CANONSBURG Jan 29, 2016 (Thomson StreetEvents) -- Edited Transcript of CONSOL Energy Inc earnings conference call or presentation Friday, January 29, 2016 at 3:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Tyler Lewis CONSOL Energy Inc - VP of IR * Nick DeIuliis CONSOL Energy Inc - President & CEO * Dave Khani CONSOL Energy Inc - CFO * Tim Dugan CONSOL Energy Inc - COO of E&P Division * Jim Grech CONSOL Energy Inc - Chief Commercial Officer ================================================================================ Conference Call Participants ================================================================================ * Neal Dingmann SunTrust Robinson Humphrey - Analyst * Pavan Hoskote Goldman Sachs - Analyst * Evan Kurtz Morgan Stanley - Analyst * Holly Stewart Howard Weil Inc - Analyst * Sameer Panjwani Tudor, Pickering, Holt & Company - Analyst * Matthew Korn Barclays Capital - Analyst * Jeffrey Campbell Tuohy Brothers - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Ladies and gentlemen, thank you for standing by and welcome to CONSOL Energy's fourth-quarter 2015 conference call results. 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, Mr. Tyler Lewis. Please go ahead, sir. -------------------------------------------------------------------------------- Tyler Lewis, CONSOL Energy Inc - VP of IR [2] -------------------------------------------------------------------------------- Thanks, John and good morning, everybody. Welcome to CONSOL Energy's fourth-quarter conference call. We have in the room today Nick DeIuliis, our President and CEO; Dave Khani, our Chief Financial Officer; Jim Grech, our Chief Commercial Officer; and Tim Dugan, our Chief Operating Officer of our E&P division. Today we will be discussing our fourth-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 risks, which we have laid out for you in our press release today as well as in previous SEC filings. We will begin our call today with prepared remarks by Nick followed by Dave and then Tim. Jim Grech will then participate in the Q&A portion of the call. With that, let me start the call with you, Nick. -------------------------------------------------------------------------------- Nick DeIuliis, CONSOL Energy Inc - President & CEO [3] -------------------------------------------------------------------------------- Good morning. I would like to kick things off with a quick recap of the macro environment in the industries in which CONSOL operates. Throughout the fourth quarter natural gas prices fell by approximately 25%, oil declined to approximately 15%, the BMA index for met coal settled another $8 a metric ton lower, and thermal coal storage is 9% above five-year averages. Over the course of the past year, the fourth public coal company recently filed for bankruptcy, and the administration continued a politically-driven assault on the production and utilization of coal. It's truly an unprecedented time in every way, shape, and form. Now even considering these issues in the coal market, CONSOL has accomplished in an extremely challenging environment some pretty staggering things. We have done this by managing what we could control. And specifically we are talking about things like safety, unit costs, capital, capital spend, gas hedging, and coal contracting. I would like to briefly touch on each one of these. Let's start with safety. Safety, most of you know, is our core value, and CONSOL had one of its best years ever in 2015, especially when you look at severity level and safety performance. So zero incidents, zero accident is our standard. That means there is still more work to be done, but we had a very good year in safety in 2015, and I applaud our employees, especially when considering the onslaught of distractions that they have had to contend with throughout the year. So whether it had to do with changes across the industry that we have seen, share price performance, headcount reductions, or you name it, there were plenty of distractions. I couldn't be more proud of our employees for upholding our number one core value throughout what's been a challenging time across the industries that we operate within. If you jump over to unit costs, unit costs for E&P and coal have been consistently impressive. We have met or exceeded all cost guidance that we provided over the past 18 months. Dave Khani and Tim Dugan are going to go into more detail in a couple of minutes, but CONSOL has put up some tremendous numbers in regards to cost improvements. For coal, we've also done this while exerting production discipline and lowering our estimated 2016 sales tons. That might be very counterintuitive, but it goes to show you that we push the status quo and we challenge our operators every day. This isn't going to be an environment where we rest on our laurels. We go over to gas hedging, throughout the year we've layered in some substantial gas and basis hedges. We're certainly glad that we did in hindsight. About two-thirds of our gas production is hedged with NYMEX and basis hedges at $3.28 in MCI. That is protected revenue; that's going to help derisk our business and internal free cash flow plan. Jump over to capital discipline. And really, more importantly capital efficiency improvements. These are probably the biggest step changes we've seen in 2015. We've significantly reduced capital primarily due to efficiency improvements that we've seen around drilling, completions, and especially cycle times. Our rate of change in cost improvements is industry-leading, and Tim Dugan is going to expand on those details in a couple of minutes. We've gone from an E&P capital spend level of a little over $800 million in 2015 to an estimated $205 million for 2016. Despite the reduction, we expect to grow gas volumes approximately 15% during the year, and we're going to enter 2017 with around 60 drilled but uncompleted wells. We've been consistently reducing capital over the past year due to these efficiencies and debottlenecking improvements, and I believe we are one of the first if not the first operators out there in terms of putting out an original 2016 budget. We will continue to benefit from capital efficiencies and production growth. We will be a byproduct of making decisions based on things like rates of return and NAV per share. Now if we shift and talk a minute about contracted tons on the coal segment side. If you are a coal producer and you don't have committed tons, you aren't going to move your tons, period. Our committed tons quite frankly should be viewed as a premium in this market. That said, as we alluded to in our release and recent announcements lowering our estimated 2016 coal sales guidance, there is volatility surrounding the time of the shipments due to high inventory levels of our customers. Now we certainly value our customers and relationships with them, some of which span multiple decades. However, I want to be clear our coal tons are sold, our customers have a contractual obligation, and our expectation is for them to stand behind their oral, written, and legal requirements. We'll continue to do our part by reducing costs as much as we can. We're also focused on fighting for the top line at the same time. All of these levers that we've focused on have resulted in our leverage ratio at the end of the fourth quarter of 3.6 times, which is a decrease from the prior quarter in what has been obviously a continued degradation across the commodities throughout the quarter. In addition, CONSOL finished the fourth quarter with approximately negative $15 million in free cash flow. Now if you remember our target, as we previously stated last quarter, was to be free cash flow neutral. Well we almost hit the goal, but we know that almost isn't good enough. That said, we do see this as a success, especially given the backdrop with the distraction we continue to see throughout the quarter in pricing, highlighted in the opening remarks that I made. Now I would like to spend a minute or two addressing the topic of asset sales, which has been a recurring theme that has been prominent in our conversations with investors throughout the second half of 2015 in particular. Based on our base free cash flow plan, we don't believe that we need to sell assets to support liquidity and our balance sheet. We're going to remain patient and selective on what assets we are willing to sell in this environment, if any. I think it's important to remind people that we originally discussed our monetization program during our analyst day mid-year 2014. In starting then we talked about having a bucket of valuable assets which we could potentially monetize over a number of years. And this was primarily driven to support our strategic transformation into a pure play Appalachian E&P company, while at the same time potentially bringing forward value for assets that are no longer quarter consoles. Our suite of potential monetization candidates has changed since then, and that's predominately a result of the success that we're seeing in the dry Utica Shale. We believe dry Utica adds substantial to the Company, and more recent disclosures on our monetization program talk about running 30 processes and stated that bids were coming in. We also said that we were running so many processes in order to create competition across these asset packages, but weren't going to be afraid to pull things into the process or out of the process since we do not believe that we need to sell assets. So despite the continued degradation across the commodities, we have completed 5 sales out of the 30 asset sale processes. In the third quarter of last year we posted about $100 million asset sales, and we recently sold in the fourth quarter a mine in Utah to a private entity. We've got a track record of success at selling assets, and when you look back starting in 2012, CONSOL has sold in aggregate $5.8 billion of assets paid for in a form of cash, royalty streams, and the assumption of liabilities. We believe we are positioned ride out this environment, but we are not willing to sell assets at depressed prices based on our internal view of NAV per share, weighted against sales proceeds opportunities. Throughout the quarter we felt that many of the potential counterparties were trying to use this environment against us, so we are still active but we are taking a more patient approach, being selective on what assets we sell and at what price. Nothing has changed regarding our strategy. We will continue to execute sales when we believe the timing is right. We believe we have the people, the assets, and the balance sheet to ride out this environment. So in summary, we don't believe that we need to sell assets to support liquidity in our balance sheet. We're going to remain patient, were going to remain selective on what assets we're willing to sell in this environment, if any. I just want to wrap up before I turn it over to Dave and Tim. Bottom line is that we value growth when pricing is strong. When pricing is weak, strength of balance sheet becomes paramount. Again, we are controlling what is within our power to control. Moves we made early on when prices began to deteriorate in 2014, those moves are paying dividends now and are going to continue to pay dividends in the future. We will continue to assess the environment we operate within and react accordingly, we'll make the prudent decisions necessary to ensure the balance sheet remains durable, and we're going to ensure that we are positioned to capitalize on opportunities when the markets turn, and the markets will turn. With that now, I'm going to change things over to Dave Khani. -------------------------------------------------------------------------------- Dave Khani, CONSOL Energy Inc - CFO [4] -------------------------------------------------------------------------------- Thanks, Nick, and good morning, everyone. My comments will tie to our updated slide deck, which is posted to our IR site under presentations to analysts. As highlighted in our press release this morning and indicated on slide 5, CONSOL posted fourth-quarter 2015 adjusted EBITDA attributable to CONSOL Energy shareholders of $206 million, cash flow from operations of $102 million, and adjusted net loss of negative $0.26, or negative $0.11 per share. There were a handful of adjustments during the quarter. Specifically, CONSOL again received the benefit of approximately $110 million resulting from recent retiree medical plan amendments. This benefit resulted in lower operating and other coal costs in the quarter, as well as lower annual cash payments going forward related to these liabilities by about $15 million to $20 million. In addition to the OPET benefit, there were some additional items such as pension settlement expense, unrealized gain on commodity derivative instruments, gain on the sale of non-core assets, and a $65 million tax valuation allowance. We've updated guidance for coal, E&P, and some corporate expenses on slides 45 and 46. But first I want to applaud our teams that have demonstrated that they can exceed our forecasts by reducing capital intensity and unit costs. We have world-class assets and people managing them. Now looking over the E&P side. As stated on slide 8, the E&P division finished the quarter with a record production of 95.5 Bcfe, and our average daily volumes now track above one Bcf per day. As Tim will discuss in more detail, we have also announced the result of our second Pennsylvania dry Utica well in Greene County, which is very exciting. The combination of a small uplift in prices and cost reductions improved margins by about $0.51 per Mcfe sequentially. We realized $2.78 per Mcfe, which benefits from our hedge position and modest uptick in liquids prices. As you can see we have about 60% of our E&P production hedged in 2016 along with our basis. Now recently basis has gotten a little worse on our open volumes, and this is reflected in our new guidance. We have approximately $300 million a day of open natural gas volumes at our current basis differential forecasted around $0.55 to $0.60 per Mcf. That said, on the E&P side we're watching the impacts of low prices on activity. We've seen several producers head into bankruptcy, small and large producers cut CapEx by 40% to 60%, and unhedged companies deferring or shuttering production. I point this out because we expect to see a supply response in 2016. Now on the cost side, we saw incredible cost performance finishing the fourth quarter, with total all-in and cash costs of $2.45 and $1.40 per Mcfe respectively. The cost performance is a combination of efficiency improvements and rising Marcellus and Utica shale volumes. Now as we layer in dry Utica, unit cost reduction should continue well into 2017 into 2020. With a much clearer picture of our costs into the future, we have stronger conviction to hedge profitability more in the outer years. Stay tuned. Now on capital, we recently brought down our E&P capital by another $185 million compared to the previous guidance of $400 million to $500 million. This is primarily driven by efficiencies that we're seeing across our E&P division, which is illustrated by our Marcellus D&C cost, now around $1 million per thousand lateral feet. Mid-stream capital has come down meaningfully, with these productivity improvements and stat pays. Now to emphasize how much we've improved and to help you think through what 2017 volumes could be, I have some key details for you. For 2014 and 2015 we've spent about $1.5 billion of G&C capital. However, as of year end 2015 we also have 102 gross docks and 42 wells fracked but not turned inline. This has a net sunk capital of about $421 million. So netting this out, we spent really a $1.1 billion to double our production to about 1.04 Bcfe at year end, 2015, from the beginning of 2014. This production though has pressure constraints leading to large volume devolving benefits that our CONE team will unlock. Now looking forward, we will only need to spend about $250 million to turn inline these 144 gross wells over the next couple of years. These wells have unconstrained net production of over 725 million cubic feet equivalent a day, enabling us to grow or offset the 50% production decline in our underlying asset base. Now let's move over to slide 10 on coal. Our total coal division sold 6.6 million tons in the fourth quarter of 2015. The PA operation's average sales price per ton decreased during the quarter to $52.57 compared to $60.10 from the year-ago quarter in 2014. Northern App thermal coal prices continued to decline due to consistently low net regional natural gas prices, weak December weather, and higher than normal inventory levels. This caused about 1 million tons of shipment deferrals that were replaced with some spot tons below our contracted price. Our total coal costs for the quarter came in $41.97, reflecting all the work to drive down unit costs at our mines, including extreme mitigation. Our Buchanan mine posted strong cost reduction sequentially and is likely the only met mine generating a profit in the United States at these low met price levels. Our PA complex was running at four days a week to manage the contract levels, and will run below capacity until shipment pace increases to our contracted levels. On the capital side, CONSOL's coal division remains in maintenance of production capital mode, and will focus on finding ways to reduce this capital in this environment. Now let's move to slide 41, which highlights our balance sheet and liquidity position. CONSOL recently announced a reaffirmation of our $2 billion credit facility, and maintains $856 million of liquidity, flat with the third quarter. Our leverage during the quarter, as Nick highlighted, came down sequentially to 3.6 times. Last quarter we detailed being free cash flow neutral with fourth quarter -- without asset sales. As Nick already highlighted, the commodity price environment got worse, particularly in December. Despite the E&P division being free cash flow positive in the quarter, CNX in total was slightly shy of its free cash flow target by about $40 million when you exclude asset sales of about $28 million, or about $15 million without [the] sales. The $28 million was part of the $75 million to $125 million target that we announced back in July of 2015 when we announced our capital budget productions. The impact from the weather on both commodity realizations and deferral of coal impacted cash flow by about $40 million in the quarter. However, looking forward we have more than offset this by squeezing more cost in capital to derisk our free cash flow plan. Now our Board has tied our 2016 short-term compensation for all minor managers and above to our free cash flow goals. So this Management team is very aligned with our overall goals to generate free cash flow to delever the balance sheet. With our internal free cash flow plan, we are confident that we can ride out this volatile market while positioning the Company to capitalize on even a modest uptick in the commodity. Our confidence in our base free cash flow plan, solid liquidity, and no maturities out for several years enables us to maintain our course and avoid the need to sell assets or tap the capital markets. Nick noted we will sell assets or -- and we will also drop down assets in one or both MLPs when appropriate. So with that, I will pass it over to Tim. -------------------------------------------------------------------------------- Tim Dugan, CONSOL Energy Inc - COO of E&P Division [5] -------------------------------------------------------------------------------- Thanks, Dave. CONSOL continues to make great strides on the E&P front, and today I would like to talk about the significant improvements to date, the accelerated rate of that improvement, and most importantly the exciting growth potential we see in our business going forward. In early 2014, we reorganized our E&P division and cross-functionally integrated asset teams. While this change was challenging initially, the new structure provided an increased focus that is really more improved and is repeatedly driving improvements in our E&P business. This is a primary driver behind our continued organic growth at lower cost and increased efficiency. This renewed focused was a point of emphasis at our analyst day in June of 2014, where we unveiled our plans to grow the E&P business with specific goals for improvement through 2016. I'm happy to say that we have met or exceeded the targets discussed at that analyst day. We targeted a 5% to 10% annual reduction in operating expenses from 2014 through 2016. We sit here today in the beginning of 2016 with operating costs approximately 25% below where we started in 2014, and our efforts on this front will continue. Operationally, we've been focused on implementing lean manufacturing techniques, the impact of which can be seen in our drilling operations, where horizontal drilling days have been reduced 29% from 14 days in 2014 to 10 days in 2015. Over this same period of time, our rig move days decreased 27% from 11 days to 8 days. We've achieved 24-hour drilling footages in excess of 1 mile several times in the last two years, with the longest being 6,118 feet. Footage drilled per day is a key drilling metric, and has improved 22% from 2014 and approximately 83% from 2013. Applying lean manufacturing techniques, data mining, and rapid adoption of industry best practices has reduced CONSOL's average operated Marcellus CapEx per 1,000 feet of lateral to less than $1 million today, with projections for another 25% reduction over 2015. In addition to reducing costs and improving operational efficiencies, well quality improvements have driven our growth as well, and we remain on track to achieve approximately 30% compounded annual production growth rate from 2013 through 2016. Now that's where we have come from, let's talk about where we're going. In this morning's press release we detailed additional results on our dry Utica and the continued strong results demonstrated by wells previously brought online. While still early, trends are beginning to emerge and the new results and data coming in are exceeding our expectations, giving us greater confidence in the dry Utica's potential and the opportunity it represents to drive dynamic growth in the Company in the relatively near future. Our evaluation of the dry Utica is driven by four main variables. One, geology and reservoir characteristics; two, production and flow back methodology; three, drilling costs; and the fourth, our acreage and infrastructure position, specifically the advantages of our high NRIs and dry gas gathering infrastructure. As a result of CONSOL's large legacy land position in the Appalachian Basin, the Company not only has an extensive acreage position of 600,000 plus net acres in the Utica, but also a large and robust data set of Utica wells, enabling the Company to move quickly up the learning curve. CONSOL has production results not only from the seven Utica wells now online across the acreage, but also from another 12 to 13 deep dry Utica wells where the Company owns either a working interest or royalty, giving CONSOL what is likely the largest well control data set in the deep dry Utica. This well control data set now extends from Belmont County in southeast Ohio through West Virginia into southwest PA and up through Westmoreland County, PA. The attractiveness of the Utica lies in its present value opportunity, as we believe the over pressured Utica rock has the potential to dramatically accelerate production volumes and therefore cash flows in the initial life of the well. While the benefits of the improved EURs from a managed pressure draw down program in the Utica are already becoming well established, greater understanding of the rocks facing distribution and natural fracture characteristics is needed to further define our completion methodologies and will determine how hard operators can pull on the well in the early stages of its life without causing material damage to the well bore or formation. In practice we have already seen results from the Utica that support the expectation of sustained upfront production. Based on our got 4-H testing as well as other mature production, we conservatively believe that we can hold higher production rates at 15 million to 20 million cubic feet per day for 9 to 12 months before they start to decline, with potentially even higher sustained production rates in Pennsylvania of 20 million to 30 million cubic feet per day, or possibly higher. With longer production history and additional well control, we'll be able to zero in on the optimal rate and time period that we can hold production flat. Pinpointing and optimized pressure draw down pace subsequently helps us optimize our completion methodologies and the type of profit employed. As the greater the ability to pull hard on a well without embedment or damage to the well bore or reservoir, the greater the reward to use higher strength but correspondingly higher cost profits. We are performing comprehensive completion modeling to determine the optimal design. These simulations combined with economic evaluation will allow us to enhance rates of return. On the drilling front, similar to early Marcellus drilling, the deep dry Utica has a learning curve. We are highly confident in our ability to lower drilling and completion costs in the dry Utica not only due to our prior success in doing so in the Marcellus and wet Utica, but also because of our early successes in Monroe County with the five dry Utica wells we drilled there last year. Our first Monroe County well came in with a drilling cost of roughly $9 million and took 84 days to drill. By our fifth well we drilled it for under $5 million and 30 drilling days. We believe through an increased understanding of geomechanics and further bottom hole assembly and mud program optimizations, we can get that cost down under $4 million and 23 drilling days. We expect the same level of cost improvement in the rest of our dry Utica areas. In the Pennsylvania dry Utica just eliminating the cost of science work conducted on the initial wells and the corresponding higher cost associated with non-productive time will generate $3 million to $4 million in savings per well. That combined with efficiency gains is over $9 million in CapEx savings. And there is much more to come. Arguably the most important differentiating factor in terms of CONSOL's present value and rates of return in the Utica is the Company's large legacy land position from its 150-plus years in business. This gives CONSOL a significant competitive advantage in terms of the number of acres controlled in fee or with low royalties, which increases in our eyes and therefore boosts rates of return. Keep in mind CONSOL owns 100% working interest in our dry Utica acreage. In southwestern PA we expect our next 75 Utica laterals to have NRIs in the mid-90%s, while our competitors are happy to be reaching NRIs in the mid-80%s. Furthermore, these wells will also benefit from the CONE gathering system in southwest PA that is already built out for the dry gas Marcellus, lowering gathering costs and the necessary capital investment in production facilities. This represents a significant advantage to CONSOL compared to those operators within place gathering systems configured for wet gas. They will need to spend additional capital to build out dry gathering infrastructure, be disadvantaged on gathering cost by paying to process dry gas volumes, or will have higher rates to compensate third-party midstream companies for the cost of building out new dry gas gathering infrastructure. While still early, continuously improving production results and a growing data set has recently led us to further increase our average EUR expectations. We've increased our EURs in the Ohio dry Utica from 2.4 Bcf per 1,000 feet to 2.8 Bcf per 1,000 foot of lateral. In the Pennsylvania dry Utica we have increased EURs from 2.4 Bcf per 1,000 thousand foot of lateral to 3.0 Bcf per thousand foot of lateral. As we continue to evaluate the data behind the southwest PA type curves, it is likely that the data will support yet another increase in type curves. If we were to run the southwest PA breakeven at 4.3 Bcf per 1,000 foot of lateral similar to our competitors, our breakeven price to achieve a 15% ATAX rate of return would be less than $1.65. As we drive our CapEx below the $15 million mark, these breakeven prices go even lower. Those breakeven prices are CONSOL specific at our advantaged high NRIs, but when we run at the low -- run them at the lower average NRIs of our peers, and all else being equal we expect other operators will have higher breakeven prices. An important point to address about the emerging Utica play is the fear in the market regarding the Utica's impact on gas prices. These fears seemingly assume a static environment for all other natural gas development and the growing Utica volumes being additive to volumes from other plays, including the Marcellus. However, with production volumes across the US declining, we expect dry Utica volumes will displace less economically advantaged production from other plays, and dry Utica producers who will be able to achieve attractive rates of return even at lower commodity price levels will further benefit from capturing market share. To close, despite being at a challenging point in the commodity price cycle, CONSOL remains firmly on track to achieve its goal to strongly grow the E&P business while reducing cost and lowering leverage. We continue to wring out the capital intensity from our E&P business. The capital required to generate an incremental Mcfe of production has come down by 44% over the two-year period from 2013 through 2015 and is expected to decrease even further in 2016. The continued performance of our wells has enabled us to achieve results with significantly less wells than previously expected, with 67 horizontal wells planned to be turned inline in 2016 versus 130 in 2015 and 176 in 2014. Our inventory of 42 completed wells that have not been turned inline and 102 drilled uncompleted wells, we expect to exit 2017 with 77 drilled uncompleted wells, which will contribute to lower required capital intensity to maintain or grow production volumes. Our duck inventory, continued efficiency improvement in the Marcellus, and now the potential of the emerging dry Utica will sustain strong debt adjusted growth rates in our E&P division going forward. With that, I will turn it back to Tyler. -------------------------------------------------------------------------------- Tyler Lewis, CONSOL Energy Inc - VP of IR [6] -------------------------------------------------------------------------------- Thanks, Tim. And John, if you could open the call up now for Q&A. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Neal Dingmann, SunTrust. -------------------------------------------------------------------------------- Neal Dingmann, SunTrust Robinson Humphrey - Analyst [2] |