Devon Energy Corp (DVN) — Q4 2022 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 outlook for Devon in 2023. Throughout the call today, we will make references to the earnings presentation to support prepared remarks, and these slides can be found on our website. Also joining me on the call today are Rick 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 materially 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 great to be here this morning. We appreciate everyone taking the time to join us. On the call today, I will cover three key topics: our record-setting performance in 2022, the strong outlook we have for 2023, and the cadence of our capital and production in the upcoming year. Now to begin with, I'd like to turn your attention to Slide 6 and 7, which cover our results for the past year. As you can see, for Devon Energy, 2022 was another year of outstanding accomplishments. We achieved all the capital objectives associated with our disciplined operating plan. We delivered the best financial performance in our company's prestigious 52-year history. And we took important steps during the year to strengthen the depth and quality of our asset portfolio. The slides on Slide 6 show a great visualization of the solid execution we delivered over the course of 2022. Production per share advanced by 9% year-over-year. This growth resulted from a combination of record oil production that has more than doubled since 2020 to accretive acquisitions and timely stock buybacks. Our streamlined cost structure captured a full benefit of favorable commodity prices, expanding per unit margins year-over-year. Returns on capital employed set a new company record at 39% for the year. This impressive return profile outpaced the S&P 500 by a substantial margin, and this strong capital efficiency translated into free cash flow reaching an all-time high of $6 billion in 2022, more than doubling the previous year. I want to congratulate the entire team at Devon for these accomplishments in 2022. This type of operational excellence and financial performance differentiates Devon as one of the premier energy companies in the U.S. Another key highlight for 2022 was the market-leading cash returns we deliver to investors. On Slide 7, we have included a comparison of our total cash payout that reached around 10% for the year versus other opportunities in the market. As you can see in the red portion of the bar, Devon's dividend payout was more than double that of the energy sector and vastly superior to every sector in the S&P 500. However, I want to be quick to add that we are not just a high-yielding dividend story, we are also compounding per share growth for investors through the execution of our $2 billion share repurchase program. By upsizing this buyback authorization twice during the year, we reduced our outstanding share count by 4% since program inception and secured shares at a substantial discount to current trading levels. We also supplemented per share growth in 2022 by deploying a portion of our excess cash toward taking advantage of unique M&A opportunities. These acquisitions in the Williston and Eagle Ford were highly complementary to our existing acreage, and we secured and met an attractive and accretive valuation and captured top-tier oil resource in the best part of these prolific fields. While tough to come by, these transactions successfully demonstrate another way our plan can create value for shareholders. On Slide 11, as we shift our focus to 2023, I want to be clear that there's no change to our disciplined strategy. At Devon, we are driven by per share value creation, not the pursuit of produced volumes. For the upcoming year, we have designed a consistent capital program to sustain production, deliver high returns on capital employed, and generate significant free cash flow that can be harvested for shareholders. Now let's run through some of the highlights of our 2023 outlook. Beginning with production, we expect volumes to build throughout 2023 to reach an average of 643,000 to 663,000 BOE per day for the full year, of which approximately half is oil. Combined with the tailwinds from share repurchases and our two well-timed acquisitions, our volumes on a per share basis are on track to deliver an attractive high single-digit growth rate once again in 2023. The capital investment required to deliver this production profile is expected to range from $3.6 billion to $3.8 billion, with these capital requirements being self-funded at pricing levels as low as a $40 WTI oil price. This low breakeven funding level showcases the durability of our business model and positions us with an attractive free cash flow yield in 2023 that screens as much as 2x higher than other key indices in the market. With this strong free cash flow, we will continue to prioritize the funding of our dividend, which includes an 11% hike to our fixed dividend payout beginning in March. We will also have plenty of excess cash after the dividend to evaluate opportunistic share buybacks or take steps to further improve our balance sheet. Lastly, on Slide 12, I would like to end today's comments with a few key thoughts on the trajectory of our capital spending and production profile as we progress through 2023. Beginning with capital, we planned for spending to be slightly elevated in the first half of the year due to the addition of a temporary fourth frac crew in the Delaware Basin. This elevated completion activity in the Delaware is expected to be wrapped up by midyear, resulting in reduced capital spending over the second half of 2023. Looking specifically at first-quarter production, we expect volumes to approximate 635,000 BOE per day. Our production during the quarter is expected to be temporarily limited by three factors: first, due to the timing of activity, we expect to bring online around 90 gross-operated wells in the first quarter. This will be our lowest quarterly amount for the year. However, activity does ramp up from here with roughly 15% more wells online per quarter over the remainder of 2023 compared to the first quarter. Another factor impacting near-term production is infrastructure downtime in the Delaware Basin due to a temporary outage at a compressor station in the Stateline area, along with some minor third-party midstream interruptions in the area. We estimate these outages will limit first-quarter volumes by around 10,000 BOE per day. However, we expect to fully resolve these issues and resume operations by the end of the quarter. Lastly, our forecast is also assuming that we elect to reject ethane at several processing facilities across our portfolio in the first quarter. This is expected to limit volumes by roughly 10,000 BOE per day during the quarter. The key takeaway here is that while our first-quarter production will be held back a bit due to the timing of activity and infrastructure, we do expect volumes to fully recover and increase over the remaining few quarters of 2023 to an average of roughly 660,000 BOE per day. So in summary, since we first unveiled the industry's very first cash return framework in late 2020, we have created tremendous value for our shareholders. 2021 was a great year, 2022 was one for the record books, and 2023 is shaping up to be another excellent year for Devon. The outlook beyond 2023 is also exceptionally bright given my belief that we are still in the early stages of a multi-year energy upcycle. This conviction is anchored by supply constraints from a decade of global underinvestment, ongoing sanctions on Russian production, a generational low in OPEC spare capacity, fiscal discipline among U.S. producers, and the inevitable rise in demand for our products as global economies normalize and grow post-COVID. I fully expect this favorable supply and demand set up to be another catalyst for our energy appreciation or equity appreciation as more investors rediscover highly profitable and value-oriented names like Devon. With that, I will now turn the call over to Clay to cover a few operational results and more details regarding our capital activity in 2023.

Thank you, Rick, and good morning, everyone. In addition to our strong 2022 financial results, Devon also continued a run of strong operational execution as well. As you can see on Slide 14, this was evidenced by several noteworthy accomplishments including a new all-time high for oil production that was underpinned by another year of world-class well productivity in the Delaware. Devon's oil-weighted production mix, coupled with our low-cost asset base, allowed us to capture record margins and maintain low reinvestment rates of just over 30% of cash flow. We also efficiently expanded our resource base in 2022 with proved reserves advancing 12% through the combination of strong drilling results and by seamlessly integrating two property acquisitions during the year. Flipping to Slide 15. You can see that these strong operating results in '22 also place us in the top echelon of capital efficiency for the entire industry, differentiating Devon in this crowded and competitive space. These operational achievements across every phase of the business demonstrate the power of Devon's advantaged asset portfolio, the success of our rigorous capital allocation process, and the quality of our people to extract the most value out of these assets through superior execution. For the remainder of my prepared remarks, I plan to discuss the key capital objectives and catalysts of our '23 operating plan. For '23, we plan to maintain a very similar activity level as compared to the fourth quarter of '22, which was the first full quarter of operations with our recently acquired assets in the Williston Basin and Eagle Ford. Overall, we plan to run consistently 25 rigs throughout the year, resulting in approximately 400 new wells placed online in 2023. Turning to Slide 16. Once again, the Delaware Basin will be the top funded asset in our portfolio, representing roughly 60% of our total capital budget for this year. To execute on this plan, we will operate 16 rigs across our acreage footprint with the sweet spots in Southern Lea and Eddy Counties in the Stateline area of Texas receiving most of the funding. Approximately 90% of our capital will be allocated towards high-return development activity in the Upper Wolfcamp and Bone Spring, while the remaining 10% will be allocated towards delineating upside opportunities in the deeper Wolfcamp that will add to the depth and quality of our inventory in the basin. Importantly, we expect overall well productivity from this program to be very consistent with the high-quality wells we have brought online over the past few years. We are also well positioned to maximize value for our production in the Delaware for the upcoming year. The marketing team has done an excellent job of diversifying across multiple transportation outlets and sales points, allowing us to avoid many of the takeaway constraints in the basin. Looking specifically at the gas volumes, approximately 95% of our gas in the Delaware is protected by either firm takeaway contracts or Gulf Coast regional basis swaps. With oil production, we expect our revenue to benefit from access to premium Brent pricing through Pin Oak's export terminal in Corpus Christi. This advanced pricing, combined with low LOE and GP&T cost structure of around $7 per BOE will drive another year of strong margins and excellent free cash flow from this franchise asset. And lastly, on this slide, I would like to provide a few more thoughts on our first-quarter infrastructure downtime in the Delaware. As pointed out on the map, in late January, we had a fire at one of our compressor stations in the Stateline area that severely damaged the electrical system and the compressor unit. The station is our largest operated compressor facility in the basin with a capacity of 90 million cubic feet per day and is a key component to our centralized gas lift operations in the surrounding area. We have secured necessary replacement equipment, and the team is currently on site repairing the facility. With this disruption and other third-party midstream downtime in the area, we expect to have a negative production impact of 10,000 BOE per day in the first quarter. With the quick reaction time and the team's focus on safety and recovery, we expect to have this facility back up and running with the affected production fully restored by mid-March, and we do not expect to have any negative production impacts dragging into the second quarter. Turning to Slide 17 and moving on to the Eagle Ford. The team has done a great job integrating the Validus acquisition into our operations, resulting in our fourth-quarter production nearly doubling to 68,000 BOE per day. With this increased scale, the Eagle Ford will play a much bigger role in our capital allocation in the upcoming year, accounting for just over 15% of our total capital spend. During the year, we plan to run a steady 3-rig program with 70% of the activity deployed towards developing our recently acquired acreage in Karnes County, with the remaining capital invested in our joint venture partner, WPX in DeWitt County. Overall, this development-oriented activity is designed to maintain steady production in 2023. Looking beyond the production trajectory, a key catalyst for this asset in the upcoming year will be the continued appraisal of resource upside from tighter redevelopment spacing and refracs. Early results indicate there's a lot more oil to be recovered from this prolific play over time. As we get more data points, I expect to provide more commentary on this important resource expansion catalyst in the near future. Moving to the Anadarko Basin. In 2022, the team's approach of wider well spacing and larger completions design consistently delivered triple-digit returns with the benefit of our $100 million carry with Dow. As we look ahead to 2023, I expect continued value creation as we plan to deploy a steady program of 4 operated rigs once again carried by Dow. This program is expected to result in around 40 new wells placed online, focused on primarily the co-development of the Meramec and Woodford formations in the condensate window of the play. The carried returns of these projects will once again be very strong, allowing us to maintain a steady production profile throughout the year while harvesting significant amounts of free cash flow. For both the Williston and the Powder River Basins, I want to begin by acknowledging the tremendous job our field personnel did in fighting through extremely challenging weather conditions over the past few months. While operations in the fourth quarter were certainly slowed due to these Arctic conditions, the production from the business was resilient, collectively averaging 80,000 BOE per day between these assets in the Williston and the Powder River Basin. Looking ahead to 2023, approximately 10% of our capital spend will be deployed across these two plays, resulting in approximately 50 new wells placed online during the year. Approximately 2/3 of the Rockies capital activity will reside in the Williston Basin. In 2023, the capital objectives for this asset are to efficiently sustain production through low-risk infill drilling, evaluate resource upside with a handful of refrac tests, and generate around $700 million of cash flow at today's pricing. In the Powder, our objective is designed to build upon the 3-mile lateral success from last year by taking the next step in the progression of the Niobrara with spacing tests of up to 4 wells per unit. These pilots would not only help us better understand spacing but also help us inform optimal landing zones and completion designs. The key takeaway here is that Powder is one of the few emerging oil plays in North America, and we have a 300,000-acre net position in the core of the oil fairway providing Devon an important oil growth catalyst for the future. Overall, we're very excited about the prospects in 2023. I believe with the high-quality slate of projects we have lined up for the upcoming year, we expect to continue to deliver top-tier capital efficiency that investors have become accustomed to. We're also well positioned to refresh and add our depth of inventory as we execute on these programs in 2023. A good visual reminder of Devon's depth of inventory and upside potential is on Slide 18. I've covered this topic at length during previous calls, so I won't go through the details today, but I do want to emphasize two key takeaways from this slide. First, we have identified roughly 12 years of high-return development inventory evaluated at mid-cycle prices. This inventory positions us to deliver highly competitive results for the foreseeable future. And secondly, I want to highlight that this inventory does not fall off a cliff at the end of year 12. We expect to systematically refresh this inventory over time as we successfully characterize and derisk the many upside opportunities that exist across our diverse set of assets. And lastly, on Slide 19, we are continuing to make significant strides in our environmental performance as outlined in our recently published sustainability report. This comprehensive report details Devon's aggressive mid- and long-term ESG targets, including those highlighted on the right side of the slide, as well as meaningful steps that we've taken towards meeting these targets. Our actions demonstrate the priority we have placed on long-term carbon reduction intensity of our operations. I'm really proud of the team's commitment to doing business the right way, which means balancing three mandates: first, providing the critical energy to power the world's economy; second, providing compelling and sustainable returns to our investors; and third, doing all of this in an environmentally conscious way. You can expect Devon to continue to raise the bar on all three of these imperatives.

Thanks, Clay. I'd like to spend my time today discussing the highlights of our financial performance in 2022 and the capital allocation priorities for our free cash flow as we head into 2023. A good place to start is with a review of Devon's 2022 financial performance, where operating cash flow totaled $1.9 billion in the fourth quarter, an 18% increase versus the year-ago period. This level of cash flow funded all capital requirements and resulted in $1.1 billion of free cash flow for the quarter. For the full year 2022, free cash flow reached $6 billion, which is the highest amount Devon has ever delivered in a year and is a powerful example of the financial results our cash return business model can deliver. Turning your attention to Slide 8. With this significant stream of free cash flow, a unique component of our financial strategy is our ability and willingness to accelerate the return of cash to shareholders through our fixed plus variable dividend framework. Under this framework, Devon's dividend payout more than doubled in 2022 to a record high of $5.17 per share. Based on our strong fourth-quarter financial performance, we announced a fixed-plus-variable dividend of $0.89 per share that is payable in March and includes the benefit of our 11% raise to the fixed dividend. Another priority for our free cash flow is the execution of our ongoing $2 billion share repurchase program. On Slide 9, you can see that we upsized this buyback authorization twice during the year, and we bought back $1.3 billion of stock at prices well below the current market level. Over the past two quarters, our buyback activity has been limited given the large cash outlays associated with our recent acquisitions and our preference to rebuild cash balances to optimize our financial flexibility. As we head into 2023, we expect to be active buyers of our stock, especially if we see trading weakness relative to our peers. On Slide 10, I'd like to give a brief update on our efforts to improve the balance sheet. In the fourth quarter, our cash balances increased by $144 million to total $1.5 billion. With this increased liquidity, Devon exited the quarter with a very healthy net debt-to-EBITDA ratio of only 0.5 turn. Our strong investment-grade financial position provides us the opportunity to return more free cash flow to shareholders and be less aggressive on debt reduction. Moving forward, we'll look to retire debt as it comes due, utilizing our healthy cash balance. Our next debt maturity comes due in August of this year totaling $242 million. We will have additional opportunities to pare down debt with maturities coming due in 2024 and 2025 as well. And finally, I'd like to highlight the excellent return on capital employed we delivered in 2022. As Rick touched on earlier, we achieved a company record 39% return on capital employed during the year. Importantly, even with today's lower commodity price environment, we expect to deliver another fantastic result with return on capital employed projected in excess of 25% based on our provided guidance and current strip pricing. This showcases the durability of our financial model to deliver highly competitive returns through the cycle. With that, I'll now turn the call back to Rick for some closing comments.

Thank you, Jeff. Great job. To wrap up our prepared remarks today, I want to reinforce that at Devon, we are unwavering in our focus to deliver differentiated results for our stakeholders, including our shareholders and employees. To meet these high standards, it all begins with our commitment to be a financially disciplined company that delivers high returns on invested capital, attractive per share growth, and large cash returns to shareholders. To achieve these financial goals, we have carefully assembled a long-duration resource base that has high graded to the very best plays on the U.S. cost curve. This resource depth, coupled with the execution capabilities of our team, positions us as a premier energy company that can deliver sustainable results through the cycle. Since the merger announcement in 2020, we have delivered on exactly what we promised to do with this disciplined operating model, and I expect more of the same in 2023. While we will be slowed down a bit in the first quarter by an unfortunate outage, the pathway to recover is well defined and communicated, and the trajectory of our business will only strengthen as we go through the year. Overall, 2023 is going to be another really good year for Devon. And with that, I will now turn the call back over to Scott for Q&A.

Thanks, Rick. We'll now open the call to Q&A. Please limit yourself to one question and a follow up. This allows us to get to more of your questions today on the call. With that, operator, we'll take our first question.

So I guess maybe if we could start off with the 2023 plan. Just wondering if you could bridge between kind of that annualized Q4 CapEx guide, which would have implied about $3.5 billion to $3.6 billion in CapEx and then the 2023 budget of kind of the $3.6 billion to $3.8 billion. Just wondering if the increase was primarily related to inflation, activity, or something else? And if the new level of CapEx is kind of the sustaining number going forward.

Thank you, Jeanine. That's a great question, and I'm glad to address it. Yes, we provided a soft guidance over the past few months, projecting our fourth-quarter performance. We're generally aligned, though slightly above previous estimates. We continue to encounter inflation, which I want to clarify. In discussions with our team, I don't perceive any new or additional inflationary pressure. What we're seeing is the adjustment of older contracts to reflect more current rates. We observed some of this in the fourth quarter and are factoring in the expectation that this will continue into 2023. Some have raised questions about our predictions for the latter half of 2023, wondering if we might see deflation or even a return to higher inflation. I would characterize our outlook as a steady rate including only slight inflation adjustments, primarily due to the maturation of our contracts. This outlook may be somewhat conservative, but based on our current perspective, that’s the situation we find ourselves in.

Okay. Great. Thank you, Clay. I appreciate all that detail. Maybe moving to you, Jeff, we heard your commentary about the buyback slowdown in Q4 for good reason. We thought maybe there could have been some kind of catch-up in the quarter because Q3 was probably impacted by the acquisitions. But can you provide any color on just the pace of the buyback in Q4? And is it reasonable to think that you could finish up the remaining 700 million in authorization, which I know would be big, but you talked about being opportunistic. But is it reasonable to think that maybe you can finish authorization by the end of Q1? Or is it more likely to kind of be done by early May when it expires?

Yes, you bet, Jeanine. Thanks for the question. Yes, you're exactly right on the back half of last year as we walked into the acquisitions with the cash outlays there as well as all the noise that you're well aware of related to blackouts during that time period and certainly in the fourth quarter as we're leading towards year-end, that made it more difficult for us to get into the market. And then frankly, we were just in a position where we wanted to build back our cash balances to maximize our financial flexibility, as I mentioned in our opening comments. Going forward, to answer your question specific to 2023, we do expect to get back into the market in a bigger way. As it relates to our authorization, as you highlight, that authorization kind of wraps up in the second quarter of this year. Of course, just as we did last year, my expectation is we'll have plenty of opportunities to go back to our Board to reload that authorization to build upon it as we work it forward. And certainly, our expectation here in the first quarter and moving into the second quarter is it will look more like the pace that you saw from us in the first half of last year as it relates to the buyback, and particularly on days like today where we're trading off relative to the group, that's a point in time where you're going to see us be real opportunistic and aggressive getting into the market and buying our shares back.

Rick, I think we will focus on capital efficiency today, but I want to begin with cash returns, if that's alright. Some of your competitors have mentioned possibly moving away from variable dividends and leaning more towards buybacks due to the variability of dividend payouts. Can you explain why you believe that the current combination of fixed and variable dividends, along with opportunistic buybacks, is the best cash return strategy for Devon?

Yes, Nitin, that's a great question. We've discussed this internally, but we always return to our initial stance from September 2020 when we announced the merger. We believe this framework offers us significant flexibility. First, we take pride in our fixed dividend, which we have consistently delivered on for decades. The variable aspect of returning 50% of our free cash to shareholders is also a transparent approach to cash returns. What we appreciate about this strategy is that it preserves our ability to engage in share repurchases or pay down debt. In fact, in the first year post-merger, 2021, we successfully reduced $1.2 billion in debt under favorable terms. Looking back, we are pleased with that decision. We believe this framework remains ideal for us, allowing for ample opportunities for share repurchases. As Jeff mentioned, when we experience dislocations relative to our peers or longer-term outlook, we will certainly consider those opportunities and act accordingly. Our commitment to this framework remains unchanged.

I appreciate that, Rick. And just as my follow-up, some of your basin peers have been talking about new technologies that can help improve recovery factors in the Delaware Basin in the Permian. I'm just curious, you mentioned the test you’re doing or the stuff that you're doing in the Eagle Ford. But anything in the Delaware that you can speak to in terms of improving well productivity or efficiencies?

Yes. I'm going to start and then let Clay finish. The reality is we have an outstanding technical team at Devon, not just in the Delaware Basin. Although some of our competitors are discussing new developments, we see longer-term opportunities both in the back-end and in the Eagle Ford. As Clay mentioned, you'll hear more from us about this in the future, and we're very excited about what we see. I want to emphasize that whether it's our incremental resource assessment to create new long-term inventory or our efforts to enhance the longevity and sustainability of our assets, we're fully engaged in these areas. I'm looking forward to discussing it further in the future. Clay, over to you.

Yes, I think, Rick, I think you nailed it. I'll add just a little bit of color. I mean I think this is kind of the brave new frontier as we think about the maturing of resource plays. The land capture, the kind of the easy, relatively easy stuff has been done. And so now we are thinking about, how do we take these overall recovery factors and where there are significant opportunities, how do we eke out that next incremental opportunity. I mentioned a couple, continued on a couple of things we're doing in the Eagle Ford as well as in the Williston. I can tell you, all of those things are extrapolatable to other basins as well. Those happen to be two of our more mature assets, where we truly understand the geology, we understand the development. We have the opportunity to kind of feather in some of these interesting approaches. So there's quite a bit of excitement around that. I would tell you it's a little too early for prime time, but you know that our focus is clearly on that as we think further out into the portfolio.

I want to come back to the comment on inflation that at the tip of the spear, you're seeing a bit less inflation. At this juncture, are you starting to sense that some of the gas directed equipment in the Haynesville is starting to get bid into the Permian? And I know you mentioned your base case is for a bit more inflation over the course of the year. It sounds like mainly on contract roll. But is there a case building for deflation in rigs and frac pumps before the end of the year, just given where gas prices are?

Thanks for the question, Scott. Currently, our service costs are above what we're seeing in the market. This indicates that over time, as conditions stabilize, service costs and prices will align either by prices increasing or service costs decreasing. In the first half of the year, we have a solid understanding of our situation. There may be a delay in seeing the benefits of this in the second half of the year. With various challenges in 2023, it's uncertain how commodity prices will trend, particularly given the significant fluctuations in gas prices recently. These rigs can easily shift between areas as needed. If this trend of price movement continues, we expect service costs to decrease, especially in the Permian region. However, I want to emphasize that we have not incorporated this expectation into our capital program; we are planning for stable, modest inflation as we approach 2023. It’s too early to include any of these developments in our forecasts. We’re currently engaged in some real-time discussions, and the sentiment has improved compared to a few months ago, which is promising. However, it remains too soon to adjust our capital outlook.

I appreciate all that color. And then just a quick one on Delaware operational efficiency. It looks like the drills and tills for this year maybe up a handful versus last year, but pretty similar level, but you guys are running a few more rigs compared to early last year, and you got that fourth frac crew coming in for the first half. Can you just speak to kind of expectations around lateral length and any other factors kind of impacting overall efficiency in the basin, kind of mix impact from wells targeted in the program this year?

Yes. Thanks for that, Scott. I would say directionally, the lateral length and the working interest when you pan out, are about the same. We may be a little bit longer overall as we started thinking about net spend; you have to think about working interest as well that varies throughout the year. It's probably within the margin of error. When I really look at the efficiency of how quickly we're getting wells down, when you're looking at days, you're looking at hours of pump time on frac crews. Those points of efficiency, I continue to see steady improvement, very encouraging in that regard. And so I would say there is a marginal increase in operational efficiency. Ultimately, what that will yield, as I mentioned a couple of times in my prepared remarks, is essentially the same type of well performance, productivity kind of year-over-year. And we're kind of claiming that as a victory, honestly. When you look at the maturation of the overall resource plays and where some of the rest of the industry is, we continue to see kind of flat productivity. Certainly, when you bake in a little bit of inflation, that capital efficiency erodes from a numerator standpoint, not from a denominator. So we're baking all that in, and we're well prepared. But when you really think about where we're at, still the remaining margin is pretty outstanding. We're very optimistic about the net financial results as we project for '23 to be quite an outstanding year.

Rick, first question to you is just on M&A. You talked about the two property acquisitions last year. How do you think about balancing incremental bolt-ons relative to buying back your stock? And what do you think the activity set around M&A could look like in 2023?

That's a great question, Neil. The foundation for us is our high standards on transactions. We will evaluate transactions and compare them to share repurchases. The strength of our model allows us to do a bit of everything. We've distributed solid dividends, executed share repurchases, and financed two very beneficial acquisitions. This combination works well for us. I believe we will continue to see consolidation in our industry, which is necessary and beneficial. We will remain disciplined and consider our long-term strategy. We have a strong portfolio and will always view these options.

And a follow-up for the team is just on the outlook for natural gas. You shared your comments around the oil markets. Gas is a lot more uncertain. It does feel like we might need to see a supply response in order to calibrate the market given where inventories are. So just perspective on the gas macro in 2023? And then how is the lower flat price for gas changing the way Devon is approaching its activity program in 2023? Do you see any changes that you need to make on the margin to respond to the margin environment?

Yes. Neil, I'll start and then I'll have Jeff follow up to clarify any of my comments. We previously stated about a year ago that we felt gas prices had risen a bit too quickly. We were surprised by how fast they increased, and I must say they have also decreased faster than I anticipated. This seems to be driven by two main factors. First, there was the issue with Freeport, which affects 2 billion cubic feet of gas per day, leading to a cumulative loss in export capability. Secondly, many regions experienced a milder winter, which impacts natural gas demand since it is still quite dependent on weather conditions, unlike crude oil. Therefore, we plan to maintain a focus on oil for as long as possible, as we believe that is a successful strategy. There are strong gas companies out there who may be better suited to answer specific questions. Jeff, how do you view this in the long term?

Yes, you bet, Neil. Thanks for the question. And I think I would echo Rick's comments. We continue to believe that longer term, there's going to be increased demand for natural gas out of the U.S. given the LNG projects that are going to be built out. Obviously, as we all know, that's still a couple of years out. And in the meantime, we're going to be susceptible to some volatility depending on what weather does and other dynamics like Freeport that impact the market. As Rick also mentioned, we view ourselves as an oil company, and 80%, 90% of our revenues are around oil. So we're more focused there. To your second part of your question, Neil, hasn't changed our game plan for this year or going forward as it relates to activity? The answer is no. Again, most of all of our activity is oil-focused and driven by the prices that we see there and the cost structure. So no big change to our game plan as a result of what we've seen in the natural gas markets.

One thing I may add is even some are more gassy development actually is here in the Anadarko. But you have to remember that a big part of that is on Meramec. And so that's a lot different kind of project than, I'd say, an Appalachia or a Haynesville-type project. Many of these wells IP 1,500 barrels a day of condensate. So they are high liquid content, and that's what drives returns. That's what drives our interest in it.

Well, Jeff, everyone, I guess someone else asked my question about the variable dividend, so I'll ask something different. It's nice to be on the call. I have two related questions, and they might both be for you, Jeff. A year ago on this call, you mentioned an ultra-low breakeven around $30. However, in your press release yesterday, you mentioned a $40 breakeven. It seems that with moderate inflation expectations, those two figures don't quite match up. Can you explain what has changed to lead to the $40 figure? A $10 increase in breakeven is what you are trying to convey?

Yes. No question, the cost structure, as we've been talking about, has moved higher on a year-over-year basis. We had the benefit for the better part of 2022 given the supply chain work that we did and the great work that the teams did to kind of lock in, kind of firm contracts with term. You're starting to see some of that unwind now as Clay referenced earlier. And so that contract refresh has resulted in the higher cost structure that you're seeing in this year. And so that's really what's driven that breakeven higher. Now there are some other impacts as you're well aware, our cash taxes, we expect to be higher this year as we've utilized the NOLs in 2022. That's been an impact that's driving that cost higher. But far and away, I know everybody is tired of talking about it, I certainly am as well. But it's the inflationary impact that we've seen across, frankly, every cost category and you use the word moderate, I would actually choose a different adjective. When you think about most of these cost categories, we've seen anywhere between 30% and 50% kind of inflation, depending on which cost category you're talking about, that's what we're walking into in 2023. And again, I'd like to think we've protected ourselves well and benefited from the other side of that for the bulk of 2022. But certainly, as we refresh contracts in the fourth quarter of last year, walking into the first and second quarter of this year, you're seeing some of that impact, and it's certainly driven that breakeven higher.

I was referring to the differences between moderate and the fourth quarter. But yes, you're right. Thank you for the correction, Jeff, and for the clarification. My follow-up question might be for you, Jeff, or for Rick. I'm looking at the free cash flow for the fourth quarter of 2022, which is basically the same as during the fourth quarter of 2021 despite higher oil and gas prices. My question is about the deferred tax, which seems set to decrease compared to the fourth quarter. On a normalized basis, Q4 would likely be lower than a year ago if the deferred tax follows your guidance. I don't want to suggest that free cash flow has peaked, but it feels that way outside of a commodity call. Considering value creation in an inflationary environment, how do you plan to increase free cash flow apart from acquisitions? What strategies support value accretion, which essentially relies on expanding free cash flow? I'll stop there.

Yes. I appreciate the question. You're spot on. I mean, that's why our focus here internally, and Clay referenced this in his comments earlier, is around the focus on that cost structure, the productivity, and the efficiency of the wells that we're drilling. That's the piece that we can control, right? Obviously, we don't have a lot of help on the revenue side. You're certainly correct to the extent that commodity prices go higher, which we frankly expect that to happen given what we've seen in the market. That certainly would be incremental free cash flow to us, but we can't count on that. And so what we're focused on as a company internally is around our cost structure and being more efficient every day in the field, in the office on the things that we can control. And so the good news, as Clay referenced, is we're continuing to see improvement on that front. We're continuing to squeeze white space out of the Gantt chart on a day-to-day on each of our projects, but it's got to be focused around cost structure because that's what we can control and that's how we can drive greater margins relative to the inflationary environment we're seeing today.

I appreciate the answer, Jeff. I guess I was thinking about taking out someone else's cost because you have got a strong track record of M&A, but I'll leave it there.

Yes, Doug, I'll add to that and support Rick's earlier comments. We believe that consolidation will occur in the industry, and this will certainly drive changes. We feel well positioned to seize those opportunities. However, as you know from us in the past, we maintain a high standard for what we bring into our portfolio and how it competes with our existing assets. We also have limited control over the timing and nature of those transactions. Therefore, we need to focus on what we can manage, which is the work we do on a daily basis.

I have two questions, please. In your press release, it appears that in the fourth quarter, the lateral length for the well tied in is about 17% lower than in the third quarter. Is there a structural reason for this, or is it just coincidental that for various reasons, the lateral length is lower across every single basin? Additionally, Clay, your press release mentioned a negative reserve adjustment of 55 million barrels of oil. Can you explain which area this pertains to and what is causing this negative revision? Lastly, do you have a medium to long-term target for net debt? I understand you plan to pay down debt based on maturity, but do you have a specific target in mind for gross net or net debt that you aim for the company to achieve in the longer term?

Paul, it's Clay. I want to address the question about reserves first, and then I'll let Jeff talk about the debt. I appreciate the question and want to emphasize how confident we are in our reserves booking process and the quality of our reserves. One significant benefit of our merger is that WPX and Devon had different auditors, and we've now engaged a third party to review both sets of books and provide a fresh analysis this year. This has been a valuable process, and while there are always some adjustments, we are closely aligned with this respected new auditor. In general, there’s no real incentive to overestimate reserves, and there are strong disincentives against doing so. We aim for a conservative outlook in line with SEC guidelines. Although reserve estimates can fluctuate, there are factors that contribute to these changes. In relation to the oil question, you mentioned shifts in rig commitments from Texas to more focus in New Mexico, which resulted in some wells falling outside the five-year classification. These wells may still be counted in other areas and tend to balance out overall. When assessing the quality of reserves over time, several crucial indicators need attention, such as development costs, PUD percentage booking, and PUD conversion rates. Observing these metrics, Devon is in a very strong position, and we have substantial confidence in our reserves. Another important aspect of the reserve booking process is looking at price revisions first, followed by evaluating cost structures. For us, our lease operating expenses increased year-over-year, which falls into the non-price-related adjustments. This is influenced by inflation rather than actual price changes. There are some interesting nuances here, but I want to reaffirm my strong confidence in our reserves process. Now, I’ll hand it over to Jeff to discuss the debt.

Before we proceed, Jeff, can you discuss the lateral length in the fourth quarter, which is about 17% shorter than in the third quarter? Is there a structural reason for this, or is it just a one-time occurrence due to other factors?

Paul, this is Scott. I'll jump in real quick and then pass it over to Jeff for the debt question. But the key driver of the shorter lateral length is largely the incorporation of Validus. You brought online in the Eagle Ford, you brought online about 30 wells in Eagle Ford. So that by nature of the drilling configuration there, they're shorter laterals. But overall, if you exclude that impact, largely, everything else was close to a 2-mile lateral, which is in line with our previous trends. So that's going to be the big variance there and probably all things equal. You should see that kind of weighting be very similar going forward given the capital plan that we have planned for 2023. Jeffrey?

Yes, Paul, your last question was about our net debt to EBITDA and any targets we have related to that. Historically, we've discussed a target of about 1x net debt-to-EBITDA. As I mentioned earlier, we are currently well below that and are comfortable with our overall leverage position. We hold a strong investment-grade credit rating and have positive discussions with rating agencies. Given the strength of our core business, we are confident in our situation. As I noted, this allows us to be less aggressive in reducing our absolute debt level. We are managing upcoming maturities over the next two to three years and plan to address those as they come due without expecting to increase debt reduction efforts. Of course, if market conditions change or something new arises, we will adapt as necessary, thanks to our cash balance and anticipated free cash flow. I want to reiterate a point Rick made earlier: the flexibility of our financial model allows us to pursue various strategies such as debt reduction, variable dividends, stock buybacks, or even evaluating cash transactions. Thus, we feel good about our leverage and will manage maturities as they come due in the next couple of years.

My first question just on the reinvestment rate, specifically. It looks like I'm showing that the rate may have increased to potentially this year, a bit over 40% versus 31% last year. I'm just wondering how do you anticipate this trending? And is this just largely driven the higher reinvestment rate because of cost? Or are there other factors we should think about when sort of determining what this reinvestment rate is going to continue to trend towards.

Yes, Neal, this is Jeff. If you're referring to our overall reinvestment rate at the corporate level, that's correct. It's simply a result of higher costs due to the inflation we've experienced and the decline in commodity prices, particularly in oil, which is more critical for us. Regarding your second question, this has not altered our strategy for this year or onward concerning our activities. The answer is no. Most of our efforts are oil-focused and influenced by the prices we observe there and the associated cost structure. Therefore, there is no significant change to our strategy due to developments in the natural gas markets.

I think it's a bit early to fully understand all the lessons learned. The situation is still quite recent, just days or a couple of weeks old. First and foremost, we are relieved that no one was injured and there were no personnel on site, which worked to our advantage. We want to assess the impact to determine if there is anything urgent we need to address at other compressor facilities with similar designs. So far, we haven't identified any issues in that area. The teams are conducting a thorough investigation alongside the ongoing repairs. At this point, there aren't any obvious problems. There are many mechanical components and moving parts involved. We will gain insights and apply what we learn, but nothing has immediately emerged that we think we could enhance in the ongoing operations.

But you do expect that literally normal play by second quarter, you said?

Yes. I would say by the middle of March, we should have production fully up and running again about that time. And so it shouldn't bleed into the second quarter. I feel really good about that.

Well, I see we're at the top of the hour. 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. Thank you, and have a good day.