Laredo Petroleum (LPI) Q3 2021 Earnings Call Transcript

Laredo Petroleum (LPI -0.89%)
Q3 2021 Earnings Call
Nov 03, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Laredo Petroleum, Inc.'s third quarter 2021 earnings conference call. My name is Brian, and I will be your operator for today. [Operator instructions] As a reminder, this conference call is being recorded for replay purposes. It is now my pleasure to introduce Mr.

Ron Hagood, vice president, investor relations. You may proceed, sir.

Ron Hagood -- Vice President, Investor Relations

Thank you, and good morning. Joining me today are Jason Pigott, president and chief executive officer; Karen Chandler, senior vice president and chief operations officer; and Bryan Lemmerman, senior vice president and chief financial officer, as well as additional members of our management team. During today's call, we will be making forward-looking statements. These statements, including those describing our beliefs, goals, expectations, forecasts and assumptions are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Our actual results may differ from these forward-looking statements for a variety of reasons, many of which are beyond our control. In addition, we will be making reference to non-GAAP financial measures. Reconciliations to these GAAP financial measures are included in our press release and presentation, which we issued yesterday that details our financial and operating results for the third quarter of 2021. If you do not have a copy of this press release or presentation, you may access it on our website at www.laredopetro.com.

I will now turn the call over to Jason Pigott, president and chief executive officer.

Jason Pigott -- President and Chief Executive Officer

Good morning and thank you for joining us today. Our strong third quarter results demonstrate our success integrating the Sabalo acquisition. We are ending the fourth quarter and 2022 with strong momentum, both operationally and financially. Before jumping into our quarterly results, let me take a few moments to reflect on our key strategic accomplishments over the last two years.

Like most of our industry prior to 2019, Laredo was stuck in a cycle of outspending cash flow to pursue growth and to maximize production. Our balance sheet was heavily levered, our inventory was largely gas-weighted and the prospect of generating sustainable free cash flow was far in the future. We are much better positioned today. In two short years, we have fundamentally transformed Laredo and are now focused on generating free cash flow, improving our margins, strengthening our balance sheet and operating with the highest ESG standards.

Laredo has always been fortunate to have a strong operational team with a track record of creating efficiencies and optimizing the development of our assets. We have all the key ingredients required for sustaining long-term value creation. Let's review some of the key highlights. First, we acquired key assets that lengthen our inventory life and grew margins through increased oil cuts.

We have added more than 55,000 net acres of oil-weighted high-margin inventory underwritten at oil prices well below today's strip. With seven years of quality oil-weighted inventory, we have fully transitioned our development program to the highest rate of return projects. Second, with an improved asset portfolio and disciplined capital investments, we are now positioned to deliver sustainable free cash flow beginning in the fourth quarter of 2021 at current commodity prices. We recognize the importance of this to investors, and we'll continue to run the company with this goal in mind; third, our capital structure has significantly improved, and we are focused on reducing leverage to under one times net debt to adjusted EBITDA, potentially as soon as 2023.

This trajectory will allow us to consider more shareholder-friendly actions in the near future and return cash to our owners. All options are on the table. And finally, we recognize that simply producing our products and delivering returns is not enough. We have redoubled our commitment to ESG excellence and are proud to be pursuing multiple projects that will reduce our environmental footprint.

We have proven our ability to capture value adding transactions in today's competitive A&D market. Our operating teams are second to none and we'll seek to continue to find innovative ways to create value on new acreage while improving margins and maximizing inventory. We will continue to seek accretive, leverage-reducing transactions to accelerate and further increase the competitiveness of our company. While we are proud of our collective accomplishments, our management team and employees are hardly satisfied, and we recognize the great opportunity that lies before us.

We are just getting started and are working hard every day to capture value for our stakeholders. I will now hand the call over to Karen for an operational update.

Karen Chandler -- Senior Vice President and Chief Operations Officer

Thank you, Jason, and good morning. Our operating performance in the third quarter was strong. And as Jason mentioned in his opening remarks, is indicative of our ability to integrate our acquisitions efficiently and profitably with focus on applying our ESG best practices to the acquired assets. Just over a year ago, our drilling and completions operations shifted from our legacy leasehold to our acquired Howard County acreage position.

Our operations teams were able to maintain Laredo's long term positive trajectory of drilling and completions efficiency gains, allowing us to further reduce our total drilling, completions and equipment costs to $525 per foot throughout 2021. Further, our innovative approach to sourcing sand for our completions operations continues to pay dividends. In late 2020, we opened a company-owned sand mine operated by a third party, located within our Howard County leasehold. This insulated us from rising sand prices and eliminated about 300,000 miles per month of trucking, further reducing cost and the emissions associated with trucking.

At the time, we expected savings of approximately $90,000 per well. Due to the inflationary pressures in sand, our savings now total over $250,000 per well relative to current market prices. With the recent strength in commodity prices, we are today seeing more pervasive cost pressures in pressure pumping, rig rates, casing, diesel and chemicals to name a few items. Our teams are working hard to offset inflation with new efficiency gains such as drilling longer laterals, utilizing offline cementing, and implementing fast line technology for faster transition times during fracking operations.

But we are anticipating inflation of around 15% in 2022 versus our midyear expectations when we communicated our initial thoughts for 2022 capital expenditures. With our move to Howard County, higher oil cuts are driving not only higher margins, but also somewhat higher LOEs. Third quarter operating costs were impacted primarily by higher workover expenses, as well as we acquired in North Howard experienced higher than anticipated ESP failures. Going forward, LOE expenses are expected to remain higher, driven by increased diesel cost and generator usage, anticipated increase in workover activity and continued optimization of artificial lift designs associated with the new acquisition areas.

We expect full company LOE to be around $4.25 per BOE for full year 2022. Our team's knowledge and experience operating in the Midland Basin drives more than low cost. Our development experience in the Midland Basin also enables real-time analysis and application of learnings. Our first two-well packages in Central Howard were developed on a spacing of 16 wells per DSU.

We believed it was important to test tighter, as well as wider spacing in the early development packages. In the subsequent two well packages, we began to transition our spacing to wider space developments, including 14 and then ultimately, 12 wells per DSU. The third and fourth well packages, which were developed at wider spacing, are currently performing 24% and 36% better than the first two well packages, driving superior economics and value per section. In our recently acquired North Howard position, results from two-well packages are showing very positive results.

As we gain longer-dated production data, we will continue to optimize our development in this area. Importantly, these packages are confirming our assumptions on spacing and the entire range of codeveloped bounded, semi-bounded and unbounded development that can occur in the area. Laredo is continuing to stay at the forefront of emissions performance in the Midland Basin. During the third quarter, we flared or vented 1.89% of produced gas.

While higher than past performance, this was driven by the integration of the acquired assets in North Howard. Excluding the North Howard assets, we further vented 0.55% of produced gas during the quarter. We are now upgrading the acquired facilities to meet our high emission standards and are working with our gas gathering and processing partner to ensure better performance to maximize production and eliminate flaring. Once the facility upgrades are complete and assuming no additional third-party gas takeaway constraints, we expect total company performance to strengthen to previous levels.

We've also entered into agreements that further our already robust commitment to emissions reduction. We have initiated the responsibly sourced gas certification process on all horizontal wells in our Howard and Western Glasscock County development areas. Significantly, this will cover the development areas that are expected to receive the entirety of our development capital in the foreseeable future. In conjunction with the RSG process, we have initiated a continuous emissions monitoring pilot on selected facilities in Howard County, furthering our commitment to measure and reduce greenhouse gas emissions.

We have set aggressive goals for the reduction of greenhouse gas and methane emissions along with the elimination of routine flaring by 2025. We are committed to achieving these goals and we'll continue to employ state-of-the-art processes and maintain high-quality facilities as we deliver on our commitments. Our performance over the last two years has been impressive. Our team has proven that we can create value through the sourcing and pricing of transactions in a fluid A&D market and then quickly integrate and improve the acquired assets.

Further, we can accomplish the integration in a responsible and sustainable manner and improve the environmental performance from the acquired assets. I will now hand the call over to Bryan for a financial update.

Bryan Lemmerman -- Senior Vice President and Chief Financial Officer

Thank you, Karen. Like operations, our financial performance this year has also been strong and has helped drive the transformation of the company. Taking a look at our third quarter highlights. First, we closed the transformative Sabalo acquisition in parcel legacy PDP divestiture on July 1.

Then in mid-July, we issued $400 million of notes due in 2029, terming out our credit facility. As part of that process, we also renewed and extended the maturity of our credit facility to 2025 and restructured our bank group, dropping eight banks that wanted to reduce their energy exposure and adding four banks strongly committed to the sector. Lastly, we announced our second significant acquisition of 2021 with the agreement to purchase approximately 20,000 net acres in Western Glasscock County, extending our oil-weighted development runway to seven years. This acquisition has since closed in the fourth quarter.

We will enter 2022 with an improved capital structure, a longer runway of high-quality oil inventory and strong operating and ESG performance. This momentum stems from our recent strategic and accretive acquisitions. Our pivot to this inventory is driving an increased oil cut, higher margins, lower leverage and an improved outlook for free cash flow. I would point you to slide seven, where we show you the improvement in our oil cut and margin uplift attributable to the increased oil cut.

Had we not pursued our acquisition strategy and our commodity mix has remained at historic levels. Our cash margin even with the dramatic increase in natural gas and NGL realizations would have been more than 20% lower than our reported numbers. At current commodity prices, we are on track to be below one and a half times net debt to adjusted EBITDA by the end of 2022 and below 1x by the end of 2023. The two-step process of reducing leverage and reducing our interest burden will position us to consider other sustainable options to return cash to our owners sooner than previously planned.

Beyond the third quarter highlights, we are seeing continued improving fundamentals, which continue to help strengthen our capital structure going forward. As I mentioned previously, we issued $400 million of notes due in 2029 with a coupon 2.25% lower than our previous benchmark note. In October, our borrowing base of our credit facility was increased from $725 million to $1 billion. Our current liquidity based on the $725 million of elected commitments is approximately $600 million.

And at current commodity prices, including our hedges, our free cash flow generation in 2022 is approximately $300 million. While these improvements are impressive, we are not nearly content to rest on our success. We continue to look for acquisitions that like the two already closed in 2021 are accretive on a per share basis and are deleveraging to the company. As Karen mentioned, we have demonstrated our ability to integrate acquisitions profitably and efficiently.

And when combined with our ESG leadership makes us a preferred buyer of assets in the Midland Basin. I will now turn the call over to Jason for some closing remarks.

Jason Pigott -- President and Chief Executive Officer

Before we take your questions, I would like to reiterate a few key points. Over the last two years, we have made significant strides transforming our company and positioning it for success. We have acquired high-margin oil-weighted assets leading to a higher oil cut and higher margins. We have put ourselves on a path to reducing our leverage ratio to below one times.

Our operations team is successfully integrating our acquisitions, and we are focused on sustainable development practices that support our environmental and safety commitments. We have a group of employees that is second to none and is motivated to come in every day and deliver on our strategy and create value for all our stakeholders. With that, operator, please open the line for questions.

Questions & Answers:

Operator

[Operator instructions] Our first question will come from Derrick Whitfield with Stifel. Your line is now open.

Derrick Whitfield -- Stifel Financial Corp. -- Analyst

Thanks, and good morning all.

Jason Pigott -- President and Chief Executive Officer

Good morning, Derrick.

Derrick Whitfield -- Stifel Financial Corp. -- Analyst

For my first question, I wanted to focus on a bigger picture topic that you referenced in your prepared comments, perhaps for yourself, Jason or Bryan. Now that you've attained seven years of oil inventory and have line of sight to a sub one and a half net debt-to-EBITDA ratio by year-end 2022 and likely sub-1 by 2023, how should we think about your preference for capital allocation between M&A, debt reduction, and return of capital as we look forward in time?

Jason Pigott -- President and Chief Executive Officer

Yes. Again, I think for us, the debt reduction is the top priority. M&A can come and go, and it's an interesting time right now where assets that were not worth very much in the past. People may be waiting for $100 oil before they sell them.

So, it's an interesting environment out there. There are plenty of packages coming to the market. But again, those can come and go. I think what we've demonstrated in the past is that we've been very thoughtful about the deals that we've done, and they have again added value to the company.

The timing has been right. We've been able to use some equity to keep from levering up. So, I think debt reduction is the primary focus. If we see good deals, we'll continue to act and grow.

Again, we're still working on achieving greater materiality in the industry. But I think the team has just done a really good job of timing these deals well and doing things that make a lot of logical sense.

Derrick Whitfield -- Stifel Financial Corp. -- Analyst

Great. And as my follow-up, I'd like to maybe shift over to your production trajectory for 2022. Last quarter's 2022 disclosures suggested flattish, perhaps slightly down full year 2022 volumes relative to your Q4 guidance. Is that still a reasonable projection following the most recent acquisition?

Jason Pigott -- President and Chief Executive Officer

Yes. Yes. I mean, it will be fairly flat year over year. I'd say we'll give more guidance come February.

We do have a lot of moving parts. I mean, there are wells that are outperforming, but there are also unbounded wells that are the ones that are outperforming. So, we're going to continue to digest the new information in Howard County. We're just now getting in our data from the Pioneer acquisition.

We've got some good test. There are wells that are being completed now and for West. So, there's just a lot of moving parts with all the deals that we've done. I would say, for us, when we look to cash flow for 2021, we're expecting about $300 million of free cash flow at $75 oil.

So, still going to be a very robust year for us next year. We are working on the capital side. We will upgrade the facilities in the newly acquired areas, and there's things like a pipeline that may or may not be in our budget if we fund it versus a third party. So, there's still a lot of moving parts, but expect cash flow for next year to be very robust even with all these moving parts.

Derrick Whitfield -- Stifel Financial Corp. -- Analyst

Understood. Great update and thanks for your time.

Operator

Thank you. And our next question will come from the line of Noel Parks with Tuohy Brothers. Your line is now open.

Noel Parks -- Tuohy Brothers -- Analyst

Good morning.

Jason Pigott -- President and Chief Executive Officer

Good morning 

Noel Parks -- Tuohy Brothers -- Analyst

Just had a couple of questions. On your discussion on emissions and flaring and your goals to eliminate that going forward, you mentioned, I believe, that you're piloting some emissions monitoring technologies. I wonder if you could just talk a little bit about that sort of what the cost looks like and whether there is a lot to choose from in terms of different vendors and equipment out there or whether you pretty much know what would work best in your facilities and I'm just trying to sort of test out how well it might work.

Kyle Coldiron -- Vice President, Development and Production

Good morning. This is Kyle Coldiron. So, our pilot project, we're actually using three different vendors for the continuous submissions monitoring. And the objective of that pilot is to determine which of those vendors kind of provides us the best product and the best view of data.

There's a lot of different variables that we're looking for in terms of kind of what a successful pilot looks like. And so, that's really the objective of this pilot. It's a year-long effort. In some locations, we have all three vendors, putting their monitoring stations on the facility.

And in other cases, we have just a single vendor monitoring that facility. I think we're choosing 10 different facilities to monitor and then we're going to start observing the data as it comes in looking at same length frequency and the amount of kind of real time duration that we have of any kind of emissions. So, that's really the objective is to figure out which of those vendors provide us the best product. I'd also add, we've done a really good job with our digital transfer here at Laredo.

We've actually got some in-house code that we've written. We've got both for thermal and optical cameras, got focused on these tank batteries, and they're actually able to start recognizing some of these emissions as well. So, we're using both internal and external technology to really, again, try to reduce our carbon footprint as much as possible.

Noel Parks -- Tuohy Brothers -- Analyst

Great. Interesting. And also discussing M&A. And as you mentioned, there are a lot of moving parts -- different moving parts with the transactions you've done to date.

And I'm just curious for what remains out there on the market. Do any of those operators or have any of them made any strides on working on emissions or flaring or other ESG issues? Or is it pretty unusual to see small operators having made new progress?

Jason Pigott -- President and Chief Executive Officer

Again, I was at a conference in Houston last week. So, I do believe some of the smaller operators are -- again, they must get caught up. I think they've been a little bit behind. It's hard to speak for everybody.

Like, again, even in the public space, there are going to be some that greenwashing their ESG efforts, and then there are some that are, again, really focused on it, doing the right thing. And I think for some of these small operators, it is a very broad spectrum that you're going to see as they put assets to market.

Noel Parks -- Tuohy Brothers -- Analyst

OK. Great. And just one last one for me. I think, as was mentioned earlier, that in the North Howard area, you're learning about founded and semi-bounded development of the different price of it.

Can you talk a little bit more about that, just what you've learned and if there's anything sort of nonintuitive that's implied by your work there?

Jason Pigott -- President and Chief Executive Officer

So, I think really nothing nonintuitive. And it's what we would expect to see. I think what we're kind of getting to there, the sudden adjusted packages, which you can see in our release, you can see that they are performing very well. And so, what we're trying to kind of communicate is that we're very happy with their performance.

Those wells are unbounded. And so, they go back on parent wells or single wells, and they are not reflective of our expectations for co-developed packages, which is our development spacing pattern plan going forward.

Noel Parks -- Tuohy Brothers -- Analyst

Fair enough. OK, good. Thanks a lot.

Jason Pigott -- President and Chief Executive Officer

Thank you.

Operator

And this concludes our question-and-answer session for today. So, now it is my pleasure to hand the conference back over to Mr. Ron Hagood, vice president, investor relations, for any closing comments and remarks.

Ron Hagood -- Vice President, Investor Relations

Thank you for joining us today. We appreciate your interest in Laredo. This concludes our call, and have a great morning.

Operator

[Operator signoff]

Duration: 26 minutes

Call participants:

Ron Hagood -- Vice President, Investor Relations

Jason Pigott -- President and Chief Executive Officer

Karen Chandler -- Senior Vice President and Chief Operations Officer

Bryan Lemmerman -- Senior Vice President and Chief Financial Officer

Derrick Whitfield -- Stifel Financial Corp. -- Analyst

Noel Parks -- Tuohy Brothers -- Analyst

Kyle Coldiron -- Vice President, Development and Production

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