Crestwood Equity Partners (CEQP) Q2 2023 Earnings Call Transcript

Crestwood Equity Partners (CEQP)
Q2 2023 Earnings Call
Aug 01, 2023, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to today's conference call to discuss Crestwood Equity Partners second quarter 2023 financial and operating results. Before we begin the call, listeners are reminded that Company may make certain forward-looking statements as defined in the Securities and Exchange Act of 1934 that are based on assumptions and information currently available at the time of today's call. Please refer to the company's latest filings with the SEC for a list of risk factors that may cause actual results to differ. Additionally, certain non-GAAP financial measures, such as EBITDA and adjusted EBITDA, distributable cash flow and free cash flow, will be discussed.

Reconciliations to the most comparable GAAP financial measures are included in the news release issued this morning. Joining us today with prepared remarks are founder, chairman and chief executive officer, Bob Phillips; president, Robert Halpin; and executive vice president and chief financial officer, Johnny Black. Additional members of the senior management team will be available for the question-and-answer session with Crestwood's current analyst following the prepared remarks. At this time, all participants are in a listen-only mode.

A brief question-and-answer session will follow the formal presentation. [Operator instructions]. As a reminder, today's call is being recorded. At this time, I will turn the conference over to Bob Phillips.

Bob Phillips -- Founder, Chairman, and Chief Executive Officer

Thank you, operator and good morning, everyone. Thanks for joining us today to discuss our second quarter 2023 results and our outlook for the second half of the year. Let me begin with a few opening remarks. And then, I'll turn it over to Robert for an operational review of the quarter and finally to Johnny to review the second quarter financial results in greater detail.

To kick things off, I want to say that we had another strong quarter of producer activity and volume throughput across our entire G&P portfolio. We give you several of the highlights of the quarter from that perspective. One, we connected 73 new wells during the quarter, bringing the year-to-date total to 143 wells connected so far, which is slightly ahead of our expectations from the beginning of the year. Two, many of the recent wells in the Bakken and the Permian, are exceeding type curves.

As our producers continued to perfect their drilling and completion techniques to recover as much of the resource as possible. We're seeing some positive trends there. The combination of well connect growth and type curve outperformance drove quarter-over-quarter volume increases across substantially all of our gathering and processing assets, as well as achieving record processing volumes in the Delaware basin. Three, we also brought online the first phase of our new three product gathering system in the City of Williston and Painted Woods areas of the Rough Rider asset in the Bakken.

This project expands our three product very critical infrastructure on the western side of the Williston and positions Crestwood to capture substantial future dedicated inventory development from Chord Energy and a number of other third-party operators that are active in that area. We are highly encouraged by the early well results from Chord and excited about the productivity from this area going forward. Down in the Delaware No. 4, we continue to see positive producer turnover on our dedicated acreage around our Delaware assets.

Earthstone energy during the quarter acquired Novo Oil and Gas which is a large customer of ours on our Willow Lake and Sendero systems, and Callon Petroleum acquired Percussion, which underpins our Panther Oil & Water gathering asset over to the east. Earthstone is extremely positive about the Eddy County acreage it acquired from Novo, the vast majority of which is dedicated to Crestwood. It's been very productive for us in recent quarters, and the company has publicly stated that it plans to reallocate a rig from their Midland basin operations to the Delaware basin to immediately begin developing the Novo acreage. So we're really excited about bringing Earthstone into the portfolio.

Callon has been similarly positive about the Percussion acreage that they acquired and we expect the company to accelerate development on our dedicated acreage later in the year. Over the last couple of years, we've seen a lot of our dedicated acreage trade hands in the Delaware basin. And we believe our producer portfolio has never been stronger. So we're excited about the future there.

Now, let me shift gears and provide some high-level commentary on a few factors that negatively impacted the results of our quarter. As many of our producer customers and midstream competitors have experienced. We've seen a lot of volatility in the commodity markets this year, particularly in the second quarter, to give you some framework, your context on the year-over-year basis, Benchmark oil, natural gas and natural gas liquids prices in the second quarter of this year declined 30%, 70% and 50% respectively. And on a sequential first quarter over second quarter basis, natural gas and natural gas liquids declined by about 20%.

So we're fighting much lower commodity prices during the quarter. The majority of our cash flow as you know was under fixed fee contracts. But we do have roughly 15% of our portfolio of cash flow that is directly impacted by commodity prices, with the majority of that being percentage of proceeds contracts on our Arrow Gathering System in the Williston and to a lesser extent on our gathering and processing assets in the Delaware Permian. With realized natural gas, NGL and crude oil prices during the second quarter well below our expectations by approximately 35% for natural gas, 40% for NGLS and 15% for crude oil, below our budgeted expectations.

We estimate that our adjusted EBITDA associated with our percentage of proceeds contracts was negatively impacted by about $8 million for the quarter due to price volatility. We've recently seen an increase in commodity prices from the lows of the second quarter with crude oil, gas and gas liquids up approximately 10%, 20% and 10% off the lows experienced in the second quarter, and that bodes well for the third quarter in the second half of the year. The second area where we faced some commodity exposure was within our NGL logistics business. As you know NGL prices experienced a fairly substantial drop in the second quarter of the year, causing a widening of the forward curve as we look out toward the winter heating season.

While this widening of the curve across the NGL markets, it drive nice incremental value to be realized across our NGL storage inventories. The logistics business did underperform our expectations during the second quarter by approximately $5 million, due largely to that drop in NGL prices during the quarter. That caused us to take a net non-cash mark-to-market loss on our inventory position. Again, that non-cash mark-to-market loss of about $5 million for the second quarter.

Now, given the widening of the curve, and the higher carries on storage, we did have a chance to increase our inventories by about 50% more than we typically do at this point in time during the fill season or the inventory build cycle. And I also want to note that the impact of the mark-to-market losses on our inventory is this quarter is purely a timing issue as our NGL inventory positions are fully hedged with fixed forward sales contracts. So as we work through the curves, headed toward the winter heating season, and ultimately deliver all that product out of storage to the market, we expect to reverse those losses and actually pick up incremental margin on the excess inventory that we built at wider forward spreads. So hopefully in the second half year, it'll turn out very positive for us.

But in the second quarter, it's $5 million non-cash yet. The final factor that negatively impacted our results in the quarter was in the G&P North segment where we experienced approximately $6 million of lower adjusted EBITDA compared to our budget expectations, largely attributable to lower volumes at Arrow. So little complicated, but while the completion activity was right on schedule on the Arrow system, we experienced lower volumes across the system, due to an increased number of wells being down or shut in for a variety of reasons including mechanical maintenance work overs. And most importantly, FRAC protection around new completion activity.

When you add it all up, we saw an average of about 10% to 15% of legacy production shut down or offline at certain points of the quarter, which negatively impacted our results, again, they're about $6 million. So considering the results for the first half of the year but updated in positive growth outlook for the third and fourth quarter, we continue to anticipate full-year adjusted EBITDA within our previous guidance range of 780 million to 860 million. I think it's clear that with these results coming in the second quarter, we expect results in the second half of the year to be on the lower half of that range due to the lower commodity prices than what we had originally forecasted. And some expected continued downtime for Arrow volumes for the balance of the year until our producers get all their production back on stream.

I want to reiterate that the fundamentals of our business remain extremely strong, with the well connects, the drilling activity, the production growth across all the assets during the quarter. And we are optimistic about the second half of 2023 and continue to have a very strong outlook for 2024 due to our capital program and the significant producer activity we've experienced to-date and through the rest of the year. And finally, before I turn it over to Robert, I want to congratulate Joanne Howard in our sustainability team for publishing Crestwood fifth annual sustainability report. The report highlights the year-over-year progress that we've attained across our ESG commitments, as well as achievements that we've made toward our second three years to sustainability strategy.

Crestwood continues to make measurable progress on our carbon management plan, and as a leader among our gathering and processing peer group, and balancing growth with environmental, social and governance objectives, and that was exemplified by the company receiving the heart energy 2023 ESG award for the public midstream category, most recently, really excited about those things. Certainly, volatile commodity prices hit us hard in the quarter, but we're rebounding in the third quarter. And with that, I'll turn it over to Robert and Johnny to cover the quarters operational and financial results. Robert?

Robert Halpin -- President

Thanks, Bob. And good morning, everyone. First, starting in the Williston basin, we connected 44 wells across the Arrow and Rough Rider Systems during the second quarter, bringing us to a total of 73 new well connects year-to-date. I'm very pleased about the level of activity we've seen across our system so far this year.

And we continue to anticipate strong producer development through the balance of the year, keeping us on track to connect between 115 to 125 new wells by the end of 2023. Now, looking more closely at Arrow, overall volumes for the quarter came in lower than expectations as we experienced higher than anticipated levels of producer downtime, negatively impacting existing well production. As Bob addressed in his comments, it is customary to see some amount of downtime on producing wells as operators take measures to enhance long-term production, most notably the utilization of frac protection, where producers will shut in or curtail producing wells in close proximity to a nearby wellbore that has been fracked during the completion stage. We have always factored these periodic disruptions into our forecast, but experienced greater levels than usual this quarter than what we have historically observed from our operators as completion activity picked up coming out of the winter season.

Along those lines from a new completion standpoint, we were very pleased to see a handful of recently turned in line well, substantially outperformed type curves, which in addition to offsetting some of the quarters downtime challenges continues to highlight the productivity of the FBIR acreage. Now, turning over the Rough Rider system, we placed into service our new three product gathering system in the city of Williston and Painted Woods areas. To-date, we brought online 13 wells in that area and we're very pleased with the production results which have been performing noticeably above budgeted type curves. We remain very bullish around the volume outlook from our dedicated acreage in this area and the productivity on the western side of the Williston basin.

This year's growth capital investments in the Williston are progressing on time and on budget and are primarily focused on the continued build out of the infrastructure on the western side of the Rough Rider system. Now, turning to the Delaware basin, we connected 24 wells across our New Mexico and Texas gathering assets during the quarter, bringing us to a total of 59 new well connects year-to-date. Strong producer activity through the first half of the year drove quarterly gas gathering volumes of 535 million cubic feet per day, a year-over-year increase of about 100%. In addition to the contribution of Sendero midstream on a year-over-year basis, gathering volumes on our Willow Lake system have grown approximately 25% when compared to last year, due to strong activity levels from both our public and private producer customers.

On the processing side, volumes hit a record high this quarter of 444 million cubic feet per day, resulting in just over 80% utilization across our 550 million cubic feet per day of total processing capacity. We continue to pursue the strategy of accelerating the utilization of our processing plants in advance to the organic production growth from our dedicated producer customers. And I am pleased to report our commercial team has successfully executed and signed two high pressure gas onload agreements that will help optimize our excess capacity over the next year or so. As we look to the balance of 2023, we now expect between 110 and 120 new well connections for full year 2023.

That being a reduction of 10 wells from the midpoint of the previous guidance range, which is largely the result of producers shifting activity into 2024 due to some of the recent A&D activity, which has driven turnover from our producer customers and has corresponding asset integration efforts ongoing. From a growth capital perspective, our spend in the Delaware continues to be on track and remains focused on well connect, system expansions and compression additions in New Mexico. Now, moving to the Powder River Basin, we connected five wells during the second quarter and 11 wells year-to-date. We remain on track to connect between 10 to 20 wells through the balance of 2023 from our existing customers.

We continue to be an active commercial discussions with large operators in the basin to bring incremental volumes onto the Jackalope system, and to increase the utilization of the Bucking Horse processing plants. Now, finally, in the storage and logistics segment, our NGL logistics business had been particularly active this quarter in response to the significant commodity price volatility that we experienced in the NGL market. Due to the widening of the spread between summer and winter prices, we have opportunistically increased our physical inventories across our NGL storage assets by more than 50% when compared to this time last year. This will add incremental margin on a full year basis as we roll forward in the year and into the winter heating season.

As a result, we expect the S&L segment in total to perform at or above the high end of our previous guidance range. And now with that, I'll turn the call over to Johnny to cover our financial results.

Johnny Black -- Executive Vice President, Chief Financial Officer

Thank you, Robert. For the second quarter of 2023, Crestwood generated adjusted EBITDA of $176 million a year-over-year decrease of 2% due primarily to lower commodity prices, adversely impacting our percentage of proceeds contracts. Additionally, Crestwood delivered $86 million distributable cash flow available to common unitholders. For the second quarter of 2023, Crestwood announced a $0.655 distribution, payable on August 14, to unitholders of record as of August 7, resulting in a quarterly coverage ratio of approximately 1.3 times.

Looking at the segment results, in the gathering and processing north segment. Second quarter 2023 EBITDA totaled $137 million, a 10% decrease in the second quarter of 2022 due primarily to reduced commodity prices impacting Arrow's percent of proceeds contracts. As Bob and Robert discussed, in addition to commodity prices, second quarter 2023 EBITDA was adversely impacted by lower volumes at Arrow, which experienced higher than expected producer downtime. This was offset by strong completion activity during the quarter across both the Arrow and Rough Rider assets.

In the gathering and processing sales segment, second quarter 2023 segment EBITDA totaled $35 million, an increase of 42% year over year. Segment growth was driven by strong volumes and development activity and the contributions of Sendero midstream and CP JV acquisitions, which were acquired in July of 2022. The growth from these acquisitions was offset by the divestitures of the Barnett and Marcellus gathering assets in the second half of 2022 and reduced commodity prices. Second quarter 2023 EBITDA was also negatively impacted by a contract amendment, which resulted in a prior period adjustments.

In the storage and logistics segment, EBITDA totaled $30 million for the second quarter a year-over-year increase of 185%. Segment EBITDA increase year over year due primarily to second quarter 2022 results being negatively impacted by hedge losses that were realized last year as a result of the significant increase in commodity prices we saw throughout the year. The increase year over year was slightly offset by the contribution from Tres Palacios in second quarter of 2022, which was sold in early April 2023. Financial results for second quarter 2023 were negatively impacted by net non-cash mark-to-market losses on NGL inventory positions that were a result of the significant drop in NGL prices during the quarter.

As Bob and Robert discussed, we expect the second quarter non-cash losses will be reversed as we deliver the product in winter heating season. Additionally, as Robert mentioned, we expect the storage and logistics segment to perform at or just above the high-end of its guidance range for the year due to the incremental storage positions we added during the second quarter. Next from a capital investment standpoint, during the second quarter, we invested $36 million in growth capital projects, most of which was related to completing the first phase of the three product gathering system expansion for Chord Energy and other third parties on the Western side of the Rough Rider system. Remaining capital requirements for this expansion will be spent through the balance of 2023 and into 2024.

In addition, we continue to invest growth capital in the Delaware basin, primarily around our GMP assets and Eddy County for well connects and compression expansions to support the substantial volume growth over the next 12 to 18 months from our dedicated producers in New Mexico. On a full year basis, we continue to expect total 2023 growth capital investments to be between $135 million and $155 million. Turning to the balance sheet, Crestwood ended the second quarter with $3.3 billion of total debt outstanding, including $417 million drawn on our $1.75 billion revolving credit facility, resulting in a consolidated leverage ratio of approximately 4.25 times and available borrowing capacity of over $950 million. Leveraged is slightly elevated this quarter due to the seasonality and working capital needs of the NGL logistics business.

And we expect leverage to decline between now and the end of the year due to combination of EBITDA growth, free cash flow allocation to debt paydown and the unwinding of NGL-related working capital. We continue to be focused on the balance sheet and remain committed to our long-term leverage ratio at target of less than three and a half times to create financial flexibility for the company. As Bob mentioned at the beginning of the call, we expect full-year adjusted EBITDA to be within the previously provided guidance range of $780 million to $860 million, but likely within the lower half of that range due to reduced commodity prices and lower volume expectations at Arrow for the balance of the year. We continue to see substantial EBITDA growth in the second half of this year, attributable to volume increases across our G&P systems, an uptick in commodity prices from the lows in Q2, and a reversal of the second quarter noncash losses and increased storage opportunities in the NGL logistics business.

As Bob and Robert mentioned in the remarks, we remain very bullish on the outlook for Crestwood, especially heading into 2024 and expect substantial free cash flow generation for the company. As EBITDA continues to grow and the growth capital requirements across the portfolio begin to step down meaningfully next year. With that operator, we're ready to open up the line for questions.

Questions & Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator instructions]. Our first question comes from Tristan Richardson with Scotiabank.

Please go ahead.

Tristan Richardson -- Scotiabank -- Analyst

Hi. Good morning, guys. I appreciate all the discussion on what you're seeing in the Bakken and Bob appreciate the clarity around maintenance and frac protection. Maybe just curious as you look in the second half of the year, I think your well connection guidance kind of implies around 47 new connection in the second half, should we expect that maybe some of that maintenance in frac protection activity by producer customer abates in the second half, will there always be some level of frac production going on as new completions occur?

Bob Phillips -- Founder, Chairman, and Chief Executive Officer

Tristan, I'm going to let Diaco handle that question. I can tell you that we have a lot of confidence in our producers. Remember, we get a margin on the gathering but to the extent they're missing their volume numbers, they're missing on full commodity value. We've had a number of meetings, internal meetings, with our producers up there to better understand why the shut ins occurred when they did, what it was related to, was it a challenge to get a work over rig? Or was it in fact, something wrong with a well, maybe changing out the pumps, after the wintertime we had a severe wintertime up there? Or finally, was it related specifically to frac protect and a number of wells being completed in the areas.

We have a lot of confidence in our producers up there. They've been up there for a long time drilling these wells. Couple of these things, we think were unique to wells that were completed or drilled and completed in the quarter. But for the most part, I think you're right, it is going to improve over time.

But I want to let Diaco specifically tell you a little bit more about what he's hearing from the producers. He's our downhole expert. So Diaco give them a sense for what we think's happening out there.

Diaco Aviki -- Chief Operating Officer

Yes. Thanks, Tristan. Hey, let me start just by reminding everyone about late start we had to the D&C season with the prolonged winter, right and high winds. So as you can expect, and Robert stated we had a significant ramp in D&C activity all across our footprint in the second quarter.

And with that downtime for frac protect, we did see our operators bring both backup from frac protect, we also saw volumes across our meters that were lower with wells down from mechanical maintenance, as they brought them back up from frac protect, which exceeded our expectations, essentially, on both fronts. It's a good problem to have, I mean, we see these wells come back with flush production. And like you said and I do appreciate the conservatism our producers are taking and protecting their and our capital investment. So we've reaffirmed our outlook for Williston to be very positive, our customers on Arrow have actually recently communicated their desires to accelerate some additional D&C activity versus their original forecast to make up for the volume risks.

So not only do we expect those wells to come back on be abated, with flush production, but we do hear them saying that they're going to accelerate to catch up on their own numbers. They see the mist on their side. Overall, as you can appreciate, the Bakken crude continues to trade, dollar over WTI. And is the barrel of choice.

I mean, the volumes in Williston continue to climb upward since the beginning of the year, as rig counts remain really healthy. And we're really excited about City of Williston. We can't emphasize that enough to continue to exceed expectations, we've got additional three mile laterals that we're going to bring on here in the coming months for Chord. And really, frankly, Chord has done a fantastic job and our teams that work extremely well together.

Did that answer your question.

Tristan Richardson -- Scotiabank -- Analyst

Yes. Appreciate it, Diaco. And then, maybe, Robert, I know it's too early to talk about 2024 capex guidance, but just thinking about the deployments you made this year in the Rough Rider expansion in the City of Williston. And then, thinking about well completions in the second half.

Is there a scenario where we could see capex lower in 2024 versus 2023 and increase the free cash flow production?

Johnny Black -- Executive Vice President, Chief Financial Officer

Yes. Tris, and I'll take that this question. This is Johnny. It's a great question.

I think the short answer to your question is yes, absolutely. Right now, the midpoint for our '23 capex program is roughly $145 million of growth capital for this year. At this point, based on the substantial amount of well connect next year, we are still expecting that number to decline pretty substantially in 2024, by roughly 25% to 30%, year over year. So I'd call it between $100 million to $110 million of capex in 2024.

And that will primarily be focused around well connect capital and gathering expansions to meet the capacity needs of our customers in the areas where they are developing. So, you call it, growing EBITDA and reduced capex should meaningfully boost our free cash flow profile next year.

Tristan Richardson -- Scotiabank -- Analyst

Johnny, appreciate it. Thank you, guys.

Operator

Next question comes from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann -- Truist Securities -- Analyst

Good morning. Maybe Johnny my first question for you specifically on leverage. I think you all said last quarter, you've talked about your leverage target moving from around 3.5 to under 3.5. So I'm just wondering, does this mean, you all will plan to get closer, much closer to the three times level? Before you think about any allocated any incremental returns? Or maybe just talk about, paying off the returns versus the debt repayment?

Johnny Black -- Executive Vice President, Chief Financial Officer

Yes. Hey, Neal, this is Johnny, I'll take that one as well. As you called it, we've been very focused on the balance sheet, and allocating all excess free cash flow to debt paid down. I think we want to get our leverage down closer to three and a half times before we start thinking about incremental returns to unitholders.

I'd say, it doesn't have to be closer to three times, I think we want to be at three and a half times on a run rate basis. And I think that's the best use of capital at this point in time, as we get into 2024, I'd say allocation of capital will really be a function of the outlook for the business at that point in time, and opportunities to reduce our cost of capital and continue to drive value for our investors. The Crestwood Niobrara asset level preferred will be high on our list to redeem, especially given the holders have redemption rights that kick in 2024. And we would like to utilize some amount of balance sheet capacity to start taking out a piece of that security and reducing our cost of capital next year.

Neal Dingmann -- Truist Securities -- Analyst

Yes, that definitely makes sense. And then, maybe just the second one I have is on commodity sensitivity. Specifically, I think it's about what you've said in the past about 15% of cash flows, correlate the commodity prices, with more sensitivity in the Bakken versus the Delta. And just wondering, is this still the case around those levels? And is there any plans to try to mitigate that? Are you fine with kind of those levels as they sit today?

Johnny Black -- Executive Vice President, Chief Financial Officer

Yes. Again, Neal, great question. And this is Johnny. You're spot on, roughly 15% of our company cashflow directly tied to commodity prices be our POP contracts in the Williston and Delaware, I'd say roughly 75% of that is in the Williston, roughly 25% of that is in the Delaware.

The rough breakdown by commodity is roughly 40% natural gas, 40% natural gas liquids and 20% crude oil. So as you can see, based on those percentages, we have a meaningful amount of margin for both natural gas and NGLs, which is where we saw the most amount of the price degradation in the second quarter. As Bob mentioned in his comments, we've already seen a nice uptick here in commodity prices from the lows of Q2 and expect further uplift between now and the end of the year based on current strip prices. I'd say we are relatively under hedged compared to our historical averages, we typically lay off about 50% of our equity production, just given the backward dated market, we were not able to get hedges in place this year in 2023.

I'd say as we start looking into 2024, we will begin laying off a portion of our commodity price risk at this point in time. I think strip levels are generally becoming more attractive at this point in time. And so, start, probably inching toward that 50% level between now and the end of the year. Once we have more definition around exact volume levels for next year.

I would just add that we do have roughly 35% of our production this year, hedged at a little less than $4 per MMBtu. And about 10% on the crude side, at about $85 per barrel. So we're not totally unhedged this year, but we did not get up to the typical level that we have gotten to historically.

Neal Dingmann -- Truist Securities -- Analyst

It's very helpful. Thanks, Johnny.

Operator

Next question comes from Ned Baramov with Wells Fargo. Please go ahead.

Ned Baramov -- Wells Fargo Securities -- Analyst

Hey. Good morning. Thanks for taking the question. Could you provide some more color on the shift in the completion of 10 wells in the Delaware into 2024? Is this related to recent M&A higher production from wells that have already been drilled or maybe something else?

Robert Halpin -- President

Yes, Ned. It's Robert. I think it's really more the first thing you mentioned. We've obviously -- people running tab on expected completion activity with all of our customers.

And as we've seen two of our operators Novo through the Earthstone acquisition, and then Callon buying Percussion. And those asset integration processes have kicked off. We just have seen a little bit of slippage in timing as the new operators get those assets under their operating teams. I think all-in-all, both of those acquisitions, I think bode very well for our outlook for the basin.

Additional commentary directly to us and public commentary from both those operators, I think is highly supportive of this acreage and how they view it in their stack from a capital allocation standpoint, I think a lot of good things to come. But it's probably going to cost us a little bit in the short-term here in '23.

Ned Baramov -- Wells Fargo Securities -- Analyst

That makes sense. Appreciate that. And then, maybe a quick question on your fixed forward sale agreements. I guess that bodes well for the reversal of mark-to-market and stronger margins in the second half.

Could you maybe go over some of the factors that could drive results in your S&L business below your expectations if any?

Robert Halpin -- President

I'll speak to that one again. Ned, I think from a margin standpoint, there's pretty good visibility to that, again, given the fact that we hedged 100% of that inventory position. And while there's accounting nuances, quarter to quarter with where we have to mark the physical inventory, that spread is fixed. I would say what could drive, some variation to the higher low-end of the range is that business operates, as you'll appreciate, on really a q1-to-q1 type timeframe, as we build inventories in the summer, and sell throughout the winter.

And so, while that margin is fixed, what is not entirely fixed is exactly the timing of when that realized gain will be recognized, as physical product gets delivered in the wintertime. And as we continue to have to mark-to-market our inventories, every quarter end between now and then. So, zero risk for the cash flow profile, I think, higher end, midpoint to high end or even materially above high end is more a function of when we take those realized gains.

Ned Baramov -- Wells Fargo Securities -- Analyst

Understood. Thanks for all the color.

Operator

[Operator instructions] Next question comes from Charles Bryant with Citi. Please go ahead.

Charles Bryant -- Citi -- Analyst

Hi. I just wanted to follow up on the potential redemption of the Niobrara press. And just kind of want to get your thoughts on how that might impact capital allocation as you move into 2024? Would that have any implications for reducing leverage to that sub- three and a half times target, and any sort of implications and how you balance that with potential distribution increases in the future, just want to get some more color there. Thanks.

Johnny Black -- Executive Vice President, Chief Financial Officer

Charles, this is Johnny speaking. So, the Crestwood Niobrara preferred is an asset level preferred that's held by three institutions today and represents about a $435 million liability that pays 10% today, and can be redeemed by the holders beginning in January of 2024. Our desire is to start removing that security from our capital structure over time to lower our cost of capital, as I mentioned in my previous comments, and really try to remove the structural complexity that's created by that asset level preferred. But also balance that, as you mentioned, with our goal and major main financial priority, preserving our attractive leverage metrics over the next few years.

So with that in mind, actually, we filed an 8k at the end of last week on Thursday of last week, where we executed an amendment with the preferred holders, that gives Crestwood, the flexibility and optionality to partially redeem a portion of the security at the beginning of next year. We now have the option to redeem roughly 255 million in security, or approximately 59% of the total at par in January of 2024. In return, the preferred holders have agreed to roll their remaining $180 million of the security or roughly 41% of the existing security for another two years at a slightly higher cost of capital going from 10% to 11%, beginning in 2024. So generally, Charles, we think this is an attractive solution to optimally address the upcoming liability as it mitigates our financing need, locks in some of the attractive capital for another two years.

And also allows our business to importantly continue to naturally delever over the next few years from the growth and free cash flow profile of the business and build the balance sheet capacity, to ultimately take it all the way out here in a few years, and fully eliminate the structural complexity created by the asset level press.

Charles Bryant -- Citi -- Analyst

OK. Makes sense. Thanks for the color. That's all I had.

Operator

Since there are no further questions at this time, I would like to turn the floor back over to Bob Phillips for closing comments.

Bob Phillips -- Founder, Chairman, and Chief Executive Officer

Thanks, operator and thanks to all of you for staying with us this morning. We are disappointed in the financial results of the quarter but we're very, very optimistic about the future. As I look at this quarter, it's a short-term negative lower commodity prices which are clearly improving in the third quarter and should continue to improve throughout the second half of the year, as well as some short-term shut in production on Arrow, which we think will come back on over time as producers get around to getting those wells back in service again, offset by some very strong long-term trends. The rig activity around our assets still remains very strong in 13 rigs, seven in the Delaware, four in the Bakken, and two in the Powder.

So we continue to have strong producer activity on our systems gives us great visibility to volume growth throughout the second half of the year. And next year. Our well connects are running at our schedule, which is a pretty good feat given all the things that have happened both weather, as well as shut-ins, as well as commodity volatility. A lot of our wells, many of our wells are outperforming their type curve.

And so, that is a strong indicator of the quality of the rock that we have dedicated under long-term contracts with our producers. And then, finally, we haven't talked about it a lot. But clearly there's going to be a big benefit in our '23 capital program as we expand in gathering system compression, and reaching out and expanding the geographic scope of all of our assets into new areas to capture undrilled inventory in the future. So a lot of things to be excited about in the future.

And with that operator, we'll thank you all for joining us today and that'll conclude the call.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Bob Phillips -- Founder, Chairman, and Chief Executive Officer

Robert Halpin -- President

Johnny Black -- Executive Vice President, Chief Financial Officer

Tristan Richardson -- Scotiabank -- Analyst

Diaco Aviki -- Chief Operating Officer

Neal Dingmann -- Truist Securities -- Analyst

Ned Baramov -- Wells Fargo Securities -- Analyst

Charles Bryant -- Citi -- Analyst

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