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Rattler Midstream LP (NASDAQ:RTLR)
Q2 2020 Earnings Call
Aug 6, 2020, 3:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Rattler Midstream Q2 2020 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mr. Adam Lawlis, VP of Investor Relations. Thank you. Please go ahead, sir.

Adam Lawlis -- Investor Relations

Thank you, Teresa. Good morning, and welcome to Rattler Midstream's second quarter 2020 conference call. During our call today, we'll reference an updated investor presentation, which can be found on Rattler's website. Representing Rattler today are Travis Stice, CEO; and Kaes Van't Hof, President.

During this conference call, the participants may make certain forward-looking statements relating to the Company's financial condition, results of operations, plans, objectives, future performance and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements due to a variety of factors. Information concerning these factors can be found in the Company's filings with the SEC.

In addition, we will make reference to certain non-GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon.

I'll now turn the call over to Travis Stice.

Travis Stice -- Chief Executive Officer

Thank you, Adam. Welcome, everyone, and thank you for listening to Rattler Midstream's second quarter earnings call. The second quarter of 2020 presented historic volatility in global energy demand and commodity prices. Rattler, despite all of its operations being located in the premier low-cost shale basin and operated by the low-cost operator in Diamondback, was not immune from this volatility.

Diamondback made the prudent decision to suspend completion activity and curtail production in the quarter, directly impacting Rattler's second quarter volumes. Diamondback has now returned all of these curtailed volumes back to production and is currently running three completion crews, both of which will help Rattler's cash flow grow significantly in the back half of the year, from the second quarter lows. And a maintenance scenario for Diamondback in 2021, Rattler will have fewer operated capital requirements and relatively flat volumes in the second half of 2020, producing free cash flow at the operated level. We are also reiterating our previously announced EBITDA guidance for the year, which at the midpoint implies growth of 6% year-over-year, even in the current commodity price environment.

Turning to our equity method investments, both the Gray Oak and EPIC crude pipelines began full commercial service in April, generating cash flow at the project level and contributing meaningfully to Rattler's EBITDA since starting up. We have also been impressed by the resilience of our OMOG oil gathering JV with volumes growing on this system in the second quarter. This highlights the quality of the acreage underpinning the system, which was the primary rationale for our investment last year. Three of our five equity investments are now operational with Wink to Webster pipeline expected to come online in 2021, and our Amarillo-Rattler gathering and processing expansion delayed until commodity prices recover and volumes return to growth in that field. We expect about two-thirds of our equity method EBITDA to convert to distributions to Rattler over the next 12 months.

Moving to our operated business. Rattler is intently focused on capital and cost control heading into the second half of 2020 and in 2021. Due to lower activity levels at Diamondback, we have reduced our operated capital spend for the back half of the year and expect to spend about half of our 2020 capital budget in a 2021 maintenance scenario for Diamondback.

On the operating cost front, we will continue to drive down operating costs and increase margins, preparing for a lower for longer commodity price environment. Although the forward outlook remains uncertain, we feel the worst is likely behind us, and we are very confident in the resiliency of the Rattler business model. Therefore, we are maintaining our $0.29 per unit distribution for the second quarter, which is flat from the previous quarter and in line with previous and current guidance for 2020.

The Board intends to review this distribution policy each quarter, but with peer-leading leverage, significant liquidity, a core business that is expected to be free cash flow positive, a large capex cycle in the rearview mirror and differentiated visibility into Diamondback's future activity, Rattler is well positioned to maintain its distribution with free cash flow generation.

In conclusion, I want to emphasize that Rattler was set up to be a sustainable self-funding business to compound the inherent volatility in our business. While diversification of customers is often seen as a benefit in the midstream space, we view Rattler's concentration with Diamondback as a clear positive. Diamondback's cost structure with low interest expense, low leverage, low cash G&A, a full hedge book, strong midstream contracts and mineral ownership through Viper Energy Partners has prepared it to operate in a lower-for-longer oil price environment.

With these comments now complete, operator, please open the line for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Jeremy Tonet with JPMorgan.

Jeremy Tonet -- JPMorgan -- Analyst

Hi. Good morning.

Travis Stice -- Chief Executive Officer

Good morning.

Jeremy Tonet -- JPMorgan -- Analyst

Just wanted to start off, it seems FANG continues to shift to the Midland. Maybe it's around 70-30 split. And if you could just kind of remind us, like how this influenced Rattler in terms of water cut and any other impact that we should be thinking about there?

Kaes Van't Hof -- President

Yeah, Jeremy, good question. Certainly, the water cut on the Midland Basin side is lower than the Delaware. But that also means, we have to spend less capital dollars on infrastructure. As Diamondback was ramping in the Delaware Basin, I mean, we were having to drill a new disposal well almost every couple of pads, and that's pretty capital-intensive side of the business. So with Diamondback moving more to the Midland, the Delaware is kind of more of a steady state to declining a bit, but we don't have to spend any more dollars out there on the SWD side. So that helps us on the capacity front. And I'd say on the Midland side, we are doing some drilling and completing some wells in some shallower zones that have a little higher water cut on the Midland side. So you're probably closer to two to three barrels of water per barrel of oil now on the forward outlook on the Midland side.

But overall, I think as -- and the numbers that we're seeing and the steady state or the safe flat plan at the parent company, Rattler's cash flow is going to grow, into Q3, and we don't see a lot of movement in the cash flow over the next four quarters with -- even with that shift.

Jeremy Tonet -- JPMorgan -- Analyst

Got it. That's very helpful. Thanks. And just want to think from kind of a higher level, if Diamondback is moving to more of a maintenance mode, what type of ongoing capital needs do you see at Rattler? Just trying to see what -- what capex we needed to kind of sustain EBITDA at these levels?

Kaes Van't Hof -- President

Yeah, Jeremy, also a good question. We're scoping out 2021 right now. I think every dollar is going to be highly scrutinized over the next six quarters. What I can tell you right now is that operated capital will be at least half of what we saw and we're seeing in 2020. So the 2020 operated capital budget is $125 million to $150 million. And I think the way I see it right now, it needs to be at least half of that in 2021.

Jeremy Tonet -- JPMorgan -- Analyst

Got it. That's very helpful. I'll leave it there.

Travis Stice -- Chief Executive Officer

And I think, Jeremy, over time, right, that number is going to continue to decline if we stay flat over a longer period of time. We don't have a crystal ball yet on 2022, let alone in the fourth quarter of 2020. But overall, less growth at the parent Co results in less need for capital at the subsidiary.

Jeremy Tonet -- JPMorgan -- Analyst

Got it. That makes sense. That's helpful. Thank you.

Travis Stice -- Chief Executive Officer

Thanks, Jeremy.

Operator

And your next question comes from the line of Phil Stuart with Scotia Bank.

Philip Stuart -- Scotia Bank -- Analyst

Good morning, guys. I appreciate you all taking the time this morning.

Travis Stice -- Chief Executive Officer

Hi, Phil.

Philip Stuart -- Scotia Bank -- Analyst

I was wondering, if we could start on the OMOG JV, I was pretty encouraged to see volumes actually increase quarter-over-quarter on that particular asset. Just curious -- I mean, I know there are two other primary operators in addition to some additional third-party operators on that system in addition to Diamondback. But just curious what the outlook is for that asset, in particular, over the next couple of quarters, if you have any visibility into what you think the third parties are going to do there? And if that asset could potentially kind of hold flat in terms of oil throughput volumes over the next couple of quarters?

Kaes Van't Hof -- President

Yeah, Phil, good question. I think overall, our partners at Oryx have done a great job operating that system. And I think they've done a lot to cut a lot of required capital out of that system, and that's resulting in significant distributions back to us pretty consistently. But we were surprised that the system grew in Q2, even in face of everything that was going on in the market. I certainly don't expect it to grow into Q3 and Q4, but the commentary from one of the largest contributors, which is QEP seemed pretty positive in the fourth quarter time frame. So we might take a dip in Q3, but I'm hoping that things come back up here in Q4. I can also say Diamondback has eight or 12 wells planned in the back half or Q4 of this year. That should carry on nicely into 2021, because we have a lot of mineral ownership up there as well as this ownership in the OMOG JV.

Philip Stuart -- Scotia Bank -- Analyst

Okay. Great. I appreciate the additional information there. And then, I guess, staying on OMOG, are there any material capital requirements for that JV kind of over the next 12 to 18 months?

Kaes Van't Hof -- President

Yeah. I mean, so when we bought that asset, we basically assumed that there was going to be need to be $100 million of total capital to build out the asset to full field development. Our latest numbers point toward a number that's 65% or 75% below that. So there's small capital requirements here and there and new well connections. But the overall burden has been reduced dramatically. And we have a small line of credit at that subsidiary. And I think that that line of credit can easily handle that -- those small capital requirements. So we're not expecting to put any more money into that business. Instead, we'll be getting money out.

Philip Stuart -- Scotia Bank -- Analyst

Okay. Sounds good, guys. That's it for me. Thanks.

Kaes Van't Hof -- President

Thank you, Phil.

Travis Stice -- Chief Executive Officer

Thanks, Phil.

Operator

And your next question comes from the line of Ujjwal Pradhan with Bank of America.

Ujjwal Pradhan -- Bank of America -- Analyst

Good morning, guys. This is Ujjwal. Thanks for taking my question. First one, on the volume outlook in second half. It seems even after a tough 2Q, the first half is tracking toward midpoint of the range for produced water and sourced water volume guidance. So as we see activity gradually resumes here, and FANG bringing back the completion crews gradually, what do you expect the cadence of the water volumes would be in the subsequent two quarters and perhaps where would exit the year?

Kaes Van't Hof -- President

Yeah. It's a good question. So certainly, on the freshwater side with Diamondback bringing back three to four completion crews, we're going to see freshwater volumes almost triple off of the Q2 lows. And then on the sourced water, excuse me, on the disposal side, the way we have it modeled right now is probably a little bit of a dip in Q3 with some more growth into Q4. And I think how we generally see it is that Q4 salt water disposal volumes will be kind of in line to maybe a little above Q2.

Ujjwal Pradhan -- Bank of America -- Analyst

Got it. Thank you. That's helpful. And on the sourced water side, it appears you're able to source around 30% of recycled sourced water, which is, I guess, at the higher end of range that you have targeted in the past. Is that something you expect to be able to repeat later? And what would be the margin read through, if that would happen?

Kaes Van't Hof -- President

Yeah, that's a good question. I think Q2 is a little skewed because we completed so few wells, right? We only completed 15 wells. So as we get more toward the 40 to 50 completions a quarter, it's going to be hard to top the 30% number that we saw in Q2. But overall, I think, we have set an internal bogey to be above 20%. And I think the margin enhancement is somewhere along in the range of $0.10 to $0.15 a barrel.

Ujjwal Pradhan -- Bank of America -- Analyst

Got it. Thanks for that. And one more, if I may. I appreciate the comment on the potential 2021 capex based on the maintenance activity expectation. I guess the expectation was, capex was supposed to come down after this year. So if you could provide more color on what sort of capital projects would that spending for under the maintenance scenario?

Travis Stice -- Chief Executive Officer

Yeah. I also don't want to get pinned in a corner on the 2021 capex numbers yet. So I'm trying to give somewhat of an at least -- at least decrease. I think as you think about the projects, most of the projects involve adding salt water disposal capacity in the Midland Basin, particularly in the Northern Martin County and Northern Howard County areas where we don't have as much infrastructure as in kind of Midland county. So most of it's going to be drilling some -- a few disposal wells as well as connecting the systems, so that we're effectively utilizing the capacity that we have. But like I said, every dollar is going to be scrutinized pretty heavily here, and we hope to continue to drive down that number for '21.

Ujjwal Pradhan -- Bank of America -- Analyst

Thanks, guys. Appreciate the color. Have a great day.

Kaes Van't Hof -- President

Thanks a lot.

Operator

And your next question comes from Pearce Hammond with Simmons Energy.

Pearce Hammond -- Simmons Energy -- Analyst

Good morning and thanks for taking my questions. I wanted to start with SWD. And just curious how you are on SWD capacity? And what you're paying right now for an SWD well, the full cost to drill and to bring it into service?

Kaes Van't Hof -- President

Yeah, Pearce, good question. I think with everything, the cost to drill and complete these wells has come down. I think in the Delaware Basin, DC, drill and complete, I guess, equip, which would be the facilities for the SWD or kind of in the $3.5 million to $4 million range versus kind of $4.5 million a year ago. And those are shallower disposal zones in the Delaware sands. Fortunately, like I said earlier in the call, we're not ramping as much as we expected in the Delaware Basin. So we're not having to drill as many of those wells in the forward outlook. But on the Midland side, you're a little deeper, you're disposing into the Ellenburger, which is 13,000 plus feet of total. So those costs are little bit more. They're probably, they probably topped out at $6.5 million, $7 million for a fully built facility and now we're probably closer to 5.5% on a total basis. So along with the capital budget being cut down from a number of projects perspective, the cost of those projects continues to decline.

Pearce Hammond -- Simmons Energy -- Analyst

Okay. Thank you, Kaes. And then my follow-up, good job on reducing operating costs. And I'm just curious how sustainable do you see that as those operating cost reductions as you move into the future and volumes start to increase?

Kaes Van't Hof -- President

Yeah. I mean, I think in a down cycle, you start to pick up pennies and without us needing to feed the Diamondback rig machine as much as we did in the last 12 months, the focus has really turned to the op cost side and being efficient with our disposal volumes. Like, for instance, in our ReWard field, we have five or six disposal wells, two of them have no royalty associated with them. So we're trying to spend as many barrels as possible to that, those particular disposal wells versus the others. So stuff like that, where you're managing not only the costs on the chemicals and the workovers and the maintenance program, but also managing that royalty and being as efficient as possible to send the lowest cost barrels to the lowest cost disposal well has become a big focus. So I think it's pretty sustainable, particularly as volumes aren't growing like they were expected to that turns the focus to the efficiency on the operated side.

Pearce Hammond -- Simmons Energy -- Analyst

Okay. Thank you very much, Kaes.

Kaes Van't Hof -- President

Thank you, Pearce.

Operator

[Operator Instructions] Your next question comes from Michael Lapides with Goldman Sachs.

Michael Lapides -- Goldman Sachs -- Analyst

Hi, guys. Thanks for taking my question. Actually, I have two of them. One, just thinking about the long-haul pipelines where you've got equity investments. How are you thinking about the ramp-up of volumes on Gray Oak and on EPIC? And kind of the earnings sensitivity that you'll face if it takes a while from volume for those pipes to really fill up?

Kaes Van't Hof -- President

Yes, Michael, I think as we've said since the IPO, we always like to model something we can't control very conservatively. And that's what we've done in our assessment of our JV cash flows across the board. So I think that prudence is paying out with us, keeping our JV EBITDA guidance intact. Certainly, volumes on both systems are probably a little lower than everybody expected two years ago. But, I think with Grey Oak having a lot of take-or-pay contracts on that system, that will ensure that we continue to get distributions. And on the EPIC front, I think their volumes are more exposed to the operators that underlie those commitments. And I can speak for Diamondback that we're sending 75,000 or 80,000 barrels a day down that system and a happy customer.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. And then total unrelated question. At the Rattler level, in a down market and with a pretty healthy balance sheet, how are you guys thinking about M&A? Like -- and what are the types of opportunities. And do you think there's a disconnect on the midstream side between maybe potential seller viewer views of what assets are worth versus potential buyer views?

Kaes Van't Hof -- President

I can certainly say that the seller's view of an asset's value is a lot different from the buyer's in this market through my experience on the mineral side, the working interest side and the midstream side. So I think with any down cycle, patience is rewarded, and I think some stability in what the future holds might create M&A. For us, though, we've been pretty adamant that any M&A we do on the Rattler side has to have a direct connection to the parent company and what the parent company is doing. The OMOG JV, for instance, is one of the big reasons we did it because we understood the quality of the acreage, and it looks like that system is performing pretty well in the face of some tough macro headwinds. So I think big M&A for us is pretty much off the table, on the Rattler side. We are excited that we got our bond deal done and added a ton of liquidity, which I think for us, ensures that this distribution is safe for the foreseeable future. And I think that's probably the big takeaway there, but not going to use that liquidity to go buy things left and right.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. Thank you, guys. Much appreciated.

Kaes Van't Hof -- President

Thank you, Michael.

Operator

And there are no further questions. I will now turn the call back to Travis Stice, CEO.

Travis Stice -- Chief Executive Officer

Thanks again to everyone participating in today's call. If you have any questions, please contact us using the information provided.

Operator

[Operator Closing Remarks]

Duration: 23 minutes

Call participants:

Adam Lawlis -- Investor Relations

Travis Stice -- Chief Executive Officer

Kaes Van't Hof -- President

Jeremy Tonet -- JPMorgan -- Analyst

Philip Stuart -- Scotia Bank -- Analyst

Ujjwal Pradhan -- Bank of America -- Analyst

Pearce Hammond -- Simmons Energy -- Analyst

Michael Lapides -- Goldman Sachs -- Analyst

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