Centennial Resource Development Inc. is planning to spend more this year for its Permian Basin operations in West Texas to prevent constraints in moving its natural gas to markets, CEO Mark Papa said Tuesday.

During a conference call to discuss fourth quarter and full-year results, Papa and CFO George Glyphis spent a few minutes discussing expected gas takeaway issues that are on the horizon in the West Texas region of the Delaware.

Papa specifically cited Apache Corp.’s gassy Alpine High development in the Delaware as potentially putting the hurt on other producer volumes.

Alpine High is a “very gassy play,” said Papa, and it “obviously is going to move a lot of gas into that Waha Hub. And then, you’ve got certainly a lot of the casinghead gas coming from the oil development in Reeves County.”

Centennial has “some concerns for 2018, 2019, 2020…In that timeframe you could have some issues on No. 1, getting our gas to Waha, and then No. 2, getting our gas away from Waha.”

Centennial took out “some transportation commitments to kind of make sure that at least for 2018 and for parts of 2019 that we’ve got firm transportation there…We’re working on doing some additional things for 2019 in there.”

Management is “comfortable” that it can move its oil and natural gas liquids from the region, Papa said. However, there is “some degree of concern about the gas question…

“In 2018, we are pretty comfortable. In 2019, we are somewhat comfortable, but we still have some work to do in 2019 and probably 2020. We think post-2020, there will be additional infrastructure in place or it is probably not going to be a problem.”

Gathering, processing and transportation, i.e. GP&T expenses, should be higher in 2018, averaging $3.20-3.80/boe versus $2.87 in 2017, as Centennial secures firm transportation for residue gas, said Glyphis.

“As a result of recent and projected drilling activity in the Delaware Basin, we believe that securing natural gas pipeline capacity out of Reeves County will become more challenging as the year goes by,” he said. “Therefore, over the past year, we entered into several transportation services agreements for essentially all of our expected gross natural gas production in 2018 in order to ensure delivery to market.”

After 2018, the Denver-based independent has some agreements and/or extensions in place, with plans to monitor future needs on an ongoing basis.

Another issue that is expected to raise operating costs this year, especially for the Delaware players, is produced water disposal, said Papa.

“That could trip you up also because for every barrel of oil you produce, you produce a significant amount of water.”

Centennial used a six-rig program in the Delaware during the fourth quarter and completed 26 wells. Oil production increased 30% sequentially and was averaging 27,400 b/d at year’s end, slightly above guidance, Glyphis said.

Average oil equivalent production totaled 44,300 boe/d, a 28% increase from the third quarter. Oil volumes as a percentage of total equivalent production were 62%.

“Going forward, we expect oil as a percent of total production to be approximately 60%,” said the CFO. The number is expected to fluctuate slightly depending on how much capital is allocated to the higher gas/oil ratio, or GOR, in Reeves County.

The plan is to continue to shift activity toward extended laterals, “as they generate significantly stronger returns in single section wells,” said operations chief Sean Smith. “In fact, we expect our 2018 average completed lateral length to increase approximately 30% year/year to approximately 7,500 feet.”

In the final three months of 2017, Centennial brought on wells from the northern and southern parts of the Delaware and was able to increase its fracturing stages, Smith said.

“Even in light of the current tightening in the overall oilfield service market in the Permian Basin, we were able to complete 721 stages, which is more than double the number of stages completed in the third quarter,” he said. “More importantly, we were able to accomplish while also increasing our overall well productivity.”

The recently completed Weaver C T34H targeting the Third Bone Spring Sand in Reeves County was Centennial’s first to use enhanced completion techniques, Smith said. Weaver was drilled with a 9,400-foot lateral and was producing more than 2,000 boe/d and 1,500 b/d of oil in its 10th day online, he noted.

“This is encouraging as we believe the Third Bone Spring Sand could be co-developed with the Wolfcamp A across a significant portion of our Reeves County position,” Smith said. “During the remainder of the year, we expect to complete several additional tests in this zone.”

Centennial in the fourth quarter also brought online the Big House C 3H in the Third Bone Spring carbonate interval using a 4,000-foot lateral, which had an initial production rate over 30 days (IP-30) of 800 boe/d, 60% oil.

Last September the independent also launched a drilling program in the northern portion of the Delaware, which runs into New Mexico. To underscore its plans, the company in early February said it spent $95 million to bolt on 4,000 net acres in Lea County, NM.

“Largely contiguous to our existing acreage, this acquisition increases our northern Delaware position by roughly 30% to over 16,000 net acres,” Smith said. “The acquisition represents an operated position with a high working interest of 95%. Additionally we estimate the acquisition will add approximately 100 gross locations to our inventory in the northern Delaware Basin.”

The first operated well in the northern Delaware, targeting the Avalon Shale, is the Pirate State 101H, with an effective lateral length of about 4,200 feet. The IP-30 rate was about 1,100 boe/d, with a 79% oil cut. During its first 60 days online, Pirate State produced around 49,000 bbl.

Centennial over the course of 2017 increased its full-year guidance three separate times, and it ended the year at the high-end of the final forecast. This year, the midpoint of oil production guidance currently is 35,500 b/d, which would be an 85% growth rate year/year.

“Importantly, we are revising our 2020 oil production target from 60,000 b/d to 65,000 b/d,” Glyphis said. “This increase is primarily a function of more prolific expected well performance and it does not constitute a change to our previously anticipated rig cadence.

“We added a seventh rig in February and expect to remain at seven rigs throughout the course of 2018.”

The oil target increase would be accomplished “without increasing our rig count or capital commitment from a previous plan,” Papa said. As he was known to do when he ran EOG Resources Inc., Papa also offered some perspective about the market.

“Oil prices have recently responded to the global inventory drawdown caused by tightening supply/demand fundamentals and the focus now turns to 2018 U.S. oil supply growth,” he said. “Many forecasting agencies are predicting U.S. oil growth of between 1.4 million and 2 million b/d this year. As I’ve previously noted, I expect actual U.S. growth will be less than many forecasters are currently predicting, which will support 2019 and future oil prices.”

Many U.S. exploration and production companies have set goals to not only reduce debt but to attempt to operate on cash flow only. Papa said that wasn’t always wise.

Unlike traditional onshore producers, Centennial, an offshoot of another Permian start-up, is “a little bit unusual,” he said. “We started out with essentially zero debt…Our current net debt is about 6%.

“So, we are outspending cash flow quite obviously in 2018. We will likely outspend our cash flow in 2019 based on our model…” and achieve neutrality in 2019 based on an estimated West Texas Intermediate crude oil price of $65/bbl.

Papa poo-pooed critics who have said it is “bad” for producers to outspend cash flow. “We designed this company to come out in our genesis with zero net debt because we knew we had to reach a certain critical mass to be a meaningful company. I define a critical mass as…60,000-65,000 b/d of oil. And by our modeling calculations, we never exceed a net debt to total cap of roughly 20%.

“So, I find it a little bit strange that sometimes we get questions about ”you know you’re outspending cash flow’ when we’re one of the lowest net debt companies and projected to be one of the lowest net debt companies even through 2019 and 2020. But…we should reach neutrality by 2019 and 2020.”

Net income totaled $30.5 million (12 cents/share) in 4Q2017, 111% more than the 6 cents/share earned in the third quarter. Centennial was not a public company for all of 4Q2016. It spent about $246 million during 4Q2017 on capital expenditures, including $226 million for drilling and completions. (D&C).

“The D&C expenditures were higher than we anticipated, primarily as a result of a shift to drilling more extended laterals,” said Gryphis. “We drilled more extended laterals in the fourth quarter compared to the previous three quarters combined, and our initial extended lateral D&C estimates per well were simply too conservative.”

The midpoint of capital spending for 2018 is estimated at $970 million, with $765 million for D&C. An additional $100 million is budgeted for well level facilities and infrastructure.

“With our operated D&C budget, we expect to drill 80-95 gross wells and complete 75-85 gross wells during 2018,” Gryphis said.

For unit costs this year, estimated lease operating expenses are $3.60-4.20/boe, higher than 2017 actuals to reflect water handling and general cost inflation.