Devon Energy Corp (DVN) — Q1 2021 Earnings Call Transcript

Good morning, and thank you to everyone for joining us on the call today. Last night, we issued an earnings release and presentation that cover our results for the quarter and our forward-looking outlook. Throughout the call today, we will make references to our earnings presentation to support our prepared remarks, and these slides can be found on our website. Also joining me on the call today are Richard Muncrief, our President and CEO; Clay Gaspar, our Chief Operating Officer; Jeff Ritenour, our Chief Financial Officer; and a few other members of our senior management team. Comments today will include plans, forecasts, and estimates that are forward-looking statements under U.S. securities law. These comments are subject to assumptions, risks, and uncertainties that could cause actual results to differ from our forward-looking statements. Please take note of the cautionary language and risk factors provided in our SEC filings and earnings materials. With that, I'll turn the call over to Rick.

Thank you, Scott. It's good to be here this morning. We certainly appreciate everyone taking the time to join us today. It has now been nearly 4 months since the closing of the merger between Devon and WPX, creating a premier U.S. energy company that possesses a powerful suite of assets and a disciplined strategy to maximize value for our shareholders. With this advantaged platform, our merger integration efforts are complete and our go-forward team is highly energized and delivering on exactly what we promised. We are executing on our maintenance capital program, capturing cost synergies, generating free cash flow, and returning significant value to shareholders through higher dividends and the aggressive reduction of debt. The progress we have made with each of these strategic objectives is evidenced in our quarterly results and this is only just the beginning. It is going to be an excellent year for Devon as we continue to advance our strategic plan. Turning your attention to Slide 3. With many investors possibly new to our story, I would like to review why Devon has the right business model to maximize value for our shareholders. To ensure that we are excellent stewards of your capital, any successful strategy in a commodity business must be grounded in supply and demand fundamentals. With fundamentals signaling maturing demand dynamics for our industry, we fully recognize the traditional E&P model of prioritizing only production growth is not the correct strategy going forward. To optimize value creation in the next leg of the energy cycle, a company must deploy a financially driven model that prioritizes free cash flow generation over production growth. At Devon, this is exactly what we are doing. We're limiting top line production growth from 0% to 5% in times of favorable conditions. We're pursuing margin expansion in earnings through scale and a leaner corporate cost structure. We're moderating reinvestment rates to levels substantially below that of cash flow. We're maintaining low levels of leverage to establish a greater margin of safety. And we're returning more cash to shareholders via our innovative fixed-plus-variable dividend policy. Our talented team at Devon takes great pride that we are leading the industry with this disciplined operating framework. I personally feel it's time for the industry to stop contemplating and talking about the possibilities of a cash return model and more quickly embrace this necessary change. High returns on capital employed, reduced reinvestment rates, and cash flow generation will determine the winners in this cycle, not the historic behavior of delivering outsized production growth. Now jumping ahead to Slide 4. And as I touched on briefly in my opening remarks, we delivered on exactly what we promised we would do in the first quarter. Our disciplined plan limited reinvestment rates to just over 60% of cash flow we substantially expanded margins, and we continue to take steps to reduce our corporate cost. As you can see on the bar chart graph to the right, with the excess cash our business is generating more than 65% of our capital allocation has been deployed toward dividends and debt reduction. This return of capital to the shareholders is a clear differentiator for Devon. Looking specifically at the dividend, we were able to accelerate cash returns in the quarter through our innovative fixed-plus-variable dividend framework, which we implemented earlier this year. The initial benefits of this generous payout policy were evidenced in March when the owners of our company received their first variable dividend in conjunction with our regular fixed dividend. Based on first quarter results, our Board has approved another fixed-plus-variable dividend of $0.34 per share. This payout represents a 13% increase versus last quarter and is more than three times that of the same period a year ago. This thoughtful and uniquely designed dividend framework is foundational to our capital allocation process, providing us the flexibility to return cash to shareholders across a variety of market conditions through the cycle. In addition to the dividend, another way we returned value to shareholders was through our recent efforts to reduce debt and enhance our investment-grade financial strength. Since the closing of our merger, we have already retired $743 million of debt. With our actions year-to-date, we have executed on nearly half of our $1.5 billion authorized debt repurchase program. And we expect to reach our target of 1x net debt-to-EBITDA by year-end. Jumping ahead to Slide 10. While first quarter production was limited due to severe winter weather, I want to be clear that our operations are scaled to generate substantial amounts of free cash flow. Specifically, in 2021, we are on track to deliver a highly attractive free cash flow yield at today's spot price. The free cash flow yield story gets even better. If you look at us on an unhedged basis and assuming year-end run rates for cost synergies. This upside case is represented by the red line, showcasing a free cash flow yield in excess of 20% and at today's pricing. With this powerful cash flow stream, I feel it is important to reiterate that we have no intention of allocating capital to growth projects until demand-side fundamentals recover, and it becomes evident that OPEC+ spare oil capacity is effectively absorbed by the world markets. On Slide 12, with our cash return business model building momentum, I want to highlight the unique value proposition that Devon offers from both a dividend and a growth perspective. To demonstrate this point, we've included a simple comparison of our estimated dividend yield in 2021 at $60 WTI pricing, assuming a 50% variable dividend payout. As you can see on the slide, Devon's implied dividend yield is not only highly differentiated compared to peers, but is vastly superior to virtually any other sector and asset class in the market today. Importantly, Devon is more than just a yield play. We have our quality and depth of resource within our portfolio to deliver sustainable per share growth that will reward shareholders for many years to come. The final topic I want to briefly touch on is with the integration of our operations progressing ahead of plan. In the very near future, we plan to issue more specific guidance on Devon's go-forward environmental priorities. This disclosure will include formal targets to reduce greenhouse gas emissions, methane intensity rates and our strategy to improve upon other key performance measures. And with that, I'll turn the call over to Clay, our Chief Operating Officer, to cover our recent operating highlights.

Thank you, Rick, and good morning, everyone. I first want to acknowledge the hard work that our organization has poured into this merger. Our team has made substantial progress integrating our organization, assets, and processes. We knew it was not the easy way to combine two strong companies; taking time to evaluate the best practices has proven to be a very valuable exercise. I'm here in the corporate office, and to each of our field offices, I've seen some great examples of setting aside historical bias, listening to new ideas, and then coming together to find the right solution for the go-forward enterprise. External forces certainly have compounded the complexity. To pile on to the challenges of the pandemic, February's winter storm was a major event that, again, tested the resolve of our team. As it turned out, once again, I saw incredible leadership, innovation, and personal sacrifice in the name of the greater good. I saw many displays of our employees not only helping in expanded capacity for Devon, but also in their communities. This exemplifies the culture of the organization that we have and continue to refine. I'm pleased with the progress that we are making. I'm exceptionally excited about the future of Devon as we benefit from each other's legacy company best practices with an incredible portfolio and a rock-solid balance sheet. Let's flip to Slide 14, and we can discuss our world-class Delaware Basin asset. Once again, the Delaware Basin was the driving force behind our operational performance for the quarter, with our capital activity focused on low-risk development projects, higher-margin production grew 19% year-over-year on a pro forma basis. This strong production result was driven by a Wolfcamp-oriented production program which accounted for roughly two-thirds of the 52 wells that commenced first production in the quarter. In the second quarter, we'll have several big pads that come online in the Stateline area, which will be a blend of Bone Spring and Wolfcamp completions. While the overall execution of our capital program was excellent in the quarter, new well activity was headlined by our Danger Noodle project in the Southwest County. This two-mile lateral development, targeting the Upper Wolfcamp, achieved average 30-day rates of 5,100 BOE per day with a 67% oil cut. Importantly, the capital cost came in 20% below our pre-general expectations, driving returns on invested capital significantly higher than planned. Another key project for us this quarter was the 11 well thoroughbred development in Eddy County that co-developed three Upper Wolfcamp intervals. Due to timing, we have only commenced first production on two wells, but thus far, these wells have been outstanding with peak rates exceeding 4,000 BOE per day. The remaining nine thoroughbred bird wells are being brought online and coupled with our current completion activity in the Stateline area. I think it's fair to state that we have a strong line of sight to our Delaware production profile and cash flow growth in the upcoming quarter. The final item I'd like to cover on this slide is the positive regulatory update regarding our federal acreage, which accounts for about one-third of our total Delaware leasehold. As many of you are aware, earlier this year, the Department of the Interior issued a directive that restricted permitting on federal land for a 60-day period. This order lapsed on March '22. And with the team's forethought and proactive planning, we navigated through the 60-day period without any impact to our day-to-day operations or full year capital plan. What is even more encouraging is that since the order has lapsed, we've received approval on more than 50 new drilling permits. In aggregate, and netting for the wells that we've drilled, we have about 500 federal drilling permits, reverting an inventory of about four years at the current drilling pace. Even though this positive regulatory news is right in line with our expectations, we will continue to be highly engaged and collaborative with policymakers to ensure that we retain the ability to effectively develop our federal leases and maximize value for all stakeholders involved. Moving to Slide 15. We continue to build upon our trend of operational excellence in the Delaware during the quarter. As you can see on the left-hand chart, our drilled and completed cost declined once again to $534 per lateral foot in the first quarter. These results rank among the very best in the industry and represent a 43% improvement from just a few years ago. This differentiated performance is underpinned by steadily improving cycle times, refined completion designs, and the deployment of leading-edge technology across all facets of the D&C value chain. Shifting to the middle chart. We also continue to act with a sense of urgency to materially improve our cash cost structure in order to get the most value out of every barrel we produce. This focus is evidenced by our first quarter results where field level costs improved 11% year-over-year. To achieve this positive rate of change, we have meaningfully reduced our recurring LOE expense across several categories, including chemicals, water disposal, compression, and contract labor. Looking ahead, I expect further improvement. The team is hard at work identifying and capturing additional savings that will generate margin expansion throughout the remainder of the year. Turning to Slide 16. Another asset I'd like to put in the spotlight today is Anadarko Basin, where we are officially back to work in this basin with two operator rigs funded by our joint venture with Dow Chemical. Both Rick and I have long histories with this basin. And literally, it's just right down the road from our corporate headquarters. I'm very impressed with the great improvements that our team has made in the last couple of years. By way of background, in late 2019, we formed this partnership with Dow in a promoted deal where Dow earns half of our interest on 183 undrilled locations in exchange for a $100 million drilling carry. In addition to the benefits of the drilling carry, returns will also improve with targeted up spacing and from midstream incentive rates that will reduce our per unit cost for Wells associated with this drilling JV. When you combine these factors and the continuing operational improvement, these returns will be exceptional. Year-to-date, we have spud eight wells in the liquids-rich core of the play and we are on track to drill up to 30 wells for the full year 2021, targeting in a mix of Meramec and Woodford opportunities. I have full confidence that the commencement of the Dow JV is the first of many positive steps Devon will take to extract value from the scalable and repeatable resource play. And lastly, on Slide 7, the key message here is that even with the severe winter weather we encountered in the first quarter, we are well on our way to achieving all of our capital objectives for 2021. Looking specifically at the second quarter, we expect the midpoint of oil production to be 288,000 barrels per day, coupled with a capital spend that is slightly elevated due to the timing of Delaware completions, and some of the midstream projects. Although the portfolio effect would typically smooth out a stack of events like this, sometimes capital from a larger number of pads and projects can fall in one quarter. Following the second quarter, capital will fall back to a more nominal rate. We will continue to work our synergy gains into the capital projections as we work our best path forward. This should continue to offset much of the inflationary pressure in the industry that we will see in a $60-plus environment. And with that, I will now turn the call over to Jeff for additional commentary on our financial results.

Thanks, Clay. For today, I will cover the progress we've made on our financial priorities and highlight the next steps in the execution of our financial strategy. Beginning on Slide 5, a key and differentiating part of our financial strategy is our ability and willingness to accelerate the return of cash to shareholders. At Devon, we have a long history of returning cash to shareholders, paying a quarterly dividend for 28 consecutive years that has increased at an average rate of more than 10% per year. To step up our game and build upon this tradition, earlier this year, we implemented our fixed plus variable dividend framework. This cash return strategy is designed to pay a sustainable fixed dividend and evaluate a variable dividend on a quarterly basis. The fixed component of this policy is our legacy quarterly dividend that is paid at a rate of $0.11 per share and targeted at a sustainable payout level of approximately 10% of operating cash flow at mid-cycle pricing. The variable dividend is intended to be a supplemental distribution of up to 50% of excess free cash flow beyond the fixed dividend. As Rick touched on earlier, this isn't just an interesting theoretical concept. We are executing on this framework, and we paid our initial fixed plus variable dividend in March of this year based on our fourth quarter results. And with our strong financial performance in the first quarter of this year, the Board approved a 13% increase in our fixed-plus-variable dividend to $0.34 per share. Both the fixed quarterly dividend of $0.11 per share and the variable dividend of $0.23 per share are payable on June 30 to shareholders. Turning to Slide 6. In addition to higher dividend payouts, another strategic priority for Devon has been the repayment of debt to further strengthen our investment-grade financial position. So far this year, we've made significant progress towards this initiative by retiring $743 million of outstanding notes. While our balance sheet is in great shape, we're not done making improvements. Today, we acted on the next step in our plan by notifying bondholders of our intent to redeem $500 million of callable 2026 notes in June. In combination, these debt reduction efforts will reduce our annual run rate interest expense by nearly $70 million, further lowering our overall breakeven per barrel. With the execution of our plan, we're on pace to reach our 1x net debt-to-EBITDA target by year-end, and these debt retirement actions extend the average maturity of our debt portfolio to approximately 13 years with over 60% of our debt maturing after 2030. Turning to Slide 7. Another area of focus that will enhance Devon's cash flow generating capabilities going forward is the capturing of merger-related synergies. The integration team has done a great job advancing this initiative year-to-date. And as a result, we are now raising our cost savings target to $600 million by year-end 2021. This updated target represents a 4% increase in cost savings compared to our previously issued guidance. While we're making strong progress across all categories, this improved outlook is driven by capital efficiency gains and the benefits of enhanced purchasing power in the Delaware Basin. Overall, about 60% of the $600 million of cost savings targets has been incorporated into our full year 2021 outlook, and we have a clear line of sight to capture the remaining synergies by year-end. The capturing of these synergies is very material and impactful to Devon, represented in a PV-10 uplift over the next five years of $2.5 billion or roughly 15% of our market cap. And with that, I'll now turn the call back to Rick for some closing comments.

Thank you, Jeff. Great job. I would like to close by reiterating this key message: the integration of the two companies is complete, and the team is delivering on exactly what we promised to do. We have prioritized free cash flow over growth. We have identified and captured cost synergies above and beyond our plan. We have a free cash flow that compares favorably to virtually any other asset class in the entire market; we're rewarding shareholders with higher dividends, and we've taken some steps to aggressively reduce the debt. Our team is focused and energized, and 2021 is shaping up to be an excellent year for Devon. This is just the beginning. Devon's future is very bright. And with that, I will now turn the call back over to Scott for Q&A.

Thanks, Rick. We will now open the call to Q&A. With that, operator, we'll take your first question.

Rick, let me start with you. One of the thoughts or incoming questions we've been getting is, call it, beyond 2021, how do you think about balancing the development CapEx portfolio renewal and returning cash to shareholders from a capital allocation standpoint, in particular, we've been getting some questions around Devon's interest in a couple of the larger Permian A&D opportunities. But just seeing where your heads at as you look to balance some of your organic opportunities and plus other opportunities in the marketplace.

Yes, Arun, that's something we'll always be contemplating. But right now, we're really focused on 2021. And the second half of this year is really shaping up to be quite strong. We're going to see great momentum going into 2022. As far as the capital plan, we've not started working that yet. That will take place at a later time throughout the year. So I think it's a little bit early. I know that investors are really interested in that. But I think suffice to say for us right now, we're really focused on having great momentum into 2022. And with a keen focus still to be on generating free cash flow and getting that back to shareholders. I think the second part of your question is around maybe some consolidation that's going on. You have seen quite a few transactions that have taken place over the last few months. I think we've been on record of saying we support that. I think some of the industry needs to do. But as far as Devon specifically, we've had a high bar that bar just continues to go up. When you start looking at the organic opportunities we have in Lea and Eddy County, New Mexico, and Loving County and Reeves County, Texas, you can just see that just in inter Delaware, we have just a phenomenal amount of running room. And so we just have to be thoughtful about that. And on top of that, we have other assets that all are playing a very key role for us in the company and the go-forward plan. So that's kind of where we are today.

Great. Great. And my follow-up, you noted more than 50 permit approvals since the moratorium lapsed. Clay, would you view this as kind of business as usual at the BLM? Or how do you characterize what you're seeing in terms of ongoing permit approvals?

It’s a bit difficult to declare things are business as usual. We collaborate closely with many counterparties, including the BLM, which is currently facing some challenges. They are still working to understand directives from the administration and the Department of the Interior. We are in a transitional phase, but that doesn't diminish our commitment to being a strong partner. We are actively working with them to ensure we maintain a proactive approach, so we don't encounter short-term issues. This strategy has proven beneficial during previous disruptions we've encountered. While we're not quite back to business as usual, we are looking forward to that for everyone's benefit.

Sorry, everyone, I had the mute button on. Jeff, I want to start with you regarding the free cash flow yield slide in your presentation. I'd like to go over some numbers to see if I understand what you are conveying. In Slide 10, you indicate a 20% free cash flow yield at $60 WTI, showing a midpoint production of 285,000 barrels a day and a 40% WTI assumption for NGLs. If my calculations are correct, the senior market cap last night was approximately $17 billion, and based on your charts, that implies about $3.4 billion of free cash flow. Dividing that by the oil sensitivity suggests a breakeven around $30, which means your breakeven price is below $30. Can you confirm or clarify if that math is accurate? In other words, what do you estimate your sustaining capital breakeven price to be today?

Yes. No, Doug, you're exactly right. The one caveat I'll make, and we denoted on the slide, obviously, we've assumed that we've captured all the synergies in this analysis. And we've also eliminated, obviously, the hedges that were burdened by in the current year. But when you put that all together and think about what the power of this business model can do going forward at these higher prices that we're currently experiencing, that's incredibly powerful. And that's what we try to demonstrate here on the slide is, although you can see from the bars, which are burdened by the current construct. When you eliminate some of that, you capture the synergies; you eliminate the commodity hedges on a go-forward basis, those are the kind of free cash flow yields that we think we can generate.

I'm trying to get to the underlying number. But to be clear, I think both Dave and Rick before had said your breakeven was in the mid-30s. I just want to make sure that what I'm understanding is actually $5 lower than that.

Yes, that's right. We're pushing to the mid- to low 30s. And that's going to go lower as NGL prices improve.

Got it. My follow-up then is, look, it's obviously, I'm trying to keep valuation very simple. Your question then becomes is how long can you do it for is basically an inventory correction. And I realize you can move capital around the different basins. But when you look at your business today, when we think about a very simple excel, sustainable business as a starting point for a valuation discussion, how long can you sustain that type of mix of 285,000, $1.7 billion of capital?

Yes, Doug, I'll let Clay weigh in on the inventory.

Yes, Doug, we're still working on gathering the quantifiable figures regarding what we consider inventory, to ensure we're aligned in our understanding. At a high level, both legacy companies had significant inventory. As we continue to operate within the 0% to 5% range, it represents multiple years of forward inventory. We closely monitor the next five years of inventory to ensure we are prepared to invest in any of those projects, which we are. For the five to ten-year range, those might require additional testing to determine the appropriate completion techniques, and we anticipate that development will take place in the coming years. I believe it's likely closer to a ten-year horizon, but we will keep refining that and work towards a more precise figure that we can discuss consistently.

That's really helpful. Hopefully, you see what I'm trying to get to, but I appreciate the answers, guys.

Yes. The summary is it's great news. We've got exceptionally low breakeven, a lot of exceptionally good inventory and exceptionally strong balance sheet. So that makes for a pretty good environment.

Yes, Doug, it's Rick. I'll just weigh in real quickly. I just think that I would give this team maybe another quarter, and you'll get a little more clarity around where that breakeven is. But I think I think your view is directionally correct, and we'll continue to tighten that up a little bit.

Yes. I want to stick on Slide 10 here. And when you talk about the 20% free cash flow yield, I want to bridge that back down to dividend yield. And as I kind of assume here, Rick, that the 20% free cash flow yield kind of accrues to a 10% variable dividend, all else equal. Plus, we're talking about 2% fixed, so low double digits sort of dividend yield as you look out into 2022 at $60 WTI. And I guess the one swing in that math, to the extent that math is right, is whether you still will be running at a sustaining program at that point? Or do you see a scenario at a $60 WTI, where you're starting to layer in growth capital?

Yes, I agree with your assessment. The numbers definitely support that view. We share the same perspective. Looking ahead to 2022 and beyond, I believe the crucial concept for us is optionality. There is certainly potential for a remarkable yield from the company. However, we must balance that with our commitment to pay down debt and reinforce the balance sheet, which is already in good condition. Optionality is key for me, and I think it's essential for our current outlook. Overall, you are absolutely right that a free cash flow yield at these levels allows us to consider a substantial variable dividend.

And Rick, what are you looking for in terms of switching from sort of a maintenance-type program, running the business for free cash flow to saying that the world needs your business to actually operate for growth, if that makes sense? Or is the bar so high to do that and your framework has fundamentally changed that you see very little scenario, very few scenarios where it would be appropriate to take a more growth-oriented approach? Does that make sense?

It does. I think we are fully committed to prioritizing free cash flow generation. Looking ahead, the growth framework we established when we announced this transaction last September remains unchanged. We anticipate up to 5% growth, which, considering various factors, is where we expect to land. Achieving 5% growth while approaching 300,000 barrels of oil per day is significant. We also need to consider the cash flow that will result from this growth. Having options is definitely advantageous.

My first question is just on return of capital. The leverage is on track to reach 1x by year-end. Your target or timeframe or less. And you've talked in the past, to the extent that the balance sheet is in good shape from leverage, cash, all that, the macro looks constructive, and you're generating good incremental free cash flow. You'd reconsider visiting the up to 50% payout on the variable? And then potentially revisiting the 10% on the base dividend? So do you think you'll be in a position to maybe start more seriously contemplating that next year? And in this situation, would buybacks just look more attractive because it's generally a means to lessen the base dividend burden?

Yes, Janine, this is Jeff. I think you're absolutely correct. As we've previously discussed, as we continue to carry out our plan and generate excess free cash flow this year, we're quite optimistic about our balance sheet, especially with the additional $500 million debt reduction announced today. We're making significant progress toward our targets. We expect to reach our goal of a net debt-to-EBITDA ratio of approximately 1x by the end of this year, if not sooner. We're very positive about the state of the balance sheet. Regarding your question, we will definitely discuss with the Board the possibility of reassessing the 50% threshold and consider allocating more cash to the variable dividend beyond that, as well as looking at the fixed dividend. The way we view the fixed dividend is through a payout ratio of cash flow around 5% to 10% based on normalized pricing, which we've traditionally considered to be in the $50 to $55 oil range. If we identify a structural change in the pricing environment, as Rick pointed out earlier, suggesting that normalized pricing is higher than the $50 to $55 range, that would prompt us to reconsider the fixed dividend. Therefore, in the near term, you can expect to see increased cash for the variable dividend and a potential rise in that threshold later this year or definitely into next year.

Okay. Great. We're looking forward to that. And then maybe our second question is a follow-up on Arun's question. You've got a high bar because you have very strong operations and a great portfolio right now. You have a strict financial framework for evaluating inorganic opportunities. And I guess our question is maybe a little more philosophical. Is financial accretion enough of a reason to do a deal as things are maturing in the industry as rate of change starts to slow down a little bit with either well results or costs with inflation on the horizon? Is that enough of a reason for financial patience? Or do you think there is still sufficient running room left with your existing capital efficiency so that you think you'll still be able to remain competitive on like free cash flow accretion over time?

Jeanine, I see it. David Harris is here with me, may have David weigh in as well. But the way I see it is financial accretion is absolutely critical. So it's really the latter of your two directions. For us, there's we do have just a wonderful inventory. We're executing very well. We do see some opportunities to improve not only cost structure but overall EURs throughout our asset base. And so we have a high bar. I don't know how else to put it. And we're going to be very, very disciplined. That's not going to change. And I know that there's a lot of talk out there. But Dave, do you want to weigh in any way you see things differently?

Yes, Jeanine, this is David. Certainly, the financial accretion is an important component of how we would think about opportunities. But as we've pretty consistently said for the last several years, it's one of a number of factors. We'd also be thinking about strategic fit within the portfolio and the possibility for operational synergies and margin expansion opportunities. Clearly, inventory would need to move towards the front of the queue to effectively compete for capital. So it's a balancing act across all those things. And as Rick and Clay and Jeff have highlighted here. We have a lot of confidence in the business, both today and as it's going to continue to improve going forward. And so that's what drives the high bar and the discipline we're going to have as we think about balancing those factors.

As you think about your free cash flow and that yield, I think the question that has come up if 50% today going into the variable could easily, whatever you said, stunning, Rick, it like, well, 50% cap works for now as you think about the balance sheet and some sustainability. But how does the Board and how do you guys think about increasing that 50% payout of free cash flow over time?

Well, I think, Jeff, Dave touched on that briefly, but I think the Board will be thoughtful, and we'll be disciplined, but also open-minded. If that's the right thing to do, that's where we're seeing and hearing feedback from our shareholders; that's the thing to do. We'll certainly look at that. Jeff, you want to weigh in?

David, the only thing I would add to my earlier comments is we're not averse to continuing to build cash and driving our net debt lower. We obviously focused on the 1x net debt-to-EBITDA target, but we're not averse to taking that even lower. But as we mentioned before, I mean, we're in an enviable position of generating a significant amount of free cash flow. We're just fundamentally of the belief that given our maintenance capital program and how we're executing, we need to return that cash to shareholders. And so I think it's likely that our Board will debate and discuss the opportunity to increase that threshold and then consider other options to continue to get cash returns back to shareholders.

Yes. And as you've talked with your shareholders, and you get some sustainability of this dividend payout, you now have two variables in the bank or will soon in June. Have you talked at all about like what yield they price to? I mean, do you get down into the 6%, 7-type percent range getting priced in? Or have you had any of those discussions at all?

Yes, David, honestly, we haven't received much clarity on that from investors during our conversations so far. I'm looking forward to it; we’re really excited to have not just one but two of these occurrences under our belt and hopefully start to attract the attention we believe they deserve. I think it's likely we will have more of those discussions going forward, but frankly, I just don’t have much visibility on that at this moment.

Rick, I want to begin by discussing how hedges have been somewhat of a burden. I noticed last night that you incurred costs of nearly $4 or $5 a barrel equivalent in the first quarter. As you approach your one times debt target and with your effective fixed-plus-variable strategy, what is the strategic outlook for hedging at Devon?

I believe that's a relevant question. It's timely, and I'd like to start it off and let Jeff wrap it up. Looking back over the past 12 to 14 months, the situation with commodities was quite different due to the pandemic. Many companies, including ours, were impacted, and we took specific actions in defense. As a result, we had some hedges that, in hindsight, seem to have left some money on the table, but at the time, we felt it was the right decision. It helped maintain confidence in the investment community and protected our cash flows, among other benefits. Moving forward, we find ourselves in a new environment, especially as we approach producing 300,000 barrels of oil per day and as our balance sheet improves. We're adopting a different perspective than we have historically. Traditionally, legacy companies preferred to hedge around 50%, although this could vary with market outlooks. However, given our current cash flows and balance sheet, the situation has changed. Jeff, what are your thoughts on this?

Yes. No, Rick, I think you nailed it. The only thing I would add on is, to your question is we feel really good, again, where the balance sheet is and the free cash flow generation capability sits today. So we're roughly kind of on the back half of this year, I think 40% hedged. As it relates to oil. And then as you move into 2022, I think we're more hovering around maybe 20% hedged. We feel really comfortable with those levels to just reiterate Rick's point. And so I don't think you'll see us add hedges in a meaningful way based on where we sit today and how the balance sheet.

Great. That's helpful. There's a lot of topics on my mind, but I don't want to be a dead force. We've touched on consolidation and Devon's growing that. But I can't help but notice also, you have five basins right now, but 80% of the capital is going to the Delaware. And I just maybe take a different tact and ask, how do those five assets fit with the long-term strategy? I mean, where does the Powder River Basin or the Anadarko fit for the long-term future of Devon right now?

No, that's a good question. Right now, we're in the first year of our integration. Each of our assets is contributing to our focus on generating free cash flow. Clay mentioned that there are initiatives in the Anadarko that could significantly enhance our returns, especially with our joint venture with Dow Chemicals. We'll always evaluate our options, but we are confident in our portfolio, our free cash flow generation, and our balance sheet. We want to be deliberate if we consider any additional portfolio optimization.

Rick, one of your largest competitors just talked about increasingly, they're going to drill the 15,000 feet lateral well. I think up until recently that most people thought only 10,000 to 12,000 is the optimum. But it seems like they are suggesting differently. So just wondering that, do you guys have a view on that? And whether that's much of an opportunity for you to improve your lateral length and improve your efficiency in here?

Yes, I'm going to let Clay handle that one.

Thank you for the question, Paul. Both legacy companies have experience with three-mile wells. On the WPX side, this was more common in the Williston Basin. There were times when the third mile did not perform as we expected, leading us to question whether we were effectively draining that section. Consequently, we didn't adopt it as a standard approach. In contrast, Devon has successfully led the industry in three-mile development in the Delaware Basin, where the third mile has proven to be highly productive and cost-effective. This has resulted in a beneficial procedure for us. However, transitioning from a two-mile to a three-mile development can be challenging, especially after organizing development for a specific area. We often refer to synergies that may not be reflected in the cash flow statement, but they are indeed valuable. We had some WPX wells planned for three-mile development, which we intended to split into two 7,500-foot developments due to our limited experience in the basin and reluctance to take risks. After merging the teams, we now have access to a wealth of high-quality operations experience that we can apply to the Stateline area, allowing us to pursue three-mile development confidently. We believe the technology to drill that third mile is effective; the real challenge lies in properly stimulating and draining it. Based on the legacy Devon experience, we have shown that this method is very effective. Thank you for the great question, I appreciate it.

And Clay said in your portfolio that what percentage of the wells over the next several years do you think you may be able to push into three-mile?

I don't know the exact number, but I would put it pretty low. Like I said, we have a couple of dozen on the Devon side. We're fairly far along on the development scenario, kind of a setup of some of our other areas, especially on the Texas side, kind of working towards the two-mile development. And so I think it will be looking for those opportunities, maybe that we had a three-mile stack or we could trade into those, but at this point, I would say it's going to remain a relatively small amount of our future development. But where appropriate, it's great to have that tool in the toolbox.

Yes. Paul, this is Rick. I want to add that our exposure in Lea and Eddy County involves federal units, which sometimes lack internal hard lines. This situation makes it advantageous for us to drill the three-mile lateral. While it's still too early to discuss our plans for 2022 and beyond, I believe our land position is quite favorable in certain areas for this approach.

Well, I think the consolidation trend has been somewhat difficult to pinpoint. Looking back to last September, there were three very appealing transactions that occurred in quick succession, but it has been relatively quiet since then. Most of the transactions that followed have involved asset-level deals, generally in the range of $200 million to $800 million, with only a few completed. It's challenging to identify a clear trend. However, I believe consolidation will likely continue to some extent, and we have always considered it to be potentially beneficial for our industry, though it varies depending on which peers we consult.

Rick, I'd be remiss if I didn't ask Clay more about this Danger Noodle project. Yes, specifically, I mean, it wasn't just the well results, but even the cost. Clay, if you could just talk a little bit, was it just focused on the Upper Wolfcamp? And what did you guys do to continue to get those costs down there like that? And can you continue that in others?

It's pretty exciting to see the cost trends. We've achieved a 43% reduction in drilling and completing compared to previous quarters, which is significant. However, there's even more potential ahead. The particular pad we worked on was drilled and completed without fully utilizing the synergies from the merger of our companies. Looking forward, we're currently testing and refining completion designs and facility designs, which presents huge opportunities. Bringing together subsurface teams who have been working separately in the legacy companies to share ideas and challenge each other has sparked some amazing and synergistic discussions. The strategies we're using for three-mile wells, supply chain bidding, and economies of scale in our chemical programs can all create substantial value. We're also leveraging technology like cameras and AI to monitor wells continuously, seeking environmental improvements. Additionally, we are focusing on enhancing preventive maintenance through machine learning. On the ESG front, Devon has a bit of a head start, but we are ramping up our efforts on the WPX side, and combining our strengths with Devon's existing work has really accelerated our progress. We are seeing positive results across the board, and I'm looking forward to elaborating on our ESG strategy in the coming months.

Great details. Rick, I know this has been asked before, but could you share some thoughts on the timing, especially regarding the Williston and the Powder? There has been a notable increase in Williston sales recently, and WPX has been quite transparent about its views on current locations there. The valuation seems to have significantly risen. On the other hand, while there hasn’t been much recent activity in the Powder, there is certainly considerable potential for upside. I'm curious if this relates to your free cash flow generation plan and if it's something you intend to address this year to decide on your next steps. Could you provide more specifics on what would influence decisions in this area?

Well, I think, number one, you see up in the Bakken, it's a great base of operating, and that's why you've seen the activity, and you actually see some pretty competitive transactions recently. So I think it just shows the value of the asset that we have up there. We've got a great team. And as we've always said, the margins up there and the leverage you get from an improving crude oil price really drive home cash flows. And we're seeing that day in and day out. So it is an area. We've been very open on that, Neal, to your question. It does not have the inventory that some of our other basins do. But it is playing a very, very important role right now, and it's cranking out a lot of cash for us. So I think we need to keep it. I think the Powder is almost the inverse of that. We have the opportunity to be very thoughtful. We have a great position there. It's very high cut; we don't have to rush. We can be very thoughtful, very strategic about that asset, and we're encouraged with some of the things we're seeing there. And I think you're going to see more activity up there from a few of the other operators. And so we'll learn from them as well. And in the meantime, we'll keep pounding the very high return, low-risk opportunities that we have in our portfolio. So I'd say right now, it's the summary of those comments are full steam ahead of that with the portfolio we have, and we're excited about it. And as we've said, it's all about generating free cash right now.

Yes. I understand it might be difficult, but regarding the divestiture comment, could you clarify whether the Bakken is currently a strong free cash flow generation asset? It seems like it wouldn't make sense to sell right now since Devon has shifted towards a free cash flow generation strategy. Is that correct?

It is.

Okay. Fair enough. Is there a point though, where that doesn't make any sense? And if that point does come, what would you all do with, say, theoretically a proceed if it were to happen, would it look like something similar to what you did with the Barnett where it would be more of a special type of scenario? Or is it just too early to kind of make that speculation?

Yes. Some of your questions are valid, but it's just too early to provide a definitive answer.

As a quick follow-up, if you are ahead of your development results and your performance has been outstanding, would you increase your capital expenditures towards the end of the year to manage your production growth? Or would you instead allocate your capital and accept a bit of production outperformance? It seems you are not entirely confident in the current oil market to pursue growth right now. However, would your asset outperformance enable you to grow, or would you hold back in the latter half of the year and conserve some capital?

Yes. I'd just say we'll probably just stick with our capital spend. It's on track, and it's looking good. We're seeing great results, and we don't see anything at this point in time to alter our plan.

Said another way, production is not going to be our limit. If we can make more production for the same capital, we're all for that. And so I think the big thing we stick to our capital. And you've heard that a number of times today, for '21 and make sure we're being as efficient with those investments we possibly can.

Rick, to you and the rest of your team there, I actually just have one question, and this sort of gets back to the point of maybe looking past '21. Rick, how much time do you and the Board and the managing spend thinking about the risk of maybe waiting too long to increase growth CapEx and the increased volumes? Is that even on your radar? Or is that just something that doesn't enter the conversation right now?

Well, I think that's something that you'll be talking about maybe down the road. Right now, our Board has spent a lot of time just focusing on what we've talked about today, and that is positioning the company to be the leader that we are in the dividend framework that we have. And so I think our Board is very pleased. We'll watch how the equity performs. We're very bullish on our equity, and we think we're going to get rewarded for this. We certainly hope so. And so that's what our Board has been focused on. We'll have plenty of time to talk about outer years in the next few quarters. But right now, we're in a good spot.

All right. Well, I appreciate everyone's interest in Devon today. And if you have any further questions, please don't hesitate to reach out to the Investor Relations team at any time. Have a good day.