Coterra Energy Inc (CTRA) 2021 Q3 法說會逐字稿

Good day, and welcome to the Coterra Energy Third Quarter 2021 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Caterina Papadimitropoulos, Investor Relations analyst. Please go ahead.

Thank you, Matt. Good morning, everyone, and thank you for joining Coterra Energy's Third Quarter 2021 Earnings Conference Call. During today's call, we will reference an updated investor presentation, which can be found on the company's website.

Today's prepared remarks will include a business overview from Tom Jorden, CEO and President; and Scott Schroeder, Executive Vice President and CFO.

As a reminder, on today's call, we will make forward-looking statements based on our current expectations. Additionally, some of our comments will reference non-GAAP financial measures. Forward-looking statements and other disclaimers as well as reconciliations to the most directly comparable GAAP financial measures were provided in this morning's earnings release, which can be found on our website. Following our prepared remarks, we will take your questions. (Operator Instructions)

With that, I'll turn the call over to Tom.

Thank you, Caterina, and thank all of you for joining us on this morning's call. I'll make a few introductory remarks followed by Scott, who will walk us through third quarter financials and fourth quarter guidance.

We have quite a crew in the room today, and I just want to make sure you know who is in the room because we may be directing questions to them given the complexity of our release. Blake Sirgo is here for operations; Dan Guffey is here for financial planning and analysis; we have Todd Roemer, our Chief Accounting Officer; we have Matt Kerin for Finance and other overarching business issues, including marketing; and of course, Scott, who will be making some prepared remarks.

The closing of the Cabot and Cimarex merger occurred on October 1. As a result, legacy Cimarex will not report third quarter financials.

I'm pleased to report that Coterra Energy is well underway with the integration of our 2 legacy companies. As you can imagine, a merger of equals between Cimarex and Cabot is not an easy task. We've been full court press since May. We have functional teams working around the clock to integrate accounting, information systems, production reporting, safety protocol, land systems, operations, marketing, legal and human resources. Each of these teams are tasked with identifying and implementing best-in-class systems and processes.

Our approach is all Coterra, all go forward. That's not the way we've done it here is not an acceptable answer. We've made great strides and we'll hit the ground running as we head into 2022.

I want to salute our exceptional people from both legacy organizations who are coming together to form a new, better Coterra from 2 outstanding legacy companies. We all share an enthusiasm and commitment to create the very best E&P company in our industry. I have great confidence that we will exceed our lofty expectations.

Speaking of confidence, this morning's announcement that we are accelerating our first variable dividend underscores and demonstrates this confidence. Coterra is built to deliver superior financial returns through the cycles. This morning's announced base and accelerated variable dividend totals a combined $0.30 per share. Coupled with the $0.50 special dividend we paid on October 22, the company will return $0.80 per share during the fourth quarter.

As these moves demonstrate, we are committed to our owners. Coterra owners benefit from assets that are second to none, a pristine balance sheet and asset diversity that will sustain and preserve our cash flow through commodity cycles. Our owners also benefit from our ongoing discipline to allocate capital to its most productive use and continually challenge the status quo.

Although Coterra is barely 1 month old, we have some excellent operational results to discuss this morning. On a pro forma basis, Coterra produced 645,000 barrels of oil equivalent per day, including 81,500 barrels of oil per day during the third quarter. As promised, we are on track to exit 2021 with oil rates that are 30% greater year-over-year compared to fourth quarter 2020.

We brought 61 wells online during the quarter and are currently running 7 rigs and will average 4 completion crews during the fourth quarter. Five of our rigs are in the Delaware Basin, 2 rigs are in Susquehanna County of Northeast Pennsylvania. We benefited nicely from higher commodity prices during the quarter. This was true across the board. Oil, gas and natural gas liquid prices were significantly higher during Q3 and have continued to strengthen. More on that later.

We continue to see excellent productivity and deliverability from our Northeast Pennsylvania assets.

Slide 8 in the investor deck we posted this morning highlights our ongoing activity level and sustainable production volumes in Northeast Pennsylvania. Our Pennsylvania operation is impressive on all fronts. We continue to make remarkable drilling progress and are bringing projects online faster than predicted. Faster drilling has meant that we can drill more wells with the same number of rigs, resulting in 4 additional wells drilled during 2021.

When acceleration occurs owing to operational excellence, it's a nice problem to have. We're also moving 7 additional completions into late fourth quarter '21 from early '22, pushing our planned Marcellus capital slightly above the upper end of our previously issued annual guidance range. As a result, we will have additional volumes coming online around year-end to take advantage of strong Appalachian winter pricing.

We continue to see a significant increase in capital efficiency in our Delaware Basin assets.

Slide 9 of our investor presentation highlights recent development projects in Culberson County. As we've previously discussed, we are observing that relaxed spacing and modestly upsized completions can significantly improve low-level returns and, in many instances, recover the same amount of oil per drilling spacing unit than more dense well spacing. We are achieving increased productivity per well, similar section recoveries and increased PV10 with substantially lower capital per drilling spacing unit.

We are also seeing excellent results from our lone 2021 Anadarko development, the 5-well Carel/Elder, which targets the Woodford Shale. Slide 11 in our deck illustrates the uplift we have seen with relaxed spacing and improved completions. Our Anadarko team has assembled a deep inventory of projects that are highly competitive for capital.

I would also like to make a few comments regarding our ESG performance. Coterra, like both legacy companies before it, is deeply committed to making ESG performance a top priority. Our industry has grand engineering challenges, and we embrace these challenges wholeheartedly. Coterra is dedicated to be a top performer in ESG metrics, to be transparent in our communication and to aim higher than state and federal requirements. We will be an industry leader in ESG performance.

As we look ahead into '22 and beyond, Coterra is well positioned to generate consistent returns. We have the flexibility to pivot in response to market constraints and opportunities, commodity price swings and operational advances.

Our capital allocation philosophy is supported by 3 pillars: geographic diversity, commodity diversity and economic windage. Geographic diversity and commodity diversity are self-explanatory. Economic windage is provided by having assets that provide some of the highest margins in our business. High margins and a low cost structure mean that returns are preserved through downdrafts in commodity prices. These pillars are our fundamental attribute and a competitive advantage of Coterra. Our capital discipline, diversity and flexibility underwrite our ability to generate outsized returns and accelerate return of capital to our owners.

With that, I will turn the call over to Scott.

Thanks, Tom. As you mentioned, given the merger closed in the beginning of the fourth quarter, the reported third quarter financials for Coterra Energy only reflect the results of legacy Cabot for this reporting period. However, my comments will include key items for legacy Cimarex also.

I would specifically like to draw attention to the following financial and operational highlights for the third quarter. Legacy Cabot generated discretionary cash flow of $309 million in the quarter, including merger-related expenses, which was driven by a 69% increase in realized natural gas prices compared to the same quarter a year ago. Looking ahead, realized natural gas prices are anticipated to increase substantially in the fourth quarter of '21, driven by the expectation for the highest average quarterly NYMEX price we have experienced since the fourth quarter of 2008.

The combined Cabot and Cimarex free cash flow for the quarter totaled $387 million, which also included merger-related cost of $100 million. Legacy Cabot's production for the third quarter was 2.36 billion cubic feet per day, which was 2% above the high end of our guidance range for the quarter. Legacy Cimarex production for the quarter was 251,000 barrels of oil equivalent per day, including 81,500 barrels per day of oil production.

Legacy Cabot incurred a total of $171 million of capital expenditures in the third quarter while legacy Cimarex incurred $165 million of capital expenditures in the third quarter, excluding capitalized expenses. I would also note that moving forward, Coterra will be reporting under the successful efforts accounting method that legacy Cabot utilized, which does not capitalize G&A and interest expenses.

During the third quarter, legacy Cabot repaid $100 million of senior notes that matured in September, reducing our principal long-term debt to $949 million. On a combined basis, Coterra exited the third quarter with a cash balance of $1.1 billion and principal long-term debt of $2.9 billion before adjustments for purchase accounting.

Our strong balance sheet provides significant financial flexibility and allows for industry-leading capital returns through the cycles as evidenced by the special dividend we made -- paid, excuse me, in October and the acceleration of our variable dividend that was announced in this morning's release.

Now a few comments on guidance. Our fourth quarter '21 combined production and expense guidance assumes that we achieve results that meet our previously issued stand-alone annual guidance. Of note, we are reaffirming our fourth quarter oil guidance, which assumes 30% year-over-year growth, as Tom highlighted earlier.

Our full year '21 combined capital is expected to be at the high end of the ranges due to increased efficiencies and an accelerate -- an acceleration of completions in late fourth quarter. Obviously, due to the timing of these actions, the increase in capital is expected to have no effect on '21 production volumes but will benefit '22 volumes, taking advantage of the strong commodity price environment we find ourselves in.

In the Permian, we are maintaining a second crew during fourth quarter '21 to complete our Lea County project versus our original annual guidance midpoint, which assumed we would drop to 1 crew in the fourth quarter.

In Appalachia, we plan to drill an additional 4 wells and complete an additional 7 wells during 2021. These completions are set to come online near year-end.

During the first quarter of '22, we plan to maintain 2 completion crews in the Permian and average just over 1 completion crew in the Marcellus. We plan to issue formal '22 guidance early next year.

The combined financial strength and free cash flow generation potential of Coterra that was originally envisioned when contemplating this combination is illustrated in these results and has been further supported by the tailwinds from the improving commodity price backdrop.

With that, Matt, I will turn it over to you for Q&A.

(Operator Instructions) Our first question will come from Neil Mehta with Goldman Sachs.

Congrats, team, on closing the transaction here and reporting your first quarter together as a company. Maybe just a high-level question to kick off. Tom, just talk about how the integration is going, bringing together the 2 cultures and what you're seeing early on that gives you confidence in the combination? And what do you think is the biggest obstacle that you need to overcome in order to achieve your goals here?

Well, Neil, thank you for that question. The integration is going very well. The single obstacle are moving trucks. We're still kind of dispersed and flying around to meet with one another. But here, as we get into November, December, we'll all be down the hall from one another, and that will certainly give us a head start.

You know what, I am wholly optimistic, and I'm optimistic for several reasons. First and foremost, and you know my background, Neil. I fundamentally believe that the only competitive advantage a company has in the long run is its culture and the quality of its people, and I have been wholly impressed with the Coterra organization from top to bottom. We have people that are energized, really talented, willing to look at problems anew and they bring an absolute commitment that's humbling to me in leading this organization.

I've made 2 trips to the field in Pennsylvania, and I have been nothing sort of blown away by the quality of that operation and the dedication of our organization to work with the local community in providing this absolutely necessary resource in a way that is, I think, community friendly. Across our platform, we have people working together to develop new tools to develop ways to make the best, most disciplined capital allocation, and there's just great energy. It's really fun to be in the middle of this. And I just -- fasten your seatbelt and watch us perform.

All right. And the follow-up is just on gas fundamentals. How are you guys seeing the market here as we go through winter but more structurally as we think about '22 and '23? And in that context, what's your approach to hedging? I believe you guys are about 20% hedged here over the next couple of quarters, so you're still relatively open. But how do you plan on attacking the curve from here?

Neil, this is Matt Kerin here. I'll address the fundamentals and then hand it over to Tom or Scott to discuss hedging philosophy. So currently, we obviously feel very bullish on the fundamentals that we've seen for gas. Obviously, we've seen a pretty big uptick in the forward curve over the last couple of months, which we think will certainly be beneficiary for Coterra going forward given the lack of hedging in place right now for 2022.

If you kind of look at the U.S. storage levels currently, we're about 10% below last year's levels and about 4% to 5% below the 5-year averages. And more specifically to where legacy Cabot operates in the Marcellus, we see similar trends in both the Eastern and Midwest storage levels. So both for the broader NYMEX benchmark, but as well as local basis, we feel really strong about where we sit entering the winter months and certainly going into 2022.

Yes, Neil. And in terms of hedging, again, like Tom talked about the integration, we're coming together. We have a formalized hedging policy. We have yet to kind of sit down at the table and collect our thoughts.

But Tom, myself and Jeff Hutton, our legacy marketing person, will be part of the hedge committee going forward. As you saw in the release this morning or in the investor deck, we did add some Cabot hedges around the time of the transaction as we saw the -- and followed the path of kind of wide collars. And I think that's still a great approach.

But we'll be -- the positive on the market that's out in front of us that Matt talked about is we have the ability to be very offensive in terms of -- on our front foot around the hedge decision versus being in a defensive posture, trying to protect things.

The other dynamic I would add, and Tom and I had a conversation probably a month ago is the fact that Coterra also changes that hedge decision from the perspective of its balance sheet and its overall financial wherewithal that there isn't as much when we were separate organizations, the need to hedge as much, but we will still use it opportunistically.

Our next question will come from Matt Portillo with TPH.

Just a quick question. Looking out into 2022, balance sheet is in pristine shape. And obviously, you've already initiated a fairly robust return of capital program for shareholders. Tom, just a higher-level question. Philosophically, how do you think about buybacks in this environment as the debt load is in good shape? You've got the basin diversification and the equity is trading at a pretty steep discount to probably long-term intrinsic fair value.

Well, that's a great question. It's certainly in our toolkit is our buybacks. We're going to have tremendous flexibility financially. As we look into 2022, I'm stunned at how constructive one can be in terms of the amount of our capital that we need to invest to stay flat or generally flat. So we're going to have great flexibility with cash even after our stated commitment of return to cash to our owners.

We're going to model it. I'll just say there's going to be one word that will guide us into 2022, and that's discipline. And we're going to be disciplined in our capital, we're going to be disciplined in our capital allocation and we're going to be disciplined in our use of funds, and we're going to look seriously at buybacks, you have to. But we're not going to do it because it's a fad. We'll do it because we think it's a prudent use of our capital. Scott, do you want to comment on that?

I think you've covered it. And it's been an arrow in the quiver of the organization for a long period of time. And I think, as Tom said, it will be fully vetted. We're in the process of pulling that together. You mentioned the intrinsic value. We need to do that deep dive on intrinsic value. We also have to think strategically about it because historically, when prices are good, your values are up even if you're at a discount from your peers. When the prices move down, then all of a sudden you bought shares at a higher price. All you got to do is look at the average cost of the legacy balance sheet of Cabot as to what that intrinsic value of the shares on the balance sheet.

So it's also part of the economic decision. To the question -- the rhetorical question, no answer required is, do you kind of leave that cash on the balance sheet and take advantage of that buyback in more lean times than where we find ourselves today? That will be all part of the discussion, Matt.

Perfect. And then maybe an asset level question for Tom and the team. Just curious, you're learning so far at Lone Rock with the new well results you've provided. How that may fit into kind of your development program in 2022 as it just relates to the returns you're seeing on that asset relative to the Delaware? And then just a medium-term question in terms of running room from an inventory perspective, particularly around Lone Rock, how you think about your inventory profile and the ability to develop that going forward?

Well, Matt, we're very pleased by the Carel/Elder project. We look at our returns fully burdened, including all overhead, all associated costs, including legacy land. And we look at that, we modeled the Carel/Elder as being highly competitive within our portfolio.

Now you mentioned Lone Rock. But we've got a portfolio of opportunities within our Anadarko asset. There's kind of 3 major areas: Lone Rock being one; the up dip kind of near the merge classically is another; and then we've got a really nice opportunity on our Western fringe. All of those are highly competitive for capital.

You asked about inventory. Our team has done a nice job of presenting a really healthy inventory of mile 3-mile horizontal well opportunities. There'll be a slice of that in 2022. I don't, at this point, can't telegraph how big a slice. But I'll say it offers tremendous flexibility from a capital allocation standpoint to have that third basin that has competitive returns. Because, as you know, from time to time, there have been market constraints, both in Appalachia and in the Permian, and having that third highly profitable area is a tremendous safety valve that we offer our owners.

So we're very high in the Anadarko. It obviously doesn't have the running room of our Pennsylvania or Delaware. But boy, it's -- deserves a place in our portfolio.

Our next question will come from Josh Silverstein with Wolfe Research.

I know you want to wait until January or February next year to provide a more formal guidance really to say, I guess, how winter shapes up. But can you just talk about how much flexibility there is in the portfolio to shift capital around for 2022 relative to just the stand-alone base plans?

Well, Josh, thank you for that question. We've talked about this in the past. When you're drilling these pad projects, you have long lead time. By the time you're into November, a lot of certainly the first half of '22 is mostly baked in. So flexibility to reallocate capital will probably be a late second quarter, second half phenomenon. I would say the first half is probably mostly already underway in terms of what will be turned in line in 2022.

Now that said, we're not shrinking from that challenge. We're going to be making -- we don't have a lot of marketing commitments, and we don't have a lot of vendor commitments. We have great flexibility to let capital flow to its most productive use. But that will probably not actually involve equipment move on the ground until second half '22.

Got it. And then just within that framework, does it even make sense to grow the Marcellus next year, even if we're at current strip pricing?

Makes sense is something that I wouldn't want to put a stake in the ground on. If you'd asked me 3 months ago what made sense, a lot of things make sense today didn't make sense 3 months ago. We're in a very strange time and that all of a sudden, we realize only goodness, energy really is important. And you see prices moving up. You see a lot of concern about where energy markets will trend and we have tremendous flexibility to adapt to that. So in terms of what will make sense in 2022, stay tuned.

Got it. And then just one more on the return on capital profile. Tom, one thing that you had wanted to do at Cimarex has built up enough cash for the 2024 maturities. Now that you're a combined company, that maturity has now grown to $1.3 billion. How do you guys want to build up cash for that? Or how much of that would you want to take out with cash relative to refinancing when the time comes?

Yes. I'm going to let Scott handle that one.

Yes. I -- Josh, I heard kind of pre-closing Tom's desire to pay off the $750 million. And I fully understand that. As you've known me a long time, I'm a debt-averse kind of guy, but I know that we have to have some debt in the capital structure. I would put that on a lower check list, lower than stock buybacks. But I think continuing to prepay debt is highlighted in the script. Cabot paid its -- Cabot actually paid $188 million back this year, $88 million earlier in the year and $100 million in September.

So I think let us kind of get together and figure out and look out in the next couple of years, but I would suspect a portion of that $1.3 billion will be paid back and a portion will be refinanced. I don't think -- nobody is looking to go to 0 debt in the organization. But maybe my gut and Tom and I, in fairness, have not talked about this, but a target level of absolute debt around $2 billion versus $3 billion kind of feels like it's in the sweet spot.

So I'd add to that. Lots of things have changed in our business. Obviously, we're under regulatory pressures, we're under pressures coming from the SEC. We're waiting to see. We're under investor pressures. When I look at those challenges, I think you would find a company like Coterra probably moving forward at a lower debt level than we would have answered 2 years ago. Now what that is, we'll see. But we used to say 1.5x debt to EBITDA. I think today, we'd be significantly below that.

Our next question will come from Michael Scialla with Stifel.

I'll ask, I guess, a couple of operational questions. Tom, you mentioned Slide 9. It seems a little perverse to me, I guess, that the industry is trending to a wider spacing with oil prices above $80, but obviously, it makes sense if you can get the same reserves with 5 wells per section that you can with 7 prior. But have you looked at that greater completion intensity with 7 wells per section? And I guess as you optimize that NPV per section, what oil price was that based on?

Well, that analysis will withstand any oil price. If you can recover the same reserves with less capital, that's not going to be a price-dependent analysis. Now that said, if you drill more wells, there will be an acceleration component. But our analysis tells us that, that is not going to catch up to the destruction of investing more capital than you need to. So we think Slide 9 is a remarkable result. We're thrilled by it and it frees up additional capital for more productive uses.

Okay. And then Slide 10, you mentioned you're trending toward the low end of the range on costs in the Permian. How are you thinking about those costs as you look out into '22? And I guess how much are you dependent upon or how much have you used simul-fracs at this point? And is that enough to offset the inflation that you've seen so far?

Yes, this is Blake. I'll take that one. We're really excited to be trending at the low end of the guidance, and that's really driven by operational efficiencies we've had throughout the whole value chain throughout the year. Drilling, completion facilities, flow back, it's all a [game of ancients] that's coming together.

We do have inflation. We've seen inflation just like everybody else, we see it in steel, we've seen in fuel, we've seen in labor. We're working right now to try to model that for '22, that will come out with our '22 plan. But we expect continued operational efficiencies to help offset any future inflation.

We have tried some frac. We've done some of those projects. We're still trying to quantify the real savings to that. But right now, we're -- we really like our zipper operations, we like our pad operations. We've seen tremendous efficiencies there.

Our next question will come from Holly Stewart with Scotia Howard Weil.

Maybe just a follow-on to Neil's question. So for Tom or Scott, any items to highlight as you guys have kind of sat down and rolled up your sleeves that maybe you didn't think about as you put these 2 companies together?

No. I think, Holly, at the end of the day, I think it was very well vetted going together. I think the interesting thing in the dynamic of putting the 2 together in the -- not just the integration after the fact, but the like-mindedness of how the 2 companies have been managed in terms of just the conservative nature of the balance sheet, where we're at, the capital plans, the technical ability. As Tom complemented, the Marcellus, we can do that same complement of the Permian and the Anadarko staff that we've met on our side.

So I don't -- there wasn't an aha moment. Obviously, it's a marriage. And for everybody on the phone that gets married, not every day is a -- there are challenges each -- can be each week, each day or whatever, just from the different push-pull on various things. Blake and I have had the opportunity to serve on SteerCo. And we've had a lot of great discussions and a lot of things come together to get us where we're at.

And like Tom said, the biggest driver right now is we just need to all get together in one location so that we can move this forward. But there was no bright spot aha moment that we said, "Oh, (expletive), we missed this.

Holly, one of the things I've been most pleased about. First and foremost, we're on track to achieve our announced G&A synergies, and I'm pleased about that. But once we got our operational teams together and really brainstormed on operational synergies, best practices, procurement and how we might be able to leverage that, there are -- there's a set of ideas longer than my arm. And our [chance is] going to be underpromise and overdeliver. And I'm very optimistic. I also want to follow up in case my wife's on the line. I don't know what Scott's talking about regarding the marriage.

Well played. Maybe my follow-up just on M&A, there appears to be a lot of assets hitting the tape, both on the oil and gas side of things. And certainly, on the gas side, there are some things that might fit into the legacy Cabot footprint. Without speaking, I guess, of the specific assets, could you just comment on your appetite for M&A maybe and gas M&A along with that?

Well, as we've said all along, we're going to have the opportunity and flexibility to take advantage of really good opportunities. We've got our plate full right now with a deep inventory of fantastic projects and plenty of challenges. And it doesn't surprise me that lots of assets are hitting the market. I think anybody who really believes what they say when they talk about discipline has to be really cautious buying assets at this uptick in prices.

We've got great organic opportunities. We're developing additional organic opportunities. And so look, if something really made sense, we have the ability to strike, but we -- to use the word appetite, we're not hungry. We've got plenty to do.

Our next question will come from David Heikkinen with Pickering Energy Partners.

Really, first things first, Scott and Tom, your comment on countercyclical building of cash and buying back stock at lows as opposed to high, if I could wash, rinse, repeat that for every conference call, it would be perfection. So thanks for that statement first.

Second thing is, as you think about the gas markets, what's your maximum capacity or flow in the Marcellus going through the winter? Do you have an assessment of where and how high that could actually go on a gross or net basis?

Well, this is Matt Kerin, Dave. So we're set up to be able to move volumes in and above the levels that we're at today if we think that the pricing was at warrants it. But as you know, we have the Leidy South project coming online, full in-service on December 1, but we've been starting to take certain portions of that capacity leading up to that full in-service. So that's going to provide us some incremental opportunities there.

But from a gathering system perspective, we've recently inked a new deal with Williams that's going to continue to expand on what we already have. So throughput is not really an issue. The question is going to be is the pricing and the returns on capital for the incremental volumes make sense for us up there or will we just be long term cannibalizing existing volumes that we already have in the market.

Okay. Yes. So price dependent, but you've got ample upside to meet demand if it comes. And then on the Delaware Basin, Tom, I liked your slide about the 5 wells per section. As you looked around at other operators and your operations, how much capital was over deployed in the basin? Like if you just think about 7 wells versus 5 wells, is there -- is that the next round of operating efficiency as you head forward and kind of look at the basin and kind of ongoing developments across your portfolio of -- how you think about that?

Yes, David, (inaudible) on the operator. We didn't stumble on to this conclusion. It's the outcome of years of deep science understanding our incremental well level deliverability. A lot of work went into this. I'll just give you an example, and I don't want to get specific on geography. But we have a project going on right now that's flowing back, where we have drilled 9 wells in the Upper Wolfcamp and next door is an operator we really respect that's drilled 12. As we analyze those 2 projects, our volumes are right on top of theirs because the geology is the same, the pressure is the same, the phase and the reservoir is the same. And we are recovering an equivalent amount of oil on our project compared to our neighbor's.

When we analyze our neighbor's project, we think it's a 100% rate of return. So if that's all you had were the wells you drilled and the volumes you flowed back, you would have a victory party and you'd celebrate 100% rate of return. Our returns are significantly higher than that 100%. And if we didn't have the well level detail, we would have missed that. And I think a lot of operators that don't do the science will look at the sum total of project output and stop there with their analysis and therein lies the missed opportunity.

Satisfaction without pressing further. That's a good summary of that operationally, too.

We drive ourselves crazy every day, and we'll continue to do so.

Our next question will come from Neal Dingmann with Truist.

Tom, just one after what's been said this morning. I'm just trying to get a sense of how you all think about now on a broader scale, growth versus the shareholder return in general and maybe even more so in times like today in order to take advantage of these higher prices?

Well, it's all about shareholder return. So we think, first and foremost, beginning and end about shareholder return. Now we will see. I think we're at a bit of a pivot point with what's happening with energy markets. I think there's been a societal realization that, oh my goodness, maybe fossil fuels are important after all. Certainly, all markets have moved up, gas markets have moved up. If we have any kind of a winner, there's going to be a serious call on natural gas in the United States. And we don't live in a vacuum. Although today, I think we are absolutely committed to everything we've said that we think growth is probably not called for.

But we wake up every day and we're flexible. So what we don't want to do is get back to this cycle where capital is destroyed by the industry putting the pedal to the floor when times are high and then suffering when times are low. We're going to be disciplined, we're going to move prudently. But we don't live in a vacuum. We will adapt to the world we live in, and there will be shareholder pressure that will also adapt to that changing world. So we have -- Coterra has great opportunity to be flexible through this changing energy landscape.

Great. Well said. And then just a follow-up. Now that everything has closed, where do you all sit just on sort of blocking and tackling on M&A? Are there some pieces that you let go? Are there some other things that you'd like to bolt on to sort of tie in? I'm just wondering any thoughts you all can share with that.

Well, we always would like to let go of stray properties. We still have some things that probably are better off in other people's hands. Not big chunks of our portfolio. But every now and then, somebody pitches, hey, we've got this set of wells. It's just not very efficient for us to operate, and we'll continue to look for those opportunities. And then we remain interested in bolt-ons. But I'll just say what I said to an earlier question, we're going to be highly disciplined. We're not empire building here, we're value creating. And that will be our goal.

Our next question will come from David Deckelbaum with Cowen.

I really just had one question. I'm curious, especially Tom, you brought up the Anadarko, and I know we're going to be getting into capital allocation in early '22 for next year. Would there be any interest on Coterra's part now at considering third-party capital or other developmental structures using someone else's wallet to develop some of the resources that you might have a difficult time allocating capital to? Or does it really just make sense just given the leverage profile now and the returns to sort of look at doing everything organically?

David, we're very open to those types of opportunities. We've explored a couple of them and kind of depends. You mentioned Anadarko, but yes, I think we'd be open to opportunities like that in some of the areas of the Permian as well. We haven't pulled the trigger on anything like that. But I'll say we have a very active team that's putting some options in front of us. So I don't know whether we'll do it or not, but your question is would we be open to it? And the answer is absolutely.

And at the end of the day, I guess, what -- if you were to pursue something like that, would you be looking -- what would you be looking to accomplish above all else? Is there -- are there areas like the Anadarko that are just not optimized from a capital perspective? Or would this have to be an opportunity that really just sort of augment near-term free cash per share?

Well, I would put this in the embarrassment of riches category, where when we look at our inventory, we have some things that are years down the road in our inventory but there are others for whom they would jump at the opportunity to confidently invest at those returns. And so when we look at that, we say, if something isn't going to get drilled for the next 8 or 10 years, and yet it has a return profile that would be highly enticing to an outside party, we look at the opportunity to accelerate that value. And that's kind of how we think of it.

Our next question will come from Doug Leggate with Bank of America.

I wonder if I could -- I hit -- I should burn the question. But I wonder if I could pull back to you a little bit of the rationale for the commotion, less volatility, stronger balance sheet. Recognition of our variable dividend is a bit of a subjective call, I guess. What about the base dividend? If you've got lower volatility on our balance sheet, why not step up the base dividend?

Doug, it's Scott Schroeder. In terms of the base dividend, let's kind of reset the platform here. Legacy Cabot had a base dividend increase in the spring of 2021. And then on announcement in May, there was a second dividend increase going from the $0.11 to the $0.125 that was memorialized right now in this first Coterra dividend that was announced.

We're firm believers in a plan to rationally grow the base dividend over time. But with having just done 2 and knowing that we're in a very robust commodity price environment, let's kind of see how this shakes out because we do, as you pointed out, have the ability to continue to return with the variable dividend structure that we put in place. And let me add on that. Remember, the legacy Cabot 1 was once a year that Coterra, because of the financial wherewithal, is going to do that assessment every single quarter, which gets dividends back in the hands of shareholders quicker.

And so again, we're all in favor of growing the base dividend, but in a methodical way. You'll remember I said in my history, I'm all for it. And I never want to get too far over our skis where we would ever have to ratchet it back. And in this legal enterprise in 31 years of paying a dividend has never had to call that audible or even reduce it, and we want to continue to build from that point.

So it's fairly big. I think the issue is about recognition (inaudible).

Hey, Doug, you're cutting out a bunch. I mean, we're hearing about every other word.

Okay. I'm sorry. It's (inaudible).

Doug, you're going to have to just follow up with us because we can't hear you.

Our next question will come from Leo Mariani with KeyBanc.

Just wanted to follow up a little bit on a few of your comments here. Certainly, I guess you guys have pledged to return 50% of basically cash flow to shareholders here. And just want to get a sense if we continue to see just a very robust commodity tape as we roll into '22, it sounds like that number could be a fair bit higher than that. You guys did talk about discipline. So it sounds like you're not planning on all that much growth for '22, so commodities are high. Just given the fact that balance sheet is really strong, it just sounds like we could be expecting certainly some increases in the returns here. Is that generally how I'm hearing here?

Yes, Leo, that would be correct, just based on the simple math of what the scenario you laid out.

Yes. Leo, I would say our action this morning to advance our variable dividend in the quarter is telegraphing that, that's our bias as we -- our bias is to lean forward. Now we want to be careful what we commit to. And -- but I think as we get quarter-by-quarter, you're going to see how we behave, and that bias will be clear.

Okay. That's helpful. And I just wanted to touch base on a couple -- number of questions here. So certainly noticed that Cabot standalone LOE was up a little bit in third quarter. So I just wanted to get any kind of color around that, if that was more maybe onetime in nature. And then just from a high-level perspective, I know you guys did provide some guidance on deferred taxes here in the fourth quarter, which is helpful. But would you guys continue to expect a decent sized cash tax shield in '22 kind of like you're seeing in 4Q? Just want to get a sense of the tax shield on the combined entity.

Leo, this is Matt Kerin. On the LOE for legacy Cabot, those numbers can move around a little bit quarter-to-quarter depending on some of the workover projects we have. So we did have an increase in workover in Q3 that kind of caused it to come a little bit above the high end of the range. But somewhere in that $0.08 to $0.10 range on a legacy Cabot basis is where we would expect that number to be kind of on a go-forward basis.

As it relates to deferred taxes, I'm going to hand it over to Dan Guffey, who's the whiz when it comes to that.

Sure. Thanks, Matt. So we gave guidance for 30% to 40% on a deferred tax basis. And we've communicated in terms of 382 limitations and built-in gains, we would expect a $1.3 billion of NOLs that were on Cimarex's balance sheet at 9/30 to be a shield that is ratably spread over the next 4 to 5 quarters. As we've discussed in prior calls, we would expect that NOL to be fully utilized during 2022 based on current strip prices.

As we walk into 2022, you can expect the deferred portion to be in that 30% to 40% range, again, depending heavily on commodity prices and investment levels, but we do expect full utilization of the NOLs by year-end 2022.

(Operator Instructions) Our next question will come from Noel Parks with Tuohy Brothers.

Just had a couple of things I wanted to check in on. You had some discussion of cost inflation, and it sounds like you anticipate being able to use operational efficiencies to offset some of that going forward. I just wonder, does that play into your thinking at all around whether strategically Coterra or the industry broader is going to need to inch back towards thinking more about scale. The focus has been so much on efficiency, maintenance drilling. But if there is steady cost inflation, at some point, it seems that the thinking does start to head more over towards perhaps operations over a narrower set of basins or just other things that lead you to sort of maximize the potential for scale.

Well, we've talked about scale a lot over the years, and I'm going to repeat what I've said in past calls. The first big ticker on scale are long laterals. If you can get 2 or 3-mile laterals, there's tremendous cost savings there. So aggregating your land to be able to do that is critically important. And then in aggregation, so you can most efficiently deploy your infrastructure dollars both gas gathering and compression, saltwater disposal and oil gathering is also important.

I think beyond that, certainly, procurement is an important scale topic. But quite frankly, I think scale can be overblown. I think once you've checked those boxes and you have a really great operational team that you're down to very small differences between certainly huge companies and scrappy little companies. If scale alone were the answer, I think the majors would have the lowest cost structure in our business. And clearly, that's not the case.

And so I think scale is important. But it's important to a point. In each of our 3 basins, we have the opportunity to have the lowest cost structure, and that's our challenge. We don't use scale as an excuse. We think we've got what we need to deliver lowest cost.

Now I want to say one other thing. Our vendors are our partners and they need to make significant living as well. They need to show up with well-maintained equipment, a commitment to safety and well-trained crews. And so we understand some of this inflation is an inevitable outcome of good partnerships. And so of course, we're going to complain like crazy, but we're also going to be supportive of our vendors.

Fair enough. And I guess one other thing I want to check in on is you have stressed the many fronts on which the combined companies enjoy tremendous workability, especially in this commodity price environment. And as you look ahead and think about product mix that you might pursue across the various basins, can you talk a little bit about how ESG or policy risk might weigh into your thoughts about oil versus gas, including what's going to happen with the federal lease permits and so on?

Well, we certainly are widely aware of the challenges. And it's not just federal, it's state, it's investor pressure, it's everywhere we look. We're committed to be a top-tier operator in ESG, as I said in my opening remarks. That doesn't necessarily fall into a commodity preference. We think we can deliver the cleanest barrel of oil and the cleanest MCF of gas, and we think a U.S. producer is desperately needed to do both.

Coterra will be at the front of the line on that. I don't think it will have any kind of thumb on the scale on capital allocation decisions, nor necessarily will commodity mix. The beauty of Coterra is capital is going to flow to its highest, most productive return. And that's what we're going to do, and we're going to be disciplined in doing that.

This concludes our question-and-answer session. I would like to turn the conference back over to Tom Jorden, CEO and President, for any closing remarks.

Well, thank you for joining us on this first Coterra conference call. We look forward to reporting results over many more quarters, delivering what we promised and reporting on our progress. But I want to thank you for a series of great questions, and we're going to get back at it. So thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.