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New Delaware wells bring encouraging results, plans to add 10th operated rig in Q4

Diamondback Energy (ticker: FANG) announced third quarter results today, with net income of $73 million, or $0.74 per share. This result significantly exceeds the $2.2 million loss the company took in Q3 2016.

The company saw 10% production growth in Q3, with output of 85 MBOEPD. Diamondback fueled this growth with 42 wells drilled and 24 wells brought on production in the quarter. The average completed lateral length jumped sharply, rising from 7,716 feet in Q2 to 9,603 feet in Q3.

Full year production guidance has been revised upward to 77.5-78.5 MBOEPD, up 3% from the midpoint of prior guidance.

Diamondback reports strong performance from its recent Wolfcamp A wells in the Delaware, where the company’s first two-well pad recorded an average 30-day IP of 130 BOEPD/1,000 feet. The Lower Second Bone Spring has also showed promise, with the company’s first well reached a 30-day IP of 195 BOEPD/1,000 feet. This well continues to exceed expectations, so Diamondback will continue to test the zone in 2018.

Diamondback (FANG) Ups Production Guidance

Source: Diamondback Investor Presentation

Diamondback recently completed two four-well pads targeting multiple zones in the Midland Basin. The Blackfoot pad targeted the Lower Spraberry, Wolfcamp A and Wolfcamp B with an average IP30 of 152 BOEPD per 1,000 feet.

Diamondback CEO Travis Stice commented on the company’s strategy, saying “Over the past five years as a publicly traded company, Diamondback has remained committed to a strategy of best-in-class execution, low cost operations and transparency. In an industry that often rewards ‘growth for growth’s sake’, Diamondback has maintained strict capital discipline, growing production over 175% within operating cash flow over the past 11 quarters… We expect to add our 10th operated rig in the coming weeks, and as we look into 2018, our strategy has not changed in that we expect to match our capital budget to our projected operating cash flow.”

Diamondback (FANG) Ups Production Guidance

Source: Diamondback Investor Presentation

Fifth year as public company

October marks the fifth year as a public company for Diamondback, a milestone Stice also commented on. “In these five years as a public company,” Stice said, “we’ve grown from a couple of dozen employees to now over 250 and from a couple thousand barrels a day production to now over 85,000 barrels a day. To our employees who were here in the early days, we’ll always be indebted to your loyalty; and to our employees who have joined us over the past years, we’ve successfully built an amazing company with a future that remains bright because of the collection of your individual talents, hard work, trust, determination and perseverance. Thanks to each of you for what you’ve done.”

Q&A from today’s Q3 earnings call

Q: Can you talk a little bit about how you guys think about that when thinking about balancing growth and return on capital versus return of capital going forward? In other words, is there a point at which you elect not to increase rig count within cash flow but rather return cash flow to shareholders?

FANG: Yes, Dave. That’s a great question and one that we model consistently going out in the future. And I think the right way to think about it is we believe the best way to generate that excess free cash flow is to get to a rig cadence of somewhere around 15 to probably 18 rigs. And I think the right way to think about that is any discretionary cash flow that’s created, think about it being redeployed until we get to that rig cadence. Once you get to that rig we feel like is the maximum efficiency on our current acreage footprint, then we can have conversations about true return of capital. But it’s certainly something in the not-too-distant future, our model shows that we’ll be able to have those conversations.

Q: Can you comment on tightness between yourselves and your service providers? And then you talk about kind of getting to a target of 15 to 18 rigs longer-term being optimal. Do you think the organization is already kind of staffed at those levels? Where have we come from a staffing level, kind of, year-to-date? And any sort of labor pass-throughs maybe you’re seeing from some of your service providers, things along those lines. That would be helpful.

FANG: I think our industry has demonstrated in times past when commodity price starts to move you start hearing your business partners on the service-side start to ask for rate increases so they can build their working capital. And look, we want our business partners to be successful, we want them to continue to build new equipment and crew that new equipment with qualified staff. And so it’s part of our business cycle and we anticipate some increases this year, as we’ve earlier guided. I think our total well cost we talked about an increase of 5% on total well costs for the year, and that was taking some of those comments under consideration.

When you look internally for Diamondback, I had mentioned we’re going to pick 10 rigs up. We’re very comfortably staffed for 10 rigs right now, and as long as we build our rig fleet every 3 to 5 months as we generate enough free cash flow to cash flow that rig, we’re not going to have internal constraints.

It’s incumbent upon Diamondback’s leadership team to always make sure we’ve got the right number of people to prosecute our plan. At about this time last year, we had about 160 employees, and now we’re up to a little over 250. So we’ve gone through likely an unprecedented growth in our company’s history, but we feel very comfortable where we sit today to be able to prosecute our plan with 10 rigs. And we’ll continue to find the best athletes in the draft, and we’ll add those players accordingly.

Q: Have you guys identified an efficient frontier on lateral lengths both on the Midland and Delaware side? I don’t know if those are necessarily different conversations that need to be had but just wondering as far as if there’s any changes on EUR per foot and obviously tying that with efficiencies on the well cost side, or is it really nearly just a technology issue of getting as far as you guys are comfortable at from as far as where technology stands today?

FANG: There’s a couple questions embedded there and I’ll kind of try to get to each one of them. The difference between the Midland and Delaware basins, there are a few differences in that on the Delaware side we do move more fluid in these wells. So the 10,000 foot company-wide seems to be about the most efficient that we’re looking at today but definitely on the Delaware side 10,000 foot is about as far as we want to push. Just being able to move that amount of fluid from a 10,000 foot well with the well deliverability we have in the Delaware, that 10,000 foot looks about right.

As we go to the Midland basin side we have several wells that are plus that 13,500, to almost 14,500 foot lateral length. So going to 15,000 foot from a technical standpoint is very doable. From an efficient frontier standpoint, we still feel we have most of the field set up just from a lease geometry standpoint for 10,000 footers but 15,000 footers are very doable in the Midland basin side.

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