EXPAND ENERGY Corp (EXE) Q2 2021 Earnings Call Transcript

Good day. And welcome to the Chesapeake Energy Corporation Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. I would now like to turn the conference over to Brad Sylvester. Please go ahead, sir.

Thank you Roko and good morning, everyone. Thank you for joining our call today to discuss Chesapeake's financial and operational results for the 2021 second quarter. Hopefully, you've had a chance to review our press releases and the updated presentation that we posted to our website yesterday and this morning. During this morning's call, we will be making forward-looking statements which consist of statements that cannot be confirmed by reference to existing information, including statements regarding our beliefs, goals, expectations, forecasts, projections, and future performance. The benefits of our proposed transaction with Vine Energy Inc. are the expected timing for the completion of the transaction and the assumptions underlying such statements. Please note that there are a number of factors that will cause actual results to differ materially from our forward-looking statements, including those factors identified and discussed in our earnings release yesterday and in other SEC filings. Please note that except as required by applicable law, we undertake no duty to update any forward-looking statements and you should not place undue reliance on such statements. We may also refer to some non-GAAP financial measures which help facilitate comparisons across periods and with peers. For any non-GAAP measure, the reconciliation to the nearest corresponding GAAP measure can be found in our materials and on our website. With me on the call this morning are Mike Wichterich, Nick Dell'Osso, Sheldon Burleson, and Tim Beard. Mike will give a brief overview of our recent results and events. And then we will open the teleconference up for Q&A. So with that, thank you. And I will now turn the teleconference over to Mike.

Hi. Good morning. Thank you for joining. We're pretty excited today here at Chesapeake, and we're glad you're here. We're going to do just a quick buy-over on our quarter. The second quarter was pretty great. We're pretty excited about it. We told you in the first quarter that this Company is going to generate a lot of free cash flow. That's what we've done in the second quarter; we did not disappoint. We had $429 million in EBITDA, $300 million in free cash flow. That went to the balance sheet. That's how you know it's real when it shows up in cash in the bank, and so we are pretty pleased. We all think this is not just a one-time event; it's a trend, which is why we're updating our guidance. You'll see we're raising guidance on EBITDA by 16%. We reduced G&A by 15%. We're not changing our CapEx, and that also feels pretty good. We do generate a lot of cash. We have a bunch of cash, even if the question becomes what to do with it. We've told you really clearly in our first quarter, the goal is to return cash to shareholders. That's why we started a fixed dividend in the first quarter. We told you at that time that we would define a variable dividend strategy by year-end. Today's that day. So, we're going to implement a variable return program that's going to take 50% of our free cash flow quarterly and pay it out. That's going to start at the beginning of next year. We're pretty thrilled about it. At the very bottom of the page, you may have seen this in a previous press release, our commitment to the environment and being a good steward of assets — we pledge that we will turn our Haynesville area into an RSG basin for us. We think that is not only the right thing to do but the smart thing to do, and we're pretty pleased that we're making great progress. Turning to the Vine acquisition, which we're really excited and fired up about. During the quarterly calls, and last time, and every time I have an investor call, I get a question often about, will Chesapeake participate in the A&D market, how will it look, what is, where's, when's, and how's? And honestly, we're very picky. We're picky, and we think this acquisition absolutely reflects that. We have what we think are five non-negotiables in any transaction. The first non-negotiable is you can't overpay. We don't think we are. This is a zero premium deal. When you look at it, you want to calculate the price. You do it yourself. It's basically the 30-day exchange ratio. That is how we based it. No premium; it feels great. We're not overpaying. The second non-negotiable is we're not going to break our balance sheet. We're not speaking of the past; we think this is a competitive advantage. You'll see our leverage is still below our long-term goal, which is fantastic. We're going to keep it. It was hard to get here. Now, you could ask, 'Hey, did you build some overhang on your stock with new Vine shareholders?' And I'd say, 'Maybe you could think about it that way.' We don't think about it that way. The Vine shareholders have been very clear on their intent. The intent is they like Chesapeake, they like the story. They want to participate in the upside. And frankly, we're happy to have them. Third non-negotiable: it's got to be creative. On the metrics, that matters. We think this transaction is. You guys will calculate it. We feel great about it. Fourth is, hey, we're looking to be better, not just bigger. And so, we think this transaction does it. Better to us means adding low breakeven drilling locations. This transaction does it. It means having scale. If you combine low breakeven, scale, and size, I think you have a winning formula to generate a lot of free cash flow. We have the locations with this. We're happy about it. We also are going to be the largest Haynesville producer. That's the scale we're looking for. The beautiful thing about this is this is an area that we've already operated in since 2008. We know the area. We can execute. We will execute. We feel great about it. Finally, we talked about our pledge to the RSG in Haynesville. We talked about it in our own assets. It was very important to us, not just to do it on those assets, but Vine assets. So, our pledge extends also to the Vine acreage. On the next page, a picture says a thousand words. The picture tells you the story, which is our next-door neighbor. It makes total sense. We have the people in place already to execute and we feel great. Next slide, I'm going to keep pressing on this, about being a good operator, we think it's obviously the right thing to do on ESG. Haynesville is the right place to be. And not only that, we think it is not just right, we also think it is a competitive advantage. It is the smart thing to do. We know that Haynesville gas goes into the LNG complex; we know the buyers of LNG want to be certified RSG. We're going to deliver it. We listen to our customers. We want to provide it. Turning to Page 6 of the deck. Again, back to the picture that tells a thousand words. We talk a lot about basis. You guys talk a lot about basis too, about the Appalachia; it's obviously a hot topic. The basis is perfectly situated to take advantage of that. This is the place to be; we're happy to be building here. It is the core strength for us. Page 7, the cost savings. Synergies have always felt mostly like a guess; it's not a guess for us. We have operations here. We have the expertise; we know we can do it. I've already mentioned, I don't think anyone has drilled more Haynesville wells than us. We have the people here to execute, and we think these synergies are absolutely real. On page 7, we talk about cash to shareholders. To me, this is put your money where your mouth is. It's one thing to talk about generating a lot of free cash flow and about synergies; it's another thing to actually promise to give it back to shareholders. The first step is we're going to increase our fixed dividend. The synergies that we're talking about, we're going to give to the shareholders. We're going to raise our fixed dividend by 27%. We think it's the right thing to do, and we're happy to do it. Also, the new variable dividend plan that we just discussed applies to these assets as well. And so, giving back cash to shareholders is what great companies do, and we're happy to be part of it. With that, Nick, why don't we go through the numbers?

Thanks, Mike. Good morning, everyone. Our pro forma outlook that we've provided in the presentation, we think sets up really well for the next couple of years. At the end of 2021, you can see we've raised our numbers. We're raising our numbers on production. We've pointed in our press release to the fact that we have improved base decline rates. This is really evident in the great work of our teams and how we've shifted our focus throughout this year and we're delivering better results, better information, better technical understanding of our assets, and maturing the way we think about the decline curves and the way we manage them. We have also a great performance out of our wedge. We're delivering well in Appalachia and Haynesville. And as we noted before, we're going to bring online some wells in South Texas towards the end of the year. It ties well together with the fact that the well saves the day is performing very well there. Some of the biggest moves on the page that we're really pleased to highlight are in the cost structure. When you look just at 2021 alone, you can see we've reduced our G&A, and it's a pretty significant move. And you can see that as we move into 2022, that's sustained. And so, when you look at the aggregate cost structure on this page of LOE, GP&T, and G&A, and to go from where we were in 2021, our previous outlook, to where we are now guiding pro forma, the transaction going forward, where we're taking into consideration the greater scale and some efficiencies of the transaction, there's a 20% decrease in the total cost structure. That's a pretty impressive move for a transaction like this and for just the current evolution of our business and how we're taking costs out. That does result in higher EBITDA per barrel equivalent. When you think about how we're investing, again, there are some things that Mike talked about as non-negotiables and important of how we run the Company from an M&A perspective, and they are from a financial approach perspective as well. Our reinvestment rate stays well under our 60% to 70% target, but we are able to stem the decline in our oil assets with this investment profile. The rate of return that we're going to target, with a pretty modest investment to stem that decline, is outstanding. So, we're really pleased about being able to lay this out and being able to show a free cash flow profile that's really attractive. On the right side of this page, you have to pay attention to the fact that this transaction is really accretive to our cash flow metrics. And when you see a transaction that is notably accretive to cash flow metrics and a Company can raise their dividends on the heels of that transaction immediately, you know that the confidence level in that accretion is high. We feel really good about that. We're pleased to be able to deliver that and look forward to executing on that program to find out what's next. Going to the next page, we have some stats on just Chesapeake relative to the peer group. Obviously, we're relatively a big Company. And so the peer group that we aspire to measure ourselves against are Companies that are bigger than us. We've talked about that scale matters; we've talked about that we think there's an advantage to having cost structure benefits from scale, we're evidencing that in our transaction this morning. And you can see that we're moving along the scale. Not where we want to be yet, but we are, if you look at the payout ratio, punching at a higher level, we think than many peers of our size. And so we believe we're headed for a position of greater scale in the industry. That payout ratio is really attractive and it's sustainable, given the reinvestment profile and given the low leverage. We're really pleased to be able to lay this out and put out the variable dividend that we announced this morning that we know is going to offer a really attractive aggregate yield. Moving on to the last page that we're going to cover is really just the checklist of how we thought about this acquisition, and really, what it's delivering to us. This is just a tremendous deal for us. It's accretive. It takes advantage of our scale and our knowledge and our history. Mike talked about we drilled more wells in this space and we have more data in this space. We understand the space better than any other operator. The position that it gives us around the marketing of gas and the proximity to LNG, and the fact that we're going to have such a large aggregation of RSG in the market this close to the Gulf Coast and the industrial and export markets, is, we think, a really significant competitive advantage. And when you marry that with our balance sheet, which now has a credit profile that's very strong and a much more attractive counterparty in these transactions, we think it's a really powerful combination. What it does to our inventory is great. You've seen some of the numbers already. We're increasing our premium locations and we've measured that for you this morning by talking about locations that are greater than a 50% return at $2.50 gas, and that's a really robust profile of an incremental 370 million locations. Dividends, we've talked about a bit. And the fact that it strengthens our ESG performance, this is a pretty well-run asset from an ESG perspective, and it offers us an opportunity to showcase and highlight our commitment to continuing to drive our emissions metrics down and improve our ESG profile. Overall, we're just really pleased with this transaction. We think it sets up really well for Chesapeake as we move into 2022. And we think about how to continue to take advantage of our scale and deliver higher returns for shareholders in the form of cash showing up in dividends. So with that, Operator, I think we'll open it up for questions. Thanks, Mike. Good morning, everyone. Our pro forma outlook that we've provided in the presentation, we think sets up really well for the next couple of years. At the end of 2021, you can see we've raised our numbers. We're raising our numbers on production. We've pointed in our press release to the fact that we have improved base decline rates. This is really evident in the great work of our teams and how we've shifted our focus throughout this year and we're delivering better results, better information, better technical understanding of our assets, and maturing the way we think about the decline curves and the way we manage them. We have also a great performance out of our wedge. We're delivering well in Appalachia and Haynesville. And as we noted before, we're going to bring online some wells in South Texas towards the end of the year. It ties well together with the fact that the well saves the day is performing very well there. Some of the biggest moves on the page that we're really pleased to highlight are in the cost structure. When you look just at 2021 alone, you can see we've reduced our G&A, and it's a pretty significant move. And you can see that as we move into 2022, that's sustained. And so, when you look at the aggregate cost structure on this page of LOE, GP&T, and G&A, and to go from where we were in 2021, our previous outlook, to where we are now guiding pro forma, the transaction going forward, where we're taking into consideration the greater scale and some efficiencies of the transaction, there's a 20% decrease in the total cost structure. That's a pretty impressive move for a transaction like this and for just the current evolution of our business and how we're taking costs out. That does result in higher EBITDA per barrel equivalent. When you think about how we're investing, again, there are some things that Mike talked about as non-negotiables and important of how we run the Company from an M&A perspective, and they are from a financial approach perspective as well. Our reinvestment rate stays well under our 60% to 70% target, but we are able to stem the decline in our oil assets with this investment profile. The rate of return that we're going to target, with a pretty modest investment to stem that decline, is outstanding. So, we're really pleased about being able to lay this out and being able to show a free cash flow profile that's really attractive. On the right side of this page, you have to pay attention to the fact that this transaction is really accretive to our cash flow metrics. And when you see a transaction that is notably accretive to cash flow metrics and a Company can raise their dividends on the heels of that transaction immediately, you know that the confidence level in that accretion is high. We feel really good about that. We're pleased to be able to deliver that and look forward to executing on that program to find out what's next. Going to the next page, we have some stats on just Chesapeake relative to the peer group. Obviously, we're relatively a big Company. And so the peer group that we aspire to measure ourselves against are Companies that are bigger than us. We've talked about that scale matters; we've talked about that we think there's an advantage to having cost structure benefits from scale, we're evidencing that in our transaction this morning. And you can see that we're moving along the scale. Not where we want to be yet, but we are, if you look at the payout ratio, punching at a higher level, we think than many peers of our size. And so we believe we're headed for a position of greater scale in the industry. That payout ratio is really attractive and it's sustainable, given the reinvestment profile and given the low leverage. We're really pleased to be able to lay this out and put out the variable dividend that we announced this morning that we know is going to offer a really attractive aggregate yield. Moving on to the last page that we're going to cover is really just the checklist of how we thought about this acquisition, and really, what it's delivering to us. This is just a tremendous deal for us. It's accretive. It takes advantage of our scale and our knowledge and our history. Mike talked about we drilled more wells in this space and we have more data in this space. We understand the space better than any other operator. The position that it gives us around the marketing of gas and the proximity to LNG, and the fact that we're going to have such a large aggregation of RSG in the market this close to the Gulf Coast and the industrial and export markets, is, we think, a really significant competitive advantage. And when you marry that with our balance sheet, which now has a credit profile that's very strong and a much more attractive counterparty in these transactions, we think it's a really powerful combination. What it does to our inventory is great. You've seen some of the numbers already. We're increasing our premium locations and we've measured that for you this morning by talking about locations that are greater than a 50% return at $2.50 gas, and that's a really robust profile of an incremental 370 million locations. Dividends, we've talked about a bit. And the fact that it strengthens our ESG performance, this is a pretty well-run asset from an ESG perspective, and it offers us an opportunity to showcase and highlight our commitment to continuing to drive our emissions metrics down and improve our ESG profile. Overall, we're just really pleased with this transaction. We think it sets up really well for Chesapeake as we move into 2022. And we think about how to continue to take advantage of our scale and deliver higher returns for shareholders in the form of cash showing up in dividends. So with that, Operator, I think we'll open it up for questions.

Thank you. We'll now begin the Question and Answer session. Today's first question comes from Scott Hanold with RBC Capital Markets. Please go ahead.

Thanks. Thanks all. A good quarter and I guess congrats on the deal. My first question here is, who is running the combined Company. You really didn't discuss that. Obviously, Vine has an established management team and you are in the process of searching for a CEO. So can you give us some sense of where that process is and whether or not some of the Vine management team are candidates?

Sure. Generally, the CEO search is ongoing. We've had tremendous interest in the position, of course, as you would expect. The committee is working on its process. We thought it would take several months. It's on target and so, we expect to have the answers relatively soon. Certainly, we never thought about who would run the Company if we weren't trying to buy a CEO in this transaction — that's absolutely not what's happening here. We wanted to buy the Company and the assets and so, we'll just let that process go. I think the real question you want answered is who's the next CEO and what's going to happen with strategy. Would we have differences? The answer is no, strategy is the same. We're going to execute this business plan. This is the business plan we're going forward with.

Okay. Just to clarify, is the Vine management team part of the CEO consideration?

We haven't gotten that far in the process to think about it.

Okay, understood. And my follow-up question is, could you just give us a little bit of color around the inventory additions that you're getting from Vine? I think in their published presentations, they've talked somewhere around 800 to 900 locations that have breakeven points close to $2, and I know you all highlighted something on the order of 370 locations that get a 50% rate of return. And then, I think in Slide 4, it indicates there may be 600, but there's a little bit of a difference. Could you give us some color on that variance?

Sure, so the 370 are premium locations and we measured that showing again greater than 50% return at $2.50 gas on Slide 4 that we get the total location number. So there are a lot more locations in that. It's a big asset. We're really pleased about how the acreage abuts our position. Generally, we're looking at four wells per section here. There are some places we'd probably keep it to three and we think there's the potential in the future to downspace some areas to five, but we really haven't baked that into our analysis. That would be an upside. So look, this is a big asset. The acreage gives us some opportunities to drill longer laterals, and that's really important to think about how the value is put together here. And so a lot of locations and a lot of really premium locations at that high rate of return and low gas price.

When you said longer laterals, is that some of the difference just extending lateral assumptions with Chesapeake's acreage, or is that just a comment of their length versus your length?

It's really more the latter. There are a few places where we're going to be able to extend some laterals by combining our acreage position, but just because of the history of drilling longer laterals than others. We've done a lot of it. It's a little harder. We have the confidence to do it. We also have the mapping, the seismic, and the data to do it well. We can pick our locations very well. And so that's something where you really bring in expertise, technology, and data to the equation here, that Vine just from a scale perspective didn't have all of that on their own.

Understood. Thank you.

And our next question today comes from Nitin Kumar with Wells Fargo. Please go ahead.

Hi, good morning, gentlemen. Thanks for taking my question. I guess my first question is around capital allocation for next year. As I look at your Slide 9, you had a standalone number of almost, let's call it, $1 billion or so for next year. You're adding some with Vine, but it seems like you're investing in oil quite a bit just to hold the production side. Could you comment on how you are looking at the capital allocation for next year and why it is so much higher than this year?

Sure. So first I would just point out that as you think about our capital allocation year-over-year, we're still at a reinvestment rate that's well below our target. And we think that's really important because we have a commitment and a discipline around how we think about deploying capital in the business, but we're absolutely going to chase return. The rate of return that's available to us in our South Texas assets today is very attractive. When you think about the fact that we came out with our budget for this year as we emerged from bankruptcy and we were wrestling with a $45 to $50 longer-term oil price curve, the world is a very different place today and the rate of return opportunity for us is very attractive, and we have production that's in decline. There's no reason we shouldn't be drilling our absolute best locations in South Texas, bringing on a few wells in our other areas that are also a great rate of return, and stemming that decline in a way that is very accretive to cash flow year-over-year. If you look at what we are ultimately going to deliver, again, we're going to have a more stable, longer-lived reinvestment rate relative to the cash flow that we can generate with this investment profile.

Okay. And I guess the second question is, Blackstone owns, I think, 70% of Vine. You alluded to their commitment to Chesapeake, but is there a lock-up or something formal that prevents them from selling their stock?

There is. There's a 60-day lock-up that's been negotiated here. There will be less than 10% of the fully diluted shares in public trading from that group. But really, our conversations with them have been about being long-term shareholders. They're believers in the story. They're believers in the idea of consolidating for scale. They're believers in natural gas. This story, for them, offers an opportunity for enhanced returns over what they were able to accomplish as a stand-alone Company. They reached a point here after going public where they felt that they had a chance for a better rate of return profile through the combination. We expect Blackstone to be shareholders for a while and we welcome them as shareholders. They're eager to be shareholders in this combined Company.

Thank you.

And our next question today comes from Josh Silverstein with Wolfe Research. Please go ahead.

Thanks. Good morning, guys. Like you mentioned before on the CEO search, you had some comments there. Between the 2022 outlook, the acquisition, dividend announcement, the forward outlook for Chesapeake seems pretty clear and you've clearly been a big part of this. I am just wondering if you had your hat in the ring here because you had suggested otherwise before. So just wanted to see how you're thinking about your role here at Chesapeake?

Sure. I think in my role as the Chairman of the Board, I have not interviewed for the job of CEO. My goal here is just to help guide the Company to a better place where I think we're heading.

Okay. And then, you also said you remain pretty active in the A&D market. You did the Vine transaction here. In the past, we've talked about the Eagle Ford being a potential divestiture candidate, but that seems off the table right now with the increased activity there. Could you just give your updated thoughts on the oil portfolio and how you view the overall mix of the production profile? You're putting yourself against peers in the slides that are a bit more diversified, so I just wanted to see how you view the overall portfolio construct now?

Sure. Look, number one, we think we have great gas assets, both in the Marcellus and the Haynesville. We're believers. Eagle Ford is interesting; it's large. It's one of our big treasuries. We think that at current prices today it's attractive to go drill down there and we're going to do it. We're going to chase returns and that will be our first and foremost goal. Do we have work to do down there? We do. We have costs, we have pipelines, we have other stuff that we have to take care of and that area is going to have to compete for capital. Today, it does. If it ever turns out that we can't compete for capital, then we'll have to do something about it then, but right now, it surely looks good and we want to keep going.

Thanks.

And our next question today comes from Charles Meade at Johnson Rice. Please go ahead.

Good morning, Mike, and Nick, and the rest of the team there. Going back to Nitin's question on the 2022 allocation: if my understanding is right, you guys are talking about adding one to two rigs in oily assets, and Mike, you were just talking about South Texas, but is, obviously, where it seems like one rig is going to go there, but is there another one that maybe is going to go to either the PRB or Brazos Valley, or should we just be thinking about the uptake being in your Eagle Ford?

You should think about it that way. We're going to go to the best return locations. Clearly, the bigger one is South Texas. That's where the activity is going to be. We could probably do a handful of wells in Brazos Valley in its core, which we think is the best place. And then we'll go from there. Clearly, the PRB is a little bit of a tail wagging the dog. We are drilling some obligation wells there this year and it has to start competing. If it doesn't compete, it won't stay long here very long.

Got it. And then, on the same point, you haven't been asked, but you beat on 2Q oil volumes, right? You guys are talking about adding rig activity. But you've also mentioned that your base declines are turning out better. So of the overall outlook for 2022 being higher than where I've been and where consensus is, do you have a sense of how much of that is related to more activity you're planning and how much of that is better base declines?

Sure. Really, we're seeing excellent performance in our base and overall assets. Our two biggest drivers are South Texas and Brazos Valley. South Texas has seen outperformance of those wells over the last couple of years, and the team has done key optimization work there. The transition to the power of our team after we took over that asset has really focused on artificial lift optimization and accelerating our accretive workover program. So both of those assets have contributed a big piece of it. Powder River Basin is also ahead as well, so I think of it as really just solid performance and really focused on that program by our team.

Thanks for that color.

And our next question today comes from an analyst with Investments. Please go ahead.

Hi, guys. Thank you guys for taking the call and congrats on the deal. It seems like a win-win for everyone involved. I was just wondering how you guys are thinking about the net debt profile going forward, and how you think about the Vine debt — is that going to be around the balance sheet or is that going to be taken out?

So Vine has three basic pieces of debt. They have their $950 million of bonds. They have a term loan, and they have a revolving credit facility. The term loan and the revolving credit facility will go away as a result of the transaction. We'll pay those off in cash. And the bonds will stay outstanding. The bonds are due in 2029 and stack into our maturity profile. If we get an opportunity to refinance those at some point where it's attractive to do so, and there's not too much friction in the transaction, we'll do that.

Okay. That's all I had. Thank you guys.

And our next question today comes from Nicholas Pope at Seaport. Please go ahead.

Good morning, guys.

Good morning, Nick.

I'm trying to reconcile the share count and make sure I have that right with this transaction. What is the Vine share count right now, and what is the total number of new shares of that conversion rate?

Sure. So the buying share count, you have to take into consideration shares at best as a result of the deal. It's almost 77 million shares, just a tick under. And then the pro forma Chesapeake share count after the transaction is 135 million Chesapeake shares. So we're issuing about 19.1 million Chesapeake shares in the transaction.

The Vine share count — I don't cover Vine, so is that a different class of shares? I'm just seeing a 41 million number and I'm trying to understand what that number difference is.

Sure. There's two classes of Vine shares. It stems from their private equity backing and the IPO. They have two classes of shares.

Got it. And then, can you talk a little bit about speed of drilling, where you guys are versus where Vine is and what — because I think you all talked about 30 wells this year, and you're running three rigs now. As you ramp that up, is that linear? I mean, how do you think about what 3 to 6 rigs means for well count in the Haynesville for a combined Company that shifts?

We're still assuming 10 wells per rig per year. That's a good pace. And we believe that continues.

That answers my questions. Thank you.

Thank you, Nick.

And our next question today comes from Doug Leggate with Bank of America. Please go ahead.

Hi. Good morning, guys. Thanks for getting me on. Mike, or maybe this is for Nick. The capital guidance talks about adding activity back to the oil assets. I think Nitin touched on this earlier. But with the output that stabilizes these production, is that how we should think about the strategy on the oil assets going forward?

I would say think about us targeting returns, Doug. Right now, we see it pretty attractive to bring a rig plus a little bit of additional activity to South Texas and like Mike noted, we'll take care of some obligation wells in the PRB and see how those do, and then we're going to bring on some really high rate-of-return wells in the Brazos Valley as well. We know that those are really low risk, high rate-of-return targets. They make sense for us to drill in this environment. And so that's how we're going to chase return with our capital. By stemming the oil decline, obviously, it puts a boost in our EBITDA; our efficiency of capital turning into cash flow in the near term is great on those assets. It's a really attractive capital allocation move for us as we think about the fact that EBITDA is growing. We think about our ideal reinvestment rate. We think about the way to maximize cash flow for shareholders. This is a better answer than not drilling those wells.

Okay. Thank you. A couple of sustaining-capital questions I'll take offline. Just two other quick ones, Nick, if I may. Finally, we did cover Vine over here, the tax receivable agreement with some shareholders — what's the status of that going forward to the new Company, and what does it mean for the combined Company's cash tax trajectory?

Great question, Doug. The tax receivable agreement that existed between Vine and Blackstone will be terminated as a result of this transaction. And there's been a negotiation to have no payment under that agreement at termination. The cash tax position of the combined Company going forward is unchanged from where we were before. We're pressing up against a point where we will project to pay some cash taxes as we have a lot more cash flow as prices rise. But as of right now, we would still project to have a very modest amount of cash taxes forecast. We think that's right. There's still a chance we end up at zero for the year. So, we're watching that closely. We'll be right near the line and adding Vine into the mix is effectively neutral to our view on forward cash taxes.

That sounds like a big win for me. The last one then to me is hedging. I mean, obviously you're locked in for 2022, but this year generating much free cash flow and the balance sheet is in such good shape, and I know you're thinking about the variable payout. Why hedge? What is the purpose and philosophy of hedging? Because you're obviously not protecting necessarily a balance sheet position and you're not protecting growth capital, so why not allow investors the headroom to what might be upside going forward given your low-risk overall portfolio?

Great question. We did put a lot of hedges on as we exited bankruptcy. It was required in the agreement and you guys have seen that we did not add any hedges this quarter because we have a pretty robust hedge profile going forward. We don't disagree with your sentiment that investors should have pretty good exposure to rising commodity prices going forward. The way we do think about it though is that we're going to spend a lot of money each year. If you just think about our capital profile that's here in front of you today, on a stand-alone business, we're just over a billion dollars and with Vine, we're obviously a little higher than that. That capital is targeting new drilling. And that new drilling has an expected rate of return that's very attractive at these levels. We should de-risk that capital program over time. So we should still have some hedge profile over time. Despite the fact that we have a great balance sheet, we won't be able to maintain our cash flow profile and our dividend profile if we didn't protect the cash flows that we expect to come out of our capital program. So what that really means over time is that you can expect us to be around 50% hedged in a given year. If you look forward into 2022, we have a pretty robust hedge profile. Vine has a good hedge position coming in there. They are heavily hedged as well. We're going to manage through that, but you should expect us to continue to think about matching a hedge program to de-risk the decision to either offset decline or have modest growth, and the cash flows you expect to come from that. It all adds up to somewhere around 50% in a given year. That always depends a little bit on price, Doug. As I've been watching the market the last few weeks, some of the collars look absolutely fantastic. I love the idea of collars when they're priced effectively. Sometimes the skew on those can make them really unattractive, but when you can lock in a price that's at or above your breakeven levels or ideally well above your breakeven levels, and you can maintain some real exposure to the upside, we love that. That's a place where our strong balance sheet gives us a lot more flexibility than it did in the past where we might have looked at the past and said we need every penny of cash price per dollar of oil price that we can get. The strength of the balance sheet says that you absolutely can take some risk around getting exposure to the upside and still protecting yourself to the downside with some cushion that you are comfortable accepting. We love collars, they just have to be priced effectively.

And the next question today comes from Neal Dingmann of Truist Securities. Please go ahead.

Morning, guys. Just a quick follow-on on what Douglas asked on the hedges. Nick, what are your thoughts on basis hedges? And while we're talking about basis, could you talk about your various regions and how you're seeing basis for the rest of the year? Looks like everything is trending in line, but love to hear your thoughts on hedging around that and where we are.

Great question, Neal. If you're not hedged in basis and you have a lot of production in the Northeast, then you're exposed. So we think about the percentage of gas that we want to have hedged out of that Northeast production, which includes basis hedges as well. We manage that percentage carefully. You can't hedge as far out in the future on basis typically without seeing some slippage in price because the timing doesn't always match, but we absolutely want to continue to proactively manage that. You also manage your transportation profile. As you know, we had a bit of transportation on the TETCO M3 line that was impacted due to the negotiation of our bankruptcy. We are going to have an opportunity to add back some transportation to that area here, which we can talk more about in the future. It's a modest amount, but it's going to give us a little bit of tailwind to our realized pricing. So we feel good about that. We will continue to proactively manage how we expose ourselves to realized prices in the basin through hedging for transportation and through other commercial actions when the prices don't work. There's been a lot of noise about basis in the Northeast this summer and a lot of maintenance. We've navigated all that pretty well. You can see that in our results from today. Our realized price held up pretty well. There have been times where some of the maintenance and other parts of the basin actually lifted our in-basin sales in Northeast Pennsylvania where we are, and then there have been other times where we had some of the same pressure that others had too. So it's been very proactive management from our team. Our marketing team stays in really close contact with our production team. They work it every day to maximize the value we receive for our gas. I think they did a great job and we expect them to continue to do it. The outlook is pretty good. As much as basis has been wide, the realized price that we're seeing in the field, especially right now this month, is very strong. You can take a wide basis to the extent that realized price is elevated quite a bit and that's what we've seen. Right now, basis looks good this quarter and realized price is very attractive.

Great details, Nick. And then maybe just one follow-up for Mike or Nick. On Slide 4, when looking at the deal, where is that overall inventory? Does a good piece of that go to your upper quartile? Another way to say that is, when you look at what you're going to be drilling, will a lot of that fall in the front of the line now once that deal is complete?

Absolutely. The 370 locations that we're talking about, those premium locations absolutely get pushed to the front of the curve. We have our own in that bucket too, but those wells will compete on day one. They are definitely front-of-line priorities.

And our next question today comes from Jordan Stuart of GoldenTree. Please go ahead.

Hey, guys. Thanks for taking the question. Somewhat of a follow-up to the last question. I'm curious how we're thinking about the portfolio as a whole now: Northeast Pennsylvania versus Haynesville versus some of the oilier stuff. As we think about forced ranking, how should we think about that now and going forward, how that might change?

Look, we're chasing returns. In Appalachia, we have a constraint in how much we can get out, so that's your first baseline best return area. After that, the Haynesville gets a bunch of capital. You can see we'll go from three to six rigs there. After that, we'll look at the balance between the two gas plays and the oil assets. So think: Appalachia first, Haynesville second, then the oilier assets based on returns.

Great, and then, obviously, if the macros improve materially enough for you guys to add activity in the oilier assets, I'm curious what type of pullback or what type of volatility would have to be introduced such that you might move in the other direction down the road?

I think we showed you in the bankruptcy coming out that a $45 to $50 long-term oil price curve meant those oil wells didn't attract capital. I think if you guide a long-term price in that range, you'd have the same result. So returns drive allocation; if prices fall back to levels like that, oil activity would have a hard time competing.

Great, very helpful, guys. Thank you.

And our next question today comes from Gregg Brody of Bank of America. Please go ahead.

Congrats on the transaction. Just quickly, and I know you've talked about investment-grade before, and I'm just curious how you think this transaction can potentially impact that. In the past, Nick, you've said you were not particularly interested in getting a third rating; I'm curious if you're thinking a little differently about that because it does seem to help the investment-grade story.

I think it helps the investment-grade story. We absolutely care about our rating. One of the things I've said in the past is that we can only put forward great results and ask the agencies to rate us appropriately. That's what we're going to continue to do. We've already spoken to the agencies a little bit about these transactions to get them up to speed, and we'll continue that over the next few weeks. This is a pretty big deal for us. It adds some scale and scale is one of the things the agencies like to see. They'd like to see us be bigger. This gives us sustainability of cash flows. There's a little bit of debt that comes with this transaction for sure, but on a pro forma basis, we're still well below one times leverage and we're generating a ton of free cash flow, which is going to grind net debt lower. So we feel good about this and we will use some cash to pay off some of their debt at closing, which helps the quantum of debt. Net debt will continue to grind lower over time. We feel really good about what this does for our pro forma credit profile. One of the reasons we care about it is that if we're going to have a meaningful seat at the table in long-term gas sales agreements, which we absolutely will with the quantum of gas we'll have available, you have to have a strong credit profile and you need to be driving towards investment grade. It's a renewed goal to get to investment-grade because of the ability to play in long-term gas marketing. We're pretty intentional about getting there and we'll be very focused on it.

Does that make getting a Fitch rating a little bit more important?

Maybe — we certainly have a relationship with the agencies and we'll continue to engage with them.

And just last one, have you indicated to the agencies whether there'd be cross guarantees here from Chesapeake to Vine and vice versa, or is that still to be determined?

No. You should think about these bonds as basically becoming a part of the Chesapeake credit profile. It will not be held in a separate non-guarantor entity. This is going to be all folded in.

Great. Really appreciate the time, guys. Thanks.

And the next question comes from Carl Malmgren with Goldman Sachs. Please go ahead.

Good morning, guys. Thanks very much for the time. Just wanted to build on one question that Greg had there around the investment-grade ratings. Scale is clearly something agencies have rewarded and you're doing that here. Are there other considerations specific to Chesapeake you can talk about? The agency sometimes will talk about companies coming out of restructuring needing time away from restructuring or needing a management track record for them to get more comfortable in moving the ratings quickly. Is there any color on those items you can discuss with us?

Good morning, Carl. Both of those items are important to the agencies. Time away from bankruptcy and showing a track record of delivery is important, and we now have two quarters where we've done that. We're on our way. We expect to continue to deliver and show discipline. I'll remind you of what Mike started the call with around the non-negotiables and the fact that this transaction meets those non-negotiables. One of those is that we will not break the balance sheet and we won't overpay for transactions. You can't do those things and warrant an investment-grade credit profile, so this is aligned. They will care about how long we've been out of bankruptcy and our track record since then; we feel good about that. They'll want to know who the CEO is; the Board expects to conclude that process in due course. We don't think those are long-term concerns, but we know they are points the agencies consider.

That's helpful. One follow-up: is there room for more transactions like this in the near term or is it digest this and then reassess?

We're focused on this transaction and we focus on one at a time. We don't think about the next one immediately, but when you have opportunities that meet those non-negotiables, it is our job to look at them. We will continue to participate in processes in our areas of operation. It's pretty hard to get them through the hoop because it's a small hoop and we have a big ball.

Thanks for the time. Good luck.

And ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the conference back over to the management team for any final remarks.

Yes, before we leave, I do have a couple of things to say. Number one, I want to congratulate the Vine team. Eric Marsh, you and your team have done a beautiful job. They're a good operator, a clean operator, and their professionalism has attributed to the success of that team and where we are today. They've been nothing but professional. Our team is impressed, so congratulations Eric and team. Also, I'd like to thank Blackstone. Blackstone is a new shareholder of ours. We're happy to have them as a shareholder. It's great when you have sophisticated investors who want to be in your stock. We have them. We welcome them. I expect to have a great relationship.

And thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.