Thank you for standing by. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the SM Energy second quarter 2022 financial and operating results Q&A call. I would now like to introduce Jennifer Samuels, VP of Investor Relations. You may now begin your conference.
Thank you, Angela. Good morning, and thank you all for joining us for our second quarter 2022 Q&A call. To answer your questions today, we have our President and CEO, Herb Vogel, and CFO, Wade Pursell. Before we get started, our discussion today may include forward-looking statements and discussion of non-GAAP measures. I direct you to slide 2 of the accompanying slide deck, page 6 of the accompanying earnings release and the Risk Factors section of our most recently filed Form 10-K and Form 10-Q, which describe risks associated with forward-looking statements that could cause actual results to differ. We may also refer to non-GAAP measures. Please see the slide deck appendix and earnings release for definitions and reconciliations of non-GAAP measures to the most directly comparable GAAP measures and discussion of forward-looking non-GAAP measures. Also, look for our second quarter Form 10-Q, which was filed this morning.
With that, I will turn it back to Angela to open it up for questions. Angela?
At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. We will now take our first question from Zach Parham with J.P. Morgan. Please go ahead.
Yes. Thanks for taking my question. I guess first just on the CapEx raise. You know, could you give us a little more detail on the decision to add a bit of activity to the 2022 program and maybe just also detail how much of the increase in the budget is from that incremental activity versus the increased inflation expectation?
Yeah. Good morning, Zach, and thanks for calling in. On the how much is from continuing operations, the basic background is, you know, we've got some great crews that are out there working for us. Even when we look within those operators, those service providers, we have some of their best crews when they benchmark them against all the crews they have running. We had about four months of activity that was open in the back part of the year, and we said, "Let's close that down." That was on the frac spread side. On the drilling side, we've been having improved penetration rates with our drilling, which is just, you know, one of those things we assume we're not gonna have improvement, and then we keep improving, and that was a benefit also.
There was some additional on the drilling side. I think we mentioned in the prepared remarks that we had about six additional drills and three turn in lines later in the year. We put in the capital for that. The way you can look at is really we just added some inflation of around 10%-15% on the inflation side, and then the remainder was for the continuing activity. That's how you could look at it.
Some of that will roll into 2023.
Yeah. Oh, yeah, I should mention for 2023 is where we actually get the benefit of a lot of that completion. There's some additional completion activity that does not result in an incremental turn in lines this year that does result in more in 2023. That help you out on that one?
Yeah. That's great color. A follow-up, really just one thing we noticed in the guidance update. It looks like you're now completing 5 additional wells in South Texas, now up to 43, and 2 less wells in the Permian. You know, anything specific that drove that mix shift, or is it more timing related? Really just looking for a little more color on that change.
Yeah, no, you picked it up, Zach. Really what that was is we had a larger gap in South Texas, so we closed that gap. It's primarily in South Texas on the frac spread side. On the Permian side, it's just the timing around the end of the year on the turn in lines. We have two that turn in line after the start of the year. You probably noticed from 2Q, we wound up shifting some that just turned in line just after the start of the third quarter. The same sort of thing. You just can't, you know, pin down exactly by a matter of a couple days which side of a year-end or month-end it's gonna be. That's all that is.
Got it. Thanks, Herb. That's great color.
You bet, Zach.
Next, we have Gabe Daoud with Cowen. Your line is now open.
Hey, thanks. Morning, everybody. Thanks for all the prepared remarks so far. Maybe just piggybacking off of Zach's question a bit more. Could you remind us? I think there were 20 completions in Midland that were supposed to or 20 wells that were supposed to be completed very early in 2023, I think January, February. Is that still the case? Then would just be curious with you securing additional equipment into 2023, how does that change your view on volumes?
Okay. Gabe, that one's difficult to answer. It's just what we said, actually previous quarter, was that we had quite a few turn in lines in the beginning of 2023, and that was the result of 4 pads in the Permian with about 20 wells. You know, we said, okay, they're actually gonna start up on the other side of the year end. That's the crux of what's going on there. What we're doing now really isn't changing those 4 pads any at all. That's really driving the turn in lines, you know, this year versus next year in the Permian. It's just the size of the pads and the fact that you need to drill them, frack them, and drill out the plugs all before bringing on all 20 wells.
You can see how that's a massive amount of activity.
No, understood. Thanks, Herb. That's helpful. Then maybe on the cash return angle, appreciate the prepared remarks from last night, but curious if you can maybe give us a little more color, and then also, do you anticipate you would do a little bit of a formulaic approach similar to peers, where you would kind of allocate X percentage of free cash flow to shareholders? Just curious how the framework could look. Thanks, guys.
Yeah. I'll just start that and then hand it over to Wade. Just, I think it's just great how fast we've gotten into this position to be able to return capital to shareholders. We're way ahead of what our original plans were, and it's just the underlying assets that we have. They keep on performing better than expected. Our base performance is doing great. The wells are doing great. The enhanced completion designs in the Permian have really paid off. The Austin Chalk has just continued to help us out on the upside. With that, I'll just hand it over to Wade because that's really what's underpinning that free cash flow generation.
I appreciate the question. I'm not sure I can add a lot. It'd be a little premature to be getting into any specifics at this point, but we are really close, and that's very exciting. Being below 1 times already and having real line of sight to getting below that net debt target of $1 billion is obviously exciting. What we shared with you in the prepared remarks hopefully helps you think about how we're thinking about it right now. Your specific question about % of free cash flow, it's too early for me to say anything about that.
You know, we're gonna do something that we're confident is very sustainable and, you know, I'll just repeat that I mentioned you could expect something in the fixed dividend area, increase there and something that's very reliable that you can count on, even at lower commodity prices. We mentioned that our thinking right now would be something in terms of stock buyback and we always have a view, an internal view on NAV. By my comments saying that we feel like that's very appropriate at these prices should obviously tell you that our current view of NAV is a higher number. Going forward, we would continue to, you know, to analyze that.
That's probably all I should say at this point.
No, understood. Thanks so much for that, Wade. Thanks, guys.
Yeah.
Quick reminder, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from Michael Scialla with Stifel. Please go ahead.
Yeah. Good morning, guys. Wanted to follow up on the change in plans with the additional rig and crew, or filling those gaps. I guess wondering how far you've contracted those and, I guess for all of your contracts, how far are you contracted? Are you into 2023? Maybe any kind of insight you can provide on what you would expect when you re-up those contracts for next year.
Yeah. Mike, thanks for joining the call. There's quite a bit behind that question actually, and it deals with the entire supply chain that we have. Let me just start with, you know, if you're gonna be drilling wells, you need to have the tubulars ready to go with all the casing. We're into 2023 on getting the firm allocation. Most of it, the price is locked down. There's some in 2023 where you still have to pin that down. The supply chain, we've got to basically run everything through the end of the year. On the rigs, we're actually not picking up incremental rigs here. We're just closing gaps that we had in the schedule where we would have given them a break for some period of time.
Rig-wise, it's the same number. It's just because we drilled faster than expected, we're getting more wells done. On the pumping service side, we're contracted, but those are different than rig contracts on the pumping service side. We've got reliable commitment from the frac service providers we're using, and that is through the end of the year and into next year. We know we can close those gaps without any problem at all, and we can continue on into next year without any issue either.
Okay. I guess, do you have any sense of what you might expect for inflation for next year based on what you've seen so far this year?
No. You know, we figured you guys would be wondering. It's just one of those things that, you know, after Russia invaded Ukraine, it was just really hard to figure out the supply chain. We fortunately had commitments through much of this year on most of what we needed, and then we locked that down real fast for this year and started going to next year much earlier than we normally would, and that went for steel. On sand, we've also now locked in our sand for 2023 for South Texas, which we had open before. We're progressively going through every single part of our supply chain, making sure we've got everything when we need it at the best price possible. It's you know, so in some cases, we know what our inflation would be for activities.
For some others, we don't yet know what it'll be like. It's gonna be just part of our normal processes in fourth quarter and, as we get into the budget for 2023, when we'll pin all that down.
Okay, understood. Wanted to ask in your prepared remarks, Herb, you mentioned, you know, 13 years of drilling inventory in the Midland Basin, and you've got some exciting results from some new zones. Looking at slide 16, you've got a lot of zones listed there. I'm just wondering what is built into that 13 years of inventory in terms of some of these new zones, and if they're not all built in, you know, what the potential upside could be there in terms of the overall inventory if these new zones work out.
Right. Mike, I'll just start by saying we have a little bit in every one of those eight zones, but what we're really doing is expanding what the potential is in each of them. We run a normal annual process on that, which will really be in November. We'll start pinning that down on how much we've added in every interval. We're not really gonna update anything on inventory until usual year-end, and then talk about them in February. It's just much more thorough and it's just a comprehensive look at what we can do and with the same criteria that we've used in previous years, and it's worked well for us, and we'll do that again.
Last year, we fortunately did a great job of replacing all the inventory we drilled up or completed in 2021, and we hope to have done the same thing in 2022. We'll see at the end of the year how that came out.
Okay. We'll look forward to that. Thanks, Herb.
Yeah. You bet.
If you would like to ask a question, please press star one on your telephone keypad now. We have a question from Zach Parham with J.P. Morgan . Please go ahead.
Hey. Just one follow-up on the A&D market. Chesapeake announced they were gonna be exiting their Eagle Ford position. While that's still early on and we don't know exactly what that sale process is gonna look like, you know, they do have some acreage that directly offsets your northern area in South Texas. You know, could that be something you're potentially interested in, and maybe just general thoughts on the A&D market in general?
Yeah. Zach, hey, thanks for asking that. Yeah. You know, on the Austin Chalk, we think there's just some great acreage out there. You know, you always gotta look at what are the specific land terms and what are the specific midstream commitments on those sorts of things to really get an assessment of value. I don't know how that looks. We always evaluate those, and if it's something that makes sense for our shareholders, we'd obviously look at it. That's a very recent announcement, so I don't know how that will look. In general, you know, it's hard to do A&D when commodity prices are where they are. There's a pretty wide bid-ask spread from our understanding of how things look with the between the sellers and potential buyers.
The sellers are looking for the buyers to buy a strip, and, you know, a buyer would be looking at more something mid-cycle or below to make sure they could get returns for their shareholders. It's not a great time from a pure A&D perspective, from our perspective and we'll see where things shake out on commodity prices. There's clearly some great acreage offsetting us in South Texas.
Thanks, Herb. That's all for me. Thanks for taking my follow-up.
You bet. Thanks, Zach.
There are no further questions at this time. I would now like to turn the call over to Mr. Herb Vogel, President and CEO, for closing remarks.
Yeah. I'll just be really brief here. Thanks for joining the call. You know, if you're wondering why invest in SM Energy now, I just wanna repeat, you know, we're producing really top-tier, low break-even assets in two excellent basins, and it's really a great time to be in SM stock. Thanks again. Have a great day.
This concludes today's conference call. Thank you for your participation. You may now disconnect.