SilverBow Resources' (SBOW) CEO Sean Woolverton on Q4 2017 Results - Earnings Call Transcript

SilverBow Resources, Inc. (NYSE:SBOW) Q4 2017 Earnings Conference Call March 1, 2018 11:00 AM ET

Executives

Doug Atkinson - Senior Manager of Finance and IR

Sean Woolverton - CEO

Steven Adam - EVP and COO

Gleeson Van Riet - EVP and CFO

Analysts

Jeff Grampp - Northland Capital Markets

Ron Mills - Johnson Rice & Company

Ben Wyatt - Stephens

John Aschenbeck - Seaport Global Securities

Operator

Good morning. My name is Felicia, and I will be your conference operator today. At this time I would like to welcome everyone to The SilverBow Resources Fourth Quarter 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you.

Mr. Doug Atkinson, you may begin your conference.

Doug Atkinson

Thank you, Felicia. Good morning, everyone. Thank you very much for joining us. Joining me on the call today's are Sean Woolverton our CEO; Steve Adam our COO; and Gleeson Van Riet, our CFO.

We posted an updated corporate presentation on to our website and we will occasionally refer to it during this call, so I encourage investors to review it.

Please note that we may make references to certain non-GAAP financial measures, which are reconciled to their closest GAAP measures in the earnings press release. Our discussion today will include forward-looking statements which are subject to risk and uncertainties many of which are beyond our control. These risks and uncertainties are described more fully in our documents on filed with the SEC which are also available on our website.

And with that, I'll turn the call over to Sean.

Sean Woolverton

Thank you, Doug. And thank you everyone for joining our call this morning. We are pleased to report another strong quarter; closing out what was a transformational year for the company. This morning, I'd like to briefly talk about what we accomplished in 2017 and our plans for 2018.

When I joined the company a year ago, I was often asked why I chose SilverBow. I believe a successful oil and gas company needs three foundational pieces: assets, finances and people. When I looked at the company, I saw an attractive Eagle Ford position, a clean balance sheet and a veteran team of oil and gas professionals. I knew the foundation was in place to support the successful company and I was excited for the opportunities to build upon that.

As I think about 2017, I believe we improved on all three facets, by adding 50% to our Eagle Ford acreage position, significantly enhancing our balance sheet with the second lien notes and adding Steve Adam as our Chief Operating Officer back in November. Specific to our assets we added 36,500 acres to our portfolio throughout the year for $50 million. We now have over 100,000 acres in our Eagle Ford portfolio. This new acreage added over 350 future drilling locations. We acquired this acreage at an attractive cost per acre providing for a very favorable full cycle economics compared to our peers and other basins.

On the financing front, we continue to prudently manage the balance sheet and in the fourth quarter we closed on a $200 million second lien senior note. This added liquidity provides for the balance sheet flexibility to accelerate our strategic growth objectives. In regards to people, we took proactive steps to strengthen our operating team to position the company for an active and successful 2018.

Steve has only been with the company a few months, and we can already see his fresh ideas and disciplined perspectives helping refine processes and implement new technical approaches across the organization.

In terms of operational execution during 2017, our shallow low cost high rate of return drilling program in Fasken and Artesia combined with our delineation campaign in our Southern Eagle Ford gas position contributed to a 40% growth in volumes compared to the fourth quarter of 2016.

On the costs side, our teams continues to find efficiencies to lower our cost structure, which drove a 35% declined in lease operating expenses. Much of our focus in 2017 was to build the foundation to become a low cost operator in the basin. We believe that with the work we have accomplished to-date combined with initiatives ongoing and soon to be enactive we are well on our way to accomplish in that. Steve will touch on this during his prepared remarks.

Information our strong operational performance translated to an improved bottom-line, resulting in adjusted EBITDA growth of 90% compared to 2016. Switching to reserves, we hit the 1 trillion cubic feet equivalent mark on our reserves, an increase of 38% compared to 2016.

Our PV-10 increase to $805 million, an increase of 82% over 2016, approximately 55% of our reserves are proved undeveloped. We believe our acreage supports multi-Tcfe of upside from here as our year-end 2017 report has minimal reserves associated with our larger blocks at Oro Grande, South AWP and Uno Mas.

Finally, in terms of our 2017 drilling campaign, we are pleased with our results. In addition to drilling our legacy higher rate of return, lower Eagle Ford well in Fasken we drilled a number of successful wells during the year that significantly advanced our understanding of other areas including Artesia, Oro Grande, and Uno Mas. Given us successful 2017 program we are increasing our activity in 2018 through the addition of a second drilling rig. This second rig will allow us to accelerate our development, unlocking value from our entire portfolio.

So shifting to 2018, this year we plan to test advanced stimulation designs with multiple ranges of sizes and volumes throughout all areas of our portfolio. Additionally, we are currently testing different choke management concepts honing in on with pressure management regimes to work best in certain areas.

Our drilling program for 2018 is structured to further delineate our Fasken upper Eagle Ford position, as well as Southern Eagle Ford gas acreage at Oro Grande, and Uno Mas so that we can move to development mode in 2019. On leasing front we are very pleased with the acreage we added in 2017, and we continue with our strategic leasing program in 2018, as this provides us with low cost inventory additions at attractive full cycle economic returns. We have approximately 10% of our 2018 budget dedicated to this leasing effort.

Beyond our existing inventory we see additional upside through stack pay development, including additional landing zones within the upper and lower Eagle Ford, as well as testing the Austin Chalk. We're still assessing how best to delineate these horizons and we believe these zones present a large potential opportunity across our assets.

We are very pleased with the resource base we're assembling although it is still early days for the Eagle Ford gas play we believe the play is gaining momentum and our activity in 2018 will go a long way towards advancing the potential of this tremendous resource.

In addition to proving the resource we are also focused on proof of cost. We need to have a low cost structure to generate competitive returns with the gas portfolio. But we are margin [ph] business and as such we continue to take actions to drive our operating expenses lower through a combination of continued efficiencies and cost reductions, as well as streamlining initiative such as the AWP Olmos divestiture is set to close today.

This divestiture further streamlines our portfolio and allows us to better leverage our existing personnel, while lowering our per unit lifting costs. You will see from our guidance we are targeting lease operating expenses, plus transportation and processing for 2018 of roughly $0.64 per Mcf at the midpoint, which we believe competes favorably with any gas play in the country.

So I will close by saying that 2017 was a foundational year for the company. We have in place the assets, financing and people to build a formidable Gulf Coast gas company. For 2018 it's a year where we look to prove the potential of this asset base.

And with that, I will hand it over to Steve.

Steven Adam

Thank you, Sean. Moving on to our operational results for the fourth quarter, volumes in the quarter were driven by strong performance from our production base, especially in Artesia, which benefited from a full quarter's worth of flush production due to a three well pad, which came online at late August. Fourth quarter production also benefited from four net wells brought to sale, including two in Fasken, one in Oro Grande and our first well in Uno Mas.

These new wells drove production to 177 million cubic feet of gas equivalent per day for the quarter, an increase of 13.6% compared to the third quarter. After adjusting for the expected Olmos divestiture pro-forma production in the fourth quarter was 168 million cubic feet of gas equivalent.

Looking out into the first quarter of 2018, we are guiding for average daily production of 156 million to 162 million cubic feet of gas equivalent per day. After adjusting for the Olmos divestiture we are guiding for pro-forma production of 150 million to 156 million cubic feet of gas equivalent per day, which assumes a March 1st closing date. This drop in production from fourth quarter to first quarter reflects a change in the number of first deliveries, frac mitigation management and the impact from the sale of our AWP Olmos property.

Specifically, as it relates to timing of first deliveries quarter-over-quarter, we brought on three net equivalent wells in the fourth quarter of 2017 compared to 1.25 net equivalent wells that we plan to bring on in the first quarter of 2018. As a reminder the six well pads we completed in Fasken during the first quarter only commenced flow back last week. Additionally to accommodate this large pad stimulation we shut in 10 wells during the month of February, representing a reduction of nearly 15 million cubic feet per day.

This dynamic of large swings in production going offline during fracing then surging upwards due to flush production, illustrates the saw tooth impact that pad timing can have on quarterly production levels.

Moving on to our new rig, it is designed for being optimally efficient at pad drilling, while our current rig is optimized for drilling the deeper gas areas in our portfolio. We do not anticipate drilling many single well pads this year. We expect to drill another six well pads sometime in the second quarter, with production coming online in the third quarter. For the full year we are expecting to complete 25 to 26 net wells, which is reflective of the timing associated with pad drilling and the addition of a second rig.

Looking at further in the year, we're expecting to see a production ramp that corresponds to our backend loaded capital budget. Our 2018 capital program calls for a budget of $245 million to $265 million, 70% of which is for drilling and completions capital. We expect to spend an additional $25 million to $30 million on leasing as well as approximately $50 million on facility and infrastructure spend.

Our infrastructure development continues to advance in Oro Grande and Uno Mas with gathering systems expected to be installed in the coming quarters as well as other separation treating and ancillary need.

Moving on to costs, we are evaluating and taking all of our unit costs, processes and procedures for our operation and supply chain functions. While much of our early cost reductions today that have been driven by reductions in saltwater disposal and chemical costs, as well as other labor costs. There are significant cost savings opportunities to debundling and selective aggregation of services along the value chain for both CapEx and OpEx spends. We are already starting to see results as we reported leasing expenses of $0.34 per Mcf equivalent in the fourth quarter compared to $0.41 in the prior quarter.

We expect our lease operating expenses per Mcfe to decline throughout 2018 due to our Olmos divestiture and the growth in production associated with the second rig. In addition, the AWP Olmos wells carry significantly higher per unit cost than our Eagle Ford assets. So their divestiture will reveal our lower LOE cost on our four Eagle Ford portfolio.

Additionally, adding the second rig to our drilling campaigns provides additional scale, which we are leveraging to selectively for pure goods and services directly for manufacturers. We also expect to offset any inflation in 2018 with additional efficiencies. For example, we are planning for improved cycle times as a result of adding a second rig to the portfolio.

Our team has done a great job thus far in assessing areas for cost reductions and we are excited to see what else we can do during the year. Keys to success for us will include improvements in bid selections, vendor performances and rigorous commercial management of our drilling completion and production services.

As I mentioned earlier, we recently completed a six well pad in Fasken, which was the largest pad in the company's history. Average well cost for this pad came in under the $5 million tight curve assumption and included three upper Eagle Ford wells, which were more weighted towards proof-of-resource versus proof-of-cost.

Developing Sag Bay [ph] at Fasken including Austin Chalk potential is a significant opportunity for us as we can leverage the existing infrastructure in place for further area upside. Additionally we also view testing additional zones at our lowest cost method of growing added inventory. As such, we are now planning more upper Eagle Ford test at Fasken due to the early results in productivity and stimulation.

In Oro Grande and Uno Mas, we have significant thicknesses in the lower Eagle Ford, including other targets across the entire Eagle Ford Section. These thicknesses potentially warrant additional landing zones, which are currently being evaluated. The challenge for us is to appraise and successfully delineate these sweet spots across these multiple interval.

We are currently evaluating our completion designs including fluids, spacing, top loadings and intensities for our Southern Eagle Ford gas wells in Oro Grande and Uno Mas. We continue to focus on stimulation designs that further optimize and effectively treat newer well bore rock volumes as opposed to reaching out with long fracing.

We pumped our second Oro Grande well, the NMC 2H with considerably less profit than our first well, as we continue to carefully test this area and optimize the balance between the increased cost associated with enhanced frac design and the corresponding increase in project returns from higher EUR.

From our 2018 program, we are planning to continue to test a range of stimulation design and proppant volumes. Specific to choke management we are testing our pressure management techniques across our entire provision. We continue to assess our managed reservoir pressure initiative for our Bracken wells, which were drilled in 2017.

We believe our pressured management approach at Bracken will provide higher recovery efficiencies and enhanced returns. This said, we are also employing various choke management practices to our wells and other areas of our Southern Eagle Ford gas position.

To better assess value and recovery method - and recoveries from these methods. As Sean mentioned, we reported reserves of just over 1 trillion cubic feet of natural gas equivalent. We believe the position we have assembled supports multi-Tcf upside from where we are today as there are minimum reported reserves associated with our larger acreage blocks at Oro Grande, Southern AWP and Uno Mas.

We like what we have in place at Oro Grande and Uno Mas with 250 to 325 feet of Eagle Ford thickness and 12,000 psi pressure. Thus we are excited about 2018 and maintain a strong pipeline of project including further completion design opportunities additional step out wells in newer areas and evaluating additional landing zones across our acreage position.

With that I'll turn it over to Gleeson.

Gleeson Van Riet

Thanks, Steve. In my comments today, I'll highlight our fourth quarter financial results, operating cost, hedging program and capital structure. Production for the quarter average 177 million cubic feet of gas equivalent per day, which represents a 13.6% increase from the third quarter, driven by strong base performance in Artesia, including contribution from a three well pad that came online late in the third quarter.

Fourth quarter production also benefited from turning four wells online on or ahead of schedule including our first well in Uno Mas. Fourth quarter revenue was $58.7 million with natural gas, representing 79% of our production and 63% of our reserves. Our average realized natural gas price excluding hedging was $2.88 per thousand cubic feet compared with $3.01 in the third quarter. Our differential was a $0.05 discount to Henry Hub and illustrates why the Eagle Ford is such a great market for selling gas.

Turning to liquid, our average realized crude oil selling price excluding hedging was $57.64 per barrel compared with $46.93 in the third quarter. A differential was $2.23 above WTI due to the fact that we sell off LOS which probably trades at a significant premium to WTI. Our average realized natural gas liquid selling price increased $2.70 in the quarter to $24.37 per barrel or roughly 44% of WTI.

Turning to hedging, we added significantly to our hedge book in the quarter and have since then even added a few more hedges. Using our 2018 guidance midpoint of 185 million cubic feet equivalent per day and assuming that same level through 2020, we were 63% hedged in 2018, 41% hedged in 2019 and 23% hedged in 2020.

At this point hedging program is integral to how we manage risk, but we plan to continue systematically adding additional hedges to further protect our cash flows. As mentioned on our last call, we entered into some NGL hedges in the fourth quarter and in addition, we're now hedging both our LOS and gas differentials to lock in favorable pricing.

Turing to costs, LOE was $0.34 per Mcfe compared to $0.41 in the third quarter, driven by continued compression optimization, labor force reductions at the field level and other costs initiatives that Steve discussed.

For the first quarter of 2018, we're expecting LOE expense of $0.35 to $0.36 per thousand cubic speed equivalent, which represents a slight uptick fourth quarter level, primarily due to lower volumes.

As a reminder, our first quarter costs guidance assumes two full month of AWC Olmos in our financial, so we would expect further reductions going forward as these higher LOE wells exit our portfolio. The AWC Olmos sale is expected to close today and has a sales price of $28.8 million with an effective date of January 1.

As such we will recognize all the production revenues and cost in our financial statements till the end of February and adjust the final settlement payment downwards by the amount of net cash generated by those assets during these first few months.

This divestiture represents 491 wells with approximately 60% of our well count and 6% of our fourth quarter production. So our move-in from the portfolio goes a long way towards cleaning up a lot of noise around our reported results, allows us to leverage our existing personnel across our core Eagle Ford footprint. Additionally, despite the wells had significantly higher lifting cost on a per unit basis, as such our full year 2018 LOE guidance of $0.25 to $0.28 is significantly lower than the $0.39 we reported for the full year 2017.

Transportation and processing costs for the fourth quarter were $0.32 per Mcfe. Adding our LOE and C&P together we have a total OpEx of $0.66 per Mcfe, which we believe compares favorably to our peers.

Production taxes came in at 3.1% of oil and gas revenues for the fourth quarter, which was a significant decline from the prior quarter, primarily due to one-time credit. Cash G&A of $5 million was up slightly compared to third quarter levels, primarily due to $1.7 million in severance cost related to the replacement of our COO, another adjustment to our officer group.

We're guiding for cash G&A for $4.7 million to $5.1 million in the first quarter of 2018 due to timing of our annual bonus payments, which always occur in the first quarter. For the full year 2018 we're guiding for cash G&A of $18.1 million to $19.1 million. In total our strong production growth and continued cost focus drove a 35% quarterly increase in adjusted EBITDA to $42 million.

Cash interest came in at $3.2 million for the quarter and increased from the prior quarter primarily due to higher borrowings under our credit facility. Additionally our interest expense reflect the half month of interest related to our $200 million second lien notes, which were issued on December 15. Our all-in-cash operating expenses including G&A came in at $1.08 per Mcfe in the quarter compared to $1.24 in the prior quarter.

We spend approximately $50 million on capital expenditures in the quarter including $22 million for leasing and acquisition. Additionally we spend $16 million on transferring our Bay De Chene plugging and abundant liability over to a third party. This BDC transaction reduces our ARO by $20.9 million, which is split between $7 million of current liabilities and $13.9 million in long-term liabilities.

We recorded a $16.3 million payables for our obligations under the sale contract, split between $11.3 million in accounts payable and $5 million in non-current liabilities. Under full costs accounting we do not recognize any gain on the $4.6 million difference between the transaction price versus the ARO LIBOR removed and instead we record a $4.6 million decrease to our capitalized oil and gas properties.

Additionally, our AWP Olmos sale will move another $6.2 million of ARO from our balance sheet during the first quarter of 2018. As such on a pro-forma basis our ARO at December 31, 2017 would be approximately $5 million, which compares very favorably to our 2015 ARO liability of over $60 million [ph]. We view this low liability level as extremely favorable for a company of our size, which further highlights the benefit of our streamline portfolio.

Our 2018 capital program of $245 million to $265 million provides for 30 to 32 net operated wells to be drilled, compared to approximately 18 net operated wells in 2017. Approximately 70% of our budget is allocated towards drilling and completion capital, driven primarily by 13 net wells drilled in Fasken, seven net wells drilled in AWP, and five net wells drilled in Oro Grande.

Since our second rig is just getting started, we won't finish completing any wells from this rig until late in second quarter, we plan to bring 25 to 26 net wells for sale in 2018, compared to approximately 22 net wells in 2017. That said, since the second rig will have a typical startup lag between spudding its first wells, completing them and then turning them to sales, we expect to end 2018 with an increased index from 6 at the end of 2017 to 10 to 12 at the end of 2018.

We're forecasting average production of 175 million to 195 million cubic feet equivalent per day for the full year 2018. Additionally, we provided first quarter 2018 guidance of 156 million to 162 million cubic feet equivalent per day on an as reported basis and 150 million to 156 million on a pro forma basis to reflect the AWP Olmos sale. Our corporate presentation includes updated first quarter and full year 2018 guidance, so please refer to it for our latest expectations.

Well the timing of the six wells Fasken pad and commencement of the second rig, with some lumpiness on our production for the first half of the year, but it sets us for strong growth in second half of 2018 and well into 2019.

Our liquidity of approximately $260 million as of December 31, 2017 consisted of $7.8 million in cash and $252 million of availability on our bank credit facility. As previously announced, our fall redetermination concluded with an increase of our borrowing base from $330 million to $370 million. However, our borrowing base was subsequently reduced to $330 million in connection with the grant associated with the issuance of the second lean note.

The proceeds from our second lean notes significantly increased our liquidity and enhanced our balance sheet flexibility and attractive cost of capital. This flexible capital has relatively benign prepayment penalties with some minimum hedging requirements, which are in line with our prudent hedging strategy and have already been taken care of.

Our strong liquidity and solid balance sheet are a testament to our entire team's efforts and I'd like to thank our banking syndicate for their continued support during our fall redetermination as well as the second lien transaction. We expect to fully fund our 2018 capital program with cash generated from operations and borrowings on our credit facility. At the end of the fourth quarter, we were in full compliance with our financial covenants and had significant headroom.

And with that, I'll turn it over to Sean to wrap up our prepared comments.

Sean Woolverton

Thanks, Gleeson. So to summarize, 2017 was a great year as we positioned ourselves with a lot of momentum to execute on our 2018 objectives. We expanded our inventory through a successful drilling campaign with successes at every field in our portfolio. As we think about 2018 and beyond, our goal is to continue to grow production by drilling wells with attractive rate of returns and maximizing our margins by leveraging our low operating costs.

We continue to focus on driving operational efficiencies and operate with a pure leading cost structure. We have developed a robust drilling inventory with a substantial number of locations that deliver attractive rate of returns and we are continuously working to high grade this opportunity set. Along with a prudent balance sheet that has strong liquidity and a veteran operating team, we are well positioned for strong growth over the coming years.

At this point, I'll turn it back to the operator for the Q&A portion of this call. Operator, we are ready for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jeff Grampp.

Jeff Grampp

Good morning, guys. Nice quarter.

Sean Woolverton

Thanks, Jeff.

Jeff Grampp

I was hoping maybe to start off if you guys could expand a little bit on some of the commentary on some of these optimization tests that you guys are looking at. Is it more I guess just kind of continuing some of the smaller tweaks and fine tuning that you guys did in 2017, or are there may be some bigger changes you guys are looking to do? Maybe just a little more details there would be helpful.

Sean Woolverton

Yes, Jeff and I start, and then we'll let Steve maybe weigh in as well as he brought some good ideas to the table for us. So you think about the large inventory set that we have across the gas spare way here, and it is really early days specifically to the upper Eagle Ford at Fasken and the large position that we've accumulated kind of in the Southern part of La Salle and McMullen.

So we wanted to test larger stimulations. We did that with the first well at Oro with 3,500 pounds per foot, very pleased with the results there. I thought we would test some lower cost concepts scaling back stimulations on the next two wells in that area to about 2,500 pounds per foot.

In light of some of the early results we're seeing, we think there is a pretty close tie now to the stimulation site. So expect that in these next series of wells that we plan to drill, and we plan to drill a dozen wells in the deeper Southern Eagle Ford gas window this year. Probably expect to really go even bigger than the 3,500 pounds per and test maybe the upper extreme.

And then of course trying to weigh that can we bring cost down. So that's kind of a general overview. And maybe I'll let Steve talk a little bit more about some of the other things we're doing on the stimulation side.

Steven Adam

Thank you, Sean. Yes, we're seeing opportunities across the entire portfolio, not just because of its massiveness SW [ph] but some of the raw characterization that we're currently having to do in this early phase of appraisal. Admittedly a lot of this is in appraisal with some delineation and yet no development.

Of interest in the stimulation design it's more than just more is better. It's a case that we've seen an opportunity that we try to leverage from the lower Fasken, which was in the development mode, that we were able to successfully say, that's kind of on a lower side of what we're seeing in terms of the opportunity.

So as we work more towards developing these resources, we've seen success in designs that are 3,500 pounds per foot and looking to go more. With that now to get into some of the detail, the increased stage density seems to also have a strong effect and to some degree it's still a mixed bag as it relates to the clusters.

However, we're seeing more and more cluster as it relates to our increased density of stages. Added to that, we've been working with some new diversion technology that's also equally been enhancing to some of the early returns. And then lastly, not in all rock areas, but in some of the rock areas, we're finding where some of the falls are calcite field as well as some of the other poor spaces have some calcite filling and then some carbonated material. As such, we've been introducing some different fluid design changes, some of that being complementary to the use of assets. So that's some of the detail to support just more than just bigger is better.

Jeff Grampp

Alright, great. Appreciate those details. And then switching over to some of the stack development test that you guys referenced, can you guys maybe give us a sense of what kind of spacing assumptions within the Eagle Ford you guys might be going down to, I guess, just kind a given what some other peers have talked about lately would be helpful to kind of get a sense for where you guys are at today and maybe where you're looking to go down to?

Sean Woolverton

Yes, we see, I'll take that one and I thank you for that question, because it's something that's really strong in our chemistry right now. Because we have so much knowledge with lower Fasken. But as we work towards these more appraisal delineation areas especially with much thicker reservoirs it's giving us an insight as what we can do both from our own knowledge as well as looking across the fence to others.

So in short, if you fast forward, I probably don't see it being any narrower than 660 end zone same play and with the potential for stack configuration to be 330. We are doing some testing in around the 800 to 850 range and we're bringing those down tighter closer towards 650 in our modeling of our frac modeling design.

Jeff Grampp

Okay, perfect. That's great detail. And then if I can sneak one more and in the release you guys referenced kind of going more from similar kind of I guess acreage capture with a big team in 2017 to more kind of execution development. So I was wondering is that I guess more function of you guys kind of being happy with the inventory levels, where they're at now? Or are we seeing opportunities maybe getting a little bit fewer and far between?

Sean Woolverton

Yes, I'll fill that one, Jeff, this is Sean, again. We are seeing more competition come into the play, which should help the momentum behind it as more operators will be in drilling as well as testing some completion designs. But with that we've seen competition increase on leasing. We have dedicated about 10% of our budget to this year to leasing. And we'll be opportunistic if we see more opportunities on leasing front we'll expand that budget if it warrants it.

And we are seeing the A&D market heat up in the Eagle Ford a number of packages have come into the market. So we'll be active on the A&D front. So we'd like the inventory we've assembled. Getting to 100,000 acre was important to us to get to that critical mass. But we're willing to push the size of the portfolio even further if it warrants it and we can generate good full cycle returns in drilling there.

Jeff Grampp

Alright, sounds good. Appreciate it.

Sean Woolverton

Thanks, Jeff.

Operator

Your next question comes from Ron Mills.

Ron Mills

All of my questions have been answered. Thanks guys.

Sean Woolverton

Appreciate it.

Sean Woolverton

Thank you.

Operator

Your next question comes from the Ben Wyatt.

Ben Wyatt

Hey. Good morning, guys.

Sean Woolverton

Good morning, Ben.

Ben Wyatt

If I can make stay on one of the questions, Jeff asked his last one on the acreage side of things, just maybe focuses on a gas window, any acreage adds that you guys do is it going to more on filling in kind of where you are, are there other parts of the gas window that you guys would go into almost a new footprint of some sort?

Sean Woolverton

You look at the scale of the Eagle Ford gas fairway going from Webb County all the way up through Crown's [ph] Trough and there is well over 1 million acres there. So, we're sitting around the 100,000 acreages. Right now we are focused on building scale around our existing areas. So really Southern AWP, Uno Mas and Oro Grande, if you look from Oro Grande up through Uno Mas we've put in about just over 55,000 net acres.

So, right now that's where we're concentrated in building more of a consolidated block from Western part of Oro Grande although we have through the Eastern part of Uno Mas. But we have our teams looking really across that entire fairway and if we see the right opportunity come along that putting in another block we will do that as well.

Ben Wyatt

Got it, that's helpful. I appreciate it, Sean. And then maybe just another question as I think about 2018, you guys obviously are on that second rig going to complete more wells this year, maybe just trying to gauge confidence you guys have around securing frac crews completing those wells. Just any kind of color you guys can provide around that?

Steven Adam

So, thank you for that question as well. One, just in support of the fast frac crew we're going to be picking up a second drilling rig that we've contracted and it's both of our rigs are supper stack rigs. So that gives us a lot of fungibility across our asset as I mentioned in the prepared remarks. To support that then on the frac side we've entered into not a level loaded, but we have entered into time slot dedication with the frac provider and we were able to also have durability in those cost throughout the entire year.

Ben Wyatt

Very good, that's - appreciate, that Steve. And then maybe lastly here for me guys congrats on the Olmos property, just curious is there anything else left to kind of clean up more wells that you guys can sell with the higher lifting costs or should we kind of think of really it's just driving down cost from the efficiency level from here going forward?

Steven Adam

Yes, really I think we're pretty streamline at this point going forward, we have about 300 producing wells, 200 of those are Eagle Ford wells that have been drilled over the last probably six to eight years, so very new wells. The reason our ARO so low is those one have to be abundant for decades.

The remaining 100 wells are lower quality wells, but really intertwined with the portfolio that we want to probably keep going forward. We may look to shed some of that, but don't see really clear cut way to do that. Those 100 wells currently make up about 1% of our production. So, I think we're down to the portfolio that we want to go with and then the only direction it would move is to add to it going forward.

Ben Wyatt

Very good. Well, guys I appreciate it, keep up to good work.

Steven Adam

Appreciate it, Ben. Thanks for your comments.

Operator

[Operator Instructions] Your next question comes from John Aschenbeck.

John Aschenbeck

Good morning, thanks for taking my questions and congrats on all the recent announcements. It's really tremendous amount of progress since just last quarter's update. So…

Sean Woolverton

I appreciate that, John.

John Aschenbeck

Yes, sure. First question is on 2018 production profile, your prepared remarks are really helpful understanding the Q1 sequential production decrease. So, just, I guess, looking through the rest of the year, what is your current guidance imply for an 2018 exit rate at least and I think you are trying tease at that this in your prepared remarks, but it seems like you should have some pretty significant momentum as you exit the year given the back end weighted schedule?

Sean Woolverton

Yes, thanks. We don't really give out guidance for a bunch of reasons but if you kind of look at our first quarter guidance right where kind of a pro-forma basis given all stuff Steve walked through going to be kind of down a little bit on Q4. I think in Q2 you can figure out kind of probably as we're starting to get the second rig we're not as impacted by the pad drilling we don't get the benefits for the second rig as much.

That said, Q2 is probably around this where Q4 would be is what I think. So the growth that we have is really back half of the year. So I think everyone can have some of their own what they think is going to happen in the back half of the year and we have to talk with you kind of offline, but I think the back half will be very strong and that's where the growth comes in and then again given that we think that that's stuff 2019 yes but it is very back and loaded and I think Q3 and Q4 both will become equally amount of growth is sort of a big picture the way I think about it. Is that helpful?

John Aschenbeck

Yes, it's extremely helpful. Thank you for that. So it kind of lead into my next question or not as exact if you will, but just looking into 2019, when you're kind of expected the transition into that data of cash flow neutrality I suppose not too longer after that you begin generating free cash flow. How do you think the going forward plan after that point, do you begin returning cash to shareholders or do you continue to pursue higher return of projects in the drill bit and just continue with growth?

Sean Woolverton

Yes, sure. I mean, look I think the management team they always look to put capital for your highest and best use and when you are a growing company and you've got a lot of opportunities to invest in high rig return projects you suppose to do that that's generally what shareholders wants.

So, I think what we look at as a management team is we live in a bulk commodity environment always have always will and the capital markets are a bit volatile too. So I think the steps we took at the end of last year putting in place the second lien to really give us that solid under pending of financing us seven year these days that doesn't get re-determined. And then leaving our revolver fully undrawn.

There is lot of liquidity a lot of financial flexibility to add on that all the hedges we have, which again kind of gives a lot of cousin should things get volatile and then you look at the low cost that really Steve is kind of putting together I think that sets us well whether we want to kind of keep leasing and growing and what we think is very attractive place for Eagle Ford or if at some point down the road we want to pay out company shareholders we could do that.

But again I think when in the growth mode where we are in our development, I think that's kind of as more a big company that has less investment opportunities that thinks about returning capital versus where we are we've got a very deep bench with a lot of attractive rate return inventory broadly.

John Aschenbeck

All right, great. Very helpful color. That's it from me, appreciate it, thanks.

Sean Woolverton

Okay. And as stated if you guys want to give a call later if any analyst want to call us to talk about modeling we're happy to do that. Because happy to guide and make sure that there are certain line with what we think.

Operator

[Operator Instructions] There are no more questions at this time.

Sean Woolverton

Okay, thank you operator and thank you everyone for joining the call. Have a good day.

Operator

This concludes today's conference call. You may now disconnect.