Diamondback Energy Q4 2021 Earnings Call Transcript

Quartr
Provided by Quartr
February 23, 2022

There are 14 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Diamondback Energy 4th Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer Please be advised that today's conference is being recorded.

Speaker 1

I would now like to hand the conference over to

Operator

your speaker today, Adam Lawlis, Vice President, Investor Relations.

Speaker 2

Thank you, Amy. Good morning, and welcome to Diamondback Energy's 4th quarter 2021 Call. During our call today, we will reference an updated investor presentation, which can be found on Diamondback's website. Representing Diamondback today are Travis Stice, Chairman and CEO Cade Stantoff, President and CFO and Danny Wesson, COO. During this conference call, the participants may make certain forward looking statements relating to the company's financial condition, results of operations, plans, objectives, future performance and businesses.

Speaker 2

We caution you that actual results could differ materially from those that are indicated in these forward looking statements due to a variety of factors. Information concerning these factors can be found in the company's filings with the SEC. In addition, we'll make reference to certain non GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon. I'll now turn the call over to Travis Stice.

Speaker 3

Thank you, Adam, and welcome to Diamondback's 4th quarter earnings call. 2021 was a great year for Diamondback and our industry, With higher product prices allowing the vast majority of our industry to 1, repair and improve balance sheets quickly 2, Accelerate returns to shareholders and 3, make significant progress on environmental objectives. At Diamondback, we reduced our absolute debt by $1,300,000,000 increased our base dividend every quarter, Initiated a return of capital framework and announced ambitious environmental goals designed to help us earn our environmental license to operate. In the Q4 alone, buoyed by commodity price strength, Diamondback generated $772,000,000 of Free cash flow with production and capital both positively exceeding expectations. We returned 67% of this free cash flow to stockholders, which was above our commitment to return at least 50% of our free cash flow to shareholders quarterly.

Speaker 3

This return was made up of $106,000,000 allocated to our growing base dividend Now at $2.40 a share on an annualized basis, which represents a current yield of approximately 2% and $409,000,000 in share repurchases as we bought back nearly 3,900,000 shares at an average price of just under $106 per share. We're at the beginning of an incredible period of value creation for the industry. And I'm confident that the capital discipline demonstrated by us and our peers in 2021 will continue putting returns and therefore shareholders first. We believe this is the best near term path to equity value creation As our shift from a consumer of capital to a net distributor of capital, Siemens itself as our long term business model. 2 months into 2022, economies are rapidly reopening around the world, stoking demand, which we believe to be close to, if not above, pre pandemic levels.

Speaker 3

On the supply side, we are witnessing some underperformance from OPEC Plus to meet this increasing demand, Calling into question spare capacity with global inventory numbers now approaching 2010 to 2014 levels. We cited both global oil inventories and OPEC spare capacity as impediments to any discussion around U. S. Public company oil growth and those issues appear to have subsided for now. However, The global balance remains tenuous at best with up to 1,000,000 barrels per day of additional Iranian barrels potentially coming online sometime this year and U.

Speaker 3

S. Growth expectations continuing to climb higher led by private companies and more importantly or more recently majors. Both of these supply factors could be bearish signals for oil. Therefore, Diamondback's team and Board believe that we have no reason to put growth before returns. Our shareholders, the owners of our company agreed.

Speaker 3

And as a result, we will continue to be disciplined, Keeping our oil production flat this year. As such, our plan for this year is simple, Maintain oil production of approximately 220,000 barrels per day by spending between 1.75 and $1,900,000,000 At current strip pricing, this production and capital spend equates to nearly 4,000,000,000 of free cash flow, which for our returns framework gives a minimum of $2,000,000,000 of cash back to our investors. At the same time, we are committed to permanent returns to our investors, which is why we continue to lean into our base dividend, Increasing it again by 20% this quarter. Our growing base dividend is our primary means of returning capital, And we've increased it by quarterly CAGR of over 10% since it was initiated in 2018. Today, we have line of sight to get our dividend to $3 a share by the end of this year if market conditions remain favorable, which would mean 25% of our 2022 distributable free cash flow would be allocated through this constant Predictable form of shareholder return.

Speaker 3

History has taught us that oil is a volatile commodity and that the macro environment will not always be this favorable. So we continue to work towards protecting our base dividend down to $35 WTI With the view that this dividend is really just a form of debt and if plus our maintenance capital budget have to be protected to the extreme downside. By continuing to focus on a fortress balance sheet and layering on strategic derivative positions to our hedge book, we are confident in our ability to perform in any environment. While the base dividend is the primary tool of returning capital, we will also utilize share repurchases and potentially variable dividends to reach at least 50% of distributed free cash flow on a quarterly basis. We continue to repurchase shares opportunistically, taking advantage of volatility while generating returns on these repurchases Well in excess of our cost of capital at mid cycle commodity prices, which today is assumed to be around $60 WTI.

Speaker 4

Through the end of

Speaker 3

the Q4, we've spent $430,000,000 or 22% of the $2,000,000,000 program our Board authorized last September. If the free cash flow returned through our base dividend and repurchase program does not equal at least 50% of free cash flow for that particular quarter, then we will make our investors whole by distributing the rest of that free cash flow via a variable dividend. This strategy gives us the ability to be flexible and opportunistic Distributing capital above and beyond our base dividend, and most importantly allows at least 50% of free cash flow to be returned. However, it is important that the Board also retains discretion on what to do with the other 50% of the free cash flow generated. As was the case in the 4th quarter, we have the ability to distribute above and beyond our 50% threshold.

Speaker 3

If we feel comfortable with our balance sheet and associated cash balance and do not have a use for excess cash, We will return that cash aggressively to shareholders. Some quarters, we will distribute 50% of free cash flow, but in others, we will have the ability to return more, just like we did in the Q4. Going forward, We fully expect to differentiate ourselves not only by our returns framework, but more importantly through our consistent execution in the field. Last year, our clear fluid design lowered our average drilling days in the Midland Basin by approximately 35%. That's an astounding achievement for our drilling department.

Speaker 3

On the frac side, our simulfrac operations continue to reduce our time on pad as we are now averaging 3,200 feet per day with our 4 well simul frac design. As we've laid out in our investor deck, these operational efficiencies have helped us mitigate the substantial cost pressures We've seen related to consumables and labor and as we noted last quarter, these gains will be permanent, giving us more variable cost control than our peers due to these industry leading drilling and completion times. Now when you bake in these cost increases and offset them with our efficiency gain, this equates to about 10% of additional capital spend year over year, which is baked into our guidance. We will try to offset this inflation by doing what we do best, Innovating, implementing new technology and drilling more efficient and better wells. As mentioned, we were able to offset A vast majority of pricing increases we faced last year through this type of innovation.

Speaker 3

And we're confident we can maintain our best in class Capital efficiency and cost structure this year. At the same time, we are fortunate to have multiple pieces of our capital cost structure locked in with contracts and dedications like our water and sand supply. As the rig count in the Permian climbs, We will continue to work to control other components of our cost structure, particularly services, labor and consumable products, while continuing to be the leader in cash margin and capital efficiency. Finally, I'd like to close by detailing the strides we've made in our environmental, social and governance practices. To begin, We met 4 or 5 environmental goals in 2021, which had a 20% weighting in management's short term compensation this year and included specific targets related to flaring, water recycling, GHG emission intensity, Produced liquid spills and total recordable incidents.

Speaker 3

Unfortunately, we did not meet our expectation of flaring less than 1% of gross gas produced. While we met this goal on legacy Diamondback acreage, which was how the goal was set, we missed our target When incorporating our acquired QEP assets, which included a QEP Bakken asset we divested in October. We will continue to improve our takeaway on the acquired Permian acreage and partnering with our midstream companies to not only structure contracts that incentivize Takeaway in price agnostic environments, but also apply performance based incentives and penalties related to flaring. All of our progress in 2021 positions us well to hit our long term goals of reducing our GHG and methane intensity by 50% 70% respectively by 2024 And recycling over 65% of our water and eliminating all routine flaring by 2025. These environmental goals hit close to home as we hold the unique title of being the only publicly traded E and P headquartered in Midland in the heart of the Permian Basin.

Speaker 3

As such, we feel an enormous social responsibility to better the community in which we live, work and play. We recently committed $2,500,000 to a complete redesign of Midland's largest public park as well as $500,000 for Midland's Meals on Wheels Arguably more important, however, our employees continue to give their time to sponsor and host camps, reading and instructional programs and public work projects. I'm incredibly proud of our team's efforts. 2021 was a great year for the company. We generated record free cash flow and distributed over 30% of it to shareholders, Strengthened our balance sheet by substantially reducing our absolute debt load and continued to produce one of the cleanest and most cost effective barrels in the industry.

Speaker 3

Looking ahead, we're confident in continued consistent operational execution and the ability to generate peer leading returns. With these comments now complete, operator, please open the line for questions.

Operator

Thank you, sir. Please stand by while we compile the Q and A roster. Your first question is from Arun Jayaram from JPMorgan.

Speaker 5

Good morning, Travis and team. I wanted to just get some broader thoughts on your plan, Travis, To allocate free cash flow in 2022, you obviously have buybacks, variable dividends And debt, while I'm assuming you want to keep some powder dry for A and D opportunities. But with the stock trading above The valuation of the stock assuming a mid cycle deck, we think you're probably going to pivot a little bit more to variable dividends, but I wanted to get your thoughts on that and how The $4,000,000,000 if the strip holds could be allocated this year.

Speaker 3

Sure. Arun, it's good business with you again. Listen, I'll tell you to the penny how much on share repurchases we bought in May, if any. But what hasn't changed, Arun, is our commitment. Whatever portion of our free cash flow that we don't spend on repurchases, we're going to return that free cash flow to our shareholders.

Speaker 3

Look, when it comes to share repurchasing, we view that as just like any other investment decision, drill a well, M and A activity. We do so, like you mentioned, at a mid cycle oil price, which for us is around $60 a barrel. And it has to generate a positive return. And when you go back and look at what Oil price has averaged since the fall of 2014, it's averaged $53 a barrel. And if you can guarantee me that the price of oil is going to be $90 or above, then I'll tell you that our shares are undervalued.

Speaker 3

But we're going to be disciplined. We're going to be opportunistic when it comes to our share repurchase programs, Just like any other form of capital allocation and what we don't repurchase in shares, we're going to return back to our shareholders in the variable dividends every quarter.

Speaker 4

Yes. I think on top of that Arun, we certainly want a fortress balance sheet. I think there's some stuff for us to do with our 2024s and 20 5 notes this year, pay down debt when things are good. And I think that could open the door for Higher returns, I think the key is 50% of free cash flow is going back to the shareholders. And if we don't have anything to do with the other 50, It's coming back as well.

Speaker 4

And we proved that in the Q4.

Speaker 5

Great. And I had one follow-up on the Permian in general. Just thinking about the industry, one of the potential headwinds for future growth will be gas takeaway, current Scrapes are just around 14 Bcf a day. We estimate there's about 17 Bcf a day of takeaway capacity. So I wanted to get your thoughts, Travis.

Speaker 5

Your net production is approaching 0.5 B. And how do you think Diamondback is Position to manage this tightness that could occur in late 2023 or early 2024?

Speaker 4

Yes. I mean, I think Arun, unlike the past, I think we have Size and scale now to contribute to pipelines and make sure it happens. We're certainly doing our part not growing. I wish other people would grow less in the Permian too, but that's a different topic. But generally, we committed to the Whistler pipeline, just announced that With this earnings, that was with our WTG commitment on gas gathering and processing committed to the BANGL pipeline, which is NGL takeaway.

Speaker 4

I'm really just trying to put our balance sheet to work to make sure pipeline capacity is strong coming out of the basin. I think we'll see some announcements here pretty soon. We saw a couple of things last week on new pipes. But I think generally the industry is Aligned that we can't go back to the way we were when it comes to flaring and particularly with gas prices up, we should all be incentivized to make sure Gas was out of the Permian.

Speaker 3

So, it's going to

Speaker 4

be tight if growth continues through 2023, but I'm pretty optimistic on 2024.

Speaker 5

Okay. So are you looking to add capacity on those 2 pipes, 1 of the 2 pipes?

Speaker 4

Yes. We would. You have to have taken kind rights to be able to do that. And so we're putting a lot of pressure on our midstream partners to either relinquish our taken kind rights to us so that we can contribute to the pipeline Like we did on the Whistler pipe, putting our balance sheet to work or incentivizing them to contribute themselves. So It's a little bit of a game of chicken with our G and Ps, but I think message is we both need to figure this out as a group and we would be willing to put our balance

Operator

Your next question is from Neil Mehta of Goldman Sachs.

Speaker 6

Good morning, team, and congratulations to everyone on the new promotions over at Diamondback. The first question is the hedging strategy. Travis, you talked about a long term $60 WTI view, curves We're trading well through that. Does it make sense to opportunistically layer in hedging and thereby lock in more of the capital returns? Or do you think given the strength of balance sheet, you can run the business more open?

Speaker 3

As our balance sheet strengthens, I think your comment about running the business a little bit more open makes sense. But having said that though, we have to make sure that we protect the extreme downside. Look, the impossible happens in 2020. Well, we don't ever think that's going to happen again. We want to make sure that we've got insurance to provide accordingly.

Speaker 3

I think We try to do deferred premium puts as our preferred hedging strategy, which kind of sets that Protection in place for us while accomplishing given our shareholders all the upside on price as well.

Speaker 4

Yes. I mean, I think we hope for the best, but prepare for the worst. And preparing for the worst is buying puts $50 The balance sheet doesn't blow out. Dividends well protected, so our free cash flow above that and try to leave as much upside for the best as possible.

Speaker 6

Yes, that makes sense. The follow-up is, Travis, you famously said, I think it was last August that Your view was it was a seller's market and stock has obviously done very well since then and your equity value has strengthened. What's your thought on the M and A environment in the Permian? Do you view Diamondback as a logical consolidator? And how do you think about the timeline of it, especially with oil above mid cycle prices?

Speaker 3

Yes. Neil, that's a good question. And it's really hard For me to see how kind of the excessive G and A that still exists in the Permian, how all of that gets consolidated. I wish I could articulate clearly What the catalyst is going to be that allows consolidation to occur because it's needed in our industry. That being said, There's

Speaker 4

a lot of companies

Speaker 3

that had 1 foot in the whistling through the graveyard With 1 foot in the grave and now a couple of years later, the oil is at $90 a barrel and they're expecting to sell out and get value on future cash flows At $90 a barrel. And as I mentioned, it's the same strategy on our share buybacks, right? If the mid cycle oil price is $60 a barrel, then it's going to be hard to close the spread between bid and ask on the much needed M and A activity has to occur here in the Permian. So while I'd like to think Diamondback could create Unreasonable value for our shareholders like we did with the QEP and Guidon acquisition. It's hard with these frothy expectations on oil price that we're seeing today.

Operator

Your next question is from Neal Dingmann of Truist Securities.

Speaker 7

Good morning, guys. Thanks for the time. My question maybe for you, Kay, is my first a little different angle on shareholder return. What I'd say there is, I'm glad to see you all have really not gotten Todd and this group, thank you for suggesting you have to pay out all your free cash flow. A question I get from investors is how do you all think you best show investors That you'll continue to be the best allocators of capital that you have.

Speaker 7

And Kay, as you mentioned, really anything is out there on a lot of Possibilities with one of those allocation choices at some point include higher production.

Speaker 4

Yes, Neil, good question. I think the Street has lost sight of value creation for E and Ps. I get that There's a lot of cash going back to shareholders, but at the end of the day, if you can generate more free cash flow with the same expectations out of the business, You're creating more value over a long period of time. Execution is going to matter, metrics matter, controlling cost matters, PDPF and D matters. And for us, all of those inputs create more free cash flow and that means more free cash flow is going to shareholders, Whether it's 50% of free cash flow in 1 quarter or 67% in another, we kind of think about this As a partnership, it's just that the partnership has a commitment to return 50% of free cash flow.

Speaker 4

If we have something to do with the other 50% that creates unreasonable value, We'll keep it, but we're not going to sit on cash and we're going to distribute a ton of cash to partners. It's just the only commitment is at least 50% of that cash is coming back.

Speaker 7

Great to hear. And then Travis, my second question probably for you is, I like the slides 1011 on margins and costs. I'm just wondering specifically, You give maybe a little more color on the primary driver of that median cash margin. I mean is it that sort of newish 10 day drilling well design that's driving that or Maybe just talk about what you would primarily point to.

Speaker 3

Yes. Certainly, we've got the benefit of The improvements that we made in 2021, as I mentioned, 35% improvement in drill times, and we're going to get a full year impact of that This year, which is helping us offset the inflationary effects. A couple of data points, Neil,

Speaker 4

That we

Speaker 3

just saw just found out about yesterday as we're getting updated in our weekly meeting. We drilled a well in the Delaware Basin. It's a 15,000 foot ladder. We drilled it to TD in 9 days, which is a record for us. And For that area, just an outstanding occurrence.

Speaker 3

And even on the Midland Basin side, where we've been drilling the most, we drilled another 3 mile lateral, 15,000 foot lateral In 7.5 days, but what's amazing about that, and that's the TD, what's amazing about that is we only spent 3.5 days in the lateral. Now we used rotary steerable and sometimes rotary steerable technology is a little harder to replicate, but that's what's possible. So We've got an organization, Neil, that continues to lean into this variable expense side. And what I can't emphasize enough is that, That's ground that's taken and never given back. When you become more efficient at something, that's always on your side of the table and it's for the good guys.

Speaker 3

So I know I kind of that's a little bit off topic there, but it's really important to hear that our organization It's locked and loaded and this machine is humming very, very efficiently. And you couldn't want a machine humming More efficiently than we are right now in an inflationary environment.

Speaker 7

You always want to hear those updates. Thanks, Travis. Thanks, guys.

Speaker 3

Thanks, Neil.

Operator

Your next question is from Derrick Whitfield with Stifel.

Speaker 8

Hey, good morning to all. Congrats on your quarter end update.

Speaker 3

Thank you, Derek. Thanks, Derek.

Speaker 8

With my first question, I wanted to focus on the flaring you experienced in Q4 With the full understanding of its importance to you based on your ESG mandate and incentive compensation, Could you speak to the higher than expected flaring you experienced? And what steps you guys can take to mitigate that in the future even with your partners?

Speaker 3

Yes. If you look on Slide 18, Derek, we laid it out with quite a bit of detail. And just as an aside, you've heard me say this before, Our Board expects management to not only lead the industry in environmental measures, but also lead the industry in disclosure. And I think 2018 is a pretty good slide. But Let me just point to something specifically.

Speaker 3

If you look in the top right of that slide, it talks about flaring by source. And if you take 3rd party planned maintenance and 3rd party unplanned maintenance, that's 80% of our flaring volumes in 2021. And particularly on the unplanned side, Which is something that we've just got to do a better job with our business partners on. Now I said in my prepared remarks, we've actually changed contracts where we can that both incentivizes and penalizes flaring performance. So We're looking to expand that concept across all of our gatherers, but we're also intentionally asking our Midstream gatherers to help us as an industry on this effort.

Speaker 3

And that's part of the reason that we're calling attention So this and to their performance on Slide 18. Now particular to the miss, I tried to lay that out. We set the goal for our flaring before we bought QEP and Guidon. And we didn't adjust our goal just because we acquired assets that had much worse flame statistics Than we did. We tried to absorb it.

Speaker 3

We did absorb it, but it cost us on our annual performance. But that's we felt like that was the right way to treat it. Once the goal is set, we honor it.

Speaker 4

Yes. I mean one thing to add, we also deferred 500,000 barrels of oil last year. I mean, we're trying to do our part here, Derek. We deferred 850,000 BOEs, 500,000 barrels of oil Because of flaring, we're just kind of asking that both sides, midstream and upstream get together to solve this industry issue.

Speaker 3

And that shouldn't be lost, Derek. That's a very key point. Think about that. We deferred over 500,000 barrels last year Just to avoid flaring. And that's a behavior that represents a substantial pivot For Diamondback and a substantial pivot if our peers follow suit for our industry.

Speaker 3

And what I believe you're seeing, Derek, you're seeing environmental stewardship more of More companies are viewing it as an operating philosophy as opposed to an expense, which it was historically or hit the volumes. And I think that's an important narrative for our industry to get out there and push. As an operating Philosophy, environmental stewardship, particularly around eliminating flaring and eliminating methane emissions Is simply the way to operate a business on a full cycle basis. And I hope that makes sense.

Speaker 8

It does and your commitment to it is quite clear. As my follow-up, I wanted to dig And a bit more on the macro side and ask if you could share your expectations for growth in the Permian in 2022 and ask if the growth rates outlined by the majors in the Permian, if that's a concern for you.

Speaker 3

Well, look, I've pointed out that on a global sense, the supply demand is pretty tenuous. And even with the announced growth from the majors, I'm not sure that The total barrels that they're producing are growing into the global equation. So that's kind of a plus. Now right here as I look out my window, I know that the Permian is running about 300 rigs right now. We're probably on the way to 3 50 or 400 rigs by the end of this year.

Speaker 3

And a large portion of that as those rigs have been operated by Permian, but I think some of the growth you're seeing on a go forward basis Will be from the majors. We've already talked about gas pipeline takeaway issues and a little bit on the NGLs, which I think Diamondback has been on our front foot Getting some strategic alliances there and oil takeaways in great shape, but it is going to create inflationary pressures. But that's what your charge to us and all of our industries charge is how to manage CapEx in an inflationary environment And not put your shareholder return program at risk. That's kind of how I think about the total Permian playbook.

Speaker 8

Great. And you guys have done a great job with that. So thanks again for your time.

Speaker 3

Thank you, Jared.

Operator

Your next question is from Doug Leggate of Bank of America.

Speaker 9

Thank you. Good morning, everybody. Guys, post the deals, I guess, the cleanup of last year, it looks like you've gone through a little bit of an inventory high grading On your latest disclosure, I just wonder if you could kind of walk us through what that looked like. It looks to us that you're sitting on about A better than 15 year inventory if you define just the quarter of that slightly longer lateral inventory you laid out So can you just walk us through what that process was and if I'm thinking about it the right way?

Speaker 4

Yes. I mean generally Doug, post deals we do a lot of trades, try to block up, Extend inventory extend laterals sometimes at the expense of lower working interest inventory that may Not the operator have shorter laterals. So that's the blocking and tackling piece that we're very focused on. And 2nd, on inventory, we've gone a little wider in both the Midland and the Delaware basins. I think our updated inventory numbers reflect that Kind of moving towards 6 to 7 wells per zone, per section in the Midland Basin versus kind of 8 being the tightest 6 60 foot spacing And the Delaware moving to kind of 4 to 5 wells a section in the primary zones versus 6.

Speaker 4

Think what we found is we're not sacrificing a ton of EUR from that unit by going a little wider, but we are Generating much better returns and much better capital efficiency. So I think the offset from a present value perspective Outweighs the loss of a couple of locations.

Speaker 9

So is it the right way to think about this on if you guys maintain your ex Growth outlook, we're looking at better than 15 years of drilling. I mean, obviously, I know it's a little bit too precise, but I'm trying to just think about the longevity of the portfolio strategy with the inventory you have today.

Speaker 4

Yes, that's fair. I will add that It's a small number, but we are completing 5 less wells at the midpoint in 2022 than we were in 2021. And as the base decline shallows out and we Get active on Salem Robertson Ranch where we have a significant percentage of minerals helping us out. That capital efficiency is going to look a little better here Over the coming years.

Speaker 9

Okay. Thank you for that. My follow-up, I hate to do it, but it's the variable dividend buyback balance sheet question. When you pay out a variable, the cash is gone. At the top of the cycle, let's say, and M and A opportunities fall by the wayside, let's assume, Then you get a correction in oil prices and the cash has been paid out as a variable.

Speaker 9

I'm just kind of curious your commentary, You mentioned variable, it's differentiated you that you haven't gone down that path. What should we take from those comments as to how you're prioritizing Setting cash on the balance sheet, continuing to buy back stock if you see intrinsic value or indeed giving a variable dividend that you don't really get a chance to get back.

Speaker 3

Yes. So it's really pretty straightforward, Doug.

Speaker 4

It's leaning to

Speaker 3

the base dividend, which we've shown every quarter Since we initiated the dividend back in 2018, and

Speaker 7

we're going

Speaker 3

to get that up to $3 a share, the market conditions don't change. The second is share repurchases. But again, there's a calculus that's involved in an investment decision for share repurchases. So to the extent we can consume 50% of our free cash flow at a good return on share repurchases, then that's what we'll do. But if we see a dislocation between commodity price, share repurchases, we'll pivot quickly and within the quarter to pay out Remaining up to 50% or at least 50% of the free cash flow in the form of a variable dividend.

Speaker 3

So in some quarters, it's at least going to be 50% And some quarters, it could be as much as like we did this last quarter, 67% or more. We're just trying to maintain at the end of the day, Doug, we're trying to maintain the greatest Flexibility to generate the best shareholder return.

Speaker 9

Travis, I apologize. What do you do with the other 50%? You did 67% in the 4th quarter.

Speaker 4

Well, right now, we'd like to continue to work on having a fortress balance sheet and having cash on that fortress balance sheet from the inevitable down cycle. So I think we're focused on kind of our mid decade maturities. If we can extend some of them, but also pay down most of them, That clears the way for a lot more cash to be put on the balance sheet and then step up The overall shareholder return from there, but I don't think we're there yet, Doug. All right.

Speaker 9

Thanks, guys.

Speaker 3

Thanks, Doug.

Operator

Your next question is from David Deckelbaum with Cowen.

Speaker 10

Good morning, guys. Thanks for the time this morning.

Speaker 4

Good day. Thanks Dave.

Speaker 10

Just wanted to revisit that last point on the balance sheet. You talked about the mid decade maturities. Is there can you remind us, is there an absolute sort of debt target that you have if you're factoring in a $60 mid cycle price?

Speaker 4

Yes. I mean, I kind of think about absolute getting down to $3,500,000,000 ish at Diamondback $1,000,000,000 ish at the subs. So $4,500,000,000 total, I think that It keeps you very well protected even at a mid cycle price, a turn or so. But more importantly, average maturity Getting extended is going to be important because that clears the way for more shareholder returns between now and 2029 when our next A big note would be due.

Speaker 10

Appreciate that. And then just my second question, The slide where you were referencing cost inflation looked like it rolled up to about 15% overall. The reference point was the Q3 20%, where I think we were paying people to stick oil in swimming pools. So 50%. And it seems relatively benign since then.

Speaker 10

I'm curious what your outlook is on what you can do and what you're factoring in, in terms of cost inflation Into the 2023, 2024 timeline, and would you do you think that there's still room to offset that With efficiencies and are you changing how you're contracting for services right now?

Speaker 3

Well, You always want your organization to continue to look for the efficiencies on the variable side. And it's hard to forecast what those are, But it's not hard to try to incentivize the culture that looks for those efficiency gains. And what they're going to look like in 2023 2024, Can't tell you, but I know we're going to continue to look for it. And I know if past performance is a good indication, we'll continue to lead the back on these type of efficiencies. Contracting long term for more of the consumables on the fixed side of the equations, Those have typically been very difficult for our industry because the time that the operator wants to lock in is the time that The service provider doesn't.

Speaker 3

We're always at odds and ends of the spectrum. So like right now, The consumable guys on the service side would love to lock in these all time high prices. Operators are reluctant to do so. So Diamondback has the size and the scale to have very meaningful conversation with our business partners on the service side. And we have those quarterly or every 6 months.

Speaker 3

And that's the way that we've chosen to manage that relationship. And Most of our service providers, we've had now for over 5 years and we've got a really good business relationship with them. Look, their margins have to expand. We understand that. But our commitment to be best in class in the highest margin Remains unchanged as well too.

Speaker 3

So it's not a straightforward calculus, David, that I can lay out for you. But I can tell you That organization will be continuing to lean into it. And I'm very confident certainly for 2022 that we'll be able to do so.

Speaker 4

Well, one comment on Slide 10, David. Slide 10 tells you exactly what we're saying, right? The rig line and the stimulation line, Rig rates are up, frac rates are up, but the efficiencies that have been gained as seen in the top half of the page means that those pieces of the well costs have not Risen like fixed costs like fuel or cement or casing.

Speaker 10

Absolutely. And thanks for pointing that And congrats on all the promotions. Thanks for the answers.

Speaker 3

Thanks, David. Thanks, David.

Operator

Your next question is from Jeffrey Laboucian of Tudor, Pickering, Holt.

Speaker 1

Good morning and thanks for taking my question. Just one for me on ESG. Obviously, a lot of progress made on the initiatives that you set out In September with your sustainability report, just looking at that section on the slide deck that you highlighted, I was wondering if you could just talk a bit about what Focused on this year, I know you hit on flaring already. And then thinking further out, it'd be interesting to hear about what sort of projects you could yourselves investing in and continue to make progress on offsetting emissions?

Speaker 3

Yes. We've been pretty clear that we're committing, I don't know, Tactically that's translated on the methane side to overhauling and reconfiguring a lot of our old mostly acquired Tank batteries that have gas pneumatic, I think we've got a slide in there that actually points that out. Yes, gas pneumatic, you can see what that is on Slides 1920. But that's been the first focus area is the gas pneumatics. And Danny, we're probably halfway through getting those Batteries changed a third to halfway through?

Speaker 4

Yes, we kind of laid out the framework to get through them all

Speaker 3

in 3 to 4 years, a couple

Speaker 4

of years ago. So We're about halfway through with the battery upgrades and still working on leak detection and repair initiatives And then flaring is our main drivers of methane emissions.

Speaker 3

And then Jeff, on methane emissions, There's just an amazing amount of innovative technology that's coming out from the service side. And we're not we haven't picked a winner yet. I don't know that there's been a clear winner, but our approach has been to field test all of them. We've probably got 5 or 6 Leading edge technology, methane sensors in the field in order to monitor these things, We monitor methane emissions real time. So we're investing alongside these technology companies on methane emissions.

Speaker 3

And then as Danny mentioned, flaring It's something we're really leaning hard into and I can't emphasize enough that we can do everything we can on our side, but if we don't get our midstream partners On the G and P side to participate, it's going to be very difficult for our industry to meet Our goal is reducing of eliminating routine clarity as defined by the World Bank. So There is a reason we're being pointed in our presentation today about asking to work Collaboratively with our G and P partners on the flaring side.

Speaker 1

Great. Thank you.

Speaker 3

Thanks, Jeff.

Operator

Your next question is from Nitin Kumar of Wells Fargo.

Speaker 11

Hi, good morning, guys. Thanks for taking my questions. A lot of ground has been covered on the cash return side, but I want to check on the base dividend. You mentioned earlier That it could be about 25 percent of free cash flow in other return portion of free cash flow in 2022. How are you thinking about it beyond the $3 per share?

Speaker 11

Is that a good limit or could we see more increases and what would drive that?

Speaker 3

Well, it really depends what the market conditions look like at that point. I mean, we can't continue to grow 10% per quarter forever, right? At $3 a share, that's over $500,000,000 a year of financial debt is what how I look at it. So I'm not saying that's a limit, but I'm saying that That's certainly what our near term focus is, is to get to that $3 a share.

Speaker 11

And I guess what I was asking was, is there Percentage of cash flow that you're targeting or something like that at mid cycle price, like how do you come up with that level?

Speaker 4

Yes, we look at it more on the breakeven side. So pre dividend breakeven right now $30 $30 a barrel. I think that number stays fairly consistent here in the coming years as capital efficiency stays strong, base declines are reduced. And then above that, our large shareholders universally have said they want a base dividend that's protected below 40 Dollar oil, right now, the base dividend was protected at $35,000,000 that will go up over time, but you also might have less shares Over time and less debt, so that frees up some more cash to go to the dividend. But overall, cash returns have been widely discussed over the last Couple of quarters and the only thing we have universally heard from large long only is more base dividend sooner.

Speaker 4

And that's why Travis is making the commitment to get to 3 by year end with board support should conditions remain.

Speaker 11

Got it. And Travis, very quick question here, but you I think you mentioned 400 rigs in the Permian in a year or so. We've talked here a little bit about Permian takeaway on the gas and NGL side, but what are the other challenges that the basin could face if we do see that kind of Growth and how are you positioned to be ahead of that?

Speaker 3

Well, I think if you're asking what are some of those constraints going to be if you get to 400 and what Diamondback is doing to prepare for that. Well, Again, a part of it goes back to the long standing relationship we have with our service partners. But secondarily, anything that requires boots or tires The Permian Basin is going to continue to be tight. And that means we're going to have to attract as an industry, we're going to have to attract More workers into the Permian Basin like we did in 2018, 2019, and that's going to you're going to see that Translate to an increase in labor costs. But again, those cost increases are going to paint Pretty much all of us with the same brush.

Speaker 4

And we'll focus like I

Speaker 3

tried to highlight earlier, we'll focus on the variable side of things we can actually Do something about, but 400, what do we peak at, Danny, out here in the Permian?

Speaker 4

It's like 4.90 and we exited pre

Speaker 3

So we're even though I think those rigs are a little bit more efficient today than they were then, we're approaching We'll approach by the end of this year sort of where we were at the end of 2019.

Speaker 11

Okay. Thanks for the answers guys.

Speaker 3

Thanks, Devin. Thanks, Devin.

Operator

Your next question is from Leo Mariani of KeyBanc.

Speaker 12

Hey, guys. Just wanted to ask a question on the potential For Fang, it's return to a little bit of production growth at some point. You clearly mentioned that here in 2022 With the looming threat of Iranian barrels, it was certainly one of the key issues that was keeping you guys away from growing. And also based on your comments, maybe we're not quite back to pre pandemic demand, but very close. So as we look into next year, if we are above pre pandemic Demand levels in the Iranian situation has resolved itself one way or the other.

Speaker 12

Could that be the time when maybe we see some modest growth And Fang, how do you think about what the right level of growth is eventually?

Speaker 3

Yes, I don't know what the right level Growth will be or when it's going to occur. I can tell you definitively right now what's being valued by our investors is a shareholder return program. And No one wants to see that shareholder return program put at risk with volume growth, not for Diamondback specifically for our industry in total. Look, the world will be calling for oil growth at some point in the future and our industry is going to have to figure out the right Way to respond while not putting the shareholder return program at risk. We've spent the last decade consuming capital And now we've got a little bit of sunshine in Austin where we can return that capital to our investors that have been waiting Patiently and sometimes impatiently for this return.

Speaker 3

So it's a good question to ask, Leo, but I can't give you The time at which Diamondback or the industry is going to respond to growth. But I'll tell you, when we do, it's going to be in conjunction with Create an unreasonable value for our shareholders.

Speaker 4

If we do. If we do. Okay, understood. And I

Speaker 12

just wanted to ask quickly on the 2022 guidance here. Maybe just starting with the CapEx, It's fairly good range, dollars 1,750,000,000 to $1,900,000,000 You did describe having a percentage of some of the services locked in for the year here. So just definitely wanted to get your thoughts on kind of what the $150,000,000 variability could be here In 2022, it sounds like you're not going to change the program and there really won't be production growth. And then just additionally, looking at the production side of the guidance, my math is right. It looks like you guys either were kind of at the very high end of the oil every quarter in 2021 or actually beat it.

Speaker 12

So as you're kind of looking at that guide in 2022, should we be thinking that You always have a slight bit of conservatism to allow for things that could go wrong in the field. Just wanted to get a little bit more color on the production and CapEx guide in 'twenty two.

Speaker 4

I think we always bake a little conservatism for the good guys into our plan. Drilling and completing 2 80 wells at your AFE number for a year is not an easy task. It might look easy for me in my Excel model, but actually doing it in the field is Pretty darn impressive. So we certainly want to give some room for guys to do what they do in the field, but also Yes, service costs are going up. I mean, Travis mentioned a very high rig count number in the Permian.

Speaker 4

If that number comes to fruition, there's going to be pressure On all the variable costs and the fixed costs in this basin. So fortunately, we have the 12 rigs we need and we have the 3 Simul frac crews we need. This is not a year where we need to go find 8 rigs and 3 crews. We might have to pay them a little more to keep working for us, but That's the risk to the high end in the back half of the year.

Speaker 12

Okay. That's definitely helpful. Thanks guys.

Speaker 4

Thanks, Neil.

Operator

Your next question is from Charles Meade of Johnson Rice.

Speaker 13

Good morning, Travis and Case and the rest of the team there.

Speaker 2

Good morning, Charles.

Speaker 13

Travis, this goes back to some of your earlier comments about the Really what seems like a linchpin for your strategy, this idea of a mid cycle oil price. Why is $60 the right price?

Speaker 3

Yes. We ask that question every day. But one of the things that's when I asked that question, one of the responses I got was what do you think the average Price was for the last 7 years and that's $53 a barrel. Right. So it's real easy To get euphoric about $90 plus oil, and in fact, I'm seeing I think I'm seeing some of that euphoria in our Right now, certainly in the commentary that's out there.

Speaker 3

But we know geopolitically there's dollars that are in today's oil price that God willing, it will be resolved without arms conflict. We know that there's Iranian barrels that are probably coming on, I said by the end of the year, but Maybe attended this month. And we've got this fervor in the Permian Basin that's continuing to lift U. S. Production forecast.

Speaker 3

And while OPEC hasn't performed up to their 400,000 barrels per day per month production increases, I think they're getting closer to it. And I don't know what their surplus is, but it's not 0 yet. So all of those things to me, You add them together, actually seem to be a little bit more bearish for crude than it does to be optimistic. And the other thing If we're wrong and oil price is higher, we're going to generate a lot of free cash And our investors are going to get a lot of that return to them. And if I'm right, well then we've protected our investments and we've made the right decisions.

Speaker 3

So $60,000,000 I don't know that it's a hard and fast number, But it's kind of the aperture at which we start all of our decisions on investments, whether it's M and A or drilling wells Or share buybacks.

Speaker 13

That's helpful. That's helpful, Travis. It seems as good as any other number to me. I just wanted to hear more of your thinking. Quick follow-up.

Speaker 13

I noticed that you guys said you drilled or I think we've drilled completed a Barnett well in the quarter. Was that on the I'm guessing that was on the Limelight acreage and is there any kind of rate of change there that was worth highlighting?

Speaker 4

Yes. We drilled a couple of wells there. I think we have a couple planned this year. It's still early in the testing phase, but At $90 oil, it certainly competes even at $60 oil, including the low entry costs, it competes on a full cycle basis, but Not yet does it compete with our core Midland and Delaware Basin position.

Speaker 3

And I think one added to that is that right now we're drilling single wells and there's a huge cost inefficiency when you're drilling single wells trying to delineate a Once you move into full cycle development and you can drill at least 4 wells, solid frac operations and combine that with efficient drilling operations, you can drive a lot Cost out of the equation, which raises the economics on a play like Limelight and actually makes it start to compete for capital with the other items in our portfolio.

Speaker 13

Got it. Thanks for the detail, guys.

Speaker 3

Thank you, Charles.

Operator

I will now turn it back over to Travis Stice, CEO for closing remarks.

Speaker 3

Thank you again to everyone listening today.

Operator

Thank you for participating in today's teleconference. At this time, you may all disconnect.

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Earnings Conference Call
Diamondback Energy Q4 2021
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