Change seemed imminent earlier this month when CEO Toby Rice took the helm at EQT Corp., but under his management the company is drastically overhauling how it spends money and in the process redefining how active the nation’s largest natural gas producer will be going forward.
During its first public call with financial analysts on Thursday to discuss second quarter results, the management team sent a clear signal that it will slow down and take a more methodical approach to execute its strategy for the company and appease restive shareholders that thrust Rice, 37, and his board candidates into power after a nine-month proxy battle.
Management is focused on lower well costs, improving capital efficiency, generating sustainable free cash flow (FCF) and enhancing returns.
“We will be taking a different approach to capital allocation than many of our peers,” said EQT’s Kyle Derham, a member of the committee overseeing the transition. Management has suspended the 2020 outlook, with it plans to issue new guidance in the next three months.
Capital spending will be determined by the number of economic projects in the queue, measured against the opportunity to buy back shares, now at historically low prices, and achieve leverage targets, Derham said. Production growth, if any at all, would be a byproduct of that strategy rather than a target.
Rice said high-cost well pads are already being pulled from the drilling schedule, and capital won’t be directed toward the drillbit for now. The new team intends to focus on land and permitting to establish a more streamlined operational plan known as “combo development” that was employed by the former Rice Energy, which was acquired by EQT for $8 billion less than two years ago.
Derham added that EQT could eventually sell its $900 million stake in Equitrans Midstream Corp., which was spun-off last year, and dump other assets as well. Management stressed, however, that it has no immediate plans to monetize the Equitrans holdings and is still committed to the beleaguered Mountain Valley Pipeline gas project.
“Planning in Appalachia is extremely difficult, and perhaps more difficult than anywhere else in the Lower 48,” Rice told analysts. “A well designed development schedule planned 36 months into the future is key to consistent operational execution that will drive lower well costs and more free cash flow.”
He pointed to a single pad developed under the former management team as proof of the 130 year-old company’s legacy issues. Wells were "squeezed" next to multiple existing wells, forcing the drilling team to use complex wellbore geometries to avoid collisions, and causing mud losses during drilling as an abundance of fractured rock was encountered downhole. Poorly planned wellhead layouts, he said, led to time-consuming rig maneuvers that were needed to drill other wells.
Meanwhile, offset wells were impacted in the process, meaning 30 Bcf/d was shut-in for an extended period of time, exacerbating legacy curtailment issues made worse by midstream constraints. Moreover, Rice said parent/child well interference also led to type curve declines.
Rigs had been sent to pads absent better locations, and teams were incentivized to hit production targets, Rice said, with less than 50% of the future schedule set up for efficient development. "This is why we are here," he said.
Management has hired personnel to help transform into a technology-driven enterprise. Eight executives have been brought in to steer the Evolution Committee. Fifty departments within EQT will also be whittled down to 16 to better unify operations. At the former Rice Energy, where Rice served as COO, the company had detailed development plans drafted for up to five years in advance, he noted.
Better planning is expected to get EQT to well costs of $735/foot, compared with current rates of about $860/foot, to generate the $500 million of annual FCF that Rice promised shareholders and smooth out other operational issues such as midstream constraints. Changes, however, won’t begin to show until next year at the earliest.
"We expect a gradual improvement in well costs, as gradual improvements are implemented and inefficient development is removed from the schedule,” Rice said. “Master planning takes time, but we expect the schedule to be predominantly combo development runs by mid-2020."
The company has a massive footprint to tame with well over 700,000 core acres scattered across the Marcellus and Utica shales in Ohio, Pennsylvania and West Virginia. The market is also tightening, and management recognizes that it needs to curb activity.
As equity markets have soured on Appalachian producers over stagnant natural gas prices, many of the basin’s leading operators have seen their values slide precipitously in recent years. Positive FCF has been hard to come by for the gassier operators, which has partly impacted their market capitalization.
However, the Rice’s takeover of EQT also comes at a time when much of the Lower 48 appears to be facing challenges. Oilfield service companies have already been stacking equipment and responding accordingly, as investors demand capital discipline and the broader oil and gas market once again faces supply and demand imbalances.
Over the last three months, the forward gas strip has continued to weaken, bringing significant pressure to the balance sheets of both private and public exploration and production companies.
While there are currently 75 rigs running in Appalachia and 50 in the Haynesville Shale, Derham said management thinks "the vast majority of these rigs are subeconomic at strip pricing. He said “the equity in gas markets is sending a clear message to operators to cut growth to maintenance levels and some will need to go further than that. While we have started to see a pullback in activity, we believe more is needed to balance the market."
All of its rig contracts are to roll off by the end of the year. The company also has minimal long-term commitments for other services, giving it more flexibility to cut costs.
EQT produced 370 Bcfe during the second quarter versus 362.5 Bcfe in the year-ago period and down from 383 Bcfe in 1Q2019. Before Rice took over, EQT had cut its year/year spending and announced a plan to keep 2019 production roughly flat at 1.480-1.520 Tcfe.
The new management team hasn’t changed this year’s guidance but capital expenditures were trimmed by the previous management team by $25 million to $1.825-1.925 billion.
The company reported second quarter net income of $126 million (49 cents/share), compared with a net loss of $77 million (minus 29 cents) in the year-ago period. Revenue increased to $1.3 billion from $950.6 million.
With the company’s new plan to sap more value from its assets not expecting to show for a year or more, the company’s stock dropped almost 7% on Thursday to close near its 52-week low at $14.82/share.