HighPeak Energy, Inc. Q2 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the HighPeak Energy 2022 Second Quarter Earnings Conference Call. Please be advised that today's call is being recorded. I would now like to hand the conference over to your speaker today, Steven Tholen, Chief Financial Officer. Please go ahead.

Good morning, everyone, and welcome to HighPeak Energy's Second Quarter 2022 Conference Call. Representing HighPeak today are Chairman and CEO, Jack Hightower; President, Michael Hollis; Vice President of Business Development, Ryan Hightower; and I am Steven Tholen, the Chief Financial Officer. During today's call, we will make reference to our August investor presentation and our second quarter 2022 earnings release, which can be found on HighPeak's website. Today's call participants may make certain forward-looking statements relating to the company's financial condition, results of operations, expectations, plans, goals, assumptions, and future performance. So please refer to the cautionary information regarding forward-looking statements and related risks in the company's SEC filings, including the fact that actual results may differ materially from our expectations due to a variety of reasons, many of which are beyond our control. We will also refer to certain non-GAAP financial measures on today's call. So please see the reconciliations in the earnings release, which was issued yesterday afternoon. Our prepared remarks will begin on Slide 4 of our August investor presentation. I will now turn the call over to our Chairman and CEO, Jack Hightower.

Steve, thank you very much for the introduction, and I am extremely excited about this quarter's performance and our continued growth strategy, being able to execute that. I'd like everybody to think about the press release and earnings release that we just had. Looking at that and studying it, it's just been a phenomenal quarter. You could say it's business as usual in terms of executing everything we set out to accomplish in the quarter. We, of course, increased our legacy HighPeak production volumes substantially. If you think about going from 12,000 something on a pro forma basis to almost doubling that, we ended up integrating properties and infrastructure into our operations. We ended the quarter with six rigs running and three frac crews running, which was an increase when you think about last year's business of almost 3x the number of rigs we had running. We commissioned our Flat Top electrical substation project, and we're in the process of converting our Flat Top field operations to electrical power. Our sand mine partnership became operational in June, integrating that into our completion operations. We increased our revolving credit facility up to $400 million, adding multiple banks to our syndication. I want to congratulate our team on what we accomplished: increasing our drilling activity, field operations, and integrating the acquisitions without adding significantly to our personnel and continuing to lower our lease operating expenses and on a per BOE basis, lowering our G&A per barrel. We are evolving on a quarterly basis, evidenced by our track record of consistent, responsible growth. I've talked about that many times. Assuming that prices hold in this range, we will start generating free cash flow next year while simultaneously continuing to materially increase our production. If you really look at the quarter and think about our differentiated growth project and our growth story, we are continuing to execute on our business plan. In my whole 52 years in business, other than making substantial acquisitions, I've never had this kind of growth profile, doubling production in one quarter. Our production average legacy production averaged over 22,000 barrels a day, and from the beginning of the year, our total pro forma production averaged over 25,000 barrels a day, almost a greater than 100% increase in production quarter-over-quarter. We have 46 wells in progress right now of horizontal wells in various stages of drilling and completion, which is tremendous growth in terms of increasing our production as we go forward. And we're doing all this on the basis of great operating margins. Our acreage position has increased from when we went public with 51,000 acres to over 97,000 acres today, a 50% increase in the last year alone. We have line of sight on acreage still in the process of purchasing, which will take us well over 100,000 acres. The company is growing with an increasing inventory, and we have a split contiguous acreage base, one of the largest two contiguous blocks in the Midland Basin, with a roughly 50-50 split between Flat Top and Signal Peak. We have the highest unhedged operating cash margin in the industry, far above any other companies. I want to thank our bank group for their continued support and the three new banks that joined our facility. We look forward to maintaining this relationship as we grow the company in the future. Our daily production growth is tremendous, and we're going to continue that as we look to the rest of this year and into next year.

Thanks, Jack. Now turning to Slide 7, HighPeak differentiated margins. Again, not all BOEs are created equal. Slide 7 highlights HighPeak's continued unhedged peer-leading margins. Our second quarter 2022 margins are 20% above our closest peer and 38% above our peer average. HighPeak is positioned to continue our margin expansion with our LOE reduction initiatives, such as the removal of generators, electrifying our operations, and expanded use of our recycling and company-owned SWD system. HighPeak will benefit from the dilution of fixed costs as production continues to increase. The main takeaway from Slide 7 is that production mix matters. An average peer production of 35,000 BOE a day would be necessary to equate to the EBITDA that HighPeak generated in the second quarter with our margin per BOE over 25,000 BOE per day on a pro forma basis. Combining our high-margin oil-weighted mix with HighPeak's differentiated growth model emphasizes the potential for shareholder value creation through levered exposure to oil price and production growth. Now turning to Slide 8, I'll provide a brief operational update on both Flat Top and Signal Peak. In Flat Top, we've added over 14,000 net acres contiguous with our block since the beginning of the year. We've begun drilling a portion of the new acreage and are in the process of integrating the associated infrastructure with our legacy operations in the area. We commissioned our local HighPeak electrical substation in late May and are converting our field operations from rental generators to cost-efficient high-line electrical power. To date, we've removed 70% of those generators in Flat Top and expect the financial benefits to show up in our LOE in the third and fourth quarters. We have also plugged in one of our drilling rigs in Flat Top to electrical power, and at today's diesel cost, the anticipated cost savings are approximately $90,000 per well. We're on track to convert a second rig to grid power by the fourth quarter. We initiated deliveries from our local sand mine partnership in late second quarter, currently supplying one frac crew with local wet sand. We will continue to increase our utilization of local sand and expect to start servicing a second frac crew in the late third or fourth quarter. When fully utilized, HighPeak will recognize roughly $300,000 per well in CapEx savings. Our crude gatherer is building out our infill gathering system in Flat Top, currently gathering roughly 40% of our oil volumes via sales and pipelines. We aim for the system to be fully operational before winter. We're also increasing our use of recycled and non-potable water in our Flat Top completion operations, currently servicing 100% of stimulation fluids for two frac crews. Now moving to Signal Peak, as Jack mentioned, we closed on the Hannathon acquisition late in the second quarter and are in the process of integrating the properties and infrastructure in our field operations. We are negotiating long-term gas and oil takeaway opportunities in the legacy Signal Peak area. With our recent positive well results, we expect favorable pricing terms. The well results from our recent Wolfcamp A and Lower Spraberry wells continue to be positive and confirm the inventory in these zones across the acquired acreage. It's reasonable to expect that we'll drill additional wells in these zones this year. We are active in Signal Peak with two rigs running and plan to turn in line 18 additional wells before the end of the year. We are very excited about this area and look forward to demonstrating additional success through the drill bit this year as we transition from the delineation phase to full manufacturing mode. ESG continues to be at the heart of every field level decision we make. As I mentioned earlier, we increased our use of recycled fluids to account for over 82% of Flat Top stimulation fluids last quarter. We continue to reap major benefits from our water system, both on the CapEx and OpEx side while drastically reducing our need for fresh water in our operations. We removed 70% of our generators at Flat Top to date and are converting the remainder to high-line electrical power, reducing our emissions and costs associated with rental and fuel for the generators. We've converted one of our Flat Top rigs to run off electrical power and expect to convert our second rig to high-line power in the fourth quarter. Our local sand mine partnership is now operational, reducing our total truck miles to get sand to our completion locations. By utilizing wet sand, we also eliminate the combustion of natural gas needed to drive typical frac sand, further reducing our emissions. We're gathering 40% of Flat Top oil production, which will greatly reduce trucked miles and emissions associated with that trucking once the system is fully built out. We continue to have a flawless safety record. The health and well-being of our employee base and our community is our absolute priority. The vast majority of our ESG initiatives are both environmentally and fiscally rewarding to all our stakeholders. If you turn now to Slide 10, mitigating capital cost escalation. I discussed this slide in detail on our Q1 call. The main takeaway here is that management is constantly looking ahead to combat rising inflationary and supply chain pressures. We're pleased to announce that we have implemented all of these items and are beginning to reap benefits associated with each. We saw these pressures coming in advance and took serious preemptive steps to protect against cost increases. Our local sand mine project is reducing costs and emissions, while also increasing operational efficiency. We are recognizing reduced downtime with sand deliveries now that we supply local wet sand due to the mine's close proximity to our field operations. We expect to increase our utilization of this wet sand in our completion operations as the mine continues to scale up into full-scale operations. And with that, I will turn the call back over to Jack.

Thank you, Mike. If you look at Slide 11, we've discussed responsible growth, strong operating margins, operational foresight, and maintaining flexibility. I have received numerous inquiries about our inventory and our plan to expand with six rigs. Everything we do aligns with our four key principles of operational foresight and operating margins while ensuring we keep a healthy balance sheet without exceeding our debt-to-EBITDA ratio. Our production cash flows are on a significant upward trend, and we are nearing cash flow neutrality. In terms of the company's value, we could actually reduce our budget and the number of rigs by nearly half while still generating over $1 billion a year, potentially up to $1.5 billion a year in operational free cash flow. We hold two of the largest contiguous acreage positions in the Midland Basin, allowing for full operational synergies. We have one of the most experienced teams focused on achieving operational excellence. We will maintain our leading margins and work on improving them. We will adapt to market conditions as we strategize for the future, emphasizing capital and operational excellence, outpacing our peers in cost structure. We have a unique advantage over competitors in managing our resources effectively. Our growth story is operationally differentiated; should oil prices decline, we can scale back our drilling rigs and cut capital expenditures. As long as oil prices remain stable, it would not be prudent for us to reduce our rigs. Concerns regarding inventory have been raised; we currently have over 50 years of rig life, equating to 8.3 years of drilling at six rigs. No matter what production growth estimates you consider, we anticipate free cash flow of $1.6 billion to $2 billion next year, which would support strong growth moving forward. We possess the inventory, the expertise, and the financial resources to expand the business. Now, we must pay attention to market shifts concerning oil prices. It's crucial to evaluate the energy industry with a macro perspective. Globally, we are seeing significant drops in production due to our decline curve, and if we were to halt drilling, we would lose 57% of our production within a year. The industry is only reinvesting about 30% of what is needed to sustain deliverability, meaning we will face an oil and gas shortage; it's not a question of if, but when. HighPeak’s growth narrative, along with its financial and operational strengths, presents a promising investment opportunity going forward. I will now open the floor to questions.

Our first question comes from Nicholas Pope with Seaport.

I was hoping you guys could update on Signal Peak a little bit more. I know you talked about it in the prepared remarks, but I guess in the first quarter, I think we brought on four or five wells. Were any brought on in the second quarter? Also, what's kind of the longer-term profile relative to your expectations on the basket of Signal Peak wells that came on earlier in the year?

Mike, since Nick's question is more geared to operations, I'll let you answer that.

Absolutely, we've had two rigs running constantly down in Signal Peak. We don't have any operational issues other than operational DUCs. As we've been drilling wells in Signal Peak, we've brought on wells as we drill and complete them. We're pleased to announce that we've now got wells in the Wolfcamp D delineated across both Hannathon to the West and IP legacy to the East. We've brought on a couple of wells this quarter in Signal Peak, and they are performing very similarly to those in the previous quarter. We're extremely pleased with our Wolfcamp D performance and the wells we brought on in the southern portion of our Signal Peak area. They perform the same and actually a little better than some of the wells to the North. We're very excited about our continued success and plan to drill several wells out of the 18 remaining wells this year.

From a geological perspective, almost half of our acreage to the west has the Wolfcamp A and Lower Spraberry locations. You can refer to the appendix for how many locations we have in terms of developing that area, not only in the Wolf A and Lower Spraberry but also considerable locations in the Wolf B. We're very excited about it and pleased with our increasing acreage position in that area.

Looking at the production figures, the previous guidance you provided after the Hannathon announcement was mid-30s for barrels of oil production for the year. It seems like there is a significant uptick for the second half of the year. Are you all still comfortable with the targets you've provided for 2022 and production guidance based on where production is looking and the anticipated additions of wells in the second half?

Yes, Mike and I will address this question. We have not changed our guidance and are excited about our growth projections. It all depends on how much interference we have across our blocks when fracking additional wells. However, we anticipate seeing growth and keeping the mid-30s range by the end of the year. We think we could do better than that, and we aim to maintain our production growth profile with six rigs drilling.

The number you mentioned for the mid-30s is an average for the year, effective from January 1 with the Hannathon acquisition. Keep in mind that the exit numbers will vary, especially after we close on the production volumes we will start to see in the third and fourth quarters. On Slide 5, you'll see a large number of wells that are in progress, and as we go forward in time, an average run rate for HighPeak with six rigs will be roughly 30 to 33 wells a quarter. A number of those are set to be turned in line soon. So yes, we expect a significant increase in production in the second half of the year.

Our next question comes from the line of Jeff Robertson with Water Tower Research.

Jack and/or Mike, I have a question regarding the six rig base. How do the decisions around pad sizes affect production and interference when bringing wells online?

From a macro perspective, if it doesn't answer your question, Mike may want to elaborate, but we do not try to run the business based on shutting in production. We do what's necessary regarding the reservoir and ensuring proper growth and maintenance. On any given day, we might have as many as 6,000 barrels a day with several offset wells shut in while drilling. Undoubtedly, drilling pads and multiple wells is much more cost-effective. We focus on profit margins, and most of our decisions protect the reservoir rather than simply driving production growth. We may experience some lumpiness in production growth, where certain quarters may be lower, but typically our production does increase significantly after wells are back online. Our focus is maintaining operational excellence without worrying about production growth alone.

That’s correct; we think six rigs is optimal for HighPeak today. Given the capital split of four rigs in Flat Top and two in Signal Peak, we want to ensure we have efficient infrastructure to support development in Signal. Fixed rigs and frac crews require balancing decisions. While we'd love to do larger pads, timing is significant, as additional wells take time to drill and complete. Capital deployment before returns must be monitored. We feel confident that our setup is the best option for us currently. Every company experiences lumpiness; as our base volume grows, we hope to ensure production consistently moves upwards. Each quarter will see increases, but it won’t always be a linear scale; it may vary based on operational efficiency. With regards to margins, we have some of the strongest in the industry. As for the generators in Flat Top, roughly 70% are offline now. As we approach the third and fourth quarters, we will see the benefits of transitioning to high-line power. Generators are costly due to rental and fuel efficiency, resulting in cheaper operations with high-line power. Third quarter differences are about $1.25 BOE and slightly over $1.50 in the fourth quarter. Remember, as production grows, we see a decrease in fixed costs. G&A will stabilize around $1 or less BOE. We managed to grow production without significantly increasing staff, which is a testament to our efficient workforce. Regarding CapEx, we anticipate that switching to highline power and utilizing local wet sand will save around $90,000 and $300,000 per well, respectively. We also aim to service two frac crews with recycled water, estimating a CapEx savings of about $200,000 per well stemming from using recycled and non-potable water over fresh water. We look at this equation holistically as we develop infrastructure for an effective realized price.

Thank you. I'm showing no further questions at this time. I would like to hand the conference back over to CEO, Jack Hightower for any further remarks.

I just want to reiterate that everything is progressing as planned. Our production is increasing, and our costs are decreasing as we implement the efficiencies Mike outlined. We are pleased with market conditions. While a decline in oil prices over the last two months is concerning, it won't last long. Despite volatility, oil prices will likely trend upward over the next year or so, and our production will continue to rise alongside improved operational efficiency and lower costs. We appreciate the support of our shareholders. It seems our market price may not reflect our growth trajectory; with production growth of double in effects in one quarter, our stock price should reflect that growth soon. Thank you very much.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.