Thanks. Welcome to Antero Midstream second quarter 2019 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to Michael Kennedy, Chief Financial Officer. Thank you. Please go ahead.
Thank you for joining us for Antero Midstream second quarter 2019 investor conference call. We'll spend a few minutes going through the financial and operating highlights, and then we'll open it up for Q&A. I'd also like to direct you to the homepage of our website at www.anteromidstream.com, where we've provided a separate earnings call presentation that will be reviewed during today's call. Before we start our comments, I would first like to remind you that during this call, Antero management will make forward-looking statements. Such statements are based on our current judgments regarding factors that will impact the future performance of Antero Resources and Antero Midstream, and are subject to a number of risks and uncertainties, many of which are beyond Antero's control. Actual outcomes and results could materially differ from what is expressed, implied, or forecast in such statements. Today's call may also contain certain non-GAAP financial measures.
Please refer to our earnings press release for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. Joining me on the call today are Paul Rady, Chairman and CEO of Antero Resources and Antero Midstream, and Glen Warren, President and CFO of Antero Resources and President of Antero Midstream. With that, I'll turn the call over to Paul.
Thanks, Mike. I'll begin my comments on AR on slide number three, titled AR Strength and Resiliency Drives AM Strength, which illustrates the increase in capital efficiency, financial strength, and scale that AR has achieved since the AM IPO in 2014. Starting with the proven capital efficiency, AR's drilling and completion CapEx has decreased 50% from $2.6 billion to $1.3 billion from 2014-2019. Over that same time period, AR has generated attractive net production growth and replaced natural decline on a production base that is now over three times as large as it was in 2014, while reducing its development cost by over 50%. In addition, AR's operational efficiencies have driven its rig count down from a peak of 21 rigs to four rigs from Cal '14 to Cal '19.
From a financial strength standpoint, AR has taken considerable steps to maintain and improve its balance sheet, driving total debt down by over $700 million and reducing leverage from 3.9 times to 2.3 times. Over the past 5 years, we have maintained our conservative approach to hedging and risk management with 100% of AR's oil and natural gas production hedged for the remainder of Cal-20 and over 90% of expected natural gas production hedged in Cal -20. Our capital efficiency and financial strength have allowed AR to achieve significant scale over the last 5 years, roughly tripling proved developed reserves that underpin the future growth at AM. Antero continues to be a dynamic and integrated organization with a track record of driving efficiencies, navigating challenging commodity price environments, maintaining financial strength, and doing what we say we're going to do.
We expect this track record to continue even at current commodity strip pricing, which is driven by AR's 10%-14% well cost reduction initiatives that I will discuss on slide number four, titled Cost Reduction Initiatives Breakdown. Over the last several quarters, we undertook an internal review of every expense line item associated with AR's well costs with the goal of becoming a peer leader in well costs. The outcome is well cost savings of $1.2 million-$1.7 million per well for a 12,000-foot lateral, bringing AR's targeted well cost to $0.83 million-$0.87 million per 1,000 feet of lateral. These savings will come from a combination of water optimization, service cost deflation, and continued efficiency gains, approximately 35% of which has already been achieved as of today.
On the water optimization front, AR is targeting approximately $800,000 per well in cost reductions from optimized completion design and a more efficient and localized flowback water management process. After successful pilots using mostly 100-mesh proppant, AR plans to reduce water used in completions from a range of 40 to 45 barrels per foot down to 35 to 38 barrels per foot in a new cost-efficient completion design. Completion design optimizes both fracture length, which is driven by water usage, and reservoir conductivity, which is driven by the type and amount of proppant, in the most cost-effective manner without any degradation in production or EURs. On the flowback water side, AR is targeting these savings through more efficient flowback water management.
AM plans to expand the scope of its water services to help AR to achieve these savings. AM expects to offset the majority of the $25 million-$35 million impact from drying up the completions with cash flow from these new water services. In addition, AR is targeting $650,000 per well in savings from, number one, vendor and service providers to reflect the deflationary commodity environment, and secondly, additional direct sourced sand and improved last-mile logistics, and thirdly, efficiency gains from improved completion stages per day, drilling days, and taphole optimization. These savings make AR a more resilient and more capital-efficient producer, which in turn ensures AM's throughput volume growth.
Assuming a similar level of drilling and completion activity in Cal-20 compared to Cal-19, or approximately 110 to 120 wells, results in a drilling and completion budget for AR of $1.2 billion to $1.3 billion, even while increasing average lateral lengths from 10,200 feet to 12,100 feet. This drilling and completion capital budget allows AR to target a 10% net production compound annual growth rate that is roughly cash flow neutral at current strip pricing. Further to AR's resiliency to commodity prices, I want to briefly touch on AR's hedge position on slide number 5, titled AR's Hedge Position. Our comprehensive hedging program, which has generated $4.5 billion of net cash hedge gains over the last 10 years, has been crucial to our success and underpins the long-term stability in AR's development plan.
For the remainder of 2019, AR is 100% hedged on its oil and natural gas production through a combination of swaps and collars at a blended floor of $2.79 per MMBtu on gas and $59.50 per barrel on oil. Looking ahead to Cal-20, AR has approximately 90% of its natural gas production hedged at $2.87 per MMBtu, or approximately 15% of current NYMEX natural gas strip prices after executing additional hedges in the second quarter of Cal-19. Looking to 2021 and beyond, AR has hedges at attractive prices between $2.88 per MMBtu and $3 per MMBtu. Altogether, AR's hedge book has a $716 million mark-to-market value as of June 30, 2019, and a $774 million mark-to-market as of yesterday, July 31, 2019. Let's move on to the AM opportunity set on slide number six, titled AM Water Operations and Future Opportunity Set.
The top half of the page illustrates the current flowback and produced water operations where AM contracts a third party to truck flowback and produced water to the Antero Clearwater facility and to third-party injection wells. The bottom half of the page illustrates AM's opportunity set. AM is planning to expand the scope of its water business to reduce third-party trucking and utilize new and existing infrastructure to transport flowback and produced water. This solution is cost-efficient for AR, improves road safety, and reduces emissions from trucking. It also allows for increased reuse of water in future completions. This business would replace AM's current cost of service business, which generates a 3% margin, with more attractive margins and double-digit rates of return.
Specifically, in our Northern Rich Gas fairway, where our development activity will be focused over the next five to eight years, we plan to, number 1, construct localized storage near our development. Number 2, utilize mobile treatment for flowback and produced water volumes. 3, implement blending operations into our fresh water system. The blended and treated volumes reused and delivered through the fresh water system for completions will continue to be charged the very same current fresh water delivery fee and will act as a reliable water source, similar to the effluent water that comes from the Antero Clearwater facility, where the effluent is put directly back into the AM fresh water system. In addition, we plan to repurpose certain segments of the existing freshwater system to transport flowback and produced water to localized blending and treatment operations, as well as to the Antero Clearwater facility.
The infrastructure build-out will be a flexible fit-for-purpose approach based on AR's development plan and will be phased in over the next several years. This localized approach highlights the benefit of a consolidated acreage position where our completion operations will be concentrated. In addition, Antero's integrated operations and communication between the upstream and midstream entities will allow us to generate cost savings and efficiencies. Antero has been a pioneer in integrated water operations in Appalachia and has significant experience operating the largest freshwater system in Appalachia. Our significant operating experience, advancement in pipeline integrity, and investment in engineering risk management give us comfort to safely build out the flowback and produced water business in a capital efficient manner.
In short, the expansion of the water business is a win-win for the Antero family as it reduces well costs and increases cash flow for AR, enhancing the resiliency of its development plan and business model while delivering an incremental cash flow stream for AM. With that, I'll turn the call over to Mike.
Thank you, Paul. For those who did not have a chance to listen in to the AR conference call, I would encourage you to listen to the replay or access the AR earnings call slides on the AR website, which go into greater detail on the cost savings initiatives that underpin the resiliency of the AR business model that Paul discussed. I'll begin my AM comments by highlighting the recently announced AM cash dividend of $0.3075 per share, 146% increase year-over-year for former AMTP shareholders and a 40% increase year-over-year for Antero Midstream Partners unitholders. The dividend at AM was the 18th consecutive distribution increase since the IPO of Antero Midstream Partners in 2014.
As depicted on slide number seven, we are on track to achieve our 2019 full-year dividend of $1.24 per share, which represents over a 13% yield on today's share price. Let's move on to the second quarter operational results, beginning with slide number eight, titled High Growth Year-over-Year Midstream Throughput. Starting in the top left portion of the page, low pressure gathering volumes were 2.7 Bcf per day in the second quarter, which represents a 34% increase from the prior year quarter. Compression volumes during the quarter averaged 2.4 Bcf per day, a 54% increase compared to the prior year quarter. Compression capacity was 88% utilized during the second quarter. Joint venture gross processing volumes averaged 1 Bcf per day, a 73% increase compared to the prior year quarter.
Joint venture gross fractionation volumes averaged 27,000 barrels per day, a 170% increase from the prior year quarter, and freshwater delivery volumes averaged 122,000 barrels per day, a 46% decrease over the prior year quarter. The decline in freshwater delivery volumes was driven by a reduction in completion activities at AR as expected. During the third quarter, Antero Resources picked up an additional completion crew, which we expect to drive an increase in completion activities and freshwater delivery volumes during the second half of 2019 compared to the second quarter of 2019. AM remains on track to achieve the volumetric targets for the first $125 million earn out payment, covering the 2017 through 2019 period that is expected to be paid in the first quarter of 2020.
Before moving on to financial results for the quarter, I'd like to touch on our operational savings and improvements on slide number nine, titled Operating Expense Improvement. Through the implementation of automation, centralized operations and field-wide best practices, operational efficiencies, and scale, we continue to drive down our per-unit operating costs. Our gathering compression per-unit operating expenses are down 40% and 48% respectively over the last five years, while freshwater per-unit OPEX is down 41%. Looking ahead, we continue to see areas of improvement in driving additional efficiencies in both our gathering and water businesses. I'm extremely proud of and would like to thank all of our Antero Midstream employees focused on operations for this impressive and relentless dedication in generating efficiencies and driving down costs. Moving on to financial results. Adjusted EBITDA for the second quarter was $206 million, an 18% increase compared to the prior year quarter.
The increase in adjusted EBITDA was primarily driven by increased throughput volumes. Approximately 70% of AM's adjusted EBITDA was generated from gathering compression, 10% was generated from our processing and fractionation joint venture and Stonewall investments, and the remaining 20% was generated from freshwater delivery and treatment. We see these percentages staying approximately the same over the next several years, with 80% of AM's adjusted EBITDA delivered from core gathering, processing, and fractionation, and 20% of AM's adjusted EBITDA derived from water. Distributed cash flow for the second quarter was $156 million, resulting in DCF coverage ratio of one times. Antero's second-quarter results place us on track to achieve our previously communicated 2019 dividend guidance of $1.23-$1.25 per share, with DCF coverage and adjusted EBITDA trending towards the bottom end of the previously announced coverage and guidance ranges.
During the second quarter, Antero Midstream invested $163 million in gathering compression water infrastructure and the processing and fractionation JV. Gathering compression water infrastructure capital investments totaled $125 million, and investments in the JV totaled $38 million. We are currently trending towards the bottom end of the capital budget guidance range of $750 million-$800 million. Moving on to balance sheet and liquidity. As of June 30, 2019, Antero Midstream had $595 million drawn on its $2 billion revolving credit facility, resulting in $1.4 billion in liquidity. AM's net debt to LTM adjusted EBITDA was 3.2 times at quarter end. I'll finish my comments on slide 10 titled DCF Profile Supports Growing Return of Capital. As a reminder, AR and AM previously provided net production and DCF growth sensitivities, respectively, for a $3.15 gas and $65 oil price scenario, and a $2.85 gas and $50 oil scenario.
While prices are well below the lower boundary scenario pricing, AR's well cost reductions, efficiency gains, and hedge position enable it to offset the difference in commodity pricing and maintain a 10% compound annual net production growth rate that is approximately within cash flow. Even at currently depressed strip pricing, this results in AM's DCF CAGR trending in the low to mid-teens after adjusting for the new completion design. Importantly, AM is still targeting high single-digit return of capital growth in 2020 as compared to 2019, supported by the DCF wedge relative to future capital estimates necessary to generate this DCF growth. This attractive growth profile and efficient capital program leveraging existing infrastructure allows AM to continue self-funding its operations and supports an increase in return of capital to shareholders for 2020. With that, operator, we are ready to take questions.
Thank you. If you'd like to ask a question at this time, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue, and you may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Again, that is star one to ask a question at this time. Our first question comes to the line of Spiro Dounis with Credit Suisse.
Hey, good morning, guys. First one, just a two-part question on some of the finer details around the new water opportunity. Just first on the top line, I believe AR mentioned spending upwards of something like $160 million on these water services and was looking to save around $50 million or so. If I just do the simple math around that, is it fair to say the top-line opportunity for AM will be something around $110 million? The second part of that is just how to think about some of the spending, the CapEx spending, to build out this infrastructure.
Yeah. The first you talk about is the LOE, or how much we spend. The $160 million, if the $50 million savings would be the $110 million for AM.
Okay. Then on the potential CapEx needed to build this out, how should we think about that?
Oh, it's over the next couple of years. It's around the $100 million range. It's well over two or three years.
Okay. That's spread out over those three years?
Right.
Got it. Okay. That's helpful. Just second one, kind of high level here, but stock's trading down materially again today, that follows a pretty challenging July. You've come out, you've reiterated guidance, you've talked to some new opportunities, you talked to capital efficiencies. Doesn't seem to be having an impact. I guess at what point does it make sense to undergo a strategic review here and consider what, if anything, could really be changed? Just trying to be clear, I'm not saying you should do anything dramatic for the sake of the share price, but if I'm echoing some feedback we receive, seems to be ongoing concerns around counterparty risk and basin risk, it just doesn't seem like reiterating guidance is going to be enough to appease that.
Yeah. I'm not sure how to answer that. I mean, we are under strategic review all the time. That's what we do. I think it's hard to impeach the business, and that we've got great rock and a great business, and taking our product to great sales points, and we're well hedged and a strong balance sheet. Yeah, I'm not sure what you're getting at. Glad to talk offline about that, but I think we're doing the right thing here.
That's fair. We can get up on that. Just last one from me.
We don't control the stock price, obviously, right?
No, no. Totally understand that. Yeah. We've seen others do it, when your yield starts to get to this level. To your point, you're always under strategic review, so I appreciate that, but we can follow up offline. Next one, I believe it was on the last call, you mentioned maybe an increasing appetite to potentially get more into long-haul business. Could you just maybe update us on where that stands?
For AM getting more into long haul pipe. Yeah, those are not the kind of things that we can talk about publicly on a call. We're always looking at opportunities, you'll hear about it if we do something.
Understood. Thanks for the caller.
Thanks, guys.
Yeah. Thank you.
Our next question is from the line of David Heikkinen with Heikkinen Energy Advisors.
Hey, good morning. I'm trying to think about your CapEx in 2020. I think the newest deck shows that growth CapEx is a little under $600 million. Just thoughts about how sticky that number is and are there things that you can do at the AM level to get CapEx down next year?
Well, that's right now looking at the AR plan. Obviously, it'll follow the AR. We have been trending lower on CapEx as we get more efficient. Still a target of $600 million with the 10% AR plan. That's still a good ballpark. We'll continue to try to refine that and bring that down.
Okay, thanks. On the pilots with your lower water usage, can you just tell us how many of those pilots you've done and how long those wells have been producing? Just anything high level on your confidence level that the production from the new completions will hold up to the production from the older style completions.
I think we started out probably between two and three years ago, whenever we do pilots on pads, and these might be pads with 10 or 12 wells, we vary the treatment on different well bores. We might do three well bores that incorporate 30-50 sand and then three well bores that are interspersed that are just pure 100-mesh. We watch those. We have a production history going back at least two, maybe three years, where we do these within the pad basis on the pilots. More recently, we've done full pads where the entire pad is 100-mesh or the entire north directed. Say six wells going north are all 100-mesh, the other six wells going south are the standard design that uses coarser mesh. We have a good sampling throughout our area.
I would say that at least 10 pads have been involved in 100-mesh piloting over the last two to three years. 10 pads, and if you say an average of at least eight wells per pad, there's probably at least 80 wells where we've piloted throughout the fairway and have seen positive results that 100-mesh provides as good, if not better sometimes, production than the traditional design. Feeling good about that. Does that answer your question, David?
Yeah. Thanks, Paul. Just one last one. If you wouldn't mind just kind of going through why you had to pull Clearwater off again in the second quarter. Thoughts going forward on achieving the efficiency through that facility that you expected when you built it. Finally, is there any legal remedy to claw back some of the underperformance from Clearwater over the last year or so?
I would say Clearwater is a good facility. It's complicated. It's got three or four different processes within it. It's just working the bugs out. We have seen greater and greater volumes. We've got a good operating team there that's growing it. Sometimes we will schedule a number of projects when we have downtime. Let's say it's 10 days or two weeks of downtime. There's a number of things that go on, not just one flaw in the operating side, but there might be two, three, four, five. That's usually what the downtime is. It's just either really improving the efficiency and adding things on. Mostly what we've been doing is just improving the process. It's a big facility, going to 50 to 60,000 barrels a day, there's a lot of moving parts there.
That's what we've been doing, and it's been good so far. Was there another part of that question, David, that I didn't address?
Just to clarify what you're saying, it's an operational issue, not a design flaw. Is that?
Right. Yeah, just operational issues. Yeah.
Okay. Our next question comes from the line of Tim Howard with Stifel.
Thanks for taking our question. Just given the kind of strategy change and DCF turning towards the low end of guidance in 2019, was there any thought of removing the 7%-9% expected capital return growth in 2020 just to build coverage? It seems like that's what investors are preferring more these days, and the stock doesn't appear to be valuing the growth.
That is building coverage. Excuse me. The 7%-9% is below our actual DCF growth of low to mid-teens that year. That does build the coverage back into the 1.2 times range. The DCF growth in 2020 does support that type of return of capital target.
Got it. Was there any thought on providing just more detailed expectations into 2020 adjusted EBITDA DCF guidance officially, given the new strategy is set and just maybe supporting investor concerns?
These are targets. Generally in the ballpark where we're at, we do a formal budget process in the fall and winter of each year. End of 2019, that gets Board approval, and that's when we come out with formal guidance.
Got it. Just pivoting to the water. How much produced water is flowing today, and maybe what's expected into 2020? Is there any thought on how much of that will be captured via pipeline as you work through 2020?
Yeah, I would say produced water now is in the 45,000-65,000 barrels a day range. Depending on the timing of turning in line pads, you'll get a surge and then it'll go down. Roughly in the high 50s. As to how much will come into the new business, we'll do as much as we can as we focus on the Northern Fairway. As much as we can, so could it be 10,000-20,000 barrels a day at least that we are polishing and blending and keeping local, in other words, decentralized and not bringing the Antero Clearwater. Could be in that range. We're just setting out in the earliest pads now, so we aim to make as big a dent as possible just because the cost structure is so superior not to have to do the long-haul trucking.
That's a good target is at least 10,000-20,000 barrels a day out of 55,000 or 60,000 total. We'll see where it goes from there. One can think, well, that'll be less for Clearwater, but as we have more than 1,000 wells producing now, and our growth rate is such that the overall water grows. Even as we do a cut with polishing and blending, still there's an overall quantity of water that continues to grow. There'll still be good water available for Clearwater.
Yeah, that was my next question. What is the expectation for Antero Clearwater in 2020 with this new strategy? Filling that 40 to 50? I think that's where it was previously.
Yeah, I think that's reasonable. Yeah. We have got our operating teams now that are very busy focused on bringing on a number of pads in the Northern Fairway, where we're working hard on coordinating flow back and produced water to take advantage of it and use that water in future completions. We'll see just how effective we can get. We'll want to be, of course, as effective as possible. In the success case, maybe the polishing and blending can take 20,000 or 30,000 barrels a day from the Northern Fairway and not move it to the south. Again, the overall number is increasing.
I think I'm giving you ballparks as to what Antero Clearwater we'll maintain at, but it could be in the 40,000 or 50,000 range while we polish and blend 10, 20, 30,000 barrels a day just as we step into this over the next 18 months.
Okay. That's helpful. Last one for me. What drives growth in the second half for Antero Midstream cash flows? I assume that the water completions, I think, were mentioned, but production is supposed to be relatively flat at AR, I think is what I heard. You just help us out with that. Thanks.
Yeah. A lot of it's the water, obviously, but also the production. You got to remember the east side of the field that's not Antero Midstream dedicated is not being developed. As it declines, even with flat AR production, that means growth for AM's volumes because the areas that AM services grow while the areas that it does not service are declining. Then you also obviously have the fresh water that increases with that increased one completion crew addition in the third quarter.
Thank you.
Thank you.
Once again, as a reminder, you may press star one to ask a question at this time. Our next question comes from the line of Barrett Blaschke with MUFG.
Hey, guys. Just looking at the commodity world as it sits today and the JV you have with MPLX and some of their commentary around more spending on their L&S segment and less on their G&P. Can you give us an outlook on where you see things going after the Sherwood 12 and 13?
Well, the outlook, of course, is for growth and more processing plants, and so that will be at Sherwood or the new, call it a twin facility that's just a couple of miles away to the west called Smithburg. New plants are being prepared there as well as DF now. The growth will continue well beyond plants 12 and 13. It's all timed out relative to our production growth curve.
There are plants on the drawing board.
Generally, it's roughly two plants a year. Sorry about that, Barrett. What'd you say?
Oh, I'm sorry. There's plants on the drawing board today to go on beyond 14 and 15, and what sort of triggers timing and investment decision on that?
Yeah. Well, we're always looking at our production curves and anticipating when we're going to need it, and we give our joint venture partner, MPLX, usually an 18-month lead time, 18 or 20 months. We all work toward that and of course, our teams are meeting every month, and so we give updates, but that's how it's coordinated.
Just one last one from me. Could you tell me how much of the volume on those plants is typically Antero volume?
Typically 100%.
Okay.
It's all Antero.
Yeah.
Yeah. I think you can see on our website, I mean, Smithburg.
That's what I thought. Okay.
Smithburg, the civil work's already being done. Smithburg one comes on, I forget, sometime next year.
First half, yeah.
First half of next year. You can see all that outlined on the website. I think we're pretty clear about that.
Okay.
Takes a lot of planning. That's what we do, and you don't see us having a lot of hiccups on the takeaway and processing and such because of all that.
It's been a long time since we've had to wait for a plant. We bring these pads on. As you can imagine, if a plant is 200 million to 215 million a day, the pads come on and choke back at 175, 200 million. A big pad will fill a plant right away, very efficient.
Thank you.
Thank you.
Our next questions are from the line of Sunil, excuse me, Sunil Sibal with Seaport Global. Please go ahead.
Hi. Good morning, guys. Thanks for all the clarity. I just wanted to go back a little bit. I think when you did the Analyst Day last year, getting to investment-grade balance sheet was the goal. Realized that you made a fair bit of progress towards that and things have changed around. I was kind of curious, how do you think about that in the current context of things and any considerations? I know you talked about the dividend growth, in light of your goal to get to IG, is there any consideration for slowing down and getting the balance sheet better beefed up?
Yeah. Well, Antero Midstream's really capped out at where Antero Resources is rated by the rating agencies. Obviously, with the current commodity price environment, Antero Resources is a strong BB credit. I don't think there's, in the next 12 months, I don't think there's any movement from the rating agencies in upgrading E&P companies just because of commodity price environment. Antero Midstream on its own right now probably would be investment-grade, with its very strong balance sheet, low threes, and scale. It is capped where AR is at.
I think you kind of talked about getting into the downstream side of things. Is there something in terms of opportunities set in the near term that you guys are looking at to make progress in that direction?
Well, we're always looking. Of course, we can't comment on if there were something imminent. We couldn't announce that till it really happens. We're always looking, we're always thinking, and I think that's all we can say about that. It's possible in the future.
Okay, got it. Thanks, guys.
Thank you.
We've now reached the end of our question and answer session. I would like to turn the floor back to Michael Kennedy for closing comments.
I'd like to thank everyone for joining us today. If you have any further questions, please feel free to reach out to us. Thanks again.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.