CONSOL Energy (CNX) Nicholas J. DeIuliis on Q2 2016 Results - Earnings Call Transcript

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CONSOL Energy, Inc. (NYSE:CNX) Q2 2016 Earnings Call July 26, 2016 10:00 AM ET

Executives

Tyler Lewis - Vice President-Investor Relations

Nicholas J. DeIuliis - President, Chief Executive Officer & Director

David M. Khani - Executive Vice President and Chief Financial Officer

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Analysts

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Holly Barrett Stewart - Scotia Howard Weil

Lucas N. Pipes - FBR Capital Markets & Co.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Biju Perincheril - Susquehanna Financial Group LLLP

James A. Spicer - Wells Fargo Securities LLC

Operator

Ladies and gentlemen, thank you for standing by and welcome to CONSOL Energy's Second Quarter Earnings Conference Call. As a reminder, today's call is being recorded.

I would now like to turn the conference call over to the Vice President of Investor Relations, Tyler Lewis.

Tyler Lewis - Vice President-Investor Relations

Thanks, Nick, and good morning to everybody. Welcome to CONSOL Energy's second quarter conference call. We have in the room today Nick DeIuliis, our President and CEO; Dave Khani, our Chief Financial Officer; and Tim Dugan, our Chief Operating Officer.

Today, we will be discussing our second quarter results and we have posted slides to our website. As a reminder, any forward-looking statements we make or comments about future expectations are subject to business risk, which we've laid out for you in our press release today, as well as in our previous Securities and Exchange Commission filings. We will begin our call today with prepared remarks by Nick, followed by Dave and then Tim.

With that, let me turn the call over to you, Nick.

Nicholas J. DeIuliis - President, Chief Executive Officer & Director

Thanks, Tyler. Good morning, everybody, and I want to start the call off by briefly discussing some of the high-level accomplishments of the quarter before we turn it over to Dave Khani and Tim Dugan, who will provide more the details.

As we laid out in the morning's earnings release, CONSOL posted another quarter of organic free cash flow from continuing operations of $46 million, and that's an increase from the last quarter. Now, last year, we started talking about our 18-month free cash flow plan and, as we sit here today, we're ahead of that plan.

Our goal has remained unchanged; however, we continue to focus on growing our NAV per share and we're going to do it through continuing to increase productivity and efficiencies, through our cost-cutting initiatives, asset sales, through modest production growth, and by capturing the upside from what's looking like a more normalized commodity.

As we continue with those efforts to complete the split of our E&P and Coal businesses, our free cash flow plan is going to help get our balance sheets to a point we can ultimately be successful in completing that goal. We often get asked when the separation could happen, and although we can't provide a definitive answer to the question, much of that timing will depend on what the commodity does.

However, it's important to note that under CONSOL's current steady state, our balance sheet and leverage ratio are self-fulfilling, self-correcting, self-adjusting, whichever term you'd want to use their. With our low-cost structure in the current commodity prices, the company's position organically delever over time in order to support a separation. So, we execute further asset sales that accelerates the timeline, but in the end, it doesn't change our game plan of focusing on what we can control.

We've also seen an influx of operators issuing equity within the E&P space particularly this year, and we believe that we're one of the few E&P companies who haven't done that. Now, why is that? Well, we take a long-term view towards creating sustainable shareholder value and this goes hand-in-hand with delevering the company through reducing costs, by improving well productivity, and selling assets at values which are accretive to our NAV per share.

So, issuing equity remains low on our list, as we evaluate options to increase that NAV per share. We can never say that we would never issue equity, since we are a public company and we've got an obligation to evaluate all options; however, at this point in time, we've got little appetite to pursue that route. Instead we look at organic levers like the reduction of costs and we're also benefiting from a comprehensive monetization program.

And speaking of the monetization program, there's a balance there that we're walking on. On one hand, we've got a track record of selling over $1.3 billion of assets over the past two years and, on the other hand, we manage our business based on conservative asset sale expectations, since ultimately, we don't need to sell assets. So, that been said, we've got ongoing asset sale processes across the board that are in progress which are part of our normal course of business.

Now, on the asset sale front, most recently, following the close of the quarter, we executed a definitive purchase and sale agreement for the sale of the Miller Creek and Fola operations. Now, this deal is not only NAV-accretive and not only consistent with our core strategy and not only another step in improving our balance sheet, but most importantly and above all else, this deal marks a definitive exit from central Appalachian coal and surface mining, which significantly derisk our business moving forward.

Now, despite of paying some cash to the buyer in order for them to post collateral for these assets, CONSOL received consideration from the buyer by the assumption of over $100 million, $103 million to be exact, of mine closing and reclamation liabilities. So, a significant risk is now dealt with in CONSOL Energy as an E&P company with only one remaining non-operated coal complex in its portfolio which is, of course, the Bailey complex operated by our friends at CNXC.

Congratulations to our team for another significant accomplishment in what's been a really unrelentingly challenging coal environment. Since 2012, we've divested approximately $5 billion in coal assets which has helped to accelerate our transformation into an E&P company, and sale of Miller Creek and Fola was another big piece of the coal divestiture puzzle.

Now, shifting to the commodity markets. In CNXC we're seeing commodity markets normalize. Its capital has been rationed, which help set the stage for CONSOL's commitment to support CNXC's common unitholders. In consultation with CNXC, CONSOL was supportive of CNXC eliminating the $6 million second quarter subordinated distribution payment and, for reasons that Dave Khani will discuss in further detail in a couple of minutes, CONSOL believes this action is going to accelerate its ability to drop the remaining 80% of the Pennsylvania cooperation into CNXC which will further advance CONSOL's broader strategy of separating the Coal and gas businesses and becoming a pure-play E&P company.

Despite the commodity environment seeing a nice tick up in prices, our team is still focused on controlling what we can control. Our unit costs, as an example and an important example, are steadily improving quarter over quarter and over the past two years specifically, our E&P unit cash costs have improved by over 30%.

These cost performance accomplishments in part has helped us exceed our free cash flow plans, and in addition to unit cost improvements, CONSOL continues to illustrate further capital efficiency and well performance improvements. Those things are highlighted by reducing our 2016 E&P capital down to the $190 million to $205 million range, while taking up 2016 E&P production guidance to 380 to 385 Bcf range, which is an increase from the original target of 378 Bcf from last quarter. So you're seeing the best of both worlds there, with reduced capital intensity coupled with increased production guidance.

Last week, we made the decision to add back two horizontal rigs in the second half of 2016. While Tim Dugan is going to discuss more of the details after Dave Khani, I want to provide a look at the filter that we used to make the decision.

As we generate free cash flow, we look forward to the best way to allocate that capital. Our main options are to put it back into the drill bit; to buy back our debt, which still continues to trade at a discount, albeit at a lower discount; acquire tuck-in acreage that falls within our development plans; and, of course, once our balance sheet reaches a point where we're more comfortable, to potentially buy back stock. And we run our analyses based on how we can grow our NAV per share the best while understanding the variables and risks surrounding each of those decisions. The decision to add two rigs but only spending $25 million of additional capital in 2016, that's going to help improve our NAV per share in our 2017 outlook.

The management team, I'll remind everybody, is compensated on free cash flow generation as well as total shareholder return. So the most recent decision to add back activity, it highlights the balance that we take when evaluating things like free cash flow and overall NAV per share, total shareholder return. But the decision to add back that activity is ultimately, in the end, always focused on growing NAV per share.

Now, before I turn it over to Dave, I just wanted to wrap up with looking at something from the perspective of as we sit here at the midway point of 2016 and just take a look and examine how we arrived where we're at today. So if you look back to the first quarter, we posted impressive cost control and capital discipline results, and we accomplished a major asset sale. That effectively positioned the company to get through the worst of the market downturn.

Now, in the second quarter, while the market remained challenging, we demonstrated that the cost improvements and the capital discipline results are sustainable long term, which is further strengthening company and getting us to a place where we've now pivoted from defensive mode to offensive mode. And going on the offensive is exactly what we intend to do.

So, through prudent decisions around capital allocation, the strong efforts on cost reductions and production efficiencies, the disciplined management team, and the strength of our asset base, we're positioned to capture significant upside as the market continues to improve in the second half of 2016 and as we get into 2017.

With that, I'm going to pass things over now to Dave Khani.

David M. Khani - Executive Vice President and Chief Financial Officer

Thanks, Nick, and good morning, everyone. As highlighted in our press release this morning and indicated on slide 3, CONSOL reported a second quarter GAAP net loss of $470 million. However, there are several noncash after-tax adjustments totaling $431 million in the quarter, including on a pre-tax basis the following: unrealized loss on our mark-to-market hedge book of $280 million and an impairment charge of $356 million on our Miller Creek, Fola properties.

As we announced the sale of those assets and expect these transactions to close in third quarter 2016, and we will likely recognize another $44 million in the third quarter. After adjusting for these items, CONSOL posted a net loss from continuing operations of $49 million or negative $0.21 per share, and adjusted EBITDA from continuing operations of $136 million.

More importantly, we continued down the path of being one of the most efficient E&P companies with growth in free cash flow. We raised our 2016 E&P volumes to 15% to 17%, and this quarter generated free cash flow of $66 million and, to date, $516 million. We also saw total capital expenditures decrease to $38 million in the quarter, which is a 50% reduction from the first quarter and reflects the improving productivity. With the sale pending of Miller Creek and Fola, we've posted about $5.1 billion of coal deal asset value, over 23 transactions since 2012. Looking forward, we anticipate posting more E&P sale transactions now that commodity prices are rising and the market appetite for these types of transactions are improving. Stay tuned.

Now looking over the E&P side, as stated in slide 5, the E&P division finished the quarter production with 99.3 Bcfe, or average daily volumes of 1.1 Bcfe per day. We also had about 4.3 Bcfe of mechanical issues and production management impacting the quarter.

On the cost side, we had another strong quarter, with total all-in and cash costs of $2.27 and $1.23 per Mcfe, respectively, a year-over-year cash cost decline of $0.35 per Mcfe and below the lower end of our guidance. The cash costs in our Marcellus, Utica, CBM, and conventional segments all came down in the quarter. We are driving nominal cost out, drilling better wells, and quickly increasing our mix towards more lower-cost Utica production.

Our Marcellus cash cost declined to $1.27 per Mcfe in the quarter and Utica to $0.83 per Mcfe with Utica now representing about 25% of volumes. As a result, we reduced our 2016 cash cost guidance by about 6% to $1.28 per Mcfe.

Now, let's talk about prices and hedges. In the quarter, our average realized sales price was $2.50 per Mcfe which includes a negative basis impact, BTU uplift, and the benefits from our hedge position. At year-end, we stated that as we drove down our costs, we would begin to hedge out longer and have begun to do so the last two quarters. If you look at slide 11, we have added about 120 Bcf of NYMEX hedges and 170 Bcf of basis hedges from 2017 to 2020 through our program hedge process.

I want to point out that we have prioritized hedging at our higher risk basis markets for 2017 to 2020, and we will begin to add hedges in our better markets going forward. This should raise our overall base hedge price for 2017 to 2020 as we implement it. While this creates more certainty on our margins, this also protect the borrowing base and liquidity which are obviously very important. As of last week, our hedge book was about $36 million underwater.

While we've been adding program and hedges, we remain bullish on the commodities and still nicely positioned to capitalize on it. First, a quick natural gas outlook. As we predicted in our third quarter 2015 call, natural gas supply for 2016 is declining. U.S. and Appalachian gas production has peaked in mid-February. Combine this decline in supply with normal summer and winter demand, we expect inventories to end injection season at more normal levels.

We anticipate the dry-docks being burned off by early next year putting supply pressures on 2017 as well. As a result, the near-term natural gas price jumped; however, the forward curve has moved up very modestly being impacted by the illiquidity out on the curve producing hedging impact and speculation of drop in rig activity.

So, while protecting our cash flows, we also positioned to capture rising markets through our open positions, rising basis, our netback power contracts, our carry position with our JV partner and though asset sales. Looking at the forward curves, our hedge book, and our operating cost structure, we anticipate E&P margins will rise in the second half of this year and in 2017 versus the first half of 2016.

Now, let's talk about Coal. CNXC reported on its second quarter earnings last night and, as you probably heard, CNXC maintained its EBITDA guidance for the year but also eliminated its second quarter subordinated distribution payment. In consultation with CNXC, CONSOL was supportive of CNXC eliminating the $6 million second quarter subordinated distribution payment, as CONSOL believes that the action will improve the coverage ratio on the common units, alleviating any risk of common unit distribution cut, will improve the yield for the common units and, therefore, will help accelerate CONSOL's ability to drop the remaining 80% of PA complex into CNXC.

As the coal markets continue to improve in light of stronger weather, rising natural gas prices, and falling coal supply, eliminating the second quarter subordinated distribution will help CONSOL advance its broader strategy of splitting the Coal and gas businesses and becoming a more pure-play E&P company.

So, let's talk about restructuring and cost savings. We spent the last three years restructuring CONSOL into becoming more of a pure-play company through refinancing $5 billion of debt, effectuating the asset sales, creating the MLP structure, and hiring the right personnel. During this period, we implemented a zero-based budgeting approach which resulted in reducing annual expenses by approximately $200 million a year.

In addition, we reduced the servicing cost for healthcare and pensions liabilities by several hundred million dollars per annum. As a result, we reduced the OPEB and pension liabilities on our balance sheet by more than $3 billion. I remind you all these items to emphasize the rate of change that has and will continue to occur to improve our NAV per share.

Let's talk about capital. As you can see, we reduced our capital spending forecast by about 25% while adding back activity and raising production guidance. Our PUD conversion costs in our plan are expected average about $0.48 per Mcfe, second lowest of the major Appalachian peers, and this comes without a significant impact from the dry Utica.

If you take a step back and analyze how we think about capital allocation, we've moved CNXC to a maintenance capital mode in the first quarter 2014, we built out and a large majority our midstream capital by 2015, we've built out the largest Appalachian land drilling opportunity sets by 2014, and we have reduced now the E&P capital intensity by about 60% in 2016. Combine this with one of the lowest basin declines at 15%, we have significantly reduced the total maintenance and growth capital and positioned each of our major entities to generate free cash flow.

Now, let's talk about liquidity and balance sheet. On slide 12, over the past 12 months, CONSOL' has paid down approximately $650 million of debt, almost doubled our liquidity to $1.3 billion, and maintained our trailing 12-month pro forma bank leverage at 3.6 times.

As highlighted by Nick, we have been one of the few companies to not issue equity to strengthen our balance sheet. We believe we can accomplish this the old fashioned way, by cutting costs, selling assets, run production, reducing capital intensity, and capturing the normalization of commodity prices. In doing so, we preserve the value for our shareholders.

Now, let's talk about valuation and some catalysts. With a nice rebound on our stock price since year-end 2015, we still have many catalysts and drivers to drive our increased performance. First, further cost-cutting and efficiencies that will reduce our unit cost even further. For example, the dry Utica cash costs are meaningfully lower than our current cash costs of $1.23 per Mcfe. Second, we will capitalize on our large asset base, either through production or asset sales. We are agnostic on how to monetize our asset base and we'll do whatever generates the highest NAV per share.

Third is improving commodity price across all our products. Fourth, rising values for MLP entities, CONE Midstream and CNX Coal Resources, which on average have risen about 100% off the lows in the first quarter. This translates to as much as a one multiple reduction on our EBITDA multiples using 2016 consensus.

And last, maintaining better capital discipline than our peers. Hopefully, we are developing a reputation for improved capital allocation and discipline. We were one of the first to drop all of our rigs last year and we are not rushing to ramp up capital with the rising prices. We believe this will translate into higher rates of return, better free cash flow, and lower cost of capital.

So, in summary, we've had another solid quarter and our team executed nicely in this market. We're now starting to come off the bottom of the market, but importantly, we're able to improve liquidity while prices were low. We're now focused on improving our leverage ratio and accelerating the separation of our E&P and Coal business.

With that, I'll turn it over to Tim.

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Thanks, Dave, and good morning, everyone. I'd like to start off with a brief market update. In general, fundamentals across the board are improving, specifically, when you look at our region. We believe that the three key drivers, pipeline takeaway capacity, weather, and rig counts, all paint a positive picture.

For new regional pipeline export capacity, we expect to see roughly 1.2 Bcf a day completed by the end of this year and up to 10 Bcf a day by the end of 2018 with other projects continuing to come online after that. The summer weather has been strong which is slowing the inventory build and the rig counts have remained below the level needed to maintain flat production not only in our region but across the U.S.

All of these items have driven the 2017 NYMEX significantly higher than it was at the time of our last call and this, in part, help to solidify our decision to bring back rigs and resume drilling activities, which I'll touch on shortly.

On the liquid side, NGL realizations have improved and are continuing to improve, thanks to incremental infrastructure, strong export volumes, and leveling supply. Mariner East I has improved and will continue to improve our ethane realizations and we expect Mariner East II to provide further enhancement to propane and butane pricing. Also worth noting is the near-record propane exports we're currently seeing of 650,000 barrels per day.

With respect to FT utilization, we're aggressively pursuing segmentation strategies with our FT to either use the same FT multiple times to our own advantage or monetize downstream segments. In the second quarter, we generated $2.3 million from FT releases.

Now, let's shift to our operations. Throughout the quarter, we've continued to observe strong performance. Our two most recently turned-in-line Marcellus pads continued to outperform type curves. The 12 well GH46 pad in Greene County, Pennsylvania, has cumulatively produced 10.5 Bcf in the first 90 days of production. This outperformance in the Marcellus has led to increasing our type curves in our prolific Green Hill field in southwest PA from 2.7 Bcf per thousand feet to 3 to 3.5 Bcf per thousand foot of lateral.

Now the Utica. As depicted on slide 11, our Gaut 4HI (sic) [4IH] well in Westmoreland County, PA is maintaining rates and pressures, and we expect it to hit line pressure in February of 2017. This well continues to impress, as do our four wells located in Monroe County, Ohio. Our GH9 deep dry Utica well in Greene County, Pennsylvania hasn't been quite as strong as the Gaut, although its performance has been in line with other operators who have dry Utica wells in this area.

So despite being in the early stages, CONSOL's confidence continues to grow for prospective dry Utica development as we accumulate more production data on the six operated wells and 22 non-operated wells where we participate. These data points have translated into our new ranking analysis, which incorporates the metric of A square root of K as a normalized measure of a well's strength.

Slide 12 highlights how we rank and how this data helps us establish a more bullish view than most in the industry. Our continuing dry Utica analysis and continued Marcellus outperformance in part and in addition to the backdrop of commodity prices normalizing, have led to the decision to add back drilling activity in the second half of the year. We intend to run a two-rig program throughout the second half of the year and drill eight wells in Monroe County, Ohio, and two Marcellus shale wells in southwest Pennsylvania. These wells will be completed in the first half of 2017 and turned in line predominantly in the second half of the year.

We rank development opportunities by area and make decisions on few future capital allocations by evaluating rates of return, infrastructure, and end markets. We also consider our dry gas to wet gas balance as well as the balance between joint venture and CONSOL's 100% owned and operated wells. There's not necessarily a hard split or percentage that we try to maintain, but we do prefer diversification between markets while maintaining a watchful hand on the production throttle. Our most recent decision is supported by expected rates of return of approximately 60% in Monroe County, Ohio. These returns assume a $9.8 million well cost for a 9,700-foot lateral, a $1.75 realized price, and 2.8 Bcf per thousand foot of lateral. Our previous estimates were based on a $10 million well cost assuming a 7,000-foot lateral. For the Marcellus Shale, in our most prolific area, Green Hill, we expect to see rates of return of approximately 55%, assuming a $7.1 million well cost for a 9,500-foot lateral, a $1.75 realized price, and 3 Bcf per thousand foot of lateral.

So, when we look at Monroe County, or the area that we call Switz, these are 100% owned and operated CONSOL pads that are rig-ready and a proven area that directly offsets our Switz 6 pad that's already producing. Three of the offset wells on the Switz 6 pad are averaging greater than 15 million cubic foot a day after nine months' production. This is an area that we're excited about, and there's available takeaway and market flexibility. In addition to the new wells, we also benefit by exiting 2016 with a robust inventory of 91 gross Marcellus and Utica shale wells that are drilled but uncompleted.

So, when you look at our diversified portfolio that helps support all of the great things that are happening in the E&P operations, we've got a lot to be excited about. The future looks bright, and we look forward to providing future operational updates.

Operator, if you could please open the line for questions.

Question-and-Answer Session

Operator

Thank you. Thank you. Our first question come from the line of Neal Dingmann with SunTrust. Please go ahead.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Good morning, guys. Say, Nick, maybe for you or Tim, just in the press release you mentioned, and I know you give some details on the 10 wells that you anticipate for the rest of the year, the eight in Monroe and the two Marcellus. Beyond this, do you see additional wells continuing in these higher-return area and I guess I'm particularly curious if you would maybe drill some follow-up wells up near the Gaut?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Well, Neal, when we put this rig plan together, as we do, we base everything not just on rate of return, but we look at end markets, takeaway capacity, land position, commitments, a lot of different factors, and that's how we came up with a list of 10 wells that we're going to drill here in the second half and we'll continue with that process as we move into 2017. But I would expect that you will see additional wells drilled up around the Gaut.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

And then, Tim, does that – that plan that you say, again, I think that makes sense on returns, does that sort of factor in next year on drilling versus completing those 91 docks, kind of, looking at that same plan?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

It does. We take the same approach to the docks as we do new wells. We get asked quite often. We got this inventory at wet docks, how do you look at those compared to continuing to drill dry gas wells, and we put the docks through the same process that we go through. We prioritize our opportunities and it's based on risk rate of return, and right now Monroe County, some of our dry gas docks have risen to the top of the list.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

And then, Tim, just one last follow-up on that. On the Utica, once you see some of these starting to hit the natural line pressure, what type of decline do you anticipate on those? Is that just kind of a typical gas well at that point?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Yeah. I don't have the decline parameters in front of me here, but we have put a decline on there based on what we've seen, what our modeling has shown us. We've done some pretty extensive modeling of our earth modeling, our completions modeling, and our rate transient analysis have given us a decline, but I don't have that number in front of me right now.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Okay. And then just lastly for either Nick or Dave. How do you all see – Dave, you mentioned, not paying down particular – not particularly using equity is one of the higher items on the list. How do you all see about paying down the $466 million on the credit facility or buying back any of those outstanding bonds?

I know that you've had an nice rally, so I'm just kind of wondering how you think about when you and Nick think of some of the possibilities how those sort of rank now that you have paid that credit facility down and the bonds have had a nice rally?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah. So, we'll make a decision about when we generate free cash flow and we will generate free cash in the second half this year organically and then hopefully also with some asset sales. So, we'll decide how we want to use that cash essentially, whether we pay down the revolver or buy back debt. So, it will be NAV-driven. We'll also make sure we're prepared for – looking out at the next redetermination and make sure we're prepared for that as well. But, again, we're going to generate free cash flow.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Got it. Thanks for the details, guys.

Operator

Our next question comes from the line of Holly Stewart with Howard Weil.

Holly Barrett Stewart - Scotia Howard Weil

Good morning, gentlemen. A couple quick questions just trying to get a sense for thoughts around 2017. I mean, I think as we look at the budget, there's probably no real reason to think the coal spending goes up next year, looks like D&C capital will actually rise just given the new rig activity in all the docks that are out there. So, just trying to get sort of a base assumption around spending for next year?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah. Just, I think, one is – we have three entities that are generating free cash flow, so you should start off and understand that. And so, when we were to raise any of our D&C capital, it will be in the light of probably making sure that we stay within cash flow overall, excluding any asset sales. But we obviously have to make a determination of how much docks we're going to bring on next year versus how many brand new wells, and so it will be a calculus we'll go through. And we have two JV partners we need to go through as well as go through our board.

Holly Barrett Stewart - Scotia Howard Weil

Okay. And then maybe just a couple of follow-ups on the guide. I mean, it looks like your basis for the quarter was good and the first half has been pretty good. So, you expanded the base differential guidance. Is there anything you're expecting in terms of weakness in the back half of the year or is this just a conservative assumption for the rest of 2016?

David M. Khani - Executive Vice President and Chief Financial Officer

So, I think we anticipate basis getting a little bit wider in the third quarter, but then getting narrower in the fourth quarter. That's basically our internal forecast using the basis hedges that we have in place as well as our open position.

Holly Barrett Stewart - Scotia Howard Weil

Okay. And then one final one if I could just on the MLP market seems to be sort of settling down here, thoughts around a drop in maybe the back half of the year, as we move into 2017 whether that's on the midstream side or the coal side of things?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah. So, for the midstream side, CONE has talked about very publicly that if they do a drop, it would be to really help for 2016 distributions. And so, now that the MLP has jumped up into a more normalized yield, that's always a possibility. And again, it would be for 2018. On the CNXC side, again, it will probably be a function of watching the coal markets and how they improve and how the capital markets will be open for drop on the CNXC side.

Holly Barrett Stewart - Scotia Howard Weil

Great. Thanks, guys.

David M. Khani - Executive Vice President and Chief Financial Officer

Welcome.

Operator

Our next question comes from the line Lucas Pipes with FBR & Company.

Lucas N. Pipes - FBR Capital Markets & Co.

Hey. Good morning, everybody, and congrats on the continued capital improvements. That's great. I wanted to follow up on the asset sale side. David, if I recall correctly, you mentioned earlier in the call that you continue to look at opportunities you don't feel like there's a need to do something. But when you think about the processes that you currently have running, what sort of magnitude – what sort of ballpark are you looking at and what areas, specifically, do you think there's interest?

David M. Khani - Executive Vice President and Chief Financial Officer

Well, if you noticed, we've executed very heavily on the coal side the last several years and with some modest E&P layered in there. I think looking forward, as the natural gas and liquids markets have improved here, and you see some transactions occur, it looks like the appetite has picked up more on the E&P side, so you'll probably see more E&P going forward and, particularly, we don't have that much coal left to sell. But as far as magnitude is concerned, I think it'll be very opportunistic.

Again, Nick talked about we do not need to sell anything. We obviously want to get our leverage down into the three times or lower, and so we have a little bit of work to do. It won't all come through asset sales; it will come through a whole variety of things. So, again, we'll put enough irons in the fire to get what we want to get done.

Lucas N. Pipes - FBR Capital Markets & Co.

That's helpful. Thank you. And then you highlighted cost cuts as another lever and you've done a great job both on the Coal and on the E&P side. What do you think is going to take it to the next kind of leg down, so to say, on the cost side, specifically, in E&P what are you looking at, what's going to get these costs even lower?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Probably a big piece of that is the dry Utica with these high volume wells getting our drilling cost down or the ranges that we've talked about, down below $10 million in Monroe County and down the $12 million to $15 million range in the deep dry Utica in Southwest, PA, getting our – that will continue our drive for capital efficiency. And then on the operating side, LOEs of the dry Utica volume certainly will help drive down our operating costs and to the overall blend and help reduce our cost as we've seen in the last couple quarters as we bring on more and more dry Utica. So, I think that will continue.

Lucas N. Pipes - FBR Capital Markets & Co.

Great. Well, thank you very much.

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

You're welcome.

Operator

Our next question comes from the line of Jeffrey Campbell with Tuohy Brothers.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Good morning. First question was with regard to the A square root to K stuff, I just want to make sure. You said, it gives you confidence about the industry view. I just want to be clear does this formula and application mean that you believe that the ultimate EUR of the Utica is greater than current industry assumptions?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Well, I think it talks about our confidence in the Utica and it gives us a much more accurate approach to evaluating what we see in the Utica, we're looking – it's normalizing for lateral length, completion techniques, well spacing, so it really normalizes all those parameters and gives you a more accurate view as opposed to comparing IPs, which really vary from operator to operator, and procedures can vary.

So we think the A square root of K just gives a more accurate view of the Utica. Now, when we talk about EURs, we think there's still a potential for upside there. When we look at the Gaut, it continues to impress us with the way it's holding up from a pressure and rate standpoint; we're seeing the same thing in Monroe County. So, we think there is potential for additional upside on the EURs.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Okay. So, if I've sort of understood what you were saying, you're saying that it gives you more confidence in the prospectivity of the Utica as a whole as opposed to maybe just an EUR uplift or whatever?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

We've got a lot of confidence in the Marcellus. And I think – as I said in my statements, we take a more bullish view on the Utica than most other operators because of the data set that we have and our acreage position. So we still think the Marcellus provides tremendous opportunity. It's still a large part of our production base, it's over 50%. We see the Utica growing, but both will be a part of our growth moving forward.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Okay. Thank you. Appreciate that. Service providers have been fairly resolute in saying that their prices have to rise to support any resumption of E&P growth. I'm just wondering, first, do you see any evidence of that yet in the impending two rigs that you're going to add, and what's sort of your forward view on that going into 2017?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Well, I think there's – when we look at our cost savings, we – in general, about two-thirds have been organic, and about a third of it has been as a result of current market conditions. And certainly when activity increases, we may see some increase in service costs, but our job is to do everything we can to keep those costs down. So that'll be an ongoing process. But we haven't yet bottom on our organic cost reductions, so there may be some offset there if we do see some increases in service costs, but we'll continue to fight that battle and work to get our costs down further.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

And, to be fair, if the prices are going up, that should suggest that commodity prices are going up as well, so it doesn't necessarily have to be negative on a margin basis, correct?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Correct. Yes.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Okay. And I'd like to ask one last question, if I may. You mentioned in the press release Marcus Hook and how it's had a salutary effect on NGL pricing. I just wondered, do you have any other irons in the fire to try to improve your NGL pricing aside from Marcus Hook, or is it pretty much tied to the growth of that facility?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Well, we're constantly working with our NGL partners to find ways to optimize our liquids portfolio, and we've been able to improve our differentials year over year and have positioned ourselves to take advantage of storage and export opportunities as the market searches for equilibrium.

Now, from a market perspective, we believe that propane netbacks, in particular, will continue to improve on tailwinds of expanding infrastructure such as Mariner East II and the potential for increased regional demand. That said, we're not just waiting on the market to correct itself; we're entering into deals on a portion of our production to layer in price and delivery diversification, and we'll continue to evaluate these opportunities going forward.

Jeffrey Campbell - Tuohy Brothers Investment Research, Inc.

Okay. Great. Thanks. I appreciate it.

Operator

Our next question comes from the line of Biju Perincheril with Susquehanna. Please go ahead.

Biju Perincheril - Susquehanna Financial Group LLLP

Hi. Good morning. Nick, if I could go back on to 2017 plans, can you give us some color on how you're thinking about whether it's going to be a free cash flow model again next year, or are you looking at spending closer to cash flow and debt reduction via asset sales?

Nicholas J. DeIuliis - President, Chief Executive Officer & Director

The filter that we'll use is the same filter and process we used to assess the two-rig activity move that was just announced. So you could factor the rate of returns and the impact on NAV per share versus other uses. As Dave said to an earlier question, there's a big push and desire, I think, from the company perspective to stay within cash flows for a given period of time. We think that creates a lot of optionality and opportunity beyond just drill bit decisions, and we want to be in a position to take advantage of that.

And the other sort of thing to consider and contemplate in this is that when we're sort of putting together the 2017 development plans or capital budgets or cash flow budgets, we've got all these other levers or places to go to get certain production growth levels, whether they're the docks in the wet area that we talked about, whether it's an incremental rig activity for new wells, as Tim said, or some other variance between the Utica and the Marcellus. So, there's different levers to pull there and mixes to look at to try to optimize.

Biju Perincheril - Susquehanna Financial Group LLLP

Understood. And then in the Green Hill area, Tim, can you talk about some of the improvements that you've instituted there and where are you in taking those improvements and applying it in rest of the acreage?

Timothy C. Dugan - Chief Operating Officer-Exploration & Production

Well, we're continuously working on improving our completion techniques, reducing our cycle times, optimizing our drilling, and it's really not field-specific. In the Marcellus, we look at all Southwestern PA and really push our learnings across the board. But I think we've seen some good quality rock there that has certainly helped us, but when you put all these other learnings that we've gained over the last two or three years in the play there, we're seeing really good rates of return, we're seeing great EURs, and it's an area of great opportunity for us.

Biju Perincheril - Susquehanna Financial Group LLLP

And then lastly, is there an update to the maintenance CapEx number that you gave on the last quarter?

David M. Khani - Executive Vice President and Chief Financial Officer

On maintenance capital, I think we said it was $250 million to $300 million range and that still holds pretty true, which puts us in the $0.65 to $0.75 zip code.

Biju Perincheril - Susquehanna Financial Group LLLP

Thank you.

David M. Khani - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

Thank you. Next, we'll go to the line of James Spicer with Wells Fargo.

James A. Spicer - Wells Fargo Securities LLC

Hi, good morning. Just some follow-up question on the balance sheet and the improvement goals here. You've talked about potentially targeting leverage of three times or lower. Just wondering if there are other metrics that you look at at the same time, whether it's debt-to-cap, revolver utilization, anything like that, and what timeframe you're targeting to achieve your goals?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah. Our target would be to try to get there by the end of 2017 if not earlier, and we look at liquidity and we'll look at other metrics depending upon the moment in time if it's in a more of the down cycle, they're going to be more defensive metrics that we'll look at, and so liquidity is another one we look at.

James A. Spicer - Wells Fargo Securities LLC

And what are your objectives in terms of liquidity? Just maintaining a minimum amount at a certain level?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah. We have an internal number that we always look and it factors in all of the risks, our open positions, and the revenue shifts, any operational glitches that we have to cover here so – and then what we get covered by insurance. So, we look at it on how much liquidity do we need to make sure we run our businesses through all parts of the cycle.

James A. Spicer - Wells Fargo Securities LLC

Okay. Great. And then secondly just on your dock inventory, I think you said you're at about 91 today. Just based on your plan for this year, where do you expect to be at the end of the year?

David M. Khani - Executive Vice President and Chief Financial Officer

I will be at 91, that's for the end of the year.

James A. Spicer - Wells Fargo Securities LLC

Oh, that's end of the year?

David M. Khani - Executive Vice President and Chief Financial Officer

Yeah, that includes the 10 wells that will be drilled with this two rig program. So, we'll close the year out at about 91.

James A. Spicer - Wells Fargo Securities LLC

And where are you today then?

David M. Khani - Executive Vice President and Chief Financial Officer

We're roughly high 70s; 77, 78.

James A. Spicer - Wells Fargo Securities LLC

Okay. All right. Thank you.

Operator

Thank you. Mr. Lewis, at this time I'll turn the conference back over to you.

Tyler Lewis - Vice President-Investor Relations

Okay. Great. Thank you, everyone, for joining us. Appreciate your interest in CONSOL Energy and look forward to speaking with you next quarter. Nick, if you could please remind the audience regarding the replay instructions.

Operator

Thank you. Today's call was recorded and is available for replay beginning at 12:30 today and running through August 2 until midnight. You may access the playback system by dialing 1-800-475-6701 and entering the access code of 375022. International callers may use 320-365-3844. Those numbers again are 800-475-6701 or 320-365-3844 with a common access code of 375022. With that, that does conclude our conference for today. We thank you for your participation. You may now disconnect.

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