Battalion Oil Corp Q4 FY2020 Earnings Call

Welcome to the Battalion Oil Fourth Quarter 2020 Earnings Call. As a reminder, today's conference is being recorded. Now I'll turn it over to Battalion's Manager of Finance, Chris Lang. Mr. Lang, you may begin.

Good morning. I'm joined by a few of my colleagues today that I'd like to introduce: Battalion's Chief Executive Officer, Richard Little; our Chief Financial Officer, Kevin Andrews; and our Chief Operating Officer, Daniel Rohling. This conference call contains forward-looking statements. For a detailed description of our disclaimer, see our earnings release issued yesterday and posted on our website. This conference call also includes references to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measure under GAAP are contained in our earnings release announcement released yesterday. We have also published an investor presentation, which may be found on our website and will be referenced during this webcast. Now our team will present a few scripted remarks, followed by Q&A. And with that, I'd like to turn it over to Rich to start things off. Rich?

Thank you, Chris. I want to first welcome everyone joining us this morning for Battalion Oil's Fourth Quarter 2020 Earnings Call. We issued our earnings release and presentation last night. We're excited to walk you through those results and describe why we find ourselves very optimistic as we enter 2021 despite the ongoing challenges we face from COVID and the recent operational issues caused by the weather. We'll provide you a more fulsome update on Battalion's response to the recent winter storms a little later. But I did want to begin my comments by commending our team for the outstanding job they did navigating a violent and life-threatening storm. Our field personnel were quick to react to all the challenges they faced. And we are proud of the balance that we’re able to strike between keeping our teams safe and providing the critical and essential service in meeting the demands of consumers in the region. We’re all well aware of the challenges the industry faced in 2020. The combined impact of the COVID-19 pandemic and the oil price war created a downturn that has been as severe as anything I’ve seen in my career. And while that may have stalled our plans to grow, it didn’t stop us from having an exceptional year. We kicked off 2020 with a new strategy, a new team, and a new name. And we spent much of the year building a new identity. We demonstrated our ability to execute, reducing well costs by 37% and adjusting operating costs per BOE by 12%, the latter of which we did in spite of temporary shut-ins in May and June, disrupting operations. We displayed our commitment to capital discipline, quickly reacting to the downturn by cutting D&C CapEx by 66%. We acted on our belief that ESG matters by creating an ESG task force and implementing measures across the board to hold ourselves to a higher standard. We actively managed our balance sheet, divesting non-core assets to meaningfully pay down debt and continuing to work with our banks to manage liquidity. We also set ourselves up for our future success by obtaining two Acid Gas Injection permits and strengthening our hedge book. After halting our capital program in the first half of 2020, we shifted our focus to optimization and efficiency. And I’d like to think our accomplishments show we made the best of a challenging year. As a result of that hard work in 2020, we are now well positioned to deliver our 2021 plan of flat to single-digit production growth, with a significant increase in free cash flow. And we believe we can accomplish this goal while targeting a 70% to 80% reinvestment rate of EBITDA. How do we achieve this? By staying disciplined in our approach. It begins at the field level, where our operations team continues its work of methodically reducing drilling and completion costs and improving our production cost per BOE. It continues with our hedge book, where we have 90% of our expected 2021 oil production hedged, providing downside price protection, but offering flexibility to add more volumes in a higher-price environment. This is all supported by the strength of our balance sheet, where we entered 2021 with $31.6 million of liquidity and expected cash flow that should allow us to maintain liquidity through the year and remain flexible to invest further if the market conditions improve. In addition to executing on our 2021 plan, we intend to continue pursuing M&A opportunities, with a focus on strategic transactions, which might provide additional scale and serve as a deleveraging event for the company. As we move forward as an industry, we here at Battalion believe ESG must be a core value to survive and thrive. Our commitment to the environment was on display this year as we exited 2020 with reduced flare intensity of 0.1 mcf per barrel, initiated a campaign focused on pit closures. We reduced truck traffic, keeping more volumes on pipe, and utilized real-time spill detection and gas monitoring to ensure we minimize our impact. Those environmental concerns bleed through into our governance structure, as we created an ESG task force to push forward key 2021 initiatives and enhanced Board oversight into ESG goal setting and performance. We’re also proud to have successfully navigated the COVID response plan with zero impact to the business despite instituting work-from-home measures for office staff, all while positively impacting our community by donating PPE to first responders and donating essential items to youth organizations. Our commitment as an organization is not only to be a top-tier operator but to do so in a responsible way. As activity ramps back up in 2021, I’d like to highlight the hard work our team has done to improve our performance on the capital front. Before we cut back on our drilling program last year, we made tremendous strides. Our cost per foot drilled had reduced by 38% from $316 per foot in the first half of '19 to $195 per foot in the first half of '20. Our feet drilled per day had improved 25%. So we were drilling our wells faster and doing it in a much more cost-conscious way. As we get back to drilling in 2021, our goal is to continue that trend, if not improve on it. Our completion performance tells a similar story. In early 2020, we were really making strides. We were pumping larger jobs on average, both proppant and fluid, and doing them at a much lower cost. As oil prices dropped, we decided to halt our plans to complete any additional wells, which left us with four drilled but uncompleted wells and no defined timeline for completing them. However, we’re excited to say that in December, we got back to work and we picked up where we left off. In addition to previously identified efficiencies that helped us drive down costs, we’re also excited to say that we were able to preempt demand in the service market and secure low per-well costs, which should really benefit us as we progress through the year. In addition to these cost savings, we’ve been pumping larger jobs with higher loading and testing fluid designs with premium surfactants, all while driving costs down by roughly 15%. As we move forward, we aim to continue bundling our services to further drive down costs while improving pad-to-pad cycle times. We’ve also talked in previous quarters about marrying our subsurface knowledge with our operational plans. We expect that to continue as we consider geology and geophysics and our fracking designs to limit initiation and pumping difficulties. The strides we’ve made with cost reductions and operational improvements are a real testament to the work our drilling and subsurface teams have put in. On the production side, 2020 was an opportunity for our production operations team to demonstrate its ability to react quickly and execute flawlessly, and they did just that. As a result of the collapse in oil prices and the onset of the COVID pandemic, we were forced to pull back on our operations in a dramatic way. In May and June of 2020, we were forced to temporarily shut in producing wells as a result of low commodity prices. Not only did we get that production back up to previous levels by Q3 2020, but we were able to exit the year having reduced our production cost per BOE by 18%. I'd like to take a moment now to discuss the impact and our response to the recent winter storms. At Battalion, we recognize the critical role we play in producing the commodities that help keep our lights on and our houses warm, particularly in challenging times like we faced recently. However, our first priority every day is the health and safety of our employees and those contractors and service providers that work with us. As the storms raged on, our goal was to keep as much production on as safely as we could. We did a good job of walking that tight rope. We have not yet been able to fully quantify the impact to our first-quarter production, including any downtime and temporary shut-ins. Our team has done a great job quickly evaluating any damage we experienced and getting us back up and running. We'll have a better understanding of the full impact of the storms, and we'll provide information on that in our first-quarter results. Before I hand it off to Kevin to review the financials, I'd like to reiterate just how important safety and environmental stewardship are here at Battalion. They are truly a key part of our strategy and a big part of the culture. If we can't do it right, we won't do it at all. We quite literally put our money where our mouth is, as we have environmental health and safety and ESG incorporated into our compensation structure. We're proud of our record, and our aim is to set the standard moving forward. Kevin?

Thank you, and good morning. I'll start with a recap of our year-end liquidity position and then touch on a few highlights from Q4 2020. As we mentioned in our press release yesterday, we completed the sale of certain of our Northern West Quito assets to Point Energy Partners for cash proceeds of $26.3 million, subject to customary post-closing adjustments. This transaction significantly enhanced our liquidity at year-end and positioned us well as we enter 2021. At December 31, 2020, the company had a liquidity of $31.6 million, consisting of $4.2 million of cash and $27.3 million of availability under our revolving credit facility. 2020 was a challenging year and one in which access to liquidity was critical. So in October 2020, we entered into a third amendment to our credit agreement with Bank of Montreal, which, among other things, allowed our borrowing base to remain at $190 million and suspended testing the Current Ratio until December 31, 2021. This amendment helped free up liquidity and added flexibility going into 2021. Our net leverage ratio was 2.2x at year-end, and we continue to assess options to reduce leverage. We also continue to focus on protecting our cash flows by actively managing our hedge book. Our approach to risk management is to hedge a high percentage of proved developed producing, layering in additional hedges as we develop our assets using swaps and two-way collars. As of December 31, 2020, approximately 90% of our expected oil production in 2021 was hedged at an average price of approximately $45. With our cash flows well protected in 2021 and the strong liquidity position at year-end, we feel confident in our ability to execute our 2021 plan while remaining free cash flow positive for the year. Now I'll walk through a few financial highlights from our fourth quarter and year-end results. Production in 2020 averaged 16,858 barrels of oil equivalent per day compared to 17,986 BOE per day from 2019, or a 6% decrease. The decrease in average daily production year-over-year was driven by our temporary shut-in of a portion of producing wells across all our operating areas in May and June 2020 as a consequence of low oil prices. Average production in Q4 was 17,293 BOE per day compared to 17,076 barrels of oil equivalent per day in Q3, with Q4 production made up of 54% oil, 24% gas, and 22% NGLs. Total revenue was $42.6 million for the fourth quarter of 2020, of which oil represented 81%. We realized 95% of the average NYMEX oil price during the quarter as well as recognizing a $1.2 million gain from our hedge program. We reported a GAAP net loss to common shareholders for the fourth quarter of $63.8 million or a loss of $3.93 per share, after adjusting for certain items, including the effect of net unrealized derivative losses in a full cost ceiling impairment. The company reflected a net loss of $7.5 million or a loss of $0.47 per share. Adjusted EBITDA totaled $8.8 million for the fourth quarter of 2020 and $70.1 million for the full year 2020. Capital expenditures for the full year totaled $89 million compared to $259 million in 2019. Of that $89 million spent in 2020, $55 million was related to drilling and completion activities and $32 million was related to the development of our treating equipment and infrastructure. This decrease in capital expenditures from 2019 to 2020 was a result of our decision to suspend our capital program at the end of Q1 2020. The fact that we are reporting a 6% year-over-year production decline in spite of a suspended capital program and temporary shut-ins across all our fields this summer is a credit to the outstanding work performed by our operating team in 2020. Looking forward to 2021, as a result of the Northern West Quito transaction, which bolstered our liquidity, we were able to accelerate our 2021 capital program as we commenced operation in four drilled but uncompleted wells this December, allowing us to preempt demand in the service market and secure advantageous pricing. We also plan to spud two new wells during Q1 2021. As a result, we expect to incur the vast majority of our capital in the first part of the year. We built this plan around maintaining our production base until we see confidence return to the commodity markets. We will remain flexible and continue to assess when conditions may be appropriate to ramp up our activity.

Thanks, Kevin. As I've stated, with a disciplined approach, we believe we are well positioned to deliver flat to single-digit production growth, while significantly increasing our free cash flow during the year. There is certainly work to do to get there, but we believe we have the right team and the right balance sheet to make it happen. We also think we're in a unique position to grow through M&A. With the strides we've made in driving costs down and paying down debt, even in a down market, we continue to believe that we can approach M&A from an advantaged position. A lot has been said about a global energy transition and a move away from oil and gas. We believe very strongly that oil and gas has a place in that future, but it has to be done in a smart and responsible way. I hope you walk away from today with the same confidence we have that Battalion has the right team and the right assets to do just that. A lot happened in 2020. And in many ways, it feels like the dust hasn't quite settled. But we view 2021 as an opportunity to come out of the gates running, and it starts to build momentum as we enter into this new future. Thank you for your interest in Battalion, and that's going to conclude our scripted remarks. I'll turn it back over to the operator to facilitate Q&A.

The first question comes from Noel Parks at Tuohy Brothers.

I just had a few quick ones I wanted to run by you. You mentioned applying your subsurface knowledge to, I guess, drilling and completion operations. I'm just wondering what sort of changes you might have in mind?

Yes. Thanks, Noel. So first, it's the understanding of where we drill the well. If we're going to steer a lateral, we tend to stay away from high-carbonate concentrated areas because we see higher frac rates, which will drive up our completion costs, and they're not as productive. So we'll steer clear of that. It's also good that we know that we’re going to be dealing with it so that we set up our stages appropriately, where you have light frac gradients for what you're pumping. The tendency when you're fracking is for the fracs to go into the lower frac radiate-type areas. You want to have the stages set up to where you stimulate rock across the entire lateral instead of having it go off to some of your lower frac gradient-type zones. That’s an example of how we might want to use or do use the subsurface in our frac designs. There are others, but that’s probably one of the key ways of driving down costs. It’s easy to understand.

Noel, I'd also just jump in. As stated, we also have used our subsurface views to really take a look at where water and H2S may be coming from. The teams have done a great job of beginning to identify that. A long way down that road is helping us as we move forward in our development to be able to try to mitigate higher water or higher H2S.

Great. And you also mentioned real-time gas monitoring as something that you're going to be doing increasingly. I just wondered, do you have a sense of what the incremental cost of that might be? And I was wondering if there was a plan to go out and maybe retrofit legacy wells with similar equipment?

Yes. Noel, what we have going right now is that we own four different clear cameras that we take around the field daily and test the different locations. So all of our locations are getting scanned and viewed to make sure that we're not having mistakes in connections and things like that. So every location is getting monitored.

Okay. Great. And a little bit of a housekeeping question. What was the DUC count at the end of the year?

Sure. As you might have seen in our comments, at the end of the year, if you're defining it as December 31, we had already started our fracs in December. We saw an opportunity where we felt like we could save on completion capital by getting an early start. We also know the tendency is for supply chain challenges to happen when the first of the year comes around, which we actually did see some of that with some of the other operators. So we started fracking two of our four DUCs before the end of the year. Then we rolled into the other two at the beginning of the year. I think of it as starting the completion of those four DUCs at the end of the year and bringing them online in the first quarter is how I think about that.

Great. And then just last one from me. You did mention a little bit of some supply chain issues you saw with other operators. Have you basically hit the bottom of the cycle for service costs and material costs at this point? Do you anticipate any inflation on the horizon? And if so, have you planned for a certain amount?

Yes. No. The majority of our activity, as you saw on our guidance, is happening in the first part of the year. We haven't built inflation into our numbers for this year on the completion side. But absolutely, I think we ought to count on, as we're seeing oil prices trading with a big handle on it, that we ought to start seeing some more activity, putting strains on the equipment that's currently being used, and that's going to result in inflation, would be my thought.

We take the next question from an unidentified analyst.

I was just wondering if you could comment on how you view hedging in the future for 2021 and inform some of the comments that you talked about related to hedging unrealized gains on positions, with the volatility around WTI. I'm just interested to see if you can comment on your outlook for how you hedge production.

Yes. I'll let Kevin answer that.

So in general, our plan is to hedge a large percentage of our expected production in 2021 and 2022. As we said on the call earlier, we're 90% hedged on oil for 2021. We have some room in 2022 to add hedges, and we have been doing that and will likely continue to do that this year. And depending on the outlook for 2023 prices, we’ll start adding hedges in early 2023 too. We do believe in hedging, especially as we increase our activity. We have planned activity; we have certain obligation wells that we plan to drill. We may decide to do more in the future depending on pricing. We will consistently try to match up our hedging program with our activity in the field.

Is being 90% hedged a target that you are aiming to maintain?

Well, I think what we typically show is that we like to protect our cash flows, and we've been anywhere from 75% to 90% of our production. The way we approach hedging is that we like the hedges to protect our cash flow. We’ve made the investment, and we want to protect those cash flows. When we see an environment like what we're in right now, we create the flexibility to invest into that market as prices increase. When we do that, we hedge those volumes as we make those investment decisions. I think we've been anywhere from 75% to 90% hedged historically.

It appears there are no further questions at this time. Mr. Little, I would like to turn the call back to you for any additional or closing remarks.

Okay. Great. Thanks. Again, I just want to thank everybody for their interest in Battalion. There's no doubt that 2020 was a difficult period in our industry, but we feel like the accomplishments that we were able to achieve only managed a stronger organization. We feel like our disciplined approach to development has positioned us well and will position us well in a recovering market. We look forward to sharing some of those accomplishments with you as we get into 2021. Thank you very much.

This concludes today's call. Thank you for your participation. You may now disconnect.