Q3 2023 Vital Energy Inc Earnings Call

Participants

Bryan J. Lemmerman; Senior VP & CFO; Vital Energy, Inc.

Katie Hill; VP of Operations; Vital Energy, Inc.

Kyle Coldiron; VP of Subsurface & Business Development; Vital Energy, Inc.

Mikell Jason Pigott; President, CEO & Director; Vital Energy, Inc.

Ronald Hagood; VP of IR; Vital Energy, Inc.

Derrick Lee Whitfield; MD of E&P & Senior Analyst; Stifel, Nicolaus & Company, Incorporated, Research Division

Presentation

Operator

Good day, ladies and gentlemen, and welcome to Vital Energy, Inc. Third Quarter 2023 Earnings Conference Call. My name is Desiree, and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.
It is now my pleasure to introduce Mr. Ron Hagood, Vice president, Investor Relations. You may proceed, sir.

Ronald Hagood

Thank you, and good morning. Joining me today are Jason Pigott, President and Chief Executive Officer; Bryan Lemmerman, Senior Vice President and Chief Financial Officer; Katie Hill, Vice President, Operations; as well as additional members of our management team.
During today's call, we will be making forward-looking statements. These statements, including those describing our beliefs, goals, expectations, forecasts and assumptions are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results may differ from these forward-looking statements for a variety of reasons, many of which are beyond our control.
In addition, we will be making reference to non-GAAP financial measures. Reconciliations to GAAP financial measures are included in the press release and presentation we issued last night describing our financial and operating results. The press release and presentation can be accessed on our website at www.vitalenergy.com.
I'll now turn the call over to Jason Pigott, President and Chief Executive Officer.

Mikell Jason Pigott

Thanks, Ron. Good morning, everyone, and thank you for joining us today. Our results in the third quarter were outstanding and were a continuation of our exceptional execution throughout the year. We are delivering on all aspects of our strategy.
In the third quarter, we announced 3 acquisitions, making a total of 5 for the year. These acquisitions increase scale, are accretive to free cash flow and add high-value inventory. We generated $91 million of free cash flow and also achieved company record production levels. We continue to demonstrate capital efficiency improvements, coming in below guidance on capital investments and reducing our leverage ratio.
We have successfully integrated the Driftwood and Forge properties we acquired earlier this year and are completing wells on those properties that are outperforming what the previous operators achieved. Additionally, we are making progress upgrading operations to our standards and seeing opportunities for synergies, future cost reductions and base production enhancement.
As we close out 2023, we have high confidence in our ability to execute on the plan for 2024 that we communicated in September. We have a proven track record of integrating and creating value through acquisitions by applying our operational expertise and proprietary technologies to enhance base production.
To reduce risk and ensure cash flow, we have hedged around 90% of our 2024 expected oil production. Free cash flow will be allocated to reduce absolute debt and decrease our leverage ratio to about 1.0x by the end of 2024.
Today, we also released our 2023 Sustainability Report and our inaugural Climate Risk and Resilience Report, updating the company's progress and performance on sustainability related matters. This is the company's fourth sustainability report and the first as Vital Energy.
In these reports, you will see that we, one, achieved 2 of 4 2025 environmental targets 3 years ahead of schedule; second, have reduced scope 1 greenhouse gas emissions by 59% and methane emissions by 87%, both from the 2019 baseline levels; third, earned TrustWell's AAA Low Methane Rating, the first company to achieve this rating.
Vital Energy is now stronger than it's ever been. Our scale, inventory depth, free cash flow yield and balance sheet strength position us to build sustainable value in 2024 and beyond.
I will now turn the call over to Katie for additional details on our strong operational performance and our success integrating the Driftwood and Forge acquisitions.

Katie Hill

Thank you, Jason. Today, I'm excited to share details about our successful integration of the Driftwood and Forge properties, including how we are driving down operating costs, improving capital efficiency and increasing production. I will also address our increased fourth quarter and full year guidance.
To start, I'd like to compliment and congratulate the entire organization for the work they are doing to integrate these assets, along with the 2 assets still in progress. Everybody is energized and going above and beyond to make these acquisitions successful.
We have a track record of rapidly onboarding and finding creative ways to capture synergies to enhance our returns. Our Driftwood and Forge deals are no exception. From a development perspective on Forge, we have now executed on all phases of operations, drilling new packages, completing acquired DUCs and managing new turned-in-lines.
The development planning process has been successful and the operational results have been extremely encouraging. All production from these wells is outperforming historical results from the previous operator by nearly 30%, and we have already reduced well costs by 10% through excellent execution work from our drilling and completion teams.
It is a similar story on the Driftwood asset. We have completed the 4 DUCs that were acquired from the previous operator. We are seeing gains through the application of our frac design and first artificial lift, which has resulted in oil production from these wells outperforming previous results by 7%.
We will soon drill the first Vital Energy design wells, and we'll work to identify significant cost reductions and efficiencies, just like we have on the Forge asset. We also deployed necessary hardware to begin applying our production technology platform, and we look to see optimization results from that effort over the next 6 months.
Operationally, we are implementing our best practices and have already optimized routes for lift operators. Our team is now handling an average of 30 wells per operator versus 7 to 15 for the previous owners. In addition to a faster deployment of the vital energy operating platform, this also allows for a meaningful impact on these operating expenses when scaled across assets.
Approximately 45% of base production on the Forge asset is produced by ESP. We are currently building out data infrastructure in the field to be able to incorporate these wells onto our digital platform, and we see the potential for the same 4% increase in run time that we have experienced on our base production in the Midland Basin.
Turning to service costs. We have consistently outperformed our capital expenditure this year in part due to our supply chain group. They had a great work keeping us ahead of some of the big inflationary pressures absorbed last year by the industry, and we are seeing deflation in certain areas this year.
OCTG, or tubular goods in particular, we tend to buy out about 6 to 9 months to meet our tubular needs. This kept us from hitting the extreme price peaks last year, but it also muted the positive deflationary impact this year. Today, we are seeing an approximate 20% reduction in our current OCTG costs when comparing to last year's average.
For simulation services, about 3/4 of our costs for 2024 are locked in. One place we saw some benefits within contracting of our second completions crew, where we saw a 30% decrease in pricing since earlier this year. These savings are significant and have been factored into our $750 million to $850 million budget range for 2024.
On the production front, we updated our Q4 total and oil production guidance to reflect strong recent performance across the asset base and earlier-than-estimated closing date for all 3 acquisitions. Fourth quarter capital guidance was also lower than what we communicated in September, again for adjustments related to timing and capital being reflected in purchase price adjustments.
We also increased our full year production outlook to incorporate the outperformance in third quarter, higher production expectations in the fourth quarter and the earlier closing dates. In closing, our execution teams are continuing to deliver high performance. We are successfully integrating our new properties and optimizing our existing assets to increase production and lower costs.
I'll now turn the call over to Bryan.

Bryan J. Lemmerman

Thank you, Katie. Vital Energy has made substantial progress in 2023, significantly strengthening our overall capital structure, generating sustainable free cash flow and furthering our ability to grow through future accretive transactions.
We announced 5 transactions this year totaling $1.7 billion, 3 of which have closed, with the other 2 expected to close in early November. These acquisitions grow scale and facilitate deleveraging as we remain disciplined in our spending to generate free cash flow to pay down debt.
We had a thoughtful approach to how we finance these transactions using a balanced split of debt and equity. When combined with our recent public debt and equity issuances, this has resulted in a simple, easy-to-understand balance sheet that provides us significant flexibility.
Upon closing of all transactions, the discharge of the 2025 notes and the conversion of Henry's preferred stock to common stock, we will have no debt maturities until 2027, more than $1 billion of liquidity and a simple capital structure of common stock, secured credit facility and unsecured notes.
We are laser-focused on generating free cash flow to reduce absolute debt and interest expense. We have hedged about 90% of our expected 2024 oil production at prices we feel are well above the long-term average price of crude.
We are well positioned to reduce interest costs, even after we pay down the RBL balance, since we have $700 million of unsecured notes that are currently callable. We expect to generate approximately $425 million in free cash flow over the next 15 months and are targeting a leverage ratio of 1.0x or less by year-end 2024.
I will now turn the call back to Jason for some final comments.

Mikell Jason Pigott

In closing, I want to thank all the Vital Energy team for their efforts to integrate and acquire 5 assets this year. Combined with our operational outperformance, we will enter 2024 in a position of strength. Thank you.
Operator, you may now open the call for questions.

Question and Answer Session

Operator

(Operator Instructions) We have one question comes from the line of Derrick Whitfield with Stifel.

Derrick Lee Whitfield

Congrats on another solid quarter. For my first question, I wanted to focus on your 2024 outlook, with the understanding that you're reiterating your previous output metrics. Could you shed some light on the activity expectations between basins and the shape of your production profile throughout the year?

Mikell Jason Pigott

Yes, for the guidance for next year, again, we've really -- it's not really changed at this point. I think one of the things the team is really working on is optimizing development between the 2 basins. And I think there's opportunities in the outperformance on the new assets that we highlighted. So again, I think there's going to be opportunities there in the future, but we're working through it.
For us, the key thing is getting these transactions closed. They're going to be close Maple this week. We should be closing on Tall City and Henry relatively soon. So we're very excited about that. And once we've got those closed, we'll continue to optimize the profile for next year. I'll turn it over to Kyle and he can give you a little bit of guidance kind of on the shape of the curve. Again, as a reminder, we do have this big package coming on in western Glasscock. But I'll turn it over to him for that.

Kyle Coldiron

Yes. So as you can see in our materials, the investment opportunity in the Delaware side of the basin is very compelling. And so as we integrate these assets and we optimize around that, we are certainly kind of looking there and figuring out how we can deploy more capital to that area. But as Jason said, we'll come out with kind of a full update on where we plan to be when we come out in February of '24.
Now that we have essentially a diversified asset base, we can invest across both the Delaware and the Permian -- and the Midland side of the basin. We're seeing a flatter oil profile than we have in the past. As we've talked about, we have large 20-well [Glasscock] package that's coming online in 1Q of '24 and it's going to ultimately peak in 2Q of '24. It's ultimately -- we kind of view 2Q and 3Q as the peak in '24. But ultimately, a flatter profile than we've seen in past years.

Mikell Jason Pigott

That's one of the -- like the benefit of scale is we had -- when you got 2 rigs running, there's more volatility in the production profile than when you have 4 rigs running or 5 rigs. So that's something that we're excited about as we achieve scale, is less volatility in the production profile.

Derrick Lee Whitfield

That's great. And then with the benefit of an additional quarter of experience in the Delaware in your first completion, could I ask you to share your broad thoughts on areas of upside relative to your initial assessment? And then more broadly -- or more specifically for the quarter, I should say, could you speak to some of the drivers of your initial well outperformance versus the legacy wells?

Katie Hill

Just to remind -- Derrick, this is Katie, we've got a really strong start over the last couple of months with the Forge asset in the Delaware. We've already achieved a 10% capital reduction with the first few months under our belt. So really excited to see our ability to continue to find capital efficiencies. I think the fact that we have a more stable program, we're able to use that scale and gain some efficiency on the services side. We've been able to go to market this quarter as we plan 2024 and already have a lot of the services for next year under contract. So really excited to be able to apply that program in Delaware.
I think we also see a lot of opportunity with the digital platform. We've seen success in the Midland Basin and achieving about a 4% improvement in uptime on ESPs, about a 15% improvement in uptime on compression. And a lot of that technology will have great application in the Delaware as well. That's probably a mid-'24 expectation as we think about getting hardware deployed first and then building sort of the software pieces on top of that. But we're excited to get these assets closed here in the next couple of weeks and go from there.

Kyle Coldiron

Derrick, I think I also heard you asked a question about Slide 8, essentially our successful integration of recent acquisitions. Looking at the profile of production of the wells that we've kind of been involved with since taking over the assets versus the legacy results, I think what you can see there is a combination of -- for those wells that we've designed the completion and pumped to completion, we definitely hit those with high proppant intensity, high fluid intensity with very tight cluster spacing. We ultimately believe that has a big impact on well results, and we think that we're seeing that here.
The other thing is really our operations team and our artificial lift strategy. We have an aggressive drawdown profile and a strategy that we employ on these wells. We've seen it work for us in '23 in Howard County, and we're also seeing it work for us here on these new assets. So we think that also contributes to this outperformance that we're seeing on Slide 8.

Operator

There are no further questions at this time. Mr. Hagood, I turn the call back over to you.

Ronald Hagood

Well, thank you for joining us this morning. We appreciate your interest in Vital Energy, and this concludes our call.

Operator

This concludes today's conference call. You may now disconnect.