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SM Energy Co  (NYSE:SM)
Q3 2018 Earnings Conference Call
Nov. 02, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the SM Energy Q3 2018 Q&A Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Jennifer Samuel, Vice President of Investor Relations, you may begin your conference.

Jennifer Samuel -- Vice President of Investor Relations

Good morning, everyone. Thanks for joining us today for a live question-and-answer discussion.

I think you've all had the time to go through our press release, pre-recorded call and presentation materials, all of which provide the details behind a great quarter and solid growth trajectory. In addition, we filed our 10-Q this morning.

As always, before we get started, I will remind you that we will be making forward-looking statements regarding our plans, expectations and assumptions for future performance. These statements involve risks that may cause our actual results to differ materially from the results expressed or implied in our forward-looking statements. Please refer to today's earnings release, the IR presentation posted to the website or Form 10-K for further discussion of these risks.

In our discussion of results for the quarter, we may reference certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliation of those measures to the directly most comparable GAAP measures are provided in the earnings release and IR presentation.

Jay Ottoson, Wade Pursell, Herb Vogel, are all here to answer your questions. And with that, I'll turn it over to Jay.

Jay Ottoson -- President and Chief Executive Officer

Well, thanks, Jennifer. Good morning, everyone, and thank you all for attending. I think the materials we released were very comprehensive and I don't see any reason to spend more time than we have to today.

So, Tiffany, why don't you just go ahead and open the line for questions.

Questions and Answers:

Operator

(Operator Instructions) Your first question comes from the line of Brad Heffern with RBC Capital Markets. Your line is open.

Brad Heffern -- RBC Capital Markets -- Analyst

Hey. Good morning, everyone. You talked about getting down your first couple of 15,000 foot laterals in the Permian. Can you talk about how much of the acreage is suitable for 15,000 foot development versus 10 mile or 1 mile?

Herb Vogel -- Executive Vice President, Operations

Brad, this is Herb. Yes, let me go with Eagle Ford first, so there is quite a bit of room for 15,000 foot, and even longer laterals in the Eagle Ford, particularly in the western area. So, yes, there is -- we don't have a number out there, and we're going to be working the inventory this fall, and publish some of the results in February.

On the Permian, it's really driven by the existing well and the least geometry. So, there's areas where there is quite a few 15,000 foot wells. We're going to figure out the optimal between 10,000 and 15,000 plus wells, and that will depend a little bit on area and location. So, basically the location and the interval (technical difficulty).

Brad Heffern -- RBC Capital Markets -- Analyst

Got it. Okay, thanks. And then I guess on the infrastructure and weather issues in the fourth quarter, of the 0.6 million barrels, how much of that is just sort of temporary one-time impact, and then how much of that affects the ramp going forward in terms of drilling delays or anything along those lines?

Herb Vogel -- Executive Vice President, Operations

Yes, Brad, that's a great question. Let me first just give you a visual. I'll spend a little bit of time on this, since I figured this question would come up.

On the rainfall, so you can picture, in September, there were about 4 plus inches of rain in the Big Spring area, and the ground got quite saturated, and at the same time, we had a lot of trenches that were being put in place or open for connecting wells and for gathering lines and for water infrastructure. That was followed by Hurricane Willa coming through, and we wound up with quite a bit of standing water everywhere. So our choices were to attempt to pump a lot of water out of those trenches and continue our operations, or to wait for the water subside.

Obviously, you can't pump forever and be successful and very efficient. So we basically elected to defer the laying of the lines, and that led to deferral of completion. So, you can picture what happened. Also it's hard to move trucks through muddy roads. So, you can picture really a deferral is how to look at this that defers our entire schedule. So, it moves everything out compared to what we had before, and so that's why you're seeing the production in 4Q drop. So, we view it as a temporary event, as temporary as rainfall events are. So, that's one event.

The other, the third-party aspect. So, first, our gas plant issue with a force majeure event, that when there is a removal of plant for some period of time, and we expect that to come back on at the end of the year. We immediately responded by tying together our gathering system. So, it go to other plants, and that's been very successful. But there are still issues that develop in the entire gathering system for all -- a lot of operators around us that defers some of the production.

On the oil pipeline, and that's another event that's relatively short, but that was just with one of our takeaway -- come really one of our purchasers, and they are long haul takeaway. So, that comes temporary, but the upshot of this event -- this is a temporary event, but it defers some of our completions. The well performance itself is great. So, you've seen from third quarter results that we actually put on fewer completions, but wound up with better than expected production.

So, that's kind of the picture that I wanted to lay out there for the 600,000 barrel estimate. And that was our best estimate as of early this week. There's some things that could make it go up, there's some things that could make it go down, but we thought that was a reasonable estimate for the quarter.

Jay Ottoson -- President and Chief Executive Officer

Yeah. Brad, I'll just make a really short comment. What you shouldn't do is just take that 600,000 barrels, and add it to the first quarter, right. We definitely deferred our completion schedule for a good portion of those barrels which means the ramp is -- it will happen, but it's going to happen a little later than we expect. So, that will have an impact.

We think, overall, we will be able to make up these volumes in our '19 program, but it will tend to push the rate later in the year as a result. And that's just a consequence of -- essentially having to defer the whole program a few weeks because of the rainfall. So, it's regrettable. Unfortunately, we haven't developed any way to control the weather yet, and -- but I think our people have done a tremendous job. I'm going to make sure I say that they've done a great job of working through all this in working in difficult conditions to keep us as close to schedule as we could. But just again nothing here that changes the value of this company, it's just an issue of timing really.

Brad Heffern -- RBC Capital Markets -- Analyst

Okay. Appreciate the comment.

Jay Ottoson -- President and Chief Executive Officer

(Multiple Speakers) fourth quarter just a little bit later.

Herb Vogel -- Executive Vice President, Operations

Yes, same number of completions in 4Q, just later than we expected.

Operator

(Operator Instructions) Your next question comes from the line of Oliver Huang with Tudor, Pickering, Holt. Your line is open.

Oliver Huang -- Tudor, Pickering, Holt. -- Analyst

Good morning.

Jay Ottoson -- President and Chief Executive Officer

Good morning.

Oliver Huang -- Tudor, Pickering, Holt. -- Analyst

You all mentioned having closed on several land trades and bolt-on acreage enabling longer laterals or increasing working interest in operated sectional units in your prepared remarks last night. Just wondering what the opportunities that here is on a go-forward basis? And also how you all are thinking about M&A on a corporate basis just given some of the recent transactions that we've seen from your peers?

Jay Ottoson -- President and Chief Executive Officer

Yes, that's a great question. We have been and I'll give our land group all a credit for this, really successful in doing trades that have cored up our position. I think, if you watched our maths over time, you can actually see that on the math, how much more cored up our position is that when we started. And we've done a number of trades, a lot of -- some large ones that we've had to talk about, others a number of smaller ones as well. And there's still a list of those out there. There's probably not as many big ones, and we tackle most of those first, but there is still opportunity we think to do some of that and drill longer.

As Herb indicated earlier, basically our program now is almost all greater than 10,000 feet, pushing 15,000 in some areas. So, we've done a lot of work there, and it's been very, very successful.

With respect to M&A, there have been a flurry of deals, and certainly been interesting to see the various rationales for every deal, and they're all a little bit different. So, let me address it from two perspectives. From a buy-side perspective for us, we do -- really do understand the value of scale in a commodity business like ours, but we generally believe that the source of most competitive advantage is asset quality. So, in our particular case, we don't feel under any particular pressure to do a deal that would be in any way diluted, just get bigger. But we're certainly open to ideas about transactions that would make our business better. And so we look at a lot of things and look at it from that perspective.

On the sell side, we really believe we're a premier operator with top-tier assets. And frankly, that we are executing extremely well on our plan that will create a lot of differential value for our shareholders over the next few years. With that said, in order to the company is for sale everyday, and I know that our Board would carefully evaluate proposals that might meaningfully accelerate or increase that value realization.

Oliver Huang -- Tudor, Pickering, Holt. -- Analyst

Okay, perfect. And I guess just switching over to the Eagle Ford, seems like the JV has been beneficial toward SM thus far on improving optimization on the design of your wells. But just kind of wondering how you all are thinking about the JV beyond 2018 and if there is any flexibility to kind of extend that program out into 2019?

Herb Vogel -- Executive Vice President, Operations

Yes, Oliver, that's another really good question. So, we were just wrapping up the Phase 1 activities, which were 16 D&C wells plus seven DUC completion, and we have three more wells to bring on for a Phase 1 and they'll all come on this quarter. We're in the midst of negotiating our second phase of that JV. It has been successful and we have a great relationship with the other parties in the JV. And what we've learned has been beneficial for improving returns. So, I can't talk about the details of Phase 2, but we're in the midst of negotiation, and I'm sure we'll be able to talk more about it when we give guidance in 2019, because obviously it will affect our 2019 CapEx spend and program in the Eagle Ford.

Oliver Huang -- Tudor, Pickering, Holt. -- Analyst

Okay. Great. Thank you.

Operator

Your next question comes from the line of Michael McAllister with MUFG. Your line is open.

Michael McAllister -- MUFG Securities -- Analyst

Thank you very much. Can you guys talk about, as you get closer to cash flow neutrality, and hopefully a positive free cash flow, SM's approach to hedging and any comments about marketing, whether it be NGLs and oil would be very helpful as well? Thanks.

Wade Pursell -- Executive Vice President and Chief Financial Officer

Hey, this is Wade, I'll address the hedging question. Yes, our hedging strategy is really tied to leverage, and we're locking in for protecting the EBITDAX. So, it's predictable that as our leverage goes down and we see that going down, and we've told you that as we approach net -- getting to cash flow neutrality and then heading toward the end of next year, you're getting leverage metrics in the lower 2s area. As you approach 2 times, I would just tell you that you would probably be seeing us hedge more like 50% area net production as you approach a year, so definitely lower is the short answer to your question.

Herb Vogel -- Executive Vice President, Operations

And this is Herb. On the marketing side, first on the NGL, we have the ability on part of our volumes from the Eagle Ford to capture ethane or to reject ethane, and that's monthly election and that's driven by what methane and ethane prices are. So, right now we are clearly in ethane capture mode, and we will continue as long as it's financially beneficial to do so.

On the other aspects, oil and gas marketing, we're continuing with what we've done in the past, and we have multiple purchasers with multiple takeaway that commit to us that they've got firm takeaway capacity. And that's been a successful strategy for us and we'll continue to do that.

Michael McAllister -- MUFG Securities -- Analyst

All right. Great. That's helpful. And then two, going back to the hedging, so the directive would be is that almost any free cash flow would go down to attack that balance sheet and create value through that?

Wade Pursell -- Executive Vice President and Chief Financial Officer

Well, it's great. Thanks for asking. It's great opportunity actually when you look at free cash flow. So, yeah, we really have three opportunities. You can accelerate activity in either the Permian or the Eagle Ford or pay down debt. And certainly my bias is to -- at this point given where our leverage is at is to use it for debt reduction. A great thing about that, and if you can say it's ever great to have debt is that our debt is call -- all that debt we have is callable at some point. We have some that's callable now. Some of that will be -- more of that will be callable in November. And we have this opportunity to essentially use that to enhance our debt adjusted per share cash flow growth rate, which is the metric we care the most about, and the one that we think shareholders should care the most about, at a very low risk, from the standpoint of using that cash. So, in a way, it's a way to -- it's just moving value from the debt side of the balance sheet to down to shareholders equity, and we think that's a great strategy going forward and certainly that's our intent.

Michael McAllister -- MUFG Securities -- Analyst

Great. Thank you very much.

Operator

I will now turn the conference back over to Mr. Jay Ottoson, CEO, for closing remarks.

Jay Ottoson -- President and Chief Executive Officer

Well, we thank you again for your attendance this morning and your interest in the company, and hope you have a pleasant day. Thank you.

Operator

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

Duration: 15 minutes

Call participants:

Jennifer Samuel -- Vice President of Investor Relations

Jay Ottoson -- President and Chief Executive Officer

Brad Heffern -- RBC Capital Markets -- Analyst

Herb Vogel -- Executive Vice President, Operations

Oliver Huang -- Tudor, Pickering, Holt. -- Analyst

Michael McAllister -- MUFG Securities -- Analyst

Wade Pursell -- Executive Vice President and Chief Financial Officer

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