing no further questions in queue.

Timothy A. Leach

Okay. Let me close by saying that I appreciate you listening to our conference call. I know there's a lot of them this morning, and Price is available and I'm available for any follow-up conversation anyone has. So thank you very much.

Operator

Ladies and gentlemen, that concludes today's conference. We thank you for participation. You may now disconnect. Have a great day.

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Concho Resources (CXO): Q4 EPS of $0.96 misses by $0.04. Revenue of $477.5M misses by $48.92M. (PR)