Cabot allocating $125 million toward exploration this year
U.S. unconventional producers significantly reduced exploration activities during the downturn.
As low commodity prices squeezed producers, most companies focused on reducing costs rather than finding new fields to develop. However, as prices begin to recover Cabot Oil & Gas (ticker: COG) is beginning to look for new opportunities, the company said in its conference call today.
Cabot expects to spend up to $125 million on exploratory lease acquisition and testing in new areas this year, 15% of total expenditures. The company intends to evaluate new platforms for future growth. According to Cabot Chairman, President and CEO Dan Dinges the company has identified two areas that may have the potential to generate competitive full cycle returns.
“These are areas where we have direct line of sight towards building sizable contiguous acreage positions that allow for an efficient operations at, most importantly, a low-cost of entry,” Dinges commented. Cabot defines a sizeable position as “one that has potential to provide over a decade of high-quality drilling inventory.” But Cabot would not identify the specific plays in its sights.
These projects are still in the early stages of evaluation, but based on current geo-modeling results Dinges is “cautiously optimistic” about their potential. The company will move forward with leasing and will test its ideas later in the year.
What to do with free cash?
Cabot projects positive free cash of over $250 million in the current year. The company is currently evaluating several possible uses of this cash:
- Accelerating production in Cabot’s current areas
- Increase funding for exploration activities
- Increase dividend or share repurchase program
- Reduce outstanding debt
Like many other unconventional operators, Cabot has reported success from increasing completion intensity. The company’s current design in the Eagle Ford increases proppant per foot by 25%, decreases cluster spacing from 60’ to 25’ and adds intra-stage diversion. This design change has increased well initial production by about 30%.
Cabot reported first quarter results today, showing net income of $105.7 million, or $0.23 per share. This exceeds the $51.2 million net loss the company reported taking in Q1 2016, and the $292.8 million loss the company experienced in Q4 2016.
Q&A from COG Q1 2017 conference call
Talk about the exploration ideas
Just on the exploratory plays. I mean, recognizing, you are probably hesitant to provide a ton of color given its early-stage nature. But just any high-level thoughts from the types of plays you’re chasing in the competitive landscape within the plays? And then are hydrocarbon or geologic – geographic diversification some of the goals here?
<A – Dan Dinges>: Yeah, primary goal, really 1, 2 and 3, is could we find an area to allocate capital that would compete with the return profile we see in our existing portfolio and therefore deliver the returns to our shareholders that would exceed where we’re investing capital right now.
So, we were indifferent regarding the commodity diversity and looking at the areas, potential competitive landscapes and a lot of areas that we’re all aware of. Through an exploration effort, we evaluated every basin that is out there. We looked at, actually, areas that were not necessarily in traditional fairway of the key basins.
But all-in-all, and balling all of that up, also looking and evaluating all the M&A transactions that have transpired, we did go through some data rooms and get a good feel for valuations out there and that’s based to be able to compare to not only did that meet our threshold of full-cycle returns, but also, did it allow for us to enhance our portfolio of projects on a go-forward spend.
And as we continue to do our exploration effort, our guys came up with good ideas that we felt justified further expenditure.
And so, when you look at our cost of entry and you look at the possible returns that we see in these two projects and you look at the scale that we’re comfortable with being able to develop, we are excited about where we’ve allocated the capital and we’re also excited about moving forward with some incremental testing.
But you’re right. I don’t want to be coy on the exploration ideas. But as you appreciate in your – the way you couch the question – we’re just not going to talk in-depth about specifics of what we’re doing. But I do appreciate the question regarding kind of our thought process on what we’re trying to achieve.
Q: Wondering if you could talk to the decision to budget $125 million this year for exploration and really just the need for a new core area when, I mean, on the surface, it’s a little less obvious with 3,000 Marcellus locations remaining.
Dan O. Dinges: In looking at our allocation of an additional $125 million, if you look historically at exploration budget and you assess the amount that we’ve allocated in the past, the $125 million is frankly right in line with where we’ve allocated in the past, except the last two years. So, there’s nothing unique about that level of capital allocation.
When we began our effort of looking at our needs in the future to enhance shareholder value, we look at the Marcellus and the Marcellus is such a low capital intensity asset, i.e. the need for the number of drilling rigs and the need for a number of frac crews to grow our production that we knew we were going to generate a significant amount of free cash.
As I mentioned, even in the most punitive realizations Cabot has had in its corporate history, in 2016 we still generating free cash and grew that asset. With this infrastructure build-out that is occurring as we speak and looking at the amount of capital necessary to fulfill all of the capacity of those new projects, it again is not going to take near the amount of free cash – near the amount of capital that we’re generating and we’ll have the free cash. So, the need to do something with the free cash is an obvious question because we have it.
We put that slide together where we’ve tried to box out and include on slide 13 the number of different considerations that we will consider with our free cash. We will touch on a number of them. We’ll touch on, I think, the distribution to shareholders with some of it. We’ll also allocate the necessary amount to our Marcellus to grow every opportunity that we get but, again, it doesn’t take much capital. And you could see by maintaining 3.7 Bcf flat for 25 years, we don’t get much over $500 million, $600 million. So, the free cash is there. We could do all these things that we’re talking about.
One of the ideas that every company that is in our space, the E&P space – every company out there, and you can look at the hierarchy of valuations and those that, in your portfolio, you recognize these companies that have significant value and have the opportunity to grow, you give them better multiples and more consideration and valuations and future valuations than you do those that do not grow.
Again, we’re not in the business to burn capital. We thought we could make an entry into new areas, take a cost-effective look at our opportunity to find new return projects that compete with or exceed what we’re allocating capital to right now. And if we are successful in that endeavor, I think Cabot shareholders are going to be rewarded handsomely for the decision.
Q: Just on Atlantic Sunrise, does FERC need a quorum to issue a Notice to Proceed?
COG Senior VP, Marketing Jeffrey W. Hutton: Michael, the simple answer is no.
Q: Okay. So, basically, you get the other permits from the states and then the current situation, they could approve it?
Jeffrey W. Hutton: Yes. If you’ve been following the other projects in Southwest PA, in Ohio, West Virginia, et cetera, the Notices to Proceed are coming out on a regular basis from the staff. Additionally, we’ve got some partial Notices to Proceed on Atlantic Sunrise for the mainline construction and you see those pop up about every week and they range from compressor station work to looping and other projects on the mainline.
