Good day, and thank you for standing by. Welcome to the SM Energy's Q3 2021 financial results and operating results Q&A conference call. At this time, all participants are in a listen-only mode. After the speaker's short remarks, there will be a question-and-answer session. To ask a question during the session, you will need to press star one on your telephone. If you require any further assistance, please press star zero. Now I'd like to hand the conference over to your first speaker today, Jennifer Samuels, Vice President, Investor Relations. Thank you. Please go ahead.
Thank you, Paul. Good morning, and thank you for joining us for our Q3 2021 question and answers call. We had a fantastic quarter. 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 two of the accompanying slide deck, page six of the accompanying earnings release, and the Risk Factors section of our most recently filed 10-K and 10-Q, which describe risks associated with forward-looking statements that could cause actual results to differ. Refer to slides 21-28 of the slide deck and pages 14-17 of the 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.
Of note, our Q3 10-Q was filed this morning. With that, I'll turn it back to the operator to take our first question. Paul?
Thank you, ma'am. We will now begin the question-and-answer session. To all participants, if you have a question, please press star one on your telephone keypad. Again, that's star one on your telephone keypad. Please stand by while we compile the Q&A roster. Your first question is from Leo Mariani with KeyBanc. Your line is open.
Good morning, guys. Just wanted to kind of ask you about kind of the plan as we head into Q4. Clearly looks like you guys are kind of slowing down, you know, on the activity side here in 4Q. Perhaps maybe you could, you know, talk a little about, you know, sort of rig pace and translate that into kind of what's happening in the field. Are you dropping some rigs? Are you temporarily dropping some crews? Maybe there's some frack holidays. Can you give us a little insight into how you're slowing down here in 4Q? I guess just the other sort of related question there is obviously commodity prices are best they've been in a number of years.
How do you think about that decision to kind of slow a bit as we head into the Q4, given that the returns right now are so great and the payouts on these wells look great?
Leo, this is Herb. Yeah, thanks for that question. For the year, you know, we accelerated into 2Q and 3Q some of our activity, and we tested a number of things like simul-fracking and other optimizations. Now we're putting together the scenarios for 2022 and how we gear up and how we lay out that program for 2022. That's really what's driving what we do 4Q, 1Q, 2Q. It's really about free cash flow over the next two-three years and laying out that program that maximizes that. That's really what we're doing there. You know, looking at the rig count at any individual time is not really gonna tell you much. What we wanna do is have a very capital efficient program.
That's really what we're driven to do, and that incorporates quite a few of those enhancements that we really tested this year during the year.
Okay. I appreciate it. I guess just wanted to ask about the chalk. Certainly some very strong well results certainly helped drive the great earnings here of late. Just wanted to get a sense of how you're thinking about what kind of phase and window to drill here in the chalk. Obviously, you guys have got acreage that kind of ranges more on the oily side to the gassier side. Do you guys have a preference, and are you thinking about drilling maybe some of the more gassy stuff, given that we have the highest gas prices we've had in a number of years, Herb?
Yeah, Leo. We're really pleased with the way the chalk's turned out. I mean, the inventory potential here and how the wells have come in has been phenomenal. We've just started doing development spacing, as you've seen, and the results are coming out quite good. We'll be laying that 2022 program out, and it'll probably be a mix of locations across our acreage position. But we haven't locked that in yet. I would say it's not gonna be just oil, and it's not gonna be just gas. It's gonna be a blend of across our position.
Okay. That's good to hear. Just lastly, can you talk about well costs in the chalk? As you move into development mode, are you starting to see money on those wells? Can you comment on that?
On the Chalk, you know, we really have continued to, as we've learned over time, more and more improvements. That's really what's driven it. We'll probably get some efficiency gains. We'll probably encounter a little bit of inflation. We have not locked in a number for 2022 yet.
Okay. Thank you.
Your next question comes from the line of Scott Hanold with RBC Capital Markets. Your line is open.
Thank you. Great quarter, guys. I was wondering, and I know it's gonna be too early to talk about 2022, but I know earlier this year you did provide a reference. You know, for investors and analysts at a much lower deck. Can you give us an updated view on that reference point, with respect to capex, given obviously a much higher commodity price and a little bit more inflation?
Along with that, as you think about 2022, and I know the point is to maximize free cash flow, but given, you know, the outperformance that you all have seen with, you know, your better completion techniques in the Midland and just great results in the Austin Chalk, when you look at next year, would you taper capex at all given production outperformance, or will you just let production end where it ends and just focus on like a well count that you think maximizes free cash flow?
Yes, Scott, you know how we do this, where we run a lot of scenarios at this time, and then as we get closer to locking the budget, then we optimize it to maximize the free cash flow over a certain period of time, two years plus. That's really what drives it. You know, we don't have a 2022 capex number or a production number yet. We've got scenarios and, you know, we use strip pricing as we get closer to the date we lock in the budget.
I can't really give any additional color there other than we're gonna incorporate what we learned this year, in terms of chalk performance, Permian performance, and the benefit of the larger completion designs and the capital efficiency from simul-frac, longer laterals, et cetera.
Understood. Could you provide a reference relative to earlier this year, the 2022 capex number and, you know, what that, in theory, looks like now based on the service cost inflation that's occurred, or anything else that's occurred with efficiencies at this point?
Yeah. We have not locked it in. Like you said, we're kind of in data gathering mode right now, I call it, where we're sorting out, okay, which service lines would we expect to see inflation, which service lines would we expect to see flat or decreases, and where can we see efficiency gain? We're in that process right now, so.
Okay
I can't get ahead of the game there.
No, I appreciate that. My follow-up question is on shareholder returns. Obviously, you're hitting your leverage reduction targets a lot sooner than expected. Can you give us a framework of when we all should think about, like, SM having that conversation about shareholder returns in more detail and when it would actually start to be an actual payout to investors?
Yes, Scott, it's a great position to be in, and I'll ask Wade to answer that one.
Yeah. Hey, Scott. Thanks for asking. Yeah, you know, we're obviously very excited to be delevering a little bit ahead of schedule, frankly. We're below two times already, which is fantastic. You know, it does relate to the quantum of debt also, though. While the debt EBITDA is falling quickly, we want that outright debt number to fall as well. You know, just from a framing standpoint, I mean, I think that's your question.
I mean, for me, getting leverage down kind of close to that 1x area and maybe absolute debt, you know, down in the $1 billion area is something to, you know, to look for that feels like a prudent area to be considering something in a meaningful way from a dividend or stock buyback program standpoint. I guess that's what I would tell you there.
Is the 1.0 leverage, you know, based on a mid-cycle price?
Yeah
or would you use, you know, whatever it is? Could you give us a little color on that?
See, that's a great question, right? I mean, I think getting below 1.5 times, if it's like at a mid-cycle price, is probably an okay area to be considering. But the 1.0 is just to factor all that in a little bit better. You know, if we get there really quickly at a price, you know, up around $80, I think that's one fact. If we're getting there and we're able to see that everything appears very sustainable at reasonable mid-cycle prices, that's different. So, all of those factor into the decision, you know, at the appropriate time to consider something like that.
All right. Appreciate the color. Thank you.
Yeah.
Your next question comes from the line of Michael Scialla with Stifel. Your line is open.
Yeah. Good morning, everybody. Maybe just another question on the cost side. You maintained that $520 per foot cost guidance for the Permian as an average for the year. Is that reflective of current wells, or could you say where the current wells are relative to that average?
Yeah. Mike, well, this year. The $520 million number was our number for the year, and you know we front-end loaded all the capex. Really the $520 million is predominantly spent with the program we had. It's a good number for the Permian. Looking forward, we're just gonna see what parts of our inflation were. Well, as I just answered, some of the sectors or service lines will see some inflation, some will be flat, and then we're gonna get some efficiency gains. We haven't set the numbers yet for 2022, and when we do, we'll see where it comes down relative to that $520 million.
Okay. A question on the Chalk. You gave a pretty wide range of spacing there for the development pilot, I guess you'd call it, at 675-1,000 feet. Are you seeing any performance difference between the wells at the low end versus the high end of that range? Can you say if you're leaning toward one end or the other as you look to advance that play to full development?
Yeah, Michael, it's early days. You know, three of them are spaced at 675 feet, and three are spaced at 1,000 feet. We've previously done those eastern tests at a 1,000-plus foot, and then those southern ones at about 1,250 feet, but staggered with the Eagle Ford at 625 feet. We're gathering data in multiple places, and we'll see how it performs. Typically, you gotta give it some time to see how they perform. We're happy, really happy with what we see and with the returns and the payoffs on those right now.
Okay. Just maybe one last one for Wade. Wade, as you look at the fixed debt, you mentioned you'd like to continue to reduce absolute debt. You did that obviously in the Q3. As you look into 2022, maybe thoughts about your ability to retire some additional debt there versus would you look to refinance the 2024 and 2025 maturities? Or are you more likely to just retire those with free cash flow?
Yeah, I think, Michael, the plan is certainly to generate free cash flow and to use that cash to actually retire debt. You know, all of our. I mean, you know, our how our maturity profile lays out. I think actually slide six in the deck does a pretty decent job of showing you kind of initial call dates and there's a lot of flexibility within our debt structure, and we do that on purpose. Early callable debt at different prices. We always have prepayable debt. I would anticipate the 2024s getting taken out first with free cash, and then we'll start as we generate cash and feel sustainable about it, you know, we'll be targeting the 2025s as we move through the year.
There's a couple of tranches there with the unsecured bonds, which are prepayable. Of course, the second lien notes, which become prepayable in the middle of the year, about eight months from now. You can imagine, I think I've said it before, that those will be kind of right in our sights as they become prepayable. We'd like to eliminate those from the capital structure. That's kind of the plan for next year.
Sounds good. Thank you.
Yeah.
Your next question comes from the line of Karl Blunden with Goldman Sachs. Your line is open.
Good morning. Thanks for the time and congrats on the deleveraging progress. Just to firm up some of the questions on the debt reduction. When you think about that, you know, roughly $1 billion more of debt to come out, does M&A play a role in that? Could that slow the reduction? Could it speed the reduction when you think about, you know, selling assets or buying assets?
I'll make it a very general comment and then let Herb comment. You know, it's one. You know, the debt within context of M&A is just one of many factors. Whether that became a deleveraging part of the process through M&A or acquisition, it would be one factor. What's exciting is we don't, you know, we don't need any transactions to execute a very deleveraging process on our balance sheet. Do we look at other ways to accelerate those things? Yes. Is debt reduction a driver? It's one factor, I guess, is the way I would answer that.
Yeah. Karl, just generally on M&A, you know, our stance hasn't changed at all. We think scale matters, but more than just a lower G&A story. We've said these criteria are that we gotta have comparable quality assets, and we have really high-quality assets. Gotta be accretive to free cash flow, and it's gotta be neutral to beneficial to leverage. That's pretty much the position we've taken. There should be some industrial logic around it and some capital efficiency if we were to do it. That's really how we look at it. It's not like we're gonna go look for M&A to go delever as a single target, basically the way to put it.
Yeah. You got line of sight to cash flow at this point. Just on the hedging strategy, we've seen a couple of other players in the space change the way they approach that. I know historically you've indicated that as leverage comes down, hedging could decline a bit. Is there any bigger change contemplated as you go forward based on your oil price views, for example? Or is that kind of the continued approach?
Yeah, great question. The short answer is no change. I mean, we've been implementing the same strategy for over a decade, and it's served us very well, especially during downturns like last year. You said it well. We tie it directly to leverage. So that means, even during periods like this where our leverage is going down, our hedge percentage will go down as well, but the hedging doesn't go away. So we have been layering in methodically smaller slivers, I would say, though. And we don't hedge too far out, and that's actually a good thing when the strips are so backwardated like they are currently. So you won't see us hedge over 50% next year.
I think I mentioned in my notes we're below 40% on a BOE basis right now for 22. The other thing that is a little unique that we do is during periods like this, we use a lot more collars than we do swaps to retain more of the upside at these higher prices.
That's helpful. Thanks very much, Wade. Thanks, Herb.
Yeah.
Once again, as a reminder to all participants, if you have a question, please press star one now. Again, it's star one on your telephone keypad. Your next question comes from the line of Gabe Daoud with Cowen. Your line is open.
Hey, good morning, guys. Question, just going back to the cost equation in the Midland. You know, you'd mentioned $520 a foot was the number all year, and then you also talked about upsize completions. I was just curious, what's the delta between just the upsize completions and maybe the base completion design that you had coming into this year? Just trying to get a sense of how meaningful that delta could be.
Yeah. Yeah, Gabe, we actually set that at the beginning of the year when we set the budget. We were running actually in Q4 below $500, and then we kind of looked at it and said with the old completion design, it would be about $500 per foot. Then we said, well, we're gonna budget $520 with this upsize completion. Those, you know, range from 2,300 pounds per foot up over 3,000. It's a uptick from our 1,800-1,900 that we were at before. That kind of tells you the number. It's about $20 incremental. Now, as we go into 2022, we'll look at what the cost environment tells us it's gonna be.
Okay. Got it. That's right. That, that's helpful. Thanks for that. And then maybe if you could just give us an update on inventory in the Permian. You know, I think maybe coming into this year you had said there's maybe eight years or 8-10 years left. Can you just give us an update on that number? Does that just assume the three primary zones there, the Wolfcamp A, B, and Lower Spraberry? Thanks, guys.
Gabe, you're aware we do that look once a year, and it kind of starts with our reserves process, which is underway right now. We update the inventory with all the different additional wells we did with different intervals, and we see what the potential is in different intervals and what the returns are. That's just a once a year process. Basically everything stands from what we showed in February, and then we update at the end of the year, and we'll share it in February again.
Okay. Understood. Thanks, guys.
Your next question comes from the line of Arun Jayaram with JPMorgan. Your line is open.
Yeah, good morning. I wanted to get a bit more detail on the new frac design that you initiated in the fall of last year. I was wondering if you could give us a sense of, you know, how the results have performed in Howard County versus maybe Sweetie Pack and how, you know it looks like you have a few months of data, and how are the CUMs trending relative to offset wells in each of those areas?
Arun, we did start implementing this in Q4, and we had some data from offset operators and others to get an idea of what these improvements could do, and we saw it as a very capital efficient, incremental capital spend. Then as I just mentioned, going from 500- 520 per foot. We put it in 80 of our completions out of the 90 in the Permian year to date. Of those, 28 have been in place over six months, and we saw a clear, very discernible uptick in the performance through six months. But as you can guess, it's a wedge that opens up over time. You know, it's premature to say exactly what the ultimate benefit will be, but we definitely saw a clear trend.
In specific places like Coyote Valley on our eastern position, we saw a significant uptick. That's the three wells, the Miracle Max wells that we showed in the slide deck. We do see a benefit, but I would say we've got a bigger database than just those 28 wells that tells us it's the right thing to do, and it's very economic to do so.
Great. Just my follow-up is, you know, SM has kinda been on the forefront of completing a lot of extended reach laterals, you know, in the Midland Basin, quite a few wells over 15K, and I think you did, you know, you've talked about one over 20. But as we started thinking about 2022 kinda capital efficiency, Herb, would you expect SM's ability to maybe drive lateral length? Could that be kind of a tailwind to your capital efficiency and start putting the math together on next year?
The way I'd answer that, Arun, is that our team, we do these scenarios, and so we really model and get to the plan that lays out the most free cash flow. You know, if that's two 10,000-foot wells versus one 20,000-foot well, we would have done the analytics to determine which was the better choice. It's very thorough and detailed, I would put it, in establishing what we're gonna do on the lateral lengths. So far, we've seen steady increases in lateral length, and that depends on the cost environment and the production of the well. All I can tell you is that we are gonna do what maximizes the free cash flow in the design of the lateral lengths.
Great. Thanks a lot. Nice result this quarter. Appreciate it.
Thanks.
That concludes the question and answer for today. I'll hand the conference back to Herb Vogel, President and CEO, for closing remarks.
Okay. Well, I just wanna thank everybody for their interest in SM Energy. We're doing our best to maximize the value of the company, and we'll continue to do so. Thanks again.
Ladies and gentlemen, this concludes today's conference. You may now disconnect. Have a great day. Thanks.