Chesapeake Energy Corporation (NASDAQ:CHK) Barclays 2022 CEO Energy-Power Conference September 7, 2022 12:30 PM ET
Company Participants
Nick Dell’Osso – President and Chief Executive Officer
Conference Call Participants
Unidentified Company Representative
Okay. Welcome, everyone. I’m not sure if it’s afternoon or morning. I’ve been up here all day. But good morning, good afternoon. We are very pleased to have with us Mr. Nick Dell’Osso, President and CEO of Chesapeake Energy. We’re in for a real treat today. Chesapeake is a premier natural gas operator with attractive positions in the Haynesville and the Marcellus. And the company has a very strong above all cash return framework that we’re looking forward to very much talking about. So before we get to our chat with Nick, we do have a couple of questions for polling. Everybody has a keypad in front of them. It’s been wiped, or there’s some hand wipe if you want to wipe it again. So I’m going to read a question, press the number for your answer, and we’ll see the results instantaneously. It’s pretty fun. It’s a nice icebreaker. First question, please.
What do you think Henry Hub will average in 2023? Number one, less than $4? Number two, $4 to $6. Hey, don’t lead the witness up here. Number three, $7 to $9. Number four, greater than $10. Nick, you don’t have a keypad. I know you’d be pressing 4 as many times as you could. Let us know. No, it’s not fair, he doesn’t get a keypad. Okay, strip is about $6.50. So strip are better. Got it, pretty good.
Next question, please. What is the expected mid cycle Henry Hub price? This one’s a little more difficult. Number one, less than $3. Number two, $3 to $4. Number 3, $4 to $5. And number 4, over $5 mid cycle Henry Hub price. I think we have a gas pool up here. Ooh, blitz, all right, $3 to $5, not bad.
Third question, please. What capital return metric is most desirable? Number one, fixed dividend. Number two, variable dividend. Number three, share buybacks. My personal favorite number four, all of the above. Something for everybody. Oh, okay, 4, great. And then the last question, please.
What do you think year-over-year service cost inflation will be next year? Number one, 5% to 10%. Number two, 10% to 15%. Number three, 15% to 20%. And number four, for all of you service bulls out there 4, 20% or more. Aha, 10% to 15%. Okay, that’s a little bit lower than some of the other responses 10% to 15%, 15% and 20%. Got it. I thought for sure more people would be in the 20% bucket, but I guess not. And that actually matches some of the commentary from the CEOs earlier today. So thank you, everybody, for participating. We’ll be publishing the results, probably sometime next week from all the sessions. Alright, we’re going to get straight into it, Nick.
Question-and-Answer Session
Operator
[Operator Instructions]
Unidentified Analyst
Alright. So Nick, maybe just from a high level, you’ve anchored the company around your strategic pillars, there’s four of them. And for those who are less familiar with them, maybe we can just dig through each one.
The first one I’d like to start with is a superior capital returns. And your framework calls for 50% of free cash flow after the base dividend to be paid out via variable, you clearly have huge capacity to sustain free cash flow. And so from our opinion, investors have an insatiable appetite for just more and more and more on cash return. So under what conditions would you revisit the 50%?
Nick Dell’Osso
We really liked the all the above approach. So I was pleased to see the survey results here. We think by having all the above approach where a big portion of the cash goes to the variable dividend and then other cash can go to stock buybacks that are really balancing both how we think about returning cash to shareholders from a tax efficient way as well as the way it will flow during cycles. We think it makes sense. We think it provides discipline into the structure. And we like it. We’ve done the variable dividend for three quarters, the mode at which we return cash to shareholders has become as interesting of a topic to our investors as anything else we talk about. We love that. We love the debate about what’s the best way to return cash to shareholders, what an awesome problem to be discussing. We like where we sit today, we’ll never be dogmatic about any of those kinds of things. We’ll try to do what makes most sense for shareholders, but we like how it’s working right now.
Unidentified Analyst
Okay. And then on the buyback in June, you doubled it to $2 billion between common stock and the warrants through yearend ‘23. So you’re about a third of the way through or so how do you determine the level of buybacks every quarter? And this is something that we’ve been asking a lot of folks today, because as we continue to look at energy equity, valuations still be below where we think they should be. We’re trying to figure out, is there something has to change on the cash return for it to get better capitalized and valuation. So a lot of companies have buybacks that are a bit more opportunistic, because that’s the natural — nature of them. But do you think that you need to kind of formalize more of it in order to get to capitalize into your valuation?
Nick Dell’Osso
Well, again, I think it fits with our all of the above approach. And it’s all relatively new for our industry. We’ve been generating excess free cash flows in industry for about a year. And so I think investors are getting used to this, and they need to see a track record for it. One of the things we’re really proud about with our buyback programs that we’ve executed on a lot of it, you see a lot of companies talk about the free cash flow that they’re generating. You see them talk about the capital that they’re allocating to buybacks, but you don’t see them able to execute on large amounts of it quickly. We’ve done that this year, we don’t have to service a balance sheet pay down, we’re, and our balance sheet is in great shape, so we don’t have any cash flowing to debt pay down. And it’s enabled us to be pretty aggressive on our share buyback, we think our stock is very much undervalued. And so until it continues to rerate, we will try to be as aggressive as we can be on the stock buyback. We did $670 million of it about in one quarter is a little more than one quarter. That’s a lot to do at one time, you probably have to find some chunky holders to trade with to do that much at one time.
You go through periods of time where you can only use your 10b5-1 because you’re in an earnings window or whatever. And you have to work through the flow of all that. So it’s a little bit unpredictable as to how exactly you can execute in chunks. But we always want to be ready when we can to buy stock with our excess free cash flow when we’re valued the way we are today.
Unidentified Analyst
And when you determine the intrinsic value. When you’re looking at buybacks, we ask the polling question. So what do you think mid cycle pricing is for natural gas?
Nick Dell’Osso
Yes, so our view of natural gas prices has elevated quite a bit over the last 18 months along with the rest of the market. We’ve seen the floor come up, we’ve seen a couple of things that have been really interesting. Primarily, the fact that coal just is not providing the relief valve is natural gas prices have gone up, especially this summer. And that gives us a lot of confidence around how we think about long-term gas prices. We know the demand will be resilient, we know that the world is short energy, and within being short energy is very short natural gas in the near term. The fact that we have a lot more LNG export out of the United States today is great thing for the world, we can deliver more energy that is affordable, is reliable and is lower carbon to the places in the world that it’s needed. We can help to offset the effects of a devastating war in Europe. And we can do so with a commodity again, that is accretive to the world’s climate goals. So we think natural gas prices, I was kind of joking on the greater than 10. I’d love for it to be greater than 10.
In some respects, in some ways, there’s absolutely no reason for it to be that high. There’s plenty of gas in the United States and around the world to be able to deliver to markets that need it. And so I think you guys in the room landed on somewhere around $3 to $5 for the long-term gas price. I can’t quibble with that. It could be $3.50. It could be $4, all those prices make sense to us. And so when we look at the curve today, we do see it much higher than that in the prompt months and that makes for great revenue receipts. But our expectation is that it does moderate around the way that the curve is backward dated, we think that’s logical.
But the floor is so much higher than it’s been. And that’s really constructive and bullish for the industry, but especially for us as a company.
Unidentified Analyst
And so part of your pivot towards natural gas, the Eagle Ford is up for sale, any color on how that process is going?
Nick Dell’Osso
It’s going really well. We’re very early in the process. We’ve had a lot of inbound interest, really pleased with the inbound interest we’ve had, it’s from a number of people that you would expect to be interested in, and it’s from a few people that really show the interest is broad. So we’re really excited about it, we think the process will go well, it’s very early, it is a set of assets that exist across a really wide geography with a lot of different characteristics. And so it very well could be more than one buyer, it could be one buyer, it could be multiple buyers. It will take us some time to sort through all that. We think time is an ally to us here we can be very patient. It’s a great asset that’s generating a tremendous amount of free cash flow, and it has a lot of interest from the market. So we’re going to work through it methodically and get a great answer for shareholders.
Unidentified Analyst
And so speaking of shareholders, is it fair to say that the proceeds will be almost directly recycled back to the shareholders, either through an accelerated buyback program, or maybe even a special dividend?
Nick Dell’Osso
I don’t know if we would do a special on this. When we think about our variable dividend program that’s really designed for the delivery of a portion of our operating cash flow, this is clearly not operating cash flow. And so the way it fits in our return model to us is more geared towards the buyback. We will pay down a little bit of debt, we will be selling off a fair amount of cash flow. So you should expect that we will reduce our balance sheet leverage by a modest amount just to keep things generally in line and the rest of it, we think, given what we know today would go to buybacks. Of course, market conditions will change in between now and when we execute. So we’ll have flexibility. We can do what makes most sense for shareholders. But based on conditions we see today, we’d lean towards buybacks.
Unidentified Analyst
Okay, great. And then maybe on the variable framework, I guess one of the push backs that we hear a lot is that variables are still somewhat pro-cyclical, gas prices go down the variable dividend gets smaller, in this case for Chesapeake is the goal to find a more consistent absolute return. So in this case, where gas prices are lower, either you would increase the base dividend, or you increase the buyback to try to keep a more consistent return.
Nick Dell’Osso
Well, I think the point of the variable is that our cash flows will be cyclical, we have a relatively mature business today that does not need to grow its top line to be relevant, it doesn’t need to grow its top line to prove to the market that there’s enough supply. And so that means we have a fairly mature supply demand equation. And if we use all of our free cash to grow, as we’ve done for the last decade plus, we will continue to deliver excess supply to the market, we know that prices will be higher, prices will be lower at different points. And so we should have a variable model of returning cash to shareholders. We think that makes a lot of sense.
So I think we should, investors should recognize that if we’re very disciplined about the way that we reinvest capital in our business, to create value for shareholders, that there will be times like now when prices are high, our margins are very high, that we will generate excess cash flow, when prices drop, we may shift and be able to gear more towards a buyback. The ideal scenario is when prices drop, you drill less you buyback more stock. We’d like to be in a position to do that. We think we will be in a position to do that. And so that would be somewhat of an offset to a variable. But I think investors should expect that cash flows from a mature business in a cyclical industry can go down when prices go down.
Unidentified Analyst
Okay, and then maybe the last one on the shareholders here. So a common feedback pushback is that there is a credit overhang. And so how do you address these concerns?
Nick Dell’Osso
We’ve seen a really significant turnover in our shareholder base over the last 18 months since we’ve emerged from bankruptcy. We’re really pleased with what we see. We have a number of new, what we consider great long-term investors that are coming into the stock, some of the long only some of the generalist funds that been away from the industry for a while are showing up in our shareholder registry, and we’re proud of that. We expect to be able to deliver a great answer for the shareholders. We’ve had a number of shareholders that were sponsors of our restructuring, begin to pare their positions a bit. And they’ve done so in what we think is a pretty responsible manner. We really haven’t seen any technical selling pressure on the stock. Most of the sponsors we had in restructuring are very large, very sophisticated institutions that know how to manage large positions. These are household names like BlackRock and Prudential and Fidelity, Franklin was one of our largest shareholders. And so as they manage their positions into what they feel comfortable with going forward, we feel really good about it.
Now, some of those shareholders have been very clear that they expect to maintain a large holding in Chesapeake for a long period of time, despite the fact that they were either sponsors of our restructuring, or in the case of one large shareholder, and Blackstone who came in through an acquisition. There again, they’re very focused on staying shareholder for a long time, earning a great return in the stock, this company is performing very well. And so we think that given the trading liquidity we have today, the general approach of that shareholder base, we’re not really worried about any future turnover in that base, we think it’s all pretty positive. Just to give you some context for it, if you think about Blackstone is our number one shareholder, and shareholders number two, and three are right behind them. So we have a couple at the top that are similarly sized. They represent about six days of trading volume in our stock. So pretty manageable size when you think about the relative liquidity we have in our shares, so we don’t worry about it.
Unidentified Analyst
Okay, good to hear.
Nick Dell’Osso
And I guess sorry, one final point on that, of course, we do have a $2 billion buyback, which we’ve used about a third. So we have a very significant buyback. If any one of those holders did start selling in a larger way, we’d be ready to use our buyback to take up that liquidity.
Unidentified Analyst
Got it. And then maybe switching to the second strategic pillar here. We couldn’t agree with you more that high quality, deep inventory that really underpin sustainable free cash flow. We can’t help but notice there’s been a lot of A&D over the last couple of months. So how repeatable are your returns in the Marcellus and the Haynesville?
Nick Dell’Osso
Oh, extremely repeatable, we have a really long inventory, 15 plus years in both the Haynesville and the Marcellus. We’re really proud of the inventory that we have, we’re not just proud of it in terms of the magnitude of total locations, but in quality, when you think about the returns that we’re generating as a business through the drill bit, they’re really outstanding. We have a slide in our deck today that we’ve pointed out in meetings this morning, we can’t talk about this slide enough, it points out that we have a really long inventory with really high quality, we have the very best capital efficiency of the natural gas group. And we have in 2022, 17 of the 20 highest IP wells in the United States. So we’re producing the highest deliverability at the best capital efficiency, and we can do it for the longest period of time. So we think the balance of quality, debt, capital efficiency, and then when you marry that, with our environmental footprint is unmatched in the natural gas space inside of Chesapeake’s portfolio, and we think it makes the most compelling investment opportunity in the space.
Unidentified Analyst
And just because you have 15 years of inventory, that’s high quality, does that mean that you’re not a buyer, if an opportunity comes up?
Nick Dell’Osso
Well, opportunities that come up have to meet what we call our non-negotiables. And it sets a pretty high bar. We would love to continue to consolidate assets that are additive to our portfolio and make us a better company. But they have to be something that’s priced, right. We don’t want to overpay for anything, they have to be accretive on cash flow metrics, and they have to fit within our balance sheet structure the way we pay for it. And they have to have an environmental footprint that’s either good starting off, or we can fix it in a hurry. So if they, if all those things come together, then you feel like you can make your company better with the assets that you add. At the end of the day, when you think about a capital allocation model after you’ve completed an acquisition, you should be able to allocate capital in a more efficient, more effective way for higher returns. And if you can, then you’ve made your company better. And if you can’t, you should pass. We’ve done two deals over the last year that we think easily meet all of our non-negotiables and have made us a much better company. If we see more in the future that meet that bar we’ll do more. But we’re not in a rush to, we don’t need to. And so we feel really comfortable with what we own today.
Unidentified Analyst
Okay, and then in terms of how you would pay for anything. And that’s just add segue into I just wanted to talk about the balance sheet. So I think there was about $ billion on the revolver at the end of June. How important is that, is it to you to pay that off by the end of the year?
Nick Dell’Osso
Well, we can manage our liquidity pretty easily. We used some cash on the revolver because we had an opportunity to buy a lot of stock in the second quarter. So we were happy to do that. We’re generating a ton of free cash flow, we can continue to manage that liquidity pretty easily. We feel very comfortable with that. Our balance sheet is in great shape. So we’ll protect that very, very carefully. Obviously, the history of this company is one that we recognize. We need to have a very strong balance sheet and we do expect natural gas to continue to be cyclical. So I hope that I’m more right when I say more than $10 on natural gas prices, but I also know that there will be warm winters in the future and there will be periods of time when gas prices fall. So we want to be in a position that we have a lot of financial flexibility when that happens. And you do that by maintaining a really low level of leverage and managing your liquidity well.
Unidentified Analyst
Okay, and then on managing liquidity, cash flow. So previously, you indicated that every $0.50 change on net gas is about a $700 million change in cash on an unhedged basis. I feel like we kind of can ignore some of the hedges that you have in place for ‘22 and ‘23. Do you have a sense of how that $700 million what that would be, including your hedge portfolio?
Nick Dell’Osso
Well, the hedges that we have in ‘22, largely as a result of the hedges we put on, when we exited bankruptcy, that all ends in the first quarter of ‘23. So our hedge program after that is really fundamentally different. It’s largely done through collars. And so we have upside, relative to the floors that we’ve put on. So it’s just a different exposure, a different level of risk mitigation in that hedge profile. We expect our realized price in 2023, to be pretty materially above what it is in 2022, despite the fact that there’s backwardation in the curve. And that’s because of the head roll off. So it’s, I’m not sure exactly how to answer your question other than to point out that our hedges do really change fundamentally on March 31 of 2023.
Unidentified Analyst
Okay, and then your last strategic pillar is your ESG commitment. So in terms of Chesapeake social license to operate, you’re the first operator to receive RSG certification basin wide. And I guess our question is, is there a customer pool for RSG that commands a pricing premium right now.
Nick Dell’Osso
So first, customer receive a basin wide and in two basins. And we’re really proud about that. That’s a commitment to having a lower carbon footprint for our production that we know is important to the world. And so that customer base, we think is growing and evolving, in its view of what RSG means. We did a deal recently with Golden Pass selling them $300 million a day of gas over a couple year period. And the fact that we were delivering them RSG was important to that discussion. The premiums that are available for RSG today are not significant frankly. They do exist, but they’re relatively small. We think it’s an important signaling, though, to the market that RSG is differentiated by buyers. And we do think that there becomes a pressure on other producers to reduce their carbon footprint and deliver a product that’s qualified for certification. We think that’s ultimately a positive for the industry if all of our peers do the same thing. We would like it if RSG is just natural gas that would be a good thing that would be a clear indicator to the world the natural gas is accretive to the world’s climate goals and helps the world deliver on affordable and reliable energy. It often gets asked to us if there is a choice there, energy security or defending the climate, and we think that’s a false choice. We think it ought to be both we think natural gas is the answer to how it’s both.
Unidentified Analyst
Just sticking to the Golden Path agreement that you just talked about. You said $300 million a day for a couple of years. Is that like netback pricing structure related to TTF JKM? Or is it Henry Hub, and you’ll hedge it out or something.
Nick Dell’Osso
It’s a domestic netback structure, yes, but we do have certainty of delivery on a pipe that we didn’t otherwise have capacity on. And we have a fixed differential to a domestic price to a Henry Hub price.
Unidentified Analyst
Okay. And it seems like investors and operators are aligned in trying to chase global gas exposure or just diversification for their markets. What’s been interesting recently is that some ENPs have just been having these announcements that they’re not only just supplying gas, but they’re doing different parts of the value chain where they’ve taken an equity stake in something or we, Devon had their announcement on getting involved in modular FLNG, Conoco and Sempra and they’re going to do some commercial agreements off the back end as well. What is Chesapeake’s appetite to chase something outside of just being a gas supplier?
Nick Dell’Osso
We’re open to it. For us the participation in LNG is all about the contracts that you’d have exposure to and what kind of a diversification of pricing you can achieve. There are facilities and counterparties where if you do participate in the pre FID funding, you can be sort of first in line or have the right to participate in international pricing in a favored way. And so those are things that we would consider. The nice thing about that though, is you’re talking about the pre FID funding for one of these facilities, which is really quite small. When we think about LNG facilities, we all think about them as multibillion dollar projects. The vast majority of that funding comes through project financing post FID. And the real equity uplift is created with pre FID funding. So if you can participate in the equity of something pre FID in relatively small dollars, the contracts that we as a supplier would be willing to agree to, for that project, de-risk it and make it qualify for FID, then you participate in the big uplift of equity that’s created as you go from pre FID to FID. You can have a nice offset or increase in value for relatively small dollars and be very aligned with that facility and coming online and delivering onto the world.
Unidentified Analyst
And then you have a nice Marcellus position. Any thoughts on East Coast LNG?
Nick Dell’Osso
We love the idea of East Coast LNG, why wouldn’t we, it would be a great thing, it’s closer to Europe, it’s close to a source of gas that is absolutely world class, and really should have much better connectivity to market, it’ll be difficult to continue to build pipe in the US that’s sufficient to deliver all that gas to the markets where it’s needed. And so it should be connected to the world market, we would love to see it happen. We recognize it’s probably a little bit difficult. But we will be big supporters and big fans.
Unidentified Analyst
So little bit difficult. Does that mean low probability? Does it more rely on kind of NEPA permitting reform? Like what do you think needs to happen really?
Nick Dell’Osso
Well, I think you need to just continue to have energy policy that embraces the idea that natural gas is the most effective solution to providing affordable, reliable and lower carbon energy. And we know that needs to happen. So it’s really hard for me to say it is low probability because it is one of the most logical steps that we should take as an economy to delivering enough energy to the world but we are big supporters of the idea and think that it should happen.
Unidentified Analyst
Okay, we have about two minutes left. If anybody has a question for the audience. We have very fast mic runners. If not, I still have a whole another list. All right. Well, Nick, I’ll give you the option. Would you like to talk Haynesville or inflation?
Nick Dell’Osso
Oh, Haynesville for sure.
Unidentified Analyst
All right. I guess I should have known.
Nick Dell’Osso
Inflation is boring. It’ll happen. It won’t be terrible.
Unidentified Analyst
Okay. Well, that settles that. So in terms of the State of the Union on the Haynesville, there is certainly concern out there about bases blowout, what’s your view on the timing, and then I’d love to hit on growth after that.
Nick Dell’Osso
Sure. Bases is going to be volatile in the Haynesville, we’ve talked a lot about how broad production growth to deliver over the next couple of years, we need to see expansions of training facilities, we need to see expansions of how we offload gas from our gathering systems. These are all small projects close to the wellhead, but they really matter a lot in the capacity that we need to deliver the volumes that would result in our growth. We can map it all out. We’ve done that on the slide in our investor deck, we sort of stair step along the capacity additions that we’ll see to be able to deliver growth volumes to the market. So it’s a lot of smaller projects. It’ll happen over the course of the next 12-18 months. And it’ll position us to be able to grow into some of the long haul takeaway pipes that we expect to come online late ’24 or early ‘25.
Unidentified Analyst
So the growth in the Haynesville I guess it’s, is it completely tied to the pipelines? I know for 4Q to 4Q next year, 5% to 7% is the estimate. Didn’t know if there was any flex in that now that the Eagle ford won’t be having any capital next year?
Nick Dell’Osso
No, I think it should generally be that number. It is tied to the infrastructure investments that we see coming. Again, those are near wellhead infrastructure investments that’s not tied to the long haul pipes that are going to go to Gillis, of which there are several. Those are going to come later. This is really more about getting the capacity expanded in the field.
Unidentified Analyst
And then last question since we have only 15 seconds. When you look into your crystal ball, where do you see Haynesville bases in say two years?
Nick Dell’Osso
I’d say back to its historical levels of the low to mid $0.20.
Unidentified Analyst
Okay, we got you on record.
Nick Dell’Osso
All right.
Unidentified Company Representative
All right. We are out of time. Thank you, Nick. This is very interesting. Thanks for watching.
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