CNX Resources Corp (CNX) 2018 Q1 法說會逐字稿

Good morning, and welcome to the CNX Resources First Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Tyler Lewis, Vice President of Investor Relations. Please go ahead, Mr. Lewis.

Thanks, Anita, and good morning, everybody. Welcome to CNX Resources First Quarter Conference Call. We have in the room today Nick DeIuliis, our President and CEO; Don Rush, our Executive Vice President and Chief Financial Officer; and Tim Dugan, our Chief Operating Officer.

Today, we will be discussing our first quarter results, and we have posted an updated slide presentation on our website. To remind everyone, with CNX acquiring the remaining 50% membership interest in CNX Gathering LLC this quarter, CNX is consolidating its results, which includes a 100% of the results from CNX, CNX Gathering LLC, CNX Midstream GP LLC and CNX Midstream Partners LP.

Earlier this morning, CNX Midstream Partners, ticker CNXM, issued a separate press release. As a reminder, they will have an earnings call at 11:30 today. The dial-in number for that call is (888) 349-0097. As a reminder, any forward-looking statements we make or comments about future expectations are subject to business risks, which we've laid out for you in our press release today as well as in our previous Securities and Exchange Commission filings. We will begin our call today with prepared remarks by Nick, followed by Don and then Tim, and then open it up for Q&A. With that, let me turn the call over to you, Nick.

Thanks, Tyler, good morning, everybody. Let's begin with a very important theme for some time now and one that has continued into the quarter. Off the heels of the separation of the company late last year and the Midstream acquisition at the beginning of this year, first quarter 2018 provided us the opportunity to really kick our capital allocation velocity into high gear, as we moved exclusively into execution mode. In short, we're in an era of playing offense and our opportunity set is robust. More on this and the thoughts on this in a moment. Before turning it over to the team for specifics on financial and operational metrics. Let's hit some of the important highlights for the quarter.

Most of you are aware, we held an analyst and investor meeting on March 13, providing a tremendous amount of updated information. Some of that information already contained a few highlights from the first quarter, with the meeting having taken place towards the end of the quarter. So I'll provide just a quick summary of you might have already heard back in March as well as some key updates.

If you turn to Slide 3 in our deck that we posted this morning. The slide really helps pull together some of the major takeaways from the first quarter, but it doesn't include everything. Said differently maybe, it was an exceptionally busy and very successful quarter. Tim Dugan is going to touch on operations in more detail. But you can see, as highlighted on the slide, that we had record production in the first quarter of 129.5 Bcf or average daily production of 1.439 Bcf per day. First quarter does include contribution from the Shallow Oil and Gas asset that we sold, which I'll get to in a moment, and that was approximately 4.5 Bcf with a 129.5 Bcf. So production was very strong, but more importantly, we achieved this record level of production through the deployment of capital investment with high internal rate of returns meaningfully above our cost of capital. As a key component, perhaps the key component of our capital allocation philosophy at work. Sticking with operations, we continued our stacked pay delineation program, turned-in-line 2 additional deep dry Utica wells, the Richhill 11 well in our Southwest PA central type curve region, and the Marchand 3M well in Indiana County, PA, which is on the Northern fringes of our CPA South type curve region. Tim is going to provide more detail, but suffice to say that we continued to be excited about the deep dry Utica and the disruptor that we think it would be in the Appalachian basin in terms of stack pay development, and the economies of scale that it brings to the table. Also during the quarter, we continued our share repurchase program. More detail on that in a moment, but yet another key component of our capital allocation philosophy at work. In addition to repurchasing shares this quarter, we also paid down approximately $391 million of our 2022 notes.

And you shift over to Midstream on Slide 3, we had a lot happen on this side of our business throughout the quarter. I mentioned earlier, we closed on the acquisition of the remaining 50% interest of the GP that our previous joint venture partner held for approximately $305 million. This now gives us 100% control of that entity. We offset the purchase price with an inaugural drop-down post acquisition of the Shirley-Pennsboro Midstream assets for $265 million. And in addition to the Shirley-Pennsboro drop this quarter, we sold our Shallow Oil and Gas assets and some other miscellaneous assets for $102 million.

Now last, but certainly not least on Slide 3, following the close of the quarter, CNX entered into an exchange agreement with HG Energy. I'll touch more on this in a few slides and what it means for CNX. I'll also highlight that we intend to go into more specifics on our CNX Midstream call at 11:30 a.m. Eastern today on how that impacts CNX Midstream.

Shifting over to Slide 4. Just mentioned that we sold our Shallow Oil and Gas assets this quarter. That brought in around $88 million in cash. What it also did was remove approximately $200 million of liabilities associated with plugging and abandonment which were previously on the balance sheet as asset retirement obligations. Now some of the highlights of the transaction are shown on that slide. But the key takeaway, at least from our perspective, is that the days of legacy liabilities when it comes to CNX Resources are over. Now this transaction finalized the process and focus that has been underway for years, and we've successfully closed that chapter in our history.

Turning to Slide 5. And as I mentioned, we continued our share repurchase program throughout the quarter and bought back over 13 million shares in total since the inception of the program back in September of '17. This equates to around $200 million out of the $450 million 1-year authorization that's in place, not only is the sheer number of shares that we've purchased in a relatively short period of time noteworthy, but what's more important is the average price at which they were acquired. Since completing the spinoff, we've repurchased shares at a weighted average price of $14.61 per share. We continue to see a significant disconnect in terms of where our shares trade relative to our internal views and net asset value per share. Rest assured, we'll continue to execute share repurchases using annual organic cash flows, balance sheet capacity up to our targeted 2.5x net debt leverage ratio and any potential proceeds from asset sales.

As we highlighted in March, looking out over our 5-year plan and given our EBITDAX ramp, the share repurchase opportunity is meaningful, and we've calculated that we have approximately $3 billion of cash using balance sheet capacity alone, which we've got the option to put towards additional share repurchases. Now some of you may be asking why we pre-released our first quarter numbers after markets closed last Friday. I can tell you that going back to our comments at the outset, regarding capital allocation and being in an era of playing offense that when we see a window, we won't hesitate to be nimble and opportunistic. The pre-release, it allowed us to get back in the market buying shares, we saw an opportunity, and we went for it. Expect much more of that kind of mindset as we move forward and when you think about it, right now we're currently or simultaneously growing cash flows at high rates of return, reducing leverage ratio and reducing share count. That's a special and unique story and one that we'll continue to execute on in an opportunistic way. So stay tuned, lots of exciting opportunities on the horizon and we look forward to providing updates as things continue to progress on that front.

Now before turning it over to our CFO, I wanted to wrap by briefly highlighting the transaction that CNX and CNX Midstream closed yesterday with HG Energy. This is a strategic transaction for CNX, for CNX Midstream and taking the liberty of speaking for HG, also for HG. All in, it's a win across the board for all 3 of those companies. Again, CNX Midstream is going to go into a lot more detail on what this means for the midstream entity later this morning, but suffice to say right now, it's quite a strong deal for CNX Midstream unitholders. For CNX, it's simple yet powerful. As part of the exchange, we received $7 million in cash plus 15,000 undeveloped Marcellus and Utica acres in our Southwest PA central type region. Of the 15,000 acres, 14,100 of those are undeveloped Marcellus, all in, assuming the same lateral length and spacing assumptions that we laid out in March, this transaction adds roughly 70 locations to our core of the core Southwest PA Marcellus inventory. After three years, under our expected activity pace, we project to have now 287 locations of the core of the core Marcellus in Southwest PA Central going into 2021. That's over a 30%, roughly a 32% increase in the core of the core inventory after 2020 compared to what it was pre-deal. With the rates of return and the economies of scale we enjoy with locations in this crucial region that bodes really well for CNX's NAV per share, cash flows, stacked pay set and capital allocation efficiency into the future.

With that as promised, I will turn it now over to Don Rush.

Thanks, Nick, and good morning, everyone. And as Nick mentioned, I will be walking through specifics of the HG transaction on our Midstream call at 11:30 today. So for those interested in more on that, please be sure to tune in then.

Shifting to CNX in the quarter now. As Nick mentioned, this was the first full quarter for CNX as a stand-alone E&P company and it was an impactful one. From the GP closing to the Shirley-Penns drop to the SOG sale, to the HG transaction, and most importantly to our year-on-year EBITDA growth, our Q1 results really show how quickly we have moved and how well we are executing. But before I discuss those results, I want to clarify a few things regarding recent changes in our financial reporting, due to our recent 100% ownership of CNX Gathering. These are laid out on Slide 7.

Prior to the closing of the transaction on January 3, we accounted for a 50% interest in CNX Gathering through the equity method of accounting. However, starting in the first quarter, we have begun consolidating 100% of the results of CNX, CNX Gathering, CNX Midstream GP LLC and CNXM into our financials.

We think it is important to understand each of these businesses, CNX and CNX Midstream individually first, and then to understand the different ways they can be grouped together. In our press release this morning, we distinguished between figures that are consolidated, meaning 100% of both companies and those that are attributable to CNX shareholders.

These attributable results' subtract CNX's noncontrolling interest in CNX Midstream, which is approximately 64%. This percentage represents the share of LP units not owned by CNX. This math is being used to highlight some of the main metrics as depicted on the slide.

Now, for capital and cash flow from operations, it's slightly different. And we look to only what each entity pays in capital and generates in cash. For CapEx, we are backing out the capital that the MLP paid, which is $14 million. And if you look at CNX Midstream's financials, you will see a gross capital number of $16 million and a net number of $14 million to the MLP. The difference between the 2 is what CNX Gathering spent, which is reflecting -- reflected on the slide.

For cash flow from operations, we simplified the approach and simply made it consistent with the EBITDA breakout percentages. We believe that separating the results for both the upstream and midstream segments gives analyst and investors the most accurate view of the operating performance of the company, which is what we are reflecting in our EBITDAX reconciliation table in our earnings release and in our slide deck on Slide 19 in the appendix.

Also to be clear, when we discussed EBITDAX guidance, we are referring to EBITDAX attributable to CNX shareholders, which includes only the attributable portion of EBITDA from CNX Midstream. To illustrate, our adjusted EBITDAX guidance for the year is reaffirmed in the range of $825 million to $850 million, and includes $60 million to $65 million of CNX Midstream's EBITDA, which is only the attributable portion of the MLP or about 36% of it.

We would recommend that analysts submit EBITDAX estimates on an attributable basis and not on a fully consolidated basis so that figures are most comparable to guidance and to other estimates. The item we view as most important is that the methods are being applied consistently to debt into EBITDA, whether it'd be consolidated, attributable share or simply upstream or midstream only. Otherwise, you'll have an inaccurate financial view, especially for things such as leverage, which I will briefly touch on in a couple of slides.

Now, moving on to the quarterly results, starting on Slide 8. In the first quarter, we had an adjusted net income attributable to CNX shareholders of $42 million or $0.19 per diluted share. And an adjusted EBITDAX attributable to CNX shareholders of approximately $236 million. As you can see on the slide, this is an increase of 90% when compared to the first quarter of 2017. This increase is exactly what we have been foreshadowing for some time now. And this sharp rise in EBITDAX supported by our hedge book and acreage position gives us confidence in our leverage ratio target and our share repurchase strategy.

And also to note, we did recognize a GAAP gain of $624 million on January 3. But we are reconciling it out of our adjusted results. I would also reiterate, as Nick said earlier, that we posted $102 million in proceeds from asset sales, primarily related to our Shallow Oil and Gas transactions. In addition to that, we completed our first drop-down into the MLP for $265 million. It's important to note that the $265 million doesn't show up on the cash flow statement in our consolidated financials since CNX received $265 million, while CNX Midstream spent $265 million. For consolidated accounting rules, the transaction was net neutral in that sense. However, if you add this to the proceeds from the asset sales in the quarter of $102 million, you can see that CNX actually received almost 375 -- $370 million from asset sales in the quarter.

Turning to Slide 9. You can see that the net -- you can see the net debt for each company on the slide, CNX and CNX Midstream at the end of the quarter. Again, we feel it is important to understand them individually. And we will continue to show each company individually as well as the attributable share method to match our EBITDA guidance. As you can see from the chart, the net debt using the attributable share method is just under $1.9 billion. Again, this amount excludes the noncontrolling interest and CNX Midstream net debt. It is worth noting that CNX does not guarantee or otherwise provide credit support for the debt of CNX Midstream.

Also in the first quarter, we amended and restated our credit facility, and increased our lender's commitments from $1.5 billion to $2.1 billion. This was possible because our initial borrowing base increased from $2 billion to $2.5 billion.

We also purchased $391 million of outstanding 2022 senior notes in the quarter. In total, our balance sheet remains top tier and in tandem with our hedge book, grants us the flexibility to execute on our plans. As such, we continued to hold target leverage at 2.5x. For our guidance, if we did nothing different, we would be on track to be below that target.

However, as we highlighted in depth at our Analyst Day investor meeting in March, that is not our plan. And we will take advantage of any additional capacity on our balance sheet for high return capital allocation opportunities, such as future share buybacks.

Slide 10 gives an update on our hedge position. In the second quarter and through 2022. We remain committed to our methodical, programmatic hedging program and will continue to keep NYMEX and basis hedges closed, which is the only way to fully protect revenue. This strategy also allows us to employ our FT strategy. Our minimal FT book we feel is an advantage compared to our peers, and we continue to see near median realizations with a fraction of the FT liabilities of our peers. In the quarter, we layered in about 168 Bcf of NYMEX hedges and 193 Bcf of basis hedges through 2022. For 2018, we are more than 80% hedged on both NYMEX and basis compared to the midpoint of our guidance range.

As I mentioned before, these locked-in revenues give us confidence in our continued EBITDAX growth and are supporting our leverage ratio target and share repurchase strategy. While on the topic of marketing, I would quickly add that our exposure to Mariner East 1 is much smaller than many of our peers, although we are still hopeful that they return to service in the next couple of days. We do rely on that line to sell some of our ethane and during the shut-in, we've simply rejected that ethane into the gas stream. This has resulted in no flow curtailments and the economic impact it had was very limited.

I'd like to walk through a few guidance and modeling highlights now on Slide 11. Overall, we are reaffirming our guidance we issued at our Analyst Day in March. That means we continued to expect total EBITDAX attributable to CNX shareholders in the range of $825 million to $850 million. This is based on total production volumes in the range of 500 Bcfe to 525 Bcfe, which we are also reaffirming. As Nick mentioned, SOG volumes were included in the 129.5 Bcf reported this quarter but we removed them for the rest of the year, as this transaction closed at the end of the quarter. That is reflected in the 500 Bcfe to 525 Bcfe annual guidance. With regards to our EBITDAX guidance, since providing guidance at our analyst investor meeting, gas prices have trended slightly higher in the quarter but were modestly offset by a reduction in the realized gain on hedging. We had an 8% sequential decline in liquids pricing as well. But the total impact is not material to our top or bottom line. Our operating cost guidance is also unchanged, despite some abnormally -- abnormal LOE costs in the first quarter, that Tim will address here shortly. And just a reminder, our full year gathering costs are benefiting in 2018 from the rapid increase of Monroe County dry Utica volumes with favorable gathering costs compared to the rest of the portfolio.

And in line with the CNX Midstream earnings release this morning, in which they reaffirmed their 2018 guidance, we continued to expect approximately $60 million to $65 million in EBITDA contribution from our attributable portion of CNX Midstream. Lastly, another operating expense, we are seeing some positive momentum in unutilized FT costs, as we've been working to release certain commitments and monetize capacity wherever possible. Our guidance remains unchanged for now, but we will update as necessary throughout the year. With that, I'll hand it over to Tim.

Thanks, Don, and good morning, everyone. With the spin transaction and the Midstream GP acquisition firmly in the rearview mirror, the team is excited to focus more and more on operational execution. And that's just what we did in the first quarter of 2018, as we drove record production volumes and lowered unit cost helping to set the stage for very strong year-over-year EBITDAX growth in the full year. Now I'd like to take a second just to clarify one statement on the HG transaction that Nick talked about that we closed late yesterday. We brought in 15,000 undeveloped acres in the Southwest PA central type curve region. 11,400 of those acres were Marcellus, not 14,100, which means we brought in 3,600 Utica acres.

So moving to Slide 12. Let's go through some of the operational highlights for the quarter. As already highlighted by the team, total sales volumes of 129.5 Bcfe represent an increase of 9% over the fourth quarter of 2017 and a 36% increase over the same period last year. Much of that increase can be attributed to the higher dry Utica volumes out of Monroe County, Ohio, as total Utica production is up almost 200% year-over-year. Our team continues to see successes, 5 completion designs and field optimization decisions in Monroe County, which we'll talk about shortly. Total production costs are down $0.22 per Mcfe year-over-year as the growth in Ohio dry Utica volumes with favorable gathering rates reduced overall gathering costs. There was an additional benefit from lower per unit DD&A year-over-year as rates were reevaluated as of year-end 2017. We expect to see DD&A unit costs around this level for the rest of the year. We did experience some higher-than-usual per unit lease operating expense in the quarter, driven by water disposal costs related to our activity schedule with a lot of these costs coming out of Monroe County where our ability to reuse water has decreased due to our activity starting to roll off in this area as we talked about at the analyst and investor meeting.

As a reminder, we have 15 total turn-in-lines in our 2018 plan, of which 6 were turned-in-line in the first quarter. Despite some of these abnormal LOE costs in the quarter, we are already seeing these costs moderate. Now regarding service costs, we continue to run 2 frac crews, which are under contract through September 2018, and we'll bring in a third crew as needed. We're not seeing service inflation to date, but there will be an opportunity for providers to renegotiate rates in September according to the terms of our contracts. Any potential increases are capped by the terms of the contracts and can be renegotiated by either side. Based on current market conditions for labor, equipment and commodities we are not expecting any major increases from renegotiations and have reaffirmed our full year 2018 capital budget.

On the drilling side, beginning in the third quarter of 2018, rig rates for 50% of our fleet are expected to drop 10% -- excuse me, 10% due to the expiration of legacy contract rates. As a result, we're not anticipating any meaningful increases in drilling costs for the year.

Slide 13 is a summary of our activity in the first quarter and the remainder of our plans for the full year. In the quarter, we ran 3 horizontal rigs, drilled a total of 19 wells, 17 of those in Southwest PA Central Marcellus and 2 in Monroe County dry Utica. In total, we turned 14 wells to sale, including 6 Southwest PA central Marcellus, 1 Southwest PA central deep dry Utica, 1 CPA South deep dry Utica. And as I mentioned, 6 in the Ohio dry Utica area of Monroe County. The 2 deep dry Utica wells are both important additional steps on the path to delineate the formation and build the stack pay factory we discussed on our analyst and investor meeting in March. The Southwest PA central dry Utica well we first announced in March, the Richhill 11E continues to undergo managed pressure testing in the early phase of its producing life. It's already provided a wealth of data necessary to optimally develop the Utica and the Richhill field and drive stack pay efficiencies in the very near future. The Marchand 3M deep Utica well is located in Indiana County PA, about 15 miles from our prolific Gaut in Aikens wells. This well is also undergoing managed pressure testing in the first weeks of its life. Marchand is a valuable data point in the broader delineation of deep dry Utica formation and CPA. But we plan to drill complete and turn in line 1 additional Utica well in CPA South in the second half of this year, near the Gaut in Aikens as we laid out at the investor meeting. Also in this slide, you can see the 2018 full year plan. The schedule is unchanged since our March meeting and we remain on track to turn in line 74 wells for the year while bringing on a fourth rig in the third quarter. Almost 2/3 of our activity for the year is in our prolific core of the core Southwest PA central, which is in CNX Midstream's DevCo I area. This activity should help drive predictable and repeatable results, maintaining an efficient operating cadence. As for the activity pace throughout the rest of 2018, we expect the second quarter to be the lightest, with a modest quarter-over-quarter decline compared to the first quarter of '18, with volumes increasing in the third and fourth quarters. Turn-in-lines are expected to peak in the third quarter, which will drive production to peak levels for the year in Q4.

Now, Slide 14. The Green Hill area in Southwest PA Central is a great example of how completion design optimization, operational advancements and well-delineated geological properties are driving capital efficiency gains in the core Marcellus. To be specific, GH55 well turned in line in the first quarter are seeing capital efficiency gains of nearly 40% compared to the wells from 2015 and 2016. This is driven primarily by improved cycle times and longer laterals. Most importantly, these completion designs and operational techniques are transferring as we speak to the Richhill, Marcellus area where we plan to execute stack pay development in the near future.

On Slide 15 is the other half of the stack pay equation, the dry Utica. In the first quarter, we continued to execute in the SWITZ area of Monroe County, Ohio, and have further refined our development plan to optimize development, not just by well or by pad, but by the entire field. As a result, we widened inter-lateral spacing from 1,100 feet to 1,350 feet, which improves capital efficiency as fewer total laterals are necessary to recover a similar level of production volumes. The result has been a 13% decline in cost per lateral foot and a 65% increase in total capital efficiency on the wider space laterals.

The map on the right of the slide illustrates why the progress we're seeing right now in Southwest PA central Marcellus and Ohio dry Utica are so important to the future of our development program. These operational techniques and field design schemes are carrying directly into Richhill where the geological characteristics are similar in both formations. The capital efficiency gains driven by these techniques and development plan will only be compounded by the expected gains from stack pay development. We will be increasing Richhill Marcellus activity substantially in the second half of this year, and plan to have the stack pay factory in manufacturing mode in Richhill by the end of 2019.

To recap, we're setting the stage for future dual-formation development with solid execution across the portfolio, as we speak. We reached record levels of production in the first quarter at 1.44 Bcfe per day. We continue to be excited about prospects for the deep dry Utica in both Southwest PA and CPA and look forward to keeping you all informed of our progress. With that, I will turn it over to Tyler.

That concludes our prepared commentary. Anita, if you could please open up the lineup for Q&A at this time.

(Operator Instructions) The first question today comes from Holly Stewart with Scotia Howard.

Maybe the first question for Tim. I know you mentioned you only have one more kind of deep Utica well planned for the year. But it looks like you pushed up the end service of the Marchand well. So should we think about this as this is the plan or could things change if well performance continues to outpace your expectations.

Well, the pushing up of the Marchand was just due to cycle time improvements across-the-board. Our plan that we laid out in March has not changed. So the wells that we laid out or the number of wells that we laid out for the dry Utica in March in the next year or 2 stays the same, and we will continue to pursue the delineation program and move into development in CPA. And in Southwest PA, as I mentioned, we'll be moving into the stacked pay mode here full fledge in 2019.

Can you -- speaking to that, can you remind us are there any official stack pay wells planned for '18?

There's just another delineation well later in the year that we highlight Holly, the -- 1 additional CPA well a little bit later in the year. I think, the first stack pay well will be -- or pad, will be in 2019. And at end of that year, we'll get more heavily into stack pay development and -- it's just an ongoing progression.

Okay, great. And then maybe one for Nick. Just to get a better sense of how you might proceed with a buyback. I know the leverage metric seems to be your sort of governor here, but you've got $250 million remaining, I think, and that expires in September. So if you exhaust that before September or if it expires, how should we think about sort of moving forward? You just get board approval for a new one or just kind of give us a sense of how to think about the ongoing buyback?

Holly, I think, it really goes back to the approach we use on why we are interested in the share repurchases. These are viewed from the get-go as opportunistic more than what I call programmatic. So it's not something or an instance where we'd want to allocate so much of our cash flows per year or per quarter to something like share count reduction. It is instead more looking for windows of time when we have disconnects between what we think the company is worth and what the shares are trading at and doing those types of activities then and at some point stopping them when you get parity to what we think the company is worth on a NAV per share basis. So looking forward to the rest of the year, I still see a window there to get really strong rate of returns on share repurchases above our margin of safety. And unless something changes materially on share price the expectation should be that we continue in some fashion. Now as to what happens when we get into sort of the end of the one-year authorization and whether we keep going or put another program in or the specific timings of when the 450 program wraps up, probably premature to say at this point, but right now we see a window and right now we plan on continuing on.

That's great. And maybe just one final one for me. Just kind of high-level looking at this strategic transaction with HG. Is there anything, since you're adding acreage, that we should expect to sort of play into the 2018, '19 development plans?

I think the way to look at that in particular with the question you're asking is 1 or 2 ways. And it really goes to, I think, it was Slide 6 in our deck that was a repeat of what we had in March. It was making the point back in March that our core of the core Southwest PA Marcellus locations, we take our activity set that we projected out over the '18, '19, '20 timeframe, we would still be left with -- at the time I think was 2017 core of the core location. So the point at that time was, we've got additional running room with Marcellus after that time period or have the opportunity to grab upside or cover contingency items in the front 3 years. This deal, when you look at it from a resources perspective, it adds to that inventory and using the acreage numbers that we quoted with our spacings, et cetera, it takes that what was 217 up to 287 of remaining inventory at the end of 2020. So that added inventory could do a couple of things on the resources side and then translate into value on the Midstream side. That could be additional upside capacity for us if we continue to compress cycle times. That could be contingency covering or fallback position, plan B, so to speak if something or some bottleneck pops up over the coming years with respect to our plans in growth. But suffice it to say, no matter which one of those 2 we end up in, these are some of the highest, if not the highest rate of return capital location options we have within the portfolio. And being able to grow that by 32% is a really good thing not just for resources, but also for Midstream. We just closed yesterday, so we're going to be working like crazy across the resources in Midstream team to figure out what impacts if any result in a new sort of optimized view out over the coming years. But I think, with everything we've laid out in March and everything we've laid out today, the overall picture, the overall game plan has not changed other than we got more running room.

(Operator Instructions) The next question comes from Welles Fitzpatrick with SunTrust.

Maybe a first one to follow up on Holly's question, and, obviously, you guys are going to talk more about this on the Midstream call. But this 70 additional locations from the transaction, is it safe to assume that those are in the kind of 9,500-foot lateral range and that the royalty is probably a little bit closer to market price than the kind of 9% to 13% that you guys currently enjoy in Southwest PA?

I don't have the breakout of the royalty interest offhand, although there is some key properties associated with some of that. I don't remember the split offhand. But in general, these are wet properties. So they sort of kind of add some of those inventories to our positions and attractive -- Tim can talk more, but attractive acreage footprint that will allow us a lot of different options on how we want to lay out the laterals.

Okay, perfect. I'm sorry, go ahead.

With the average lateral lengths that we've laid out from our Analyst Day.

Okay, wonderful. And then just a modeling one. Obviously, the water disposal costs you hit on pushed up 1Q LOE. But, obviously, you have full year guidance out there, but should we see a big drop into 2Q with the shallow divestiture. Presumably those had a much higher per unit LOE. I know the production wasn't that flush.

I think, the shallow operating wells were -- did have a higher operating cost. So the impact of that will be reflected. Those being moved out. And then as far as the water, we've already taken steps to improve those costs. That was really -- a lot of that was tied to activity set. It was also impacted by weather. We had to take more of our water to disposal. And because of the weather that we saw early on in the quarter, more operators had to take water to disposal because of slowdown in activity and created some long wait times at disposal wells and increased our disposal costs. But we've already taken steps to improve that significantly.

Okay, that makes sense. And then just one last one from me. Any update on the Cardinal open season and post the CBM sale. Is that thought of internally as much more of a drop candidate than a sale candidate?

Yes. So no further updates on any open season there. But the -- we've laid it out as a potential drop candidate into CNXM. We do think highly of the asset, it's a positive free cash flow producing asset. Like anything, we're always looking to maximize opportunities anytime they present themselves. But right now, we're just going to continue to enhance the value there.

The next question comes from Sameer Panjwani with Tudor.

On the Utica and Southwest PA and Central PA, are you planning to test spacing in 2019. Just looks like you're little bit tighter versus the Ohio Utica where spacing was widened out a little bit?

That will be -- I think that will be a part of the natural progression, as we move from delineation into development mode with the 2 Aikens wells that we drilled. We did some testing that would give us some thoughts into spacing. But yes, as we do more and more that will be part of our development process, understanding proper spacing, proper completion designs and size, and we will move forward with that.

Okay, great. And then on the asset exchange with HG. Looks like you're giving up a bit on the Midstream side. Just wanted to see if there was any impact to the drop-down EBITDA potential? And then kind of following on with that. Does the transaction on the Midstream side help the Midstream entity potentially pull forward, I guess, the timing of any potential drop downs?

Yes, great question. So ultimately on the $200 million of potential drop at EBITDA, that was -- the vast, vast majority of that was EBITDA associated with CNX assets and CNX properties. So very de minimis to the $200 million that we quoted at Analyst Day. And we do feel that it enhances the MLP's ability on the drop side of the fence. And we'll get into that more on the second call. But the certainty in distribution growth coupled with potential upside of incremental volumes, incremental wells being drilled, enhances its ability to finance things sooner than it otherwise could have. So we feel this is a big enhancer to both the Midstream company's sort of streamlined value and its ability to do drops with CNX Resources.

Okay, perfect. And then last one from me. Just thinking about the leverage metric governor at 2.5x. As you guys think about it internally in terms of potential capacity for additional buybacks, do you guys internally think about it on an annualized, kind of, full year basis or do you kind of look at it as a quarterly annualized number on the EBITDA?

Yes, so another great question. I think, sort of how we talked a little bit about making sure you look at things multiple ways earlier on in the call. It's important and we think it's important to do similar for our leverage ratio target. So we kind of take a holistic approach. We do look at trailing 12 months. We look at next 12 months. We look at last quarter annualized, and we kind of use all 3 of those to kind of govern a comfortable place going forward. This, we feel, allows us to ensure that we're tracking properly and in a good spot, whether we have growing EBITDA, potentially declining EBITDA, flat EBITDA. Those 3 across the board will always kind of keep you in a comfortable zone. So we look at them all, and we'll continue to look at them all as we go forward.

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Lewis for any closing remarks.

Thanks Anita, and thank you, everyone, for joining. We look forward to speaking with everyone again next quarter. Thank you.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.