Rattler Midstream LP

Ladies and gentlemen, thank you for standing by, and welcome to the Rattler Midstream Q2 2020 conference call. At this time, all participants are in a listen-only mode. After this speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today. Mr. Adam Lawless, VP of Investor Relations. Thank you. Please go ahead, sir.

Thank you, Teresa. Good morning, and welcome to Rattler Midstream's second quarter 2020 conference call. During our call today, we will reference an updated investor presentation, which can be found on Rattler's website. Representing Rattler today are Travis Tsai, CEO, and Case Vantoff, President. During this conference call, the participants may make certain forward-looking statements relating to the company's financial condition results of operations, plans, objectives, future performance, and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements due to a variety of factors. Information concerning these factors can be found in the company's filings with the SEC. In addition, we will make reference to certain non-GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon.

I'll now turn the call over to Travis Dice. Thank you, Adam. Welcome, everyone, and thank you for listening to Rattler Midstream's second quarter earnings call. The second quarter of 2020 presented historic volatility in global energy demand and commodity prices. Rattler, despite all of its operations being located in the premier low-cost shale basin and operated by the low-cost operator in Diamondback, was not immune from this volatility. Diamondback made the prudent decision to suspend completion activity and curtail production in the quarter, directly impacting Rattler's second quarter volumes. Diamondback has now returned all of these curtailed volumes back to production and is currently running three completion crews, both of which will help Rattler's cash flow grow significantly in the back half of the year from the second quarter lows. In a maintenance scenario for Diamondback in 2021, Rattler will have fewer operated capital requirements and relatively flat volumes in the second half of 2020, producing free cash flow at the operated level. We are also reiterating our previously announced EBITDA guidance for the year, which at the midpoint implies growth of 6 percent year-over-year, even in the current commodity price environment. Turning to our equity method investments, both the Gray Oak and Epic Crude pipelines began full commercial service in April, generating cash flow at the project level and contributing meaningfully to Rattler's EBITDA since starting up. We have also been impressed by the resilience of our OMOG Oil Gathering JD, with volumes growing on this system in the second quarter. This highlights the quality of the acreage underpinning the system which was the primary rationale for our investment last year. Three of our five equity investments are now operational, with Wink to Webster pipeline expected to come online in 2021, and our Amarillo-Rattler gathering and processing expansion delayed until commodity prices recover and volumes return to growth in that field. We expect about two-thirds of our equity method EBITDA to convert to distributions to Rattler over the next 12 months. Moving to our operated business, Rattler is intently focused on capital and cost control heading into the second half of 2020 and in 2021. Due to lower activity levels at Diamondback, we have reduced our operated capital spend for the back half of the year and expect to spend about half of our 2020 capital budget in a 2021 maintenance scenario for Diamondback. On the operating cost front, we will continue to drive down operating costs and increase margins, preparing for a lower for longer commodity price environment. Although the forward outlook remains uncertain, we feel the worst is likely behind us and we are very confident in the resiliency of the Rattler business model. Therefore, we are maintaining our $0.29 per unit distribution for the second quarter, which is flat from the previous quarter and in line with previous and current guidance for 2020. The Board intends to review this distribution policy each quarter, but with peer leading leverage, significant liquidity, a core business that is expected to be free cash flow positive, a large CapEx cycle in the rearview mirror, and differentiated visibility into Diamondback's future activity, Rattler is well positioned to maintain this distribution with free cash flow generation. In conclusion, I want to emphasize that Rattler was set up to be a sustainable, self-funding business to combat the inherent volatility in our business. While diversification of customers is often seen as a benefit in the midstream space, we view Rattler's concentration with Diamondback as a clear positive. Diamondback's cost structure with low interest expense, low leverage, low cash G&A, a full hedge book, strong midstream contracts, and mineral ownership through Viper Energy Partners has prepared it to operate in a lower for longer oil price environment. With these comments now complete, operator, please open the line for questions.

As a reminder, to ask a question, you would need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from Jeremy Tonnet with J.P. Morgan.

Hi, good morning. Good morning. Good morning. Just wanted to start off, it seems faying continues to shift to the Midland. Maybe it's around 70-30 split. And if you could just kind of remind us, like, how this influenced Rattler in terms of water cut and any other impacts that we should be thinking about there.

Yeah, Jeremy, good question. You know, certainly the water cut on the Midland Basin side is lower than the Delaware water but that also means we have to spend less capital dollars on infrastructure. As Diamondback was ramping in the Delaware Basin, we were having to drill a new disposal well almost every couple pads, and that's a pretty capital-intensive side of the business. So with Diamondback moving more to the Midlands, You know, the Delaware is kind of more of a steady state to declining a bit, but we don't have to spend any more dollars out there on the SWD side. So, you know, that helps us on the capacity front. You know, I'd say on the Midland side, you know, we are doing some drilling and completing some wells in some shallower zones that have a little higher water cut on the Midland side, so you're probably closer to two to three barrels of water per barrel of oil now on the the forward outlook on the minimum side. But overall, you know, I think, you know, as in the numbers that we're seeing and the steady state or the, the state flat plan at the, at the parent company, you know, Rattler's cashflow is going to grow into Q3. And we don't see a lot of, a lot of movement in the cashflow over the next four quarters. You know, with, with that, even with that shift.

Got it. That's very helpful. Thanks. And, Just want to think from kind of a higher level, if Diamondback's moving to more of a maintenance mode, what type of ongoing capital needs do you see at Rattler? Just trying to see what, you know, what CapEx would be needed to kind of sustain EBITDA at these levels.

Yeah, Jeremy, also a good question. You know, we're scoping out 2021 right now. You know, I think every dollar is going to be highly scrutinized. over the next six quarters. You know, what I can tell you right now is that operated capital will be at least, at least half of what we saw and we're seeing in 2020. So the 2020 operated capital budget to 125 to 150 million. And, you know, I think, I think the way I see it right now, it needs to be, you know, at least half of that in 2021. Got it.

That's very helpful. I'll leave it there.

And I think, you know, Jeremy, over time, right, that, that number is going to continue to, to decline if we stay flat over a longer period of time. We don't have a crystal ball yet on 2022, let alone the fourth quarter of 2020. But overall, less growth at the parent co. results in less need for capital at the subsidiary. Got it.

That makes sense. That's helpful. Thank you. Thanks, Jeremy.

And your next question comes from the line of Phil Stewart with Scotiabank.

Good morning, guys. I appreciate you all taking the time this morning. I was wondering if we could start on the OMOG JV. I was pretty encouraged to see volumes actually increase quarter over quarter on that particular asset. I'm just curious, I mean, I know there are two other primary operators in addition to some additional third-party operators on that system in addition to Diamondback. But just curious, you know, what the outlook is for that asset in particular over the next couple of quarters, if you have any visibility into, you know, what you think the third parties are going to do there and if that asset could potentially kind of hold flat in terms of oil throughput volumes. over the next couple of quarters?

Yeah, Phil, good question. You know, I think overall, you know, our partners at Oryx have done a great job operating that system, you know, and I think they've done a lot to cut a lot of required capital out of that system, and that's resulting in, you know, significant distributions back to us, you know, pretty consistently. But, yeah, we were surprised that the system grew in Q2, even in the face of everything that was going on in the markets. I certainly don't expect it to grow into Q3 and Q4, but the commentary from one of the largest contributors, which is QEP, seemed pretty positive in the fourth quarter timeframe. So we might take a dip in Q3, but I'm hoping that things come back up here in Q4. I can also say Diamondback has eight or 12 wells planned in the back half or Q4 this year. That should carry on nicely into 2021 because we have a lot of mineral ownership up there as well as this ownership in the OMOG JV.

Okay, great. I appreciate the additional information there. And then I guess staying on OMOG, are there any material capital requirements for that JV kind of over the next 12 to 18 months?

Yeah, I mean, you know, so when we bought that asset, you know, we basically assumed that there was going to be, need to be $100 million of total capital to build out the asset to full field development. You know, our latest numbers point toward the number that's, you know, 65 or 75% below that. So there's small capital requirements here and there and, you know, new well connections. But, you know, the overall burden has been reduced dramatically. And, you know, we have a small line of credit at that subsidiary, and I think that that line of credit can easily handle, you know, those small capital requirements. So we're not expecting to put any more money into that business. Instead, we'll be getting money out.

Okay. Sounds good, guys. That's it for me. Thanks. Thank you, Phil. Thanks, Phil.

And your next question comes from the line of Iswal Pradham with Bank of America.

Good morning, guys. This is Urjual. Thanks for taking my question. First one on the volume outlook in second half, it seems even after a tough 2Q, the first half is tracking towards midpoint of the range for produced water and sourced water volume guidance. So as we see activity gradually resume here and, you know, FANG bringing back a completion cruise gradually, What do you expect the cadence of the water volumes to be in the subsequent two quarters and perhaps where we would exit the year?

Yeah, that's a good question. So, you know, certainly the, you know, on the freshwater side with Diamondback bringing back three to four completion crews, you know, we're going to see freshwater volumes almost triple off of the Q2 lows. And then on the source water, excuse me, on the disposal side, You know, the way we have it modeled right now is probably a little bit of a dip in Q3 with some more growth into Q4. And I think how we, you know, generally see it is that Q4 saltwater disposal volumes will be kind of in line to maybe a little above Q2. Got it.

Thanks, Chris. That's helpful. And On the sourced water side, it appears you were able to source around 30% of recycled source water, which is at the higher end of range that you have targeted in the past. Is that something you expect to be able to repeat later, and what would be the margin agreed to if that were to happen?

Yeah, that's a good question. I think Q2 is a little skewed because we completed so few wells. We only completed 15 wells. As we get more towards the 40 to 50 completions a quarter, it's going to be hard to top the 30% number that we saw in Q2. But, you know, overall, I think we've set an internal bogey to be above 20%. And, you know, I think the margin enhancement is somewhere along in the range of 10 to 15 cents a barrel.

Got it. Thanks for that. And one more if I may. Appreciate the comment on the potential 2021 CapEx, you know, based on the maintenance activity expectation. I guess, you know, the expectation was CapEx was, you know, supposed to come down after this year. So if you could provide more color on what sort of capital projects would that be spending for, you know, under the maintenance scenario?

Yeah, you know, I also don't want to get pinned in a corner on the 2021 CapEx numbers yet. So I'm trying to give, you know, somewhat of an at least decrease. You know, I think as you think about the projects, you know, most of the projects involve adding saltwater disposal capacity in the Midland Basin, particularly in the northern Martin County and northern Howard County areas where, you know, we don't have as much infrastructure as in kind of Midland County. So most of it's going to be drilling a few disposal wells as well as connecting the systems so that we're effectively utilizing the capacity that we have. But like I said, every dollar is going to be scrutinized pretty heavily here, and we hope to continue to drive down that number for 21. Thanks, Keith.

Appreciate the call. Have a great day. Thanks a lot.

And your next question comes from Percy Hammond with Simmons Energy.

Good morning, and thanks for taking my questions. I wanted to start with SWD and just curious how you are on SWD capacity and what you're paying right now for an SWD well, the full cost to drill and to bring it into service.

Yeah, Pierce, good question. You know, I think with everything, you know, the cost to drill and complete these wells has come down. You know, I think in the Delaware Basin, you know, D.C., drill and complete and, I guess, equip, which would be the facilities for the SWD, are kind of in the $3.5 to $4 million range versus, you know, kind of 4.5 a year ago. And those are, you know, shallower disposal zones in the Delaware Sands. You know, fortunately, like I said earlier in the call, we're not ramping as much as we expected in the Delaware Basin, so we're not having to drill as many of those wells in the forward outlook. But on the Midland side, you know, you're a little deeper. You're disposing into the Ellenberger, which is 13,000-plus feet of total depth. So those cost a little bit more. You know, they're probably topped out at $6.5 million, $7 million for a fully – built facility and now we're probably closer to five and a half on a total basis. Along with the capital budget being cut down from a number of projects perspective, the cost of those projects continues to decline.

Okay, thank you, Case. And then my follow-up, good job on reducing operating costs, and I'm just curious how sustainable you see those operating cost reductions as you move into the future and volumes start to increase.

Yeah, I mean, I think in a down cycle, you start to pick up pennies, and without us needing to feed the diamondback rig machine as much as we did in the last 12 months, the focus has really turned to the op cost side and being efficient with our disposal volumes. For instance, in our reward field, we have five or six disposal wells. Two of them have no royalty associated with them, so we're trying to send as many barrels as possible to those particular disposal wells versus the others. So stuff like that where you're managing not only the costs on the chemicals and the workovers and the maintenance program, but also managing that royalty and being as efficient as possible to send, you know, the lowest cost barrels to the lowest cost disposal wells become a big focus. So I think it's pretty sustainable, you know, particularly as volumes aren't growing like they were expected to. You know, that turns the focus to the efficiency on the operated side.

Okay. Thank you very much, Case.

Thank you, Pierce.

Once again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from Michael Lapidus with Goldman Sachs.

Hey, guys. Thanks for taking my question. Actually, I have two of them. One, just thinking about the long-haul pipelines where you've got equity investments, how are you thinking about the ramp-up of volumes on Greyhawk and on Epic? and kind of the earnings sensitivity that you'll face if it takes a while for those pipes to really fill up.

Yeah, Michael, I think as we've said since the IPO, we always like to model something we can't control very conservatively, and that's what we've done in our assessment of our JV cash flows across the board. So I think that prudence is paying out with us keeping our JV EBITDA guidance and tax. Certainly, you know, volumes on both systems are probably a little lower than everybody expected, you know, two years ago. But, you know, I think with Grey Oak having a lot of take-or-pay contracts on that system, that will ensure that we continue to get distributions. And on the Epic front, you know, I think their volumes, you know, are more exposed to the operators that underlie those commitments. And I can speak for Diamondback that we're sending 75 or 80,000 barrels a day down that system and a happy customer.

Got it. And then total unrelated question. At the Rattler level, in a down market and with a pretty healthy balance sheet, how are you guys thinking about M&A? And what are the types of opportunities and do you think there's a disconnect on the midstream side between maybe potential seller-viewer views of what assets are worth versus potential buyer views?

I can certainly say that a seller's view of an asset's value is a lot different from the buyers in this market through my experience on the mineral side, the working interest side, and the and the midstream side. So I think with any down cycle, patience is rewarded, and I think some stability in what the future holds might create M&A. For us, though, we've been pretty adamant that any M&A we do on the Rattler side has to have a direct connection to the parent company and what the parent company is doing. The OMOG-JV, for instance, is One of the big reasons we did it, because we understood the quality of the acreage, and it looks like that system's performing pretty well in the face of some tough macro headwinds. I think big M&A for us is pretty much off the table on the Rattler side. We are excited that we got our bond deal done and added a ton of liquidity, which I think for us ensures that this distribution is safe for for the foreseeable future, and I think that's probably the big takeaway there, but not going to use that liquidity to go buy things left and right.

Got it. Thank you, guys. Much appreciated. Thank you, Michael.

There are no further questions. I will now turn the call back to Travis Dice, CEO.

Thanks again to everyone participating in today's call. If you have any questions, please contact us using the information provided.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.