Coterra Energy Inc

NYSE:CTRA

Earnings Call Transcript 2018-Q3

[Operator]

Good day. And welcome to the Cabot Oil & Gas Corporation Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]

Please note this event is being recorded. I would now like to turn the conference over to Dan Dinges, Chairman, President and CEO. Please go ahead.

[Dan Dinges, Chairman, President and CEO]

Thank you, Shaun, and good morning to all. Thank you for joining us for today's Cabot third quarter 2018 earnings call. We do have a number of executive management team with me at the table. I would first like to emphasize that on this morning's call, we will make forward-looking statements based on current expectations. Also, some of our comments may reference non-GAAP financial measures. Forward-looking statements and other disclaimers, as well as reconciliations to the most directly comparable GAAP financial measures are provided in this morning's earnings release.

For the third quarter of 2018, Cabot generated net income of $122.3 million or $0.28 per share, compared to $0.04 per share for the prior year comparable quarter. Adjusted net income for the third quarter of 2018 was $108.9 million or $0.25 per share compared to $0.07 per share for the prior-year comparable quarter.

For the third quarter of 2018, Cabot's cash from operating activities was $242.2 million compared with $189.1 million in the prior-year comparable quarter. Discretionary cash flow for the third quarter 2018 was $298.8 million compared to $207.2 million in the prior-year comparable quarter.

Cabot returned to free cash flow generation during the third quarter of 2018 delivering $28.6 million of free cash flow compared $4 million in the prior-year comparable quarter. We've now generated positive free cash flow for nine of the last 10 quarters and expect this trend to be the new normal given the inflection point we find ourselves at today.

As previously reported earlier this month, daily equivalent production for the quarter was 2.029 Bcfe per day which represents a 10% increase relative to the prior-year comparable quarter, and a 7% sequential increase relative to the second quarter of 2018. On a divesture adjusted basis, third quarter 2018 daily equipment production increased 19% relative to the prior-year comparable quarter.

Realized natural gas prices increased 16% relative to the prior-year comparable quarter despite a 3% decline in NYMEX benchmark prices driven by an improvement in pre-hedge basis differentials from minus $0.99 last year to minus $0.54 this year.

Our unit cost continue to improve as we posted an 18% decline in cost relative to the prior-year comparable quarter. Cash unit cost which excludes DD&A stock-based compensation and other non-cash charges were below $1 per Mcfe for the quarter [hovering] our ability to generate strong levels of cash flow even in a low natural price cycle.

During the quarter we returned $188.5 million of capital to our shareholders through dividend and share repurchases and also paid off $237 million tranche of a 6.4% senior notes that matured in July resulting in over 15 million of annualized savings going forward. Our continued reduction in capital employed coupled with our growth and earnings has resulted in a return on capital employed for the trailing 12 month of 10.8% and improvement of over 500 basis points relative to the trailing 12 months ended in September 30, 2017.

Our capital allocation update, in this morning's press release we highlighted our commitment to returning cash to shareholders through the continued execution of our share repurchase program and the announcement of our third dividend increase in the last 18 months. Our share repurchases reflect continue to believe that our stock is currently trading below intrinsic value while the dividend increase highlights confidence in the company's ability to generate strong levels of free cash flow going forward.

Year-to-date Cabot has repurchased 30 million shares and win including year-to-date dividend payments as well as our expected dividend payments for the fourth quarter we will have returned over $820 million of cash to shareholders in 2018 representing a total shareholder year yield of almost 9% based on our market capitalization. Since we reactivated our share repurchase program since second quarter of 2017, we have reduced our shares outstanding by over 7% to 431.2 million shares.

As a reminder, we currently have approximately 20 million shares remaining authorized under our share repurchase program. We also highlighted our commitment to returning over 50% of our annual free cash flow shareholders going forward. We believe our firm commitment to provide this level of payout shareholders annually while still preserving financial flexibility to remain opportunistic to all commodity cycles maximizes our ability to create long-term value for our shareholders.

Our focus on increasing return of capital coupled with an expectation for continued earnings growth should allow us to deliver continued improvement in our return on capital employed which already significantly exceeds our cost of capital.

The Cabot's long-term plan to be successful, we have highlighted our four critical infrastructure projects to be completed during 2018. While we have frequently provided updates on the progress of these projects, today I'd like to provide specific details on these major accomplishments as our marketing strategy to create new major takeaway Greenfield pipeline and development in key basin and demand has finally and effectively come together.

Regarding in-basin demand, we're happy to confirm that the Moxie Freedom power project was successfully placed in service during the second week of August. As with all startups we have had some volatility during the first few months of service by placing the 1,000 megawatt facility in service prior to the winter season is a great milestone for Cabot.

Moving on to the Lackawanna Energy Center with the Trains 1 & 2 fully in service, we are only waiting Trains 3 to complete this testing - to complete its testing phase. Currently Train 3 remains on schedule for December 1 and we are anxious for this mammoth 1,485 megawatt power facility to be 100% complete and fully in service for our December business.

In summary, our two large-scale power projects will add significant invasion demand for Cabot for years and provide basis for an additional project as we continue efforts to increase local demand in the Northeast Pennsylvania area. On October 6, 2018 the Atlantic Sunrise project was placed in the service for Cabot. No single project could be viewed as significant and material to Cabot's financial and operating stream as this new 170 mile Greenfield pipeline that will connect Cabot's position in the Northeast Pennsylvania asset area to the Atlantic Coast market area.

On the operating front, we had several seamless successful transition as we diverted gas from in-basin out of multiple sources and immediately filled our new pipe to full capacity. With Cove Point LNG facility already in service, this new pipeline provides a direct path enabled Cabot to capitalize on its 20 year 350 million per day supply contract with Pacific Summit Energy and realize an opportunity we all have been waiting and working towards for over five years.

That said, the in-service Atlantic Sunrise also triggers several other significant events for Cabot. To start pipeline now allows for service to commence for the following sales agreement. One, a 15-year 500 million per day sales to Washington Gas Light, secondly, a 50 million per day sales to southern companies, and third a three-year 150 million per day sale to an undisclosed customer.

To recap, on October 6 Cabot commenced delivery of 700 million cubic foot per day to three new sales customers while delivering an additional 350 million per day to Cove Point for a total of 1.05 Bcf per day to new markets with significantly better pricing realizations. With the addition of close to 400 million cubic foot per day of new in-basin demand from the power plant, Cabot has successfully shifted its primary pricing mix from supplier pricing to market area pricing for close to 1.5 Bcf per day, a milestone that frankly is unheard of in today's environment.

I might add these are not temporary in nature as these transactions for the most part average 10 to 20 years in duration. Personally I would like to thank both our Pittsburgh-based employees and our field personnel along with our partners and board for the commitment and execution of this step change event for Cabot.

Moving on to our recent announcement of the new Leidy South project. We feel good about the scale and timing of this expansion of the new pipeline infrastructure. This 250 million a day - per day project consist primarily of additional compression for Cabot's new capacity which will significantly decrease the risk surrounding cost and construction timing. This project also allows for about 20% lower transportation rate to move our production down to the Washington DC market area. More to come on this new addition to our marketing portfolio.

Now moving into the fourth quarter and the full-year update for 2018. This morning we also reaffirmed our previously announced fourth quarter 2018 net production guidance of 2.225 to 2.275 Bcf per day. Additionally we reaffirmed our 2018 growth production guidance range of 7% to 8% or 12% to 13% on a debt adjusted per share basis and our full-year capital budget of $940 million.

Based on recent forward curves, we expect to generate approximately $200 million of free cash flow during the fourth quarter and approximately $250 million of cash flow for the full-year highlighting the impact of our increased production volumes, improved local realizations, our sales agreement to the Moxie Freedom and the Lackawanna Energy Power plant and our access to new markets via the Atlantic Sunrise pipeline.

On the local realizations front, we have experienced a significant improvement in prices since the beginning of the fourth quarter driven by the in-service of the Atlantic Sunrise project during the first week of October prior to Atlantic Sunrise coming online, local gas prices averaged to $1.40 compared to an average of 2.90 since the in-service of Atlantic Sunrise.

Cash prices in the Northeast have continue to improve throughout the month with this week average price over $3.10. For reference, last year October local cash prices averaged $0.72 highlighting the impact of new takeaway from the area and increase in-basin demand.

Now moving on to the 2019 preliminary operating plan. This morning we also provided our 2019 production growth guidance range of 20% to 25% or 25% to 30% on a debt adjusted per share basis. This production growth is based on a capital budget range of $802 million to $850 million where we land within this capital range will ultimately be dependent upon our use of natural gas macro in 2019, 2020 for which this coming winter season will certainly have a large impact.

The demand remains strong and supply growth does not overwhelm. We could easily target the higher end of the capital range allowing for stronger trajectory heading into 2020. However, if winter weather disappoints, while growth continues to outperform expectations and we're more than comfortable targeting the lower end of our capital range with a focus on maximizing free cash flow and returns on capital which will result in a modestly lower 2019 exit win.

I would also note that our 2019 capital guidance includes approximately $10 million of capital for pad construction and drilling in our expiration area. We have continued to make progress on evaluation of this area but our progress has been slowed somewhat lower than forecast due to - slower than forecast to permitting in weather delays.

Currently I estimate that our valuation will be complete sometime in the latter part of the first quarter of 2019. Based on current market indications for NYMEX and basis differential, we expect our natural gas price realizations for 2019 to average $0.30 below NYMEX resulting in free cash flow levels of $650 million to $700 million for the year or over a 7% free cash flow yield based on our current market capitalizations.

Additionally, this program would generate earnings per share growth greater than 60% and return on capital employed over 20% both of which are extremely competitive when compared to the broader S&P 500 averages.

As it relates to production range for 2019, let me first highlight that this has nothing to do with well performance or asset quality. In fact, we recently released production data for the state of Pennsylvania for August further confirms this with Cabot delivering 15 of the top 20 wells in the state.

And instead the current production levels forecast versus our preliminary guide back in February is a result of extremely capital efficient program that only requires three rigs and two completion crews and includes larger pad and longer laterals that require at various times existing production to be shut in on offset pads and completion operation.

These pads or wells may be shut in anywhere from a month to six-month depending on location. I would also note that these shut in wells returned to pre-shut in rates once placed back in production. Our expected production growth in 2019 is only 25% to 30% on a debt adjusted per share basis off of a two plus Bcf net per day base it is slightly lower than our original forecast.

However, so is our capital budget lower by a considerable amount when incorporating the impact of higher expected realized price our free cash flow expectations are in line with our estimates from our earlier projection. So we do remain excited about the setup for 2019 driven by our ability to generate a healthy combination of growth and earnings per share. Free cash flow and ROCE.

With that Shaun, I’ll be more than happy to answer any questions.

[Operator]

[Operator Instructions] Our first question comes from Leo Mariani with NatAlliance Securities. Go ahead Leo.

[Leo Mariani, NatAlliance Securities]

Just wanted to follow up a little bit on your comments regarding guidance for 2019. Just trying to get sense obviously you’re targeting slightly lower CapEx, slightly lower production growth you explained some of the rationale. But just big picture is there kind of concerted effort by Cabot here to spent a little bit less money and just kind of generate more free cash flow with the thought of returning much higher percentage of that to shareholders. So a lot of this just kind of part of a master plan and a shift to return more of that capital just wanted to get some of the thinking behind that.

[Dan Dinges, Chairman, President and CEO]

Well it’s exactly that Leo we have - the last couple of years been directing our attention to a value model versus a growth model. Our efforts to become the lowest cost producer out there I think is certainly realized and our efforts to return capital to shareholders and also a return on capital has been highlighted in our prior comment. So our plan is a laser focused on having a value model coupled with modest growth.

And I think in this environment particularly in an environment that has a healthy supply component to it, I think it's the prudent way to go and we're one of a few companies out there that can manage with superior assets, manage a return of cash to shareholders, return on capital that competes favorably with not only our space but also the broader S&P 500. And it’s our objective to continue along these lines we put benchmarks in our release of returning a 50% of our free cash flow to shareholders.

And we're doing everything we can to balance both the capital spend and be able to react if you will to what the macro market does in the space. We see absolutely zero reason to grow into an environment if in fact the commodity price does not provide superior returns.

[Leo Mariani, NatAlliance Securities]

So I guess just to that end assuming that gas prices stay strong as you work into 2019 and your free cash flow goals are materialized. And I guess should we continue to expect to see potential bump up in the share repurchase program in consideration for even higher dividends as we work our way in next year?

[Dan Dinges, Chairman, President and CEO]

No, we're putting in there if in fact you do have the commodity price improvements we think this winter is going to be an interesting period with the supply and storage being where it is. If we do have a winter event I think it's going to and certainly we've been shutdown in a couple of areas to be able to get needed pipelines to the Northeast area.

We haven't been able to get a pipeline across New York, but we think that some of those customers are going to suffer a higher energy cost up there if we do experience a cold winter in light of our ability or lack of ability to be able to get the natural gas into areas that they certainly the market is needed and has asked for. And with that improvement in pricing, we do plan on delivering as we laid out a return of our cash flow to shareholders.

[Leo Mariani, NatAlliance Securities]

And I guess just lastly can you folks just talk about progress on sort of the new generation frac design on some tests in the Upper Marcellus?

[Dan Dinges, Chairman, President and CEO]

While we have said in the past that our design we’re landing on for the most part is our gen-5 design which we talked about in the past. We've also indicated that we are - as part of our 2018 program we have a number of Upper Marcellus test that we are also completing. We've indicated that the early look at the Upper Marcellus meets with our or exceeds our expectation of what we put out as far our production curve.

And we don't see anything that is going to deter from our position that the Upper Marcellus is a distinct and accretive zone different than the Lower Marcellus. So we're comfortable with that position everything we've seen and what we’ve done with our completions out there supports that position. And once we have more production to be able to represent the production curve and the curve fit we will be adding more clarity and support and be more open with what we see early time.

[Operator]

Our next question comes from Charles Meade with Johnson Rice. Please go ahead Charles.

[Charles Meade, Johnson Rice]

This is another question. I think maybe it's an attempt to kind of simplify some of the detailed thoughts you gave us. Can you give us an idea of what data points will be on, kind of, your internal dashboard or the kind of the dashboard of management there as you guys decide to dial up or dial down on CapEx? I imagine, NYMEX is part of it but also your local basis where you'd be delivering incremental volumes and also, share price? But are there other items there? Or is that the right way to think about it?

[Dan Dinges, Chairman, President and CEO]

It’s all the above Charles, if you have a say, we have a disastrous winter season and you get softness in the price. You have overpressure pipelines up there where they have restrictions on pressures and it hits the price point for our natural gas pricing well. It’s not going to make sense to just continue to ramp up as our asset would allow a bunch of gas into that environment.

On the other side if in fact as forecast there is going to be the possibility of a colder winter and there would be a strong support through the winter on the commodity price which would challenge the market to supply the demand that might be anticipated. We will we will be part of that demand equation, spend the money.

Phil Stalnaker is here, who runs our North region. His group will move forward expeditiously to continue to execute their program in a very efficient manner and we will be able to ramp up our deliveries in what we think would be a timely fashion.

Now it's not instantaneous when we start ramp up spending capital but it does support the back end of 2019 rolling into the 1920 winter season where if in fact the storage is similar to what we see and we want to enhance our possession rolling into that winter season all macro points considered NYMEX and some of the points you brought up Charles we will be fully capable of upping our 2019 exit and our expected 2020 production levels.

[Charles Meade, Johnson Rice]

And then following up a little bit on that point. You gave some interesting color in your prepared remarks about the local basis up there before and after Atlantic Sunrise came on. And then, obviously, those - that was - those numbers that you gave, I believe, you said above 40 before and 290 after, that seems pretty dramatic to me and better than I would have guessed. But could you talk about how that - how it did versus your expectations, what you guys were going to see before and after, and if anything has surprised you?

[Dan Dinges, Chairman, President and CEO]

Well, we certainly have - always had the expectation that Atlantic sunrise was not only going to take out of basin and that's the supply basin. Our 850 million that we had committed to that pipeline but it was also going to be an incremental 850 million to get to the Atlantic Sunrise full capacity of 1.7 Bcf a day that is being taken out of basin. I think a direct result of the enhanced position of the basis and in the improvement in the basis is a direct result of 1.7 Bcf a day being evacuated from the supply base.

So to tell you how quick it happened for us, Jeff has mentioned being a little granular that at 10 AM the Atlantic Sunrise project was commissioned on October 6, and a little more than two hours later we had already transferred out of the supply basin 850 million cubic foot a day to the market basin where we were getting and receiving different price points.

So that's how quick we moved it out of basin and others I don't know they're coming that others for the other 850 million, I'm sure it was done in a timely basis because we were going to be reaching the bread a better price point but along with his evacuation certainly the dynamics of the storage and the early predictions of winter has had an effect on the local basis.

But it is reflected in our guidance of having 2019 expectation of our realizations being $0.30 less NYMEX is a significant improvement where we have been in the last four years.

[Operator]

Our next question comes from Brian Singer with Goldman Sachs. Please go ahead, Brian.

[Brian Singer, Goldman Sachs]

There is a glass half - empty glass half full way of looking at greater than 50% commitments to returning free cash flow or the commitment to returning greater than 50% of free cash for the shareholders. Certainly I think people can look and say, wow look here as a company that is committing to share repurchase and dividends and then the other side would be what's going to happen to the other 50% or slightly or less than 50%. Can you add some color on how you're thinking about the remainder of that free cash flow the extent that that would be - that paydown acquisition expiration and then maybe give us an update on the expiration side well as part of that.

[Dan Dinges, Chairman, President and CEO]

Yes, you can look at the past Brian and you followed us for a long time. We have always managed in - what I would couch as a conservative method and a conservative management of our balance sheet. We did not have any problems keeping close to $1 billion of cash on our balance sheet when we sold our Eagle Ford and closed on that. We had cash on our balance sheet right now with $1.8 billion undrawn on our facility and that position just that we sleep well, at night I think our shareholders sleep well with that at night and if in fact we found an opportunity to utilize that additional 50% of our free cash flow in a prudent way the way we manage the rest of our business.

We would think about that and we would have a ability to execute on an opportunity if in fact we see it. The issue is with our tremendous capital efficiency how we allocate our capital. What we expect when we allocate our capital sets a high bar and that high-class problem makes it rather difficult to find a competitive area to allocate that incremental 50% but at this time we're comfortable having it on our balance sheet.

Scott's referencing, I didn't answer the expiration side. We’ve been delayed up there because of the construction build out, some weather slow down permitting issues to try to get to the data gathering point we need to drill and complete tasks that slowdown has pushed into where we think the completion of what data gathering that we had set out when we first started this effort that we need to evaluate the project.

We think we’ll have gathered in the middle to the latter part of the first quarter and then have an evaluation certainly subsequent to gathering that data. We will make the appropriate call just as we have in the past on whether or not we want to allocate capital further or we do - will begin with our refill project and with that, we don't see it can compete for capital we’ll call it a day on that project and move on.

Between now and gathering that data or in 2019 we expect that they - and we budgeted about $10 million for 2019 to accomplish that.

[Brian Singer, Goldman Sachs]

And then my follow-up is with regards to any type of constraints that maybe impacting production currently. Can you talk about whether there's any flexibility without meaningful incremental spending, should the pressure situation be right in that and in the Marcellus to bring more production online? So what degree is there - what level is there production heightened. What is the environment in which you would bring that on?

[Dan Dinges, Chairman, President and CEO]

Our guidance is a - what I would couch is a conservative guidance from the standpoint that we are ramping up into our gathering system. Our guys in the field along with the Williams personnel continues to look at the most efficient way to ramp up production into the system. We look for all different kinds of ways to make our gathering system efficient.

We scheduled where we complete well, when we bring on wells in a way that balances the current production within a particular pod area of the gathering system to compare to another area in the gathering system in the field area that would allow us to bring on completed well into an area that the production is kind of trended down where we would not have as much inner pod pressure issues associated with our new production and its effect on old wells.

So we balanced that way out in advanced as we schedule drilling and completions and the number of wells we drill off a pad. As we go through this completion operation and you look at having to offset, shut in offset wells so we would mitigate any of the frac hits or pressure sensitivities that's been done throughout our industry. Everywhere that you have laterals that are in close proximity to new laterals are in close proximity to old production that’s happening across the entire industry space.

And everybody is dealing with how you manage bringing on completions and bringing on new wells and its effect on offset production. So our guidance we think is conservative in that respect on how we have sensitized that impact and mitigated that impact and we made our best guess forecast on how many days we’ve had certain wells or pad shut in as we bring on new wells. And that again just a balancing act but I can assure you every opportunity we have to bring a well back on that's been shut-in and to expedite or reduce the shut in period but we’re going to do that. But we feel like we've managed through our guidance the effects of that process.

[Operator]

Our next question comes from Doug Leggate with Bank of America/Merrill Lynch. Please go ahead Doug.

[Doug Leggate, Bank of America/Merrill Lynch]

On the quarter I wonder if I could just touch by kind of couple of the comments you made about in base and capacity. And the line of sight you have for you’re basically the constraints on your growth as you go forward. Obviously you've laid out 4 Bcf a day gross today. Realistically when do you think you’ll get there given all of the above in terms of capital allocation piece of growth market conditions and so on what do you think is the timeline when we see you lift your production to that level?

[Dan Dinges, Chairman, President and CEO]

Well Doug - it’s a great question and I'm sure one that everybody would like to see us lay out a three-year, four year, five year forecast. But there is so many variables that go into laying out that forecast I’d first start by saying that if in fact the market will allow the macro market would allow us to ramp up production even beyond 4 Bcf a day in the earliest possible timeframe. Our assets and our efficiencies would allow us to do that.

We might bring on another rig, we might bring on another frac crew, we might schedule it out a little bit different, but we could stage in a reasonable timeframe a tremendous ramp up and production with our – asset base that we have. With that being said to guide to a ramp up it would be a timeframe that takes into consideration all the variables whether it's NYMEX pricing, whether it is the storage impact on pricing, whether it's the weather, whether it's the supply side by other operators up there and is it is going to be – and a growth for the second growth out there by others.

If that happens and it's going to have I would think a negative effect on the capital efficiencies of those companies that grow for the sake of growth. And we all kind of looked at what is prudently and rationalizations of the market that oversupplied at any given time and I think at some point in time the market and those participating in the market are going to make a rational decision that say that growth is not everything in this business that you better be able to create a significant value become a low-cost producer and participate and giving back some to the shareholder in that manner as opposed to growth for the sake of growth.

So we're not going to step out on the limb of forecasting three years, four years out into the future because of the variables I could say this that if in fact we forecast some sort of growth out there even though I know we could get it operationally if in fact the market influences is and the macro influence did in a way that would not be prudent from a value consideration to grow into that we would probably get hammered because we cut back on our guidance and we did not allocate the capital to get there.

Even our 2019 program illustrates that we felt like we were prudent and in dialing back our capital spend, dialing back our 2019 guidance to 20% to 25% growth in 2019 which is 25% to 30% growth on a debt adjusted per share basis. And that's of a 2 Bcf plus net production we think that's fairly robust production regardless of what we said earlier.

We think that's fairly productive, but we get reports that have come out and some of the headlines and reports are, guidance and production is light in 2019. Yeah its light okay its only 20%/25% but we think it's also reasonable to take in consideration the value proposition that Cabot brings to the table.

[Doug Leggate, Bank of America/Merrill Lynch]

Well appreciate the long answer Dan and I think the debt adjusted metric is the right one to look at your point. My follow-up hopefully a quick one I really just wanted to take a more holistic view as to the free cash flow story here because just obviously extraordinary. I just wonder first of all if and when you get to that 4 Bcf a day what is the sustaining capital look like and [indiscernible] to hold that it seems to me that in your pursuit of obviously trying to create shareholder value may be the market is not looking at you the right way.

Perhaps the free cash annuity story is a very different valuation metric than the E&P story if you like so I’m just curious would you ever consider in some way changing the company structure MLP comes to mind something of that nature not exactly in our form obviously but you get the idea as free cash annuity how do you feel about the current company structure to meet your goal and what would that sustaining capital look like if and when you did get the 4 Bcf gross production number?

[Dan Dinges, Chairman, President and CEO]

Yes, great question Doug and certainly directionally, how we try to operate first the maintenance capital that’s required to get to our expected you know our growth trajectory and pick your number of what we have in our guidance or what we have in our current infrastructure capacity of 4 Bcf. Our maintenance capital which is always critical when you talk about an MLP is extremely low when I would venture to say our maintenance capital compared to any other assets out there is unparalleled on what it takes to maintain a level of production.

But it is probably you know here's a swag $650 million to $750 million as a maintenance capital number out there. With that maintenance capital you can use your own back of the envelope numbers of 4 Bcf production profile throw in whatever commodity you want, commodity price you want.

We're going to generate a lot of free cash and to get back to your MLP consideration that cash flow that distribution if you will is something that we are guiding towards in the future. It’s our expectation that we will deliver that return of capital to shareholders and it's our expectation that we are going to manage to a return on capital that we think will - in the long term compete very favorably with the S&P 500 benchmarks that are used out there. And I think, one, a generalist looks at Cabot and it sees that even in a commodity based environment that we would be able to still deliver on a return of capital return on capital, a yield that is competitive and consistently at or above other industries in the 500. I think then we will get a multiple credit that we would all enjoy. And that is kind of our longer term vision that we have.

[Doug Leggate, Bank of America/Merrill Lynch]

Yes, I guess - again, I appreciate the long answer, Dan. I guess my consideration was more - as you move into a more sustained cash tax-paying position, the free cash story speaks for itself on this. Maybe if I may just one very last quick one. Given how strong everything is in the Marcellus, how do you kind of slowdown or given up on your diversification ambitions, are you quite obvious with what you've got or should we still anticipate updates on the exploration front?

[Dan Dinges, Chairman, President and CEO]

Well, yes. You could expect expiration updates and behind the gathering of data that I've referenced in the first quarter of 2019. And as far as our ongoing vision and what we do with our capital, it's compelling and I think incumbent upon myself and the Management team to look at any way that we can continue to enhance shareholder own value. That is a broad open ended what you might do.

However, I think from a street perspective, investor perspective, look back historically on how we made decisions in this Company and I think that you would have to have a little bit of faith that if we do make decisions that we're going to make prudent decisions on how we might spend or allocate available capital.

But it is continuously our effort to not only enhance our lot on shareholder value and how we create value in the future, it's also our obligation to mitigate any kind of risk that we might see out there as far as diversity or one base in consideration.

Again, we've always had that though. We've always had and we've that now for years that consideration because that's how Cabot's been viewed. Again, we haven't jumped to just jump. We have to look at the value consideration, value proposition.

[Operator]

Our next question comes from Michael Hall with Heikkinen Energy Advisors. Please go ahead, Michael,

[Michael Hall, Heikkinen Energy Advisors]

Congrats on a solid update. I was curious on a few things, maybe first on the payout side of things has been covered a good bit but how should we think about the relationship to payout of that free cash flow relative to gas prices? Is there any connection there, meaning, as gas prices increased so are you more willing to pay out even higher - materially higher than 30% or lower gas prices environment you hold onto more of it? Is that a reasonable way to think about it or any color on that?

[Dan Dinges, Chairman, President and CEO]

Well, there's options available for that. We've kind of guided on a percentage of free cash flow generated and we'll stick with that guidance. You have available if you wanted to speculate, which this is speculation. If you wanted to say, okay, we had a period of time where the commodity prices went up 450 and generated a lot of free cash. Maybe there'd be discussion of a special dividend. But that speculation again on my part, but that's one way you could look at it.

But I think we would still as far as sideboards guide towards a 50% of our free cash flow

and work within those parameters. But, I think speculation to talk better otherwise.

[Michael Hall, Heikkinen Energy Advisors]

And in terms of the payout, like, I mean how about the split between dividends and buybacks, what's your current thought process on that? Obviously one requires a little more maybe commitment than the other I guess from a long term standpoint. What's - like if we were to split the payout, I mean how might that look dividend draw buyback?

[Scott Schroeder, Chief Financial Officer]

We're not going to get granular on that. As we've said before, we like both of those vehicles equally as well. What we don't want to find our self in is being a little too aggressive over a period of time on the dividend and then get caught in a down market that we will periodically have in this industry somewhere out in the future.

So it's a measured approach on the dividend. As you can see, a year ago or so we made a big step change and then we've had a couple smaller increases. We'll be methodical in those increases with the dividend and continue to be mindful of the underlying, what I'll call, firm commitment, that the dividend payment presents before - as we go forward in the future.

As our cash flows continue to expand you could see more dividend increases. But the highlight yesterday is the fact that with this inflection point with all the new pipelines, the infrastructure projects, we're very comfortable moving to the $0.07, which is $0.28 per year right now.

[Michael Hall, Heikkinen Energy Advisors]

And then there's some views out on longer dated on the gas market around. Some potential challenges in supply-and-demand that may emerge, call it 2020 plus. As continued supply growth particularly that as a basin Northeast but also in the Northeast potentially overwhelms demand. You guys have a view kind of broadly on long dated supply-and-demand dynamics and then what's the kind of sense or how should we think about that in the context of the free cash flow outlook?

[Dan Dinges, Chairman, President and CEO]

I think the supply-and-demand function is going to remain as a topic of conversation. There's going to be a number of impacts I think on both sides. Supply side, I've referenced already at some point, once you get this near term infrastructure build out on the pipelines that have been recently commissioned and the allocation and direction gas is allocated, I think the basin and certainly the Appalachian basin is the largest supply area in the country.

I think there will be some rationalization of how you grow into the future. I don't think there's going to be growth for the sake of growth. And I think there'll be rationalizations. I've said in the past, I think there'll be opportunities for consolidation in the basin. I think to become a lower cost producer I think some are going to maybe require some synergies to be able to get to a point where they deliver acceptable returns to their investors.

But from a demand standpoint, there's going to be demand inflections. The LNGs approval even though there's been delay on LNG, we think that is certainly coming. There's projects that are under construction right now, that's going to have the impact. We think the exports are going to be part of the equation. Not on everybody's radar screen, we think in-basin demand opportunities are going to be in the future.

And when gas is allocated in basin, it kind of doesn't get out there in the market the fact maybe the macro pricing. It's priced maybe as - maybe what we have done with our power plant, priced on a power benchmark versus a NYMEX benchmark.

But there are 26, I think in-basin projects that are being discussed in the Ohio, Pennsylvania area. If you look at all of those 26 projects and you kind of get them up to speed and you commission them along the levels and size that are forecast up there, that's greater than 3.5 Bcf of in-basin demand, that I don't think a lot of people talk about.

And I think that is going to be impactful particularly if you have the rationalizations that we're looking at. So I think the supply-demand balance and being able to manage that is something that industry if acting prudently and accepts the value model a little bit more than growth, I think we'll manage well and I think it'll be managed at a price point that will certainly be attractive for Cabot investors.

[Operator]

Our final question comes from Jane Trotsenko with Stifel. Please go ahead, Jane.

[Jane Trotsenko, Stifel]

My first question is regarding free cash flow. Does your free cash flow guidance include any cash tax refund proceeds, and if it's an organic free cash flow or post dividend free cash flow?

[Matthew Kerin, Vice President and Treasurer]

Jane, this is Matt. So our Q4 and 2018 guidance does assume that refund of the empty credit carry forwards. As far as cash taxes in 2019, the current guide assumes that we just have 100% of our income taxes differ but there's no refund.

[Jane Trotsenko, Stifel]

And you guys don't include the dividends in that free cash guidance?

[Matthew Kerin, Vice President and Treasurer]

We do not.

[Jane Trotsenko, Stifel]

It's pre-dividend, right?

[Matthew Kerin, Vice President and Treasurer]

That's correct. It's a discretionary cash flow less capital.

[Jane Trotsenko, Stifel]

That's perfect. And then the second question is regarding Atlantic Sunrise and its impact on transportation gathering and processing line. I saw that you guys are guiding to kind of flattish per unit transportation gathering and processing expense quarter-over-quarter for 4Q, despite that Atlantic Sunrise has been online since early October. So I'm kind of curious if we should see a pickup in per unit expense in 2019? I was surprised that we didn't see it in 4Q 2018.

[Scott Schroeder, Chief Financial Officer]

No, we're guiding for next year for 2019, $0.66 gathering transport. The reason you don't see that pick up in our gathering transport line is that we are netting transportation costs for the sales on Atlantic Sunrise against the realized pricing. So if you go and look for instance in our guidance slides for Q4, you'll see that the volumes that are reaching trans goes on $0.69 New York, they're actually deducting around $0.65 from those to account for the transport deduct. So it's already accounted for in our $0.30 differential guidance for 2019.

[Operator]

This concludes our question-and-answer session. I would now like to turn the conference back over to Dan Dinges, for any closing remarks.

[Dan Dinges, Chairman, President and CEO]

Thank you, Shaun, and thanks for the questions. And I am pleased that there are a number of questions that we've received directed towards the value model that Cabot is putting forth. Again to reiterate we do look forward to continuing our same style of managing our balance sheet and how we allocate capital. We'll have a focus on value and what it does for our shareholders. So, thanks again and look forward to catching up on the next quarterly teleconference and year-end teleconference. Thank you, Shaun.

[Operator]

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