California Resources Corp Q4 FY2021 Earnings Call

Good day and welcome to the California Resources Corporation Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. I would now like to turn the conference over to Joanna Park, Vice President of Investor Relations and Treasurer. Please go ahead. Thanks. Welcome to California Resources Corporation's Fourth Quarter 2021 conference call. Participating on today's call is Mac McFarland, President and Chief Executive Officer, and Francisco Leon, Executive Vice President and Chief Financial Officer, as well as several members of the CRC Executive Team. I'd like to highlight that we have provided slides on our Investor Relations section of our website, www.crc.com. These slides provide additional information into our operations and fourth quarter results. And we have also provided information reconciling non-GAAP financial measures discussed to the most directly comparable GAAP financial measures on our website as well as in our earnings release. Today's conference call contains certain projections and other Forward-Looking Statements. And these statements are subject to risks and uncertainties and may cause actual results to differ. Additional information on factors that could cause our results to differ are available in the company's 10-Q and 10-K. A replay will be made available for 30 days following the call on our website. As a reminder, we have allotted additional time for question-and-answer at the end of our prepared remarks. We ask that participants limit their questions to a primary and one follow-up. With that, I will now turn the call over to Mac.

Great. Thank you, Joanna. 2021 was the year in which we repositioned CRC for the future. We continued to deliver safe, reliable production and advanced our Carbon Management business for the zero-carbon fuel of the future. In our core oil and gas operations, we demonstrated the strength of our strategy on CRC's streamlined business model by generating $466 million in free cash flow in 2021, the highest level of free cash flow since the inception of CRC. We did that by providing low carbon intensity and low decline production of 100,000 barrels equivalent per day while maintaining our strong environmental and safety record. We also rationalized our portfolio through the previously announced acquisition of the working interest in mirror and the sale of non-core assets, demonstrating active portfolio management as a key element of our business strategy, which we continued in February by also divesting our non-core non-operated interest in the Lost Hills assets. We exited the year with approximately 95,000 BOE per day of production, which reflects our 2021 portfolio activity and we expect just under a 2,000 BOE per day impact from the Lost Hills divestiture in 2021, which has been included in our 2022 production guidance. Furthermore, we expect to exit 2022 basically flat on oil production. Francisco will provide additional details and elaborate on this further, but you can also see this on page 25 of the accompanying presentation. Active portfolio management allows us to focus on CRC's fully operated fields with lower carbon intensity and future CCS optionality. On the carbon management business side, we were very active in 2021 and we'll continue to advance our strategy in 2022. We are expanding our new business by progressing CTV deal structures, project milestones, exploring future financing options, and moving forward with our discussions with numerous potential partners, stakeholders, and technology providers. We are advancing CTV emissions discussions for the first 1 million tons per annum for Carbon TerraVault 1 and we plan to provide additional details on these discussions later this year. While prospects and details continue to be discussed, the recurring theme in our discussions is the significant interest in the commercial scale solution of carbon sequestration. Further, we are preparing additional permit applications to meet our targeted injection of five million tons per annum in 2027. CRC is targeting filing new EPA Class VI permits for incremental CTV storage projects for a total of 200 million metric tons or more by the end of this year. That is inclusive of the applications we have already filed for CTV 1. By filing these applications, it puts us on the path to receive permits by the end of 2025 and that allows us to stay on track for our goal of the five million tons of injection by 2027. Over the past few months, we have received fairly comprehensive comments from the EPA on the permits for A1A2 and 26R, the combination of which is known as CTV 1. The dialogue has been, and continues to be, constructive with the EPA in support of our previously outlined timing expectations. In addition to the EPA process, the local land-use permit and environmental analysis for CTV 1 are advancing under current county leadership, and we would expect to see them completed next year. We look forward to working with both agencies while advancing our Carbon Management business. In 2021, as you'll see in the company slides, we're deploying approximately $85 million in our Carbon Management business across capital, OpEx, and G&A. This allows us to advance pending permits, do early stage development and file the new applications for that first 200 million metric tons, unlock the next several hundred million tons of available space after this initial 200 million metric tons and deploy initial capital for CTV 1. We believe this investment is consistent with our previously disclosed economic type curve and will develop projects with significant returns. And these dollars represented tangible investment in our low carbon strategy and a real commitment to California's zero-carbon future. With decades of data and operating experience, we believe CRC is well-positioned to provide commercial and scalable carbon management solutions, coupling this with California's Net Zero Ambition can make a significant impact not only from an environmental perspective but also by creating enduring value for our shareholders. Lastly, we plan to maintain our solid financial foundation and free cash flow generation. Looking into 2022 and after adjusting for divestitures, our core E&P business is expected to generate nearly $400 million in free cash flow before our carbon management investments highlighting the strength of our assets and the efforts of our employees. By our current forecast with liquidity of over $670 million and a leverage multiple of less than half a turn net debt to EBITDA, CRC has a strong financial foundation that provides further support for our future goals, aspirations, and our strategic initiatives. As a result of our robust financial position, we are expanding our shareholder return strategy. We're doing this by maintaining our current fixed dividend strategy, which currently yields approximately 1.7% and by raising the share repurchase program from $250 million to $350 million. We are extending the program through the end of 2022. This increase in dollars represents a 40% increase to the overall program. As always, none of this is possible without the contributions of our CRC employees. I'd like to thank the team for all your efforts. Delivering these impressive results in 2021 during a transformative year, as well as dealing with COVID-19 was truly remarkable. We appreciate all of those joining on the call today and thank you for your ongoing interest in CRC. And with that, I'll turn the call over to Francisco.

Thanks, Mac. Good afternoon everyone and thank you for joining us on this call. During this year of transformation, the company achieved all of our key strategic objectives. In 2021, CRC produced a net 100,000 barrels of oil equivalent per day, and 60,000 net barrels of oil per day. By pursuing our inventory of high return quick payback maintenance projects in addition to select horizontal opportunities, CRC held oil production relatively flat throughout 2021 after adjusting for acquisitions and divestitures and PSC effects. The uniqueness of California's market dynamics continues to showcase the demand for our low carbon intensity product. CRC's commodity realizations remain strong across all of our streams, and we expect 2022 realizations to range within historical norms. As laid out in our hedging slides and in conjunction with an increasing 2021 commodity price environment, we experienced a $319 million cash loss on commodity derivative contracts. As a reminder, the majority of these losses are from legacy hedges that were put on as a requirement of the 2020 RBL. Turning to the cost side of the business and on Slide 11, I'm particularly proud of the efforts of our operations team. Our 2021 operating costs, excluding PSC effects, decreased modestly by $0.14 per BOE compared to the 2019 cost when we were operating under pre-COVID conditions in a relatively similar commodity environment. These results are more remarkable when considering energy prices increased nearly 40% from the comparative 2019 period. As a reminder, although higher natural gas prices increase our energy costs, CRC benefits from higher natural gas prices as we are net long natural gas. Our 2021 G&A costs declined year-over-year, primarily due to our ongoing cost-saving efforts and previously announced workforce reductions. In 2021, we invested $194 million in capital. This level of investment largely maintained production throughout the year due to our backlog of OpEx maintenance opportunities on our drilling program, which yielded estimated wellhead IRRs of over 100%. These results contributed to CRC's 2021 EBITDAX of $860 million and record free cash flow of $466 million. Throughout the year, CRC demonstrated our commitment to shareholder returns and financial strength by buying back approximately $150 million of CRC shares or approximately 4.1 million shares through our share repurchase program and initiating a quarterly dividend in the fourth quarter returning approximately 35% of 2021 free cash flow to shareholders. Our strong financial foundation was further enhanced as we built our cash balance to $305 million at year-end up from $28 million of cash at the end of 2020 and reduced our net leverage ratio to less than half a turn by year-end. The value of our oil-weighted proven reserves is evidenced by our PV of $6.2 billion at 2021 SCC price deck which expands close to $8 billion at $80 Brent, which is more than double our current enterprise value. The significant cash flow generation capability of our declining and low capital intensive assets allows us to continue to self-fund our low carbon E&P business, continue to deploy additional shareholder returns, and fund our Carbon Management activities. In our view, CRC represents a unique investment that is rare in the energy sector. As we step into 2022, CRC divested our non-operated Lost Hills Field, which in 2021 produced approximately 1,900 net barrels of oil per day for proceeds of $55 million. The Lost Hills Field had one of the highest cost structures in our portfolio, and its carbon intensity was approximately 21% higher than our portfolio's average. As part of this transaction, CRC retained the right to pursue, capture, transport, and store 100% of the CO2 produced from the Lost Hills steam generators. This transaction closed on February 1st, 2022, and complements our low carbon intensity ambitions, reduces our cost structure, and brings forward value that, in our perspective, can be further deployed towards future carbon management goals. In addition to this transaction, we were able to further bolster our liquidity by adding $60 million to our commitments and their revolving credit facility which now has commitments of $552 million up from $492 million. Moving to our 2022 operational outlook on Slide 18. We expect to maintain our oil production from 2021 December exit to 2022 December exit despite previously discussed portfolio transaction and the potential adverse impacts of PSCs at higher oil prices. As a rule of thumb, for every $10 increase in Brent prices, there is approximately a 1,000 BOE per day reduction to our net oil production as a result of our PSCs. The opposite also applies; with every $10 decrease in Brent, we gain approximately 1,000 BOE per day in net oil production. This is why our guidance slide shows lower production with higher financial metrics. We've provided additional details on the PSC effects in the supplemental materials of our earnings presentation. Our operations team is expected to further reduce our controllable non-energy costs by an additional 5% as it builds off our successful horizontal BOE drilling program. Our current 2022 plan has four drilling rigs in operation throughout the year. As you are all aware, CRC benefits not only from low decline, low capital intensive production, but also from a large integrated infrastructure across California. It helps us reduce our costs, optimize production, and provide supplemental revenue streams that further increase our earnings capability. In the first quarter of 2022, we're undergoing a required 10-year maintenance turnaround at CRC's cryogenic gas plant, or CGP1. The plant processes NGLs and natural gas from the Elk Hills and surrounding fields. We expect it will return to full pre-turnaround production levels by the second quarter of '22. The plant's downtime is expected to have an approximate 6,000 BOE per day impact on our first quarter, and an approximate 2,000 BOE per day impact on our full-year production. While this maintenance period was expected to start during the summer of '22, we decided to pull forward the timing of this turnaround to benefit from lower procurement costs and better expected end-year deals in the summer of '22. Our 2022 guidance is consistent with our capital allocation strategy, which prioritizes the financial, operational, and future growth aspects of CRC. First, we expect to continue our strong operational and production performance. Based on our current guidance at $82.50 per barrel, CRC's 2022 average net oil production is expected to be above 58,000 barrels of oil per day. Second, our $300 million to $335 million EMP capital program includes drilling and completion and work-over capital of approximately $250 million to keep our oil production flat from December exit to December exit with the remaining capital covering our CGP1 turnaround, other mechanical integrity, and field upgrade projects. After these investments, we expect to deliver at the midpoint of our guide, close to $400 million in free cash flow in an $82 Brent price environment. This is before approximately $85 million is deployed into our carbon management business and would allow for roughly $250 million of potential shareholder returns, further underscoring the strength of our business. Finally, I am very excited about CRC's current position and the strength of our forward outlook, as evidenced by our share repurchase program increase and the deployment of capital towards our Carbon Management business. We are forecasting significant and sustainable free cash flow which could translate into additional shareholder returns and further growth optionality with our Carbon Management business. Please note that we have provided detailed analysis of our quarterly and annual financial and operational results in our 2022 guidance in the attachments to our earnings release.

Yes. Thank you, Francisco and a lot in there on the production and getting to the overall net numbers, but we'll get into that in the Q&A. Look, CRC has a uniquely positioned asset base that allows us to provide the needed energy today and meet the goals of tomorrow with net zero fuel for the future. We remain committed to our cash flow priorities of building upon our carbon management and shareholder returns. As an investment, we believe CRC represents a large low decline production base with significant inventory for stable cash flows coupled with a unique energy transition opportunity and solid financial footing. Thank you for your interest in CRC and thank you for joining us on today's call. We'll now open the line for questions and I'll turn it back to the operator.

We will now begin the question-and-answer session. If you are using a speakerphone, please pick up your handset before pressing the keys. At this time, we will pause momentarily to assemble our roster. The first question will be from Scott Hanold of RBC Capital Markets.

Hey, good afternoon. I guess good morning, to you all out there.

Hey, Scott.

I feel like I might be repeating myself from last quarter with my questions, but as I reflect on the past 8 to 12 months while you have transformed CRC's strategy and goals, the Carbon Management business generated considerable excitement from investors last fall. However, it seems there's now a sense of impatience, with everyone wanting answers sooner rather than later. My first question is about the status of those interested in participating in Carbon TerraVault. I know you are committed to achieving a million tons by the end of this year, but could you provide more details on a few points? For instance, do you sense that the incoming interest indicates a strong motivation to take action? Additionally, what kinds of questions are you finding you need to address from them?

Thank you for the question, Scott. Let me start by addressing it and then we can see where the conversation goes. These projects, as we've demonstrated during our Carbon Strategy Day, require a significant investment of time. The development timeline spans several years, during which we deploy capital. As we have mentioned previously, we are focusing on advancing what we consider to be the most time-consuming task, which is securing and permitting pour space. We are working to establish that pour space over this timeframe as we obtain the necessary permits. Eventually, we will reach a stage where the crucial step is to finalize agreements with the emitter or the CO2 source for storage. We are not quite there yet, as we have indicated, and that's why we remain dedicated to this process. The main concern is that these agreements have yet to be finalized. There have been some recent developments announced, but not a significant number of deals have been completed. There is considerable price and contract discovery that still needs to take place, and we are actively collaborating with our counterparts to establish executable contracts that would allow us to support a project. This involves pioneering activities such as determining take-or-pay terms, minimum volumes, and other requirements, which are not straightforward. As we navigate through this process, it also influences financial terms and conditions. We are working with our partners on this, and they are also engaged in discovering pricing. I believe there is motivation from all parties to move forward, and this motivation will likely grow over time as California continues to lead the country in the energy transition. Initiatives like the LCFS are encouraging stakeholders to explore these opportunities. I'll pause here and see if Chris Gould, our Sustainability Officer, has anything else to add.

Yeah. Thanks, Mac. I think you covered it. And I would just add in terms of the motivation aspect to that. As Mac said, California has a net zero goal, parts of the segments that are covered under that are part of the 40% reduction by 2030. So there certainly is motivation by those sorts of emission sources. I will remind everybody that the total emissions of 425 million tons in California, EFI, Stanford, and alike of estimated that approximately 60 million of that is addressable for CCS. Our 20 million tons per annum is roughly 1/3 of that addressable market. So from my perspective, we're seeing that's a great indication of a large-scale pipeline that is meaningful in the context of the demand in California.

Okay. Just to clarify one thing, do you find it's more of a push or pull in terms of these discussions with the admitters? Do you need to convince them of why they need to do this or are they very clear on the issues there and what they need to do?

Yes, Scott, I think everyone is aware of the necessity. Some view it as an opportunity because they can gain additional cash flow from the carbon regulations and the credits provided. Others perceive it as an impending cost of doing business, especially with the CCA, where greenhouse gas allowances have increased by 50%, from $20 a ton to around $30 a ton, making it more of a cost burden. These regulations may increasingly resemble a cost of doing business that needs to be addressed. Whether people see it as a cost to eliminate or a new revenue stream, they are engaged with the need. It’s about reaching an agreement on terms and conditions and discovering the right price. Scott, I understand the impatience, as I personally feel it too; however, these are long-term projects that require time. We are taking necessary steps, starting with getting the tanks approved and in place for carbon storage.

Got it. Okay. Now that makes sense, and then my second question, on the dollars, you are spending $30 million, $40 million, you're just spending on capital on CCS projects or I guess the Carbon Management projects. What is that going to accomplish? $30, $40 million of capex, what is that going to do?

Carbon TerraVault 1 is an old oil and gas field, and we are currently focused on plugging and abandoning wells in preparation to ensure the site is fully ready, leaving only the injection wells and the necessary piping for midstream operations.

Understood. Thank you.

The next question will be from Doug Leggate of Bank of America.

Good afternoon, Doug.

Doug, your line is open if you wish to ask a question. Perhaps your line is muted. We will move on then to the next question from Leo Mariani of KeyBanc. Doug, you can always re-queue when you're ready.

Just wanted to ask a question on the oil guidance here in 2022. Just want to make sure I understood this. Do you talked about exit '21 oil being the same as exit '22? That's pretty clear, but I guess what I'm asking is, are you factoring in the 1,900 barrels a day of divestiture which is occurring in 2022? So are we seeing a situation where exit '22 is 1,900 barrels a day lower than exit '21 or is it flat so you actually have 1,900 barrels a day of growth in '22?

Sure, Leo. Francisco has covered much of this in detail, but I recommend looking at page 25 in the presentation that comes with our earnings release. I'll let Francisco explain it further. This chart should help clarify your question.

Yeah. Leo, so yes, the answer is flat entry to exit taking into account the loss of divestiture. So we offset the barrels that we divested with the drilling wedge that we're going to bring forward with the four drilling rigs.

Okay. That's helpful. And can you all just talk to the current kind of regulatory environment, and permitting environment in California around the oil well that you're drilling here in 2022? Can you maybe talk to kind of how much inventory you have on the permit side, is there a year or two of backlog? Is it only a handful of months? What can you tell us around that?

Leo, regarding the permitting situation we're facing, let me discuss our drilling program, specifically the wedge mentioned earlier. We are quite confident in our flexible plan that enables us to carry out the four-rig program in various ways depending on the permits we obtain. The Kern County EIR is currently entangled in litigation, and permits in that area that we do not already possess are not being issued at this time. With that in mind, we have incorporated this into our overall development plan and believe we can manage it in a couple of ways, including moving rigs. However, this will not hinder our progress, and we anticipate that the lawsuit will resolve itself this year, allowing us to resume normal operations in Kern County. Mike Preston, our General Counsel, is available if there's anything he would like to add regarding the lawsuit.

I think I would just say that we have permits in hand whether or not things are delayed as a result of the suit through year-end. We have more permits than we have wells that we're planning to drill this year. So as you already indicated, we have flexibility depending on whether that EIR lawsuit is resolved in the near-term versus the long-term. We've had constructive dialogue with the regulators on a process forward around the issues that are raised in that suit.

Okay.

Leo, I would just say it as simply as this, we are confident that based off of the permits in hand and our drilling program that we can deliver our guidance.

Okay. Now, that's really helpful. And I guess is the state itself kind of the CalGEM side actually issuing much in the way of permits right now? Or, is there maybe a little kind of gridlock on their side these days?

We're getting permits outside of Kern County. There are permit issues for other types of production methods that don't impact us, as you may know, around WST, well stimulation around high-pressure cyclic steaming. So there are permit issues that are impacting others in the industry that don't really have an impact on us. We feel like we have a constructive dialogue. The litigation has slowed the process, but we think that we'll get past that. In the meantime, the regulator has been working with us to try and resolve those issues.

Okay. Thanks guys.

Thanks, Leo.

And the next question is from Doug Leggate with Bank of America. Please go ahead.

Good morning, guys. I'm so sorry. I had you on speaker phone, and when you called my name, I hit the wrong button and hung up on you. So I am so sorry. Just full disclosure, that's what happened.

No worries, Doug.

I have a couple of questions. Mac, we've discussed this previously, but in light of Leo's inquiries about climate change, I'm interested to know if you are pursuing the carbon sequestration permits independently of any EUR permits. If that is the case, has there been any progress with the regulator or the state on this matter? The economic implications could be significant if that were to happen.

I wouldn't say that I'm unclear about the part where you mentioned being tied to something. Are we committed to not doing it or committed to doing it? What I can say is that we are currently focused on obtaining permits for carbon sequestration or storage. I view the use of carbon for oil recovery as a combination of carbon storage and oil recovery. I believe it has potential, particularly considering California's current situation, as the concept of enhanced oil recovery using CO2 floods has not been executed in recent times. This approach is likely to progress alongside permanent storage solutions. I wouldn't say we are firmly committed one way or the other. We are actively moving forward with our CalCapture project, which, as you know, aims to capture carbon and utilize it for CO2 flood recovery in the Stevens formation at Elk Hills. We are continuing to explore this, and fundamentally, by doing so, we are storing carbon. In fact, when using CO2 floods derived from an industrial source, there is the potential to produce zero or even negative carbon intensity crude. I believe this is an avenue worth pursuing in the future, but for now, our focus is on completing the storage process, evaluating CalCapture, and keeping an eye on future opportunities.

Thanks. I don't want to labor the point, but I guess one of the things we think is missing from the market's understanding of your story is that at some point that theoretically puts you back on a modest growth path presumably. Do you think that's fair? I know it's several years away, but do you think that's a fair way of thinking about the successful conclusion of the permitting?

I believe we have a significant opportunity. It's well known that transitioning from primary recovery to water flooding, which is our current focus, results in low carbon intensity crude production in most of our fields. After water flooding, the next recovery method available is CO2 flooding. We are considering this option, but at present, our priority is on storage.

Okay. Thank you. My last question is really if you can tolerate that is just a quick one on hedging. I mean, obviously as kind of a shame where you guys are in 2022, but it seems to me that you're going to have a pretty tremendous inflection if the strip holds into 2023. I'm just wondering how you're thinking about the hedging strategy beyond what you had to do fewer RBL. And I'll leave it there. Thanks.

You are correct. We need to act according to the RBL, and we have been actively hedging our position. There were discussions regarding some of the swaps we implemented, but overall, our approach has involved rolling up the strike prices of our puts to maintain upside potential while increasing protection for the downside, for instance, raising the $40 puts to $70 or $75. Additionally, we have been purchasing more puts to keep some upside. This has shaped our hedging strategy, incorporating necessary swaps as required by the RBL.

Great stuff, thanks, fellas, and sorry about the mishap.

Hey, no problem, Doug. Take care.

The next question is from Eric Seeve of GoldenTree. Please go ahead.

Hey guys. Thanks for the call. A few questions. First, on the facilities capex, I know that that includes $15 million being spent on CGP1, and it sounds like that's a once in ten years type project. Is facilities capex $15 million per year higher-than-normal because of that or are there other things that are also included that may be making it higher than it would be in a normal year?

Hey, Eric. No, you're absolutely right on just trying to find a page in the presentation here, it's page 21 that shows that. I'll let Francisco get into the details, but if you remove that, you get to a more typical facility spend, we have a lot of surface operations as an integrated business. This is a one-time, well not one-time, but every 10-years as you described, where we're doing vessel inspections that you have to shut the plant down to do pressure vessel inspections that are required regulatory as well. So Francisco do you want to elaborate on the capital?

I'm happy to provide more details, Eric. The NCN workover is projected to be around 250, give or take, and this is part of our effort to maintain oil production. As you mentioned, the CGP1 average is an expense that occurs about every ten years. Once we account for that, the rest of the year looks typical from a facilities perspective. We still have some mechanical integrity work to do, along with a few one-time expenses like our small solar investment and some corporate IT items. However, the CGP1 average is really the main one-time expense we're facing. What’s encouraging is that we're seeing a lower capital requirement to maintain production at 250 million, compared to our previous guidance of 275 million. While the 275 million is an expected figure over several years, this year we anticipate spending less. We will keep monitoring the performance of our horizontal drilling operations.

This concludes our question-and-answer session. I will now turn the conference back over to Mac McFarland for any closing remarks.

Yeah, again, we think CRC, and I appreciate everybody being on the call today. We appreciate your interest. We believe CRC is uniquely positioned with low carbon, low decline assets in a growing carbon management business. We believe we have a very strong financial position by which to build upon that allows us to pursue these strategic objectives, as well as to provide strong shareholder returns through our share repurchase and quarterly dividends. With that, thank you for joining today's call, and goodbye.

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.