Rice Energy (RICE) Daniel J. Rice on Q2 2016 Results - Earnings Call Transcript

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Rice Energy, Inc. (NYSE:RICE) Q2 2016 Earnings Call August 4, 2016 9:30 AM ET

Executives

Julie E. Danvers - Director-Investor Relations

Daniel J. Rice - Chief Executive Officer & Director

Toby Z. Rice - President, Chief Operating Officer & Director

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Derek A. Rice - Executive Vice President-Exploration

Analysts

Kyle Rhodes - RBC Capital Markets LLC

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Jonathan D. Wolff - Jefferies LLC

Ben Wyatt - Stephens, Inc.

Operator

Good morning and welcome to Rice Energy's Second Quarter 2016 Earnings Conference Call. At this time, all participants will be in listen-only mode. After today's presentation, there'll be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Julie Danvers, Director of Investor Relations, to cover a few housekeeping items. Please go ahead.

Julie E. Danvers - Director-Investor Relations

Good morning, everyone, and thank you for participating in Rice Energy's second quarter 2016 results conference call. With me today are Daniel Rice, CEO; Toby Rice, President and COO; Gray Lisenby, Senior Vice President and CFO; Derek Rice, EVP of Exploration; and Rob Wingo, Senior Vice President of Midstream and Marketing.

Before we begin, I'd like to remind you that our remarks including the answers to your questions contain forward-looking statements. We refer you to our earnings release for a detailed discussion of these forward-looking statements and the associated risks. In addition, during this call we may make references to certain non-GAAP financial measures. Reconciliations to the applicable GAAP measures can also be found in our earnings release.

A few administrative items to cover quickly. First, we have a new investor presentation available for download on our website, which we will reference during today's call. Second, we will file our 10-Q with the SEC later today, which will be accessible through our website or the SEC's EDGAR system. Third, we'll be participating in the Barclays Energy-Power Conference in September and look forward to seeing everyone in New York.

Lastly, as a reminder, the results for Rice Midstream Partners are consolidated in Rice's results. We will host RMP's earnings conference call at 11:00 AM Eastern today. To participate in the live webcast, please visit www.ricemidstream.com and a link will be available on our homepage.

I would now like to turn the call over to Daniel Rice, IV, CEO of Rice Energy.

Daniel J. Rice - Chief Executive Officer & Director

Thanks, Julie, and good morning, everyone. As you may have seen in last night's press release, we had a great second quarter marked by record E&P production growth, record midstream throughput growth from Rice Midstream Holdings and Rice Midstream Partners, record cost reductions for E&P CapEx and OpEx, and we exited the quarter with the strongest balance sheet and most liquidity since our IPO.

Toby and Gray will cover our operational and financial accomplishments in greater detail. So I'd like to spend my time sharing our updated view on natural gas prices and how we're positioning Rice to benefit the most from this bullish thesis.

Today in Appalachia, there are 34 active rigs. And as we stated in last quarter's earnings call, we believe 50 rigs to 55 rigs are needed to maintain the basin's current production rate of approximately 22 Bcf per day. Given we're substantially below these maintenance levels, we expect production to be flattish in the second half of 2016 continuing into 2017 as the rest of the country is in decline.

Furthermore, there's approximately 10 Bcf to 15 Bcf per day of new Appalachian takeaway capacity expected to come online in the next 24 months that will have to be sourced with local supply. Although there's some debate around the timing of certain projects, we do expect the vast majority of the contracted projects to be placed into service, which will significantly improve local pricing.

These items have been the crux of our thesis of strengthening gas prices and we've been positioning Rice for a while now to benefit the most as this thesis continues to play out. First, we've maintained a steady drilling program for 2016 with an outsized portion of total D&C capital earmarked for initial production in 2017. Second, our disciplined hedging philosophy allows us to be patient before significantly adding new 2017 hedges.

Third, we have accumulated a right-sized FT portfolio with growing exposure to improvements in local pricing, and by design we have increasing exposure to improving local prices and by 2020, we expect at least 40% of total production to receive improved local pricing. This holistic strategy of positioning for success in the drill bit, hedging and firm transportation allows us to be nimble and opportunistic as market dynamics continue to improve.

We further reduced our well costs significantly during the second quarter by an average of approximately 20%, which Toby will describe in more detail. We also updated our 2016 average well costs to $850 per lateral foot in the Marcellus and $1,275 per lateral foot in Utica. With these cost reductions, our single-well returns in the Marcellus and Utica are now averaging approximately 95% at strip pricing.

These robust returns support a strong case to bring more of that accretive value forward, particularly when we're investing within a favorable service price environment. As this year's drilling and completion projects are tracking several months ahead of schedule and approximately $60 million under budget, we will be reinvesting these savings into Ohio completion activity with first production scheduled in early 2017.

Separately, we continue to see some pretty attractive land opportunities within our core focused area. And given our strong balance sheet, we are prudently increasing our land budget by $20 million.

I'm excited for Toby and Gray to cover the quarter in more detail. So with that, I'll turn it over to Toby to discuss our operational highlights for the quarter.

Toby Z. Rice - President, Chief Operating Officer & Director

Thanks, Danny. As Danny mentioned, we continued to set new records this quarter, bringing online 18 wells in the month of April alone, reducing operating costs 43% year-over-year and driving down well cost.

During the quarter, we invested approximately $95 million to drill and complete operated Marcellus and Ohio Utica wells. Our upstream teams continue to benefit from improved cycle times, longer laterals and further cost reductions from market conditions.

In the Marcellus, development cost for the second quarter averaged $700 per lateral foot, among the lowest well costs in Southwest Pennsylvania. Our second quarter costs were 24% lower than the first quarter, mainly attributable to shorter cycle times, lower service costs and longer laterals. During the quarter, we drilled 11 gross Marcellus wells with an average lateral length of 11,000 feet and average drilling times of 18 days, which is 32% faster compared to our first quarter average.

On the completions front, the development efficiencies and service cost savings are similar to what we're seeing on the drilling side. During the quarter, we completed six gross Marcellus wells with an average lateral length of 6,000 feet. Incorporating our drilling and completion savings, we reduced our 2016 development cost from an average of $1,150 per lateral foot to an average of $850 per lateral foot, a 26% reduction in well cost.

In the Utica, development costs for the quarter averaged $1,150 per lateral foot, which was 17% lower than the first quarter. We reduced our 2016 development costs from an average of $1,450 per lateral foot to an average of $1,275 per foot. During the quarter, we successfully drilled four gross wells with an average lateral length of 9,000 feet and average drilling times of 24 days, which is approximately 30% faster compared to our first quarter average. We completed nine gross Utica wells with an average lateral length of 8,900 feet.

The efficiencies and cost savings we're realizing through drilling and completions are also being realized by our production team. For the quarter, our lease operating expense totaled $0.13 per Mcf, which was 43% lower than the prior-year quarter and a 28% decrease relative to first quarter 2016. These cost savings were driven by lower equipment rental cost and reduced water disposal costs.

Looking ahead, we remain committed to our focus on safety, continuous improvement and identifying opportunities to further reduce costs and improve our best-in-class growth and returns.

With that, I will now turn the call over to Gray to discuss second quarter financial results and updated guidance.

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Thanks, Toby. During the second quarter, we turned to sales 15 net wells and our net production averaged 758 MMcfe per day, which was an increase of 43% year-over-year and 12% above first quarter 2016. The Marcellus accounted for 68% of our production and the remaining 32% was from the Utica.

Our hedge book continues to enhance our revenue structure with second quarter post-hedge realized price of $2.75 per Mcf compared to a pre-hedge price of $1.77 per Mcf. Our adjusted realized price of $2.77 per Mcf included the uplift from our firm transportation capacity optimization.

Our disciplined hedge strategy and diversified FT portfolio translates to 89% of remaining 2016 production hedged at $3.25 Henry Hub and 72% of expected production transported to favorable markets outside of Appalachia. Furthermore, we have approximately 650 BBtu a day of 2017 production hedged at $3.12 per MMBtu.

We continue to make significant strides reducing our operating costs and total E&P cash costs for the quarter were $0.90 per Mcf, a 5% decrease year-over-year. We generated second quarter EBITDAX of $131 million, which is a 34% increase over second quarter 2015 with a strong EBITDAX margin of 59% which we expect to continue to improve over time.

We achieved this strong EBITDA growth in spite of a decrease in gas prices, highlighting the benefit of our hedging strategy and high-volume wells. Second quarter CapEx totaled $148 million comprised of $95 million in drilling and completion, $19 million in non-operated activity, $14 million in land and $20 million at Rice Midstream Holdings.

Looking at our second quarter 2016 balance sheet and liquidity, our leverage was a lean 1.3 times on an adjusted fully consolidated LTM basis. Though we are likely at the most challenging point in the cycle, our balance sheet is in the best shape it's ever been. Our second quarter C-corp liquidity position was $1.4 billion consisting of $1.1 billion of E&P liquidity and $300 million of RMH liquidity.

Shifting to midstream. At Rice Midstream Holdings, we delivered 658,000 dekatherms per day of throughput, a 184% increase over the prior-year quarter and a 45% increase relative to first quarter 2016 with 67% third-party volumes primarily driven by Gulfport. We amended our new CNX gathering agreement across 13,000 gross acres in Northeastern Monroe County and conveyed the rights to Strike Force. This is consistent with our strategy of aligning ourselves with high-quality producers in the best geological areas.

Just recently, CNX announced they'll be ramping up development of the Monroe County acreage which is included in the dedication to Strike Force. CNX is drilling some really great wells in this area and we enjoy seeing their great well results paired with our producer-oriented midstream approach.

For Rice, dropdowns are a financing lever we can pull that provides alternative sources of liquidity. RMP is well capitalized to follow on (11:31) the potential acquisition of a portion of Rice's Ohio gathering system as it recently completed a successful equity offering raising $164 million of net proceeds.

Given the strong balance sheets and results at both Rice and RMP, we are in a flexible position to time a dropdown in a manner that maximizes proceeds to Rice and in support of RMP's distribution growth. We're excited about the significant anticipated future growth from our two Ohio systems driven by Rice and Gulfport that will also continue to support RMP's top-tier distribution growth for the foreseeable future.

Glancing at RMP, RMP had a strong quarter of approximately $38 million of EBITDA and 1.86 times Bcf coverage. The quarter was driven by strong throughput growth by RMP sponsor and prolific third-party growth ahead of expectations along with accelerated water services activity.

RMP recently announced a distribution increase to approximately $0.22 per Mcf, a 6% increase over first quarter 2016 and a 17% increase over prior-year quarter, which places RMP in the first tier of the IDR split, highlighting the significant expected future value of our general partner. We think it's important to note we entered the splits six quarters after going public within a very tough commodity price environment.

On a combined basis, RMH and RMP had dedications totaling 266,000 acres with approximately 50% from third parties. These dedications are in the four most active counties at the core of Appalachia and we believe it is the highest growth dry gas gathering system in the country.

Before I wrap up my comments, I will quickly summarize our updated guidance. As project cycle times have shortened, we've updated our expected spud and online well counts to reflect these efficiencies. We tightened our production range and raised the midpoint to 730 MMcfe a day for 2016.

Total D&C is unchanged and we're reinventing cost savings into accelerated development in the Utica and increasing our land budget by $20 million to opportunistically add leasehold. RMP also received an added benefit of this reinvestment by increasing their 2016 water services EBITDA.

We've lowered our operating costs for the year, most significantly on the LOE side. And expected total cash operating costs for the year are expected to be lower by approximately 10% with the range of $0.97 to $1.08 per Mcf. Additionally consolidated cash G&A has come down slightly with a larger portion allocated to midstream.

Looking ahead to the remainder of the year, we expect third quarter production levels to be flattish to second quarter with an increase in the fourth quarter of 2016.

In summary, we have a unique combination of highly economic wells, a strong balance sheet and differentiated midstream value that positions us well to take advantage of and invest in a more favorable service price environment and to continue to drive growth and create value for our shareholders.

We'd now like to open up the call for Q&A. Operator.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. Our first question comes from Kyle Rhodes with RBC Capital. Please go ahead.

Kyle Rhodes - RBC Capital Markets LLC

Hey. Good morning, guys, and congrats on the solid quarter here. Maybe for Toby or Derek, I was hoping to get a little bit more color on the capital efficiency gains you mentioned in the release. Can you break down the most recent step change lower in the service costs versus efficiencies? And then can you remind us your current completion design in the Marcellus and Utica and if there's been any noticeable changes to that recipe on this latest batch of wells. Thanks.

Toby Z. Rice - President, Chief Operating Officer & Director

Sure. This is Toby. When looking at well costs, there's three categories that we look at that really influence well costs. Operational efficiencies, service costs and the last one just as important is lateral lengths. So looking at the Marcellus from an operational efficiency standpoint just to give you an example, the drilling speeds and drilling times that we've accomplished relative to last year. In 2015, we had a horizontal rig. It could drill about 30 wells per year. With recent performance, a horizontal rig can drill 50 wells per year, which is an example of the operational efficiencies we're seeing.

Service cost side, we're benefiting from a lower service cost like everybody else. But really the story on the Marcellus is lateral lengths this quarter. We averaged 11,000 foot lateral lengths compared to our yearly average which I think is around 7,200 feet for this year. As far as the completion design is concerned, we're pumping the same robust frack design this quarter that we always have. So we have not changed our designs from a completion perspective. And did that cover your questions?

Kyle Rhodes - RBC Capital Markets LLC

Yeah. I snuck a few in there. I appreciate it. And then just maybe one follow-on here maybe for Gray. Is there a July production number you can share? And then just is there any impact baked into 3Q guide from higher line pressures? Thanks.

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Yeah. We don't have a July production update. But as we said on the call, Q3 production will be roughly flat. That's not from higher line pressure. It's just the way our schedule works out. We had a lot of wells come online in Q1 and Q2. And we'll have production growth resume in Q4. So more just operationally schedule-driven.

Kyle Rhodes - RBC Capital Markets LLC

Got it. Is there a completion count or I guess current in-line count you can give for 3Q and 4Q?

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Yeah. We'll follow up with you after the call on that one.

Kyle Rhodes - RBC Capital Markets LLC

Okay, great.

Operator

The next question comes from Neal Dingmann with SunTrust. Please go ahead.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Good morning, boys. I know you don't have 2017 guidance out. But really, Dan, I just want to know your thoughts on organic or external growth going forward given your strong current cash position obviously after the equity deal and as well as the material amount of possible dropdowns.

Daniel J. Rice - Chief Executive Officer & Director

So Neal, is the question more on acquisitions and growth on the acreage side or is it more on development?

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

I'm kind of wondering both. Obviously, now for a while there was concern that perhaps you guys had too much leverage and now it's the other side where you've got a strong, obviously, balance sheet. You've got all these dropdown potential. So I guess when you, Gray, or Toby think about things for next year, I'm just wondering how big could either acquisitions be or how much could you turn up the organic growth?

Daniel J. Rice - Chief Executive Officer & Director

Yeah. So first on the acquisition piece and just on the growth on the acreage side, we haven't lost any of our discipline. Now that we have a much stronger balance sheet, we're still just as disciplined. But I think we're suddenly probably more nimble and able to do things. So we're looking at everything under the sun within our core focus area. But it has to meet the criterion that we've laid down (19:01) in the past couple of conference calls with you all. So there certainly wouldn't be any surprises as we continue to look at opportunities.

I think when you look at just our ability to accelerate development, I think the one thing that's probably really important to be able to just distinguish is everything that we're seeing playing out with gas prices starting to rise and this thesis actually starting to crystallize, we've already done a ton of work on just the positioning with really prefunding a lot of 2017 production growth by spending a lot on drilling completion activities in 2016. So for us, we're really not in a position where we even need to react because we've done so much to just position ourselves. So I think, for us, it's really just continuing to stick to the script and just continue to just execute the plan. And I think just looking at the results from the second quarter, I think there's a huge amount of value if we're just keeping our eye on the current quarter and the next quarter and just continuing to execute the plan and continue to drive down costs and drive up value creation for our shareholders.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Okay, and then just one last one. You had a little bit of reallocation. Obviously, efficiencies you're seeing in the Marcellus; you were able to, look like, take some of that cash and put it in the Utica. Your thoughts about why do that versus not just continue to ramp up the Marcellus even more given the efficiencies.

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Yeah, Neal, this is Gray. From a returns perspective, both plays look great. So that decision was more operationally-driven. We had about 11 wells teed up in the Utica that were drilled and midstream was ready. So it was strictly operationally driven.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Got it. Got it. Makes sense.

Daniel J. Rice - Chief Executive Officer & Director

And I would say just on the efficiencies, Neal, we're seeing cost savings in both areas. It's really just in terms of allocating that capital where we can get the most bang for our buck and putting that money back to work.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

But, Danny, takeaway is not an issue, I don't assume, on either?

Daniel J. Rice - Chief Executive Officer & Director

No.

Neal D. Dingmann - SunTrust Robinson Humphrey, Inc.

Got it thanks.

Operator

It seems there's no other questions. Oh, there's a follow-up by Kyle Rhodes with RBC Capital. Please go ahead.

Kyle Rhodes - RBC Capital Markets LLC

Hey, guys. I'll throw one more in here. Just on the increased land budget, where do you guys see acreage positions winding up at year end both in the Marcellus and Utica given the incremental $20 million spend here?

Toby Z. Rice - President, Chief Operating Officer & Director

So I'll tell you our leasing rates are pretty much where they've been at, somewhere in the $4,000 to $6,000 an acre range. So we could see the addition of up to maybe another 5,000 acres given that.

Kyle Rhodes - RBC Capital Markets LLC

Is there a focus, Marcellus versus Utica or is it evenly split?

Toby Z. Rice - President, Chief Operating Officer & Director

I would say it's evenly split between the two.

Kyle Rhodes - RBC Capital Markets LLC

Got it. Thanks, guys.

Operator

Our next question comes from Jon Wolff with Jefferies. Please go ahead.

Jonathan D. Wolff - Jefferies LLC

Morning.

Daniel J. Rice - Chief Executive Officer & Director

Good morning, Jon.

Jonathan D. Wolff - Jefferies LLC

Hey. I don't know how much you can talk about this. But in terms of drops into RMP, the first piece of the Ohio gathering system, it's pretty clear what you're doing there. I think you had said you'd maybe go in thirds. Maybe you could talk about that. And then sort of the next tranche, the second system, where that might fit.

And then you probably have an internal model of what the GP might be worth. And you probably won't answer my question. But do you have any views you can share on how the GP cash flow grows over time?

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

So taking them one at a time. On the first drop, our thinking is still consistent with what you describe, dropping it in thirds. And obviously like you said, RMP and Rice are both set up to do that very well later this year. The second drop, high level thinking about it towards the end of 2017.

And then in terms of GP growth and value – I'm not sure it's in our current investor deck. But on a previous one, we outlined very simply what our IDR cash flow is expected to be and it will grow pretty significantly as we get into 2018 and especially into 2019. So I do think it's something that you will continue to see be a bigger part of our story. And by 2018, we'll have about $20 million of IDR cash flow and still grow into 2019. So...

Jonathan D. Wolff - Jefferies LLC

And in terms of the two systems, what timeline would you say to get the utilization rate that feels like a dropdown candidate?

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

When you say they -

Jonathan D. Wolff - Jefferies LLC

...the first one.

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

When you say two systems, I assume you're talking about our existing Ohio system and our Strike Force system.

Jonathan D. Wolff - Jefferies LLC

Correct.

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

Yeah. So on slide 36 of our old investor pres, from our previous full investor pres, we've guided to $120 million to $160 million of EBITDA in 2018 from both systems. The majority of that will be our existing Ohio system with our Strike Force system ramping up more into 2019.

Jonathan D. Wolff - Jefferies LLC

Okay. And I think you've spoken about it. But is there a contemplation of like an RMGP or something like a holding company at some point that might hold the GP asset?

Grayson T. Lisenby - Chief Financial Officer & Senior Vice President

We're already well set up. We have a GP holding box on slide two of our current investor pres. As you can see, we've got a GP holdings box. So it's well set up to do that. And we'll obviously capture value opportunistically as we go forward especially into 2018 and 2019.

Jonathan D. Wolff - Jefferies LLC

It's helpful. Thank you.

Operator

The next question comes from Ben Wyatt with Stephens. Please go ahead.

Ben Wyatt - Stephens, Inc.

Hey. Good morning, guys. One just quick one on acreage. At times, there's pushback on maybe lack of inventory versus peers. I know you guys kind of feel like you have a decade or so and that's enough. But how do you guys think about the deep Utica that you guys have in PA versus adding in your core Marcellus-Utica? Does there come a point where you guys start to look a little harder at just developing the deep Utica?

Derek A. Rice - Executive Vice President-Exploration

Yeah, this is Derek. I think right now we're sort of taking a wait-and-see approach as far as deep Utica. We think it could potentially be an important part of the rights story, call it three to five years from now. But I think if we had the option today of drilling deep Utica wells or leasing fresh Marcellus acreage within our core, we're going to take leasing fresh Marcellus acreage until we can prove that deep Utica can compete with Marcellus' economics. So we're going to put that money to work on the leasehold side and wait to see how – the way Utica plays out.

Ben Wyatt - Stephens, Inc.

Very good. And then maybe just one more on the leasing side. And you guys might have mentioned this earlier. But is there more of an opportunity of kind of increasing working interest in your area or actually picking up acreage, kind of a mix there? What is maybe the bigger opportunity?

Toby Z. Rice - President, Chief Operating Officer & Director

Well, I'd say in Pennsylvania, adding acreage organically in trades is primarily the mechanisms where we're going to be increasing our drillable acreage count. And in Ohio, you have those opportunities plus the ability to purchase working interest from offset operators.

Ben Wyatt - Stephens, Inc.

Very good. Well, guys, I appreciate it. Keep up the good work. Thanks.

Daniel J. Rice - Chief Executive Officer & Director

Thanks, Ben.

Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Daniel Rice for closing remarks.

Daniel J. Rice - Chief Executive Officer & Director

Thanks, everyone, for joining us this morning. Have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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