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SRC Energy Inc. (SRCI) Q1 2019 Earnings Call Transcript

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SRC Energy Inc. (AMEX: SRCI)
Q1 2019 Earnings Call
May. 02, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, greetings, and welcome to the SRC Energy Inc. 2019 first-quarter conference call. [Operator instructions] As a reminder, this program is being recorded. It is now my pleasure to introduce your host, John Richardson, IR manager.

Thank you. You may begin.

John Richardson -- Investor Relations Manager

Good morning, everyone. This is John Richardson, SRC's investor relations manager. Thanks for joining us to discuss SRC's first-quarter results for the period ended March 31, 2019. With me today is SRC's CEO, Lynn Peterson.

Also available to answer questions during the Q&A session will be our CFO, Jimmy Henderson; Chief Operations Officer Mike Eberhard; and Chief Development Officer Nick Spence. Please be advised that our remarks today include answers to your questions -- including answers to your questions, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated. Those include risks relating to commodity prices, competition, technology, environmental and regulatory compliance, midstream availability and others described in our filings with the Securities and Exchange Commission, which are incorporated by reference.

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We disclaim any obligation to update these forward-looking statements. In addition, we may provide certain non-GAAP financial information in this call. Relevant definitions and GAAP reconciliations may be found in our earnings release and 10-Q, which can be found on our website at srcenergy.com in the Investor Relations section. Following the prepared remarks, time permitting, we'll open the call to your questions.

I would like to remind everyone that a replay of this audio webcast will be available via the company's Investor Relations page at www.srcenergy.com. I'd now like to turn the call over to the CEO of SRC Energy, Mr. Lynn Peterson. Lynn?

Lynn Peterson -- Chief Executive Officer

Thanks, John. Good morning, everyone, and thanks for joining us this morning. We filed our Form 10-Q last evening, and you can refer to it for detailed information. Our excellent operational performance for the quarter has been somewhat overshadowed by the recent legislative news.

As you all know, Colorado's governor signed into law Senate Bill 181 recently. While we do not support the bill in its entirety, we do believe that the process of its passage forced both sides to work together for the common good. We were pleased to hear Gov. Polis state numerous times that the war between industry and activists is over.

Ballot initiatives impacting our industry will not be this administration's priority in 2020, and this bill should further reduce the risk of potential ballot initiatives in 2020. Just as we have experienced over the past four years, SRC will continue to move forward with its operations, recognizing that the work is now shifting to the COGCC's rule-making process and the reorganization of the commission. We anticipate little change to our program as focus on environmental impact and safety has always been a key to our strategy. We believe that with dialogue between parties, even when we disagree, there can be a favorable outcome for all.

Colorado still has its viable laws that provide the oil and gas industry and its investors certainly moving forward. As investors recognize this new reality, we anticipate our equity will improve over time. Subsequent to the bill being signed, the one primary question we receive from our investors relates to drilling permits. Therefore, I would like to highlight that we continue to receive drilling permits from the state on an ongoing basis.

Since the beginning of 2019, SRC had received a significant number of drilling permits without much change to the time required for processing. Now moving to operations. Our team did an outstanding job in the first quarter of 2019. We had a strong start to the year, with oil production in the first quarter rising 15% sequentially and 45% year over year.

Total production during these same periods increased 10% and 45%, respectively. Our first-quarter production exceeded our initial expectations for several reasons. First, our production benefited from the midstream buildout and associated lower line pressures largely as a result of increased allocations to operators. We saw a significant improvement in DCP's ability to effectively manage its systemwide line pressures during the winter months, avoiding the number of freeze-offs that we had experienced last winter and maintaining consistent throughput for its customers.

Second, as we exited 2018, we had a number of wells waiting to be turned to production in early 2019. So consequently, we see the benefit for many of these wells for the full quarter. The SRC team turned 33 wells to production during the quarter. Thirdly, we had participated in some non-operated completions in late 2018.

And we continue to see flush production from these properties to carry through the quarter. We anticipate that these volumes will decline through the remainder of 2019. And lastly, we benefited from better-than-expected production associated with our GC2 wells that SRC began operating in the fourth quarter of 2018. However, the production is expected to be on a normal decline going forward.

It's important to note that these volumes do not flow through the DCP's system. With the release of our operations update last week, we took the opportunity to update our 2019 production guidance. When we put our 2019 guidance together in January, there was an abundance of uncertainty related to midstream, politics and weather. Therefore, we raised certain items.

Based upon actual results in the first quarter, as well as reduced uncertainty related to SB 181 and midstream buildout, we raised the midpoint of our production guidance range by 7% to 64,500 BOE per day. When we look at the full year, we have discussed our expectation that we would reduce completion cadence after the second quarter. We also anticipate our non-operated production declining as we continue to limit our participation in non-operated wells primarily as a result of our trades made in prior years to reduce this exposure. As we moderate the number of wells turned to sales, we anticipate that our commodity mix shifting to lower oil percentages throughout the year.

The lower oil cut is the second -- in the second half of the year will reduce our barrels of oil equivalent as we exit the year. With the reduction in new wells turned to sales, we are planning to return wells to production that have been shut in over the last year or two. In our updated guidance, we have made what we believe are conservative assumptions about the timing, production levels and commodity mix of these wells. And we will continue to update as we return them to production.

Clearly, our production guidance is primarily driven by the midstream capacity and not by capital expenditures. This is a very fluid situation, but we are seeing significant capital deployed by DCP and other gas processors. We continue to risk this capacity in a number of ways and will adjust as we move forward. Looking on the cost side.

Our lease operating expense on a unit basis in the first quarter was above our guided range for the year. Operating expenses during the first quarter are typically impacted by more seasonal activity around winter operation, and it was no different this year. We also remind our investors that the company took on a large number of vertical wells in late 2018 with the closing of GC2. Vertical wells inherently carry a higher lease operating unit cost.

We continue to believe that unit operating costs for the full year will be within our guided range of $2.50 to $2.75 per BOE. As we stated in our initial guidance, SRC's drilling and completion activity will be interrupted during the year to align SRC's production capacity with midstream availability. Late in the second quarter, we plan to release our completion crew with the expectation that a new electric fleet from Halliburton will be in place in the third quarter. This new frac fleet aligns nicely with SRC's focus on health, safety and the environment given its low emissions profile and quiet operations.

We also plan to farm out one of our drilling rigs during the second half of the year to minimize the number of drilled uncompleted wells at year end. Our current plan is to return to a two-rig program in the fourth quarter. Like production guidance, our capital expenditure budget was predicated on the current midstream infrastructure, which is rapidly changing. Therefore, the pace for activity is subject to adjustment as we move through the year.

It's important to point out, for the quarter, our cash flow from operations exceeded our capital expenditures, including all corporate costs. With the first quarter's D&C capex of $110 million expected to be the high point of the year, we have a good start to achieving real free cash flow this year. Switching to midstream infrastructure. We are pleased that DCP Midstream's additional capacity related to the O'Connor two plant continues to be on schedule and is expected to be in operation late in the second quarter of 2019.

This plant is designed for 200 million per day of processing capacity, with an additional 100 million per day of bypass capacity. We anticipate the utilization of this capacity will ramp to full rate as we move into the second half of the year. As DCP management has publicly stated, they remain committed to the future of the DJ Basin, with the first phase of the one Bcf per day Bighorn facility now expected to be commissioned in mid-2020. It is important to again note that the activity of other midstream operators in the basin as we see capacity growing significantly over the next several quarters.

As an update to our activity, the Mountain View Comprehensive Drilling Plan continues to make its way through the system. And we anticipate final approval from the COGCC in the second half of 2019. This CDP will ensure operator status allow for methodical permitting process over a significant area. In closing, Colorado needs us, and SRC is delivering for each and everyone of our communities.

With that, I'd like to turn the call back to the operator and open the line for Q&A.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Welles Fitzpatrick from SunTrust.

Welles Fitzpatrick -- SunTrust Robinson Humphrey -- Analyst

I appreciate the commentary on line pressures. Do you have a -- is there a number that you could throw out to us on where the pressures are nowadays? And also, do you have any updated messaging from DCP as to the capacity for Bighorn on 2020?

Lynn Peterson -- Chief Executive Officer

Wow. There's been a lot of maintenance going on. They're trying to hook the new plant in, so there's been some up and downtime. So I think the pressures have been kind of all over the board here recently.

Mike, would you like to comment on any of that?

Mike Eberhard -- Chief Operations Officer

No, you're right. I mean we've been down to the low 300s and up -- back up to 400. So it's all over the place right now as they normalize the system in getting ready for the Plant 11 coming on. So -- but we're able to work with it.

Welles Fitzpatrick -- SunTrust Robinson Humphrey -- Analyst

OK. That's perfect. And then the NGL reroute from Belvieu to Conway, is that something that we should model forward in the year? Or has that -- have you been able to get those volumes routed back to Belvieu?

Jimmy Henderson -- Chief Financial Officer

Welles, it's Jimmy. Yes, just to clarify, DCP handles that allocation. This is all under their capacity that they've arranged for through their -- to support their processing efforts. And so it's really up to them.

I'd say for the remainder of the year that that's going to continue until we see some expansion of fractionation capacity at Mt. Belvieu. We'll be -- or DCP will be utilizing both Conway and Belvieu for their fractionation needs.

Welles Fitzpatrick -- SunTrust Robinson Humphrey -- Analyst

OK. That's perfect. And then just one last one. It looks like Weld is moving to officially designate unincorporated Weld as controlled by the county at least as of yesterday.

Is that -- I mean, obviously, that's a positive. Does that have any impact on the CDP timing? I'm guessing no.

Lynn Peterson -- Chief Executive Officer

Yes. Let's let this play out a little bit. I mean this just came out yesterday. So let's see where all this goes.

I think we're in great shape. I'm excited where we're going. So I don't think it's going to have a big impact one way or another. We have a great relationship up there.

We'll continue it.

Operator

Our next question comes from the line of Jeoffrey Lambujon from Tudor, Pickering, Holt & Co.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Good to hear that you guys are still getting permits despite the ongoing reorg of the COGCC. And obviously, good that you guys are expecting the CDP permitting to kind of move through the process as we get to the back half of the year. I guess as it stands today, before all that, before additional permits are in hand, can you just refresh us on where you stand in terms of number of years permitted for undrilled wells?

Lynn Peterson -- Chief Executive Officer

Yes. We're still kind of carrying the two-year type of inventory here. Obviously, you're dropping a rig for a little bit, change that a bit. But generally speaking, that's our goal.

That's kind of the shelf life until we get to the CDP approval.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Got it. And then on the reorg process itself, any comments there on the milestones to watch for and just what you guys are expecting in terms of timing for some resolution, how it all looks in the end?

Lynn Peterson -- Chief Executive Officer

No. I think right now, we hope to have a nine-member board kind of restructured here in the near term. And then that's going to move to a smaller board. I believe it will be a total of seven, with five voting members, and two will be nonvoting.

And that's supposed to be in place somewhere on or before July 1, 2020. Again, I think it depends a little bit on the rule-making process, how quickly this moves through the system. But generally, that's where we're headed. And again, I don't think this is going to cause as much interruption here.

We've been moving ahead just as normal, just like we have last four years. Believe me, it's not been a big issue for. So we're pleased. Our main focus is -- really goes back to the midstream side of this thing.

And we got to get more capacity built in, and it's coming. But we're sitting here waiting for it. So --

Operator

[Operator instructions] Our next question comes from the line of Stark Remeny from RBC Capital Markets.

Stark Remeny -- RBC Capital Markets -- Analyst

I hate to beat a dead horse on this, but I've got a few clarification questions on SB 181. I appreciate the operational commentary. I'm just curious if you guys expect any cost impacts, whether it's well cost increase due to new equipment or just LOE changes due to new monitoring processes? And then are there any portions of the bill that you guys see as a potential risk due to ambiguity?

Lynn Peterson -- Chief Executive Officer

I think clearly, until we get through the rule-making, we've got to all be careful on how we move forward here. So our team is fully engaged in all aspects of this, working with trade organizations that are working with the legislative branch. And so I think this is part of the process that we have to continue to be diligent about. As far as costs, Mike, Nick, do you guys have thoughts? I think in all of these cases, we internally are thinking some minor upward adjustments.

I think all these regulatory things tend to bring some cost here at some point. So I don't think it's a material change to our operations by any means, but I wouldn't be surprised seeing some small additional amount. Guys, do you want to comment there? Nick? Mike?

Nick Spence -- Chief Development Officer

I think you hit it on the nail on the head there. No room for any material changes, that's for sure.

Mike Eberhard -- Chief Operations Officer

No, exactly. Regulation usually doesn't reduce any cost for us. But even the monitoring systems and such, there's a lot of technology coming out that's helping with that. So we don't anticipate a lot of significant increases, but it will impact us a little bit.

Stark Remeny -- RBC Capital Markets -- Analyst

Excellent. And I just had one kind of quick clarification on the severance and ad valorem tax changes. How do you guys see that playing out in terms of just net impact to your reported tax costs or production tax costs?

Jimmy Henderson -- Chief Financial Officer

Are you referring to a legislative change? Because there was -- they didn't address severance tax or production taxes generally as part of SB 181. We might see that at a later date, but it hasn't been addressed yet. If you're referring to adjustment in the first quarter, that's just a normal quarter since we actually pay the ad valorem tax for the previous year and run it through the tax calculation. There's always an adjustment in Q1.

So not exactly sure what you're referring to, but hopefully, that covers your question.

Operator

Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn the floor back over to management for closing.

Lynn Peterson -- Chief Executive Officer

OK. Thanks again for joining us this morning. We figured it'd be quick. It was a pretty straightforward Q.

With many of the bleak issues at least partially behind us, we look forward to starting a new chapter and continue to develop SRC's top-tier assets in a safe and efficient manner. The midstream buildout in the basin is of utmost importance, and we will coordinate our activity level with available gas processing capacity. SRC appreciates the strong support for the oil and gas industry that comes from Weld County. We remain dedicated to working with local officials at all levels and believe that our open dialogue and transparency with these groups will further strengthen already strong relationships.

I would also like to thank our staff for their dedication, hard work and focus on safety. I'm very proud of the character and the resiliency of our team it displays every day. We'll be attending some conferences over the coming quarters, so we look forward to seeing many of you at these events. In the meantime, please reach out to John Richardson if you have any questions.

And have a wonderful day. Thank you.

Operator

[Operator signoff]

Duration: 26 minutes

Call participants:

John Richardson -- Investor Relations Manager

Lynn Peterson -- Chief Executive Officer

Welles Fitzpatrick -- SunTrust Robinson Humphrey -- Analyst

Mike Eberhard -- Chief Operations Officer

Jimmy Henderson -- Chief Financial Officer

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Stark Remeny -- RBC Capital Markets -- Analyst

Nick Spence -- Chief Development Officer

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