Coterra Energy Inc

NYSE:CTRA

Earnings Call Transcript 2021-Q3

[Operator]

Good day and welcome to the Coterra Energy Third Quarter 2021 Earnings Conference Call. All participants will be in a 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 Caterina Papadimitropoulos, Investor Relations Analyst. Please go ahead.

[Caterina Papadimitropoulos, Investor Relations]

Thank you, Matt. Good morning, everyone. And thank you for joining Coterra Energy’s third quarter 2021 earnings conference call. During today's call, we will reference an updated investor presentation which can be found on the company's website. Today's prepared remarks will include a business overview from Tom Jorden, CEO and President and Scott Schroeder. Executive Vice President and CFO.

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

Following our prepared remarks, we will take your question, please limit yourself to one question and one follow up.

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

[Tom Jorden, President and Chief Executive Officer]

Thank you, Caterina, and thank all of you for joining us on this morning's call. I'll make a few introductory remarks followed by Scott who will walk us through third quarter financials and fourth quarter guidance. We have quite a crew in the room today. And I just want to make sure you know who is in the room because we may be directing questions to them given the complexity of our release; Blake Sirgo, Vice President Operations, Dan Guffey is here for financial planning and analysis. We have Todd Roemer, our Chief Accounting Officer, we have Matt Kerin for finance and other overarching business issues including marketing, and of course Scott who'll be making some prepared remarks.

The closing of the Cabot and Cimarex merger occurred on October 1 as a result, legacy Cimarex will not report third quarter financials. I'm pleased to report that Coterra Energy is well underway with the integration of our two legacy companies. As you can imagine, a merger of equals between Cimarex and Cabot is not an easy task. We've been full court press since May. We have functional teams working around the clock to integrate accounting, information systems production reporting, safety protocol, land systems, operations, marketing, legal and human resources. Each of these teams are tasked with identifying and implementing best in class systems and processes.

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

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

Speaking of confidence, this morning's announcement that we are accelerating our first variable dividend underscores and demonstrates this confidence. Coterra is built to deliver superior financial returns through the cycles. This morning's announced base and accelerated variable dividend totals are combined $0.30 per share coupled with the $0.50 special dividend we paid on October 22. The company will return $0.80 per share during the fourth quarter. As these moves demonstrate, we are committed to our owners. Coterra owners benefit from assets that are second to none, a pristine balance sheet and asset diversity that will sustain and preserve our cash flow through commodity cycles. Our owners also benefit from our ongoing discipline to allocate capital to its most productive use and continually challenge the status quo.

Although Coterra is barely one month old, we have some excellent operational results to discuss this morning. On a pro forma basis, Coterra produced 645,000 barrels of oil equivalent per day, including 81.5000 barrels of oil per day during the third quarter. As promised, we are on track to exit 2021 with oil rates that are 30% greater year-over-year compared to fourth quarter 2020.

We brought 61 wells online during the quarter and are currently running seven rigs and will average four completion crews during the fourth quarter. Five of our rigs are in the Delaware Basin, 2 rigs are in Susquehanna County of Northeast Pennsylvania.

We benefited nicely from higher commodity prices during the quarter. This was true across the board, oil, gas, and natural gas liquid prices were significantly higher during Q3 and have continued to strengthen, more on that later.

We continue to see excellent productivity and deliverability from our Northeast Pennsylvania assets. Slide 8 in the investor deck we posted this morning highlights our ongoing activity level and sustainable production volumes in Northeast Pennsylvania. Our Pennsylvania operation is impressive on all fronts. We continue to make remarkable drilling progress and are bringing projects online faster than predicted.

Faster drilling has meant that we can drill more wells with the same number of rigs, resulting in four additional wells drilled during '21. When acceleration occurs owing to operational excellence, it's a nice problem to have. We're also moving seven additional completions into late fourth quarter '21 from early '22 pushing our plan Marcellus capital slightly above the upper end of our previously issued annual guidance range. As a result, we will have additional volumes coming online around year end to take advantage of strong Appalachian winter pricing.

We continue to see a significant increase in capital efficiency in our Delaware basin assets. Slide 9 in our investor presentation highlights recent development projects in Culberson County as we previously discussed, we are observing that relaxed spacing and modestly upsized completions can significantly improve low level returns and in many instances recover the same amount of oil per drilling spacing unit than more dense well spacing. We are achieving increased productivity per well, similar section recoveries and increased PV-10 with substantially lower capital per drilling spacing unit.

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

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

As we look ahead into 2022 and beyond Coterra is well positioned to generate consistent returns. We have the flexibility to pivot in response to market constraints and opportunities, commodity price swings, and operational advances. Our capital allocation philosophy is supported by three pillars, geographic diversity, commodity diversity, and economic windage. Geographic diversity and commodity diversity are self-explanatory. Economic windage is provided by having assets that provide some of the highest margins in our business. High margins and a low-cost structure mean that returns are preserved through downdrafts and commodity prices. These pillars are our fundamental attribute and a competitive advantage of Coterra. Our capital discipline, diversity and flexibility underwrite our ability to generate outsized returns and accelerate return of capital to our owners.

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

[Scott Schroeder]

Thanks, Tom.

As you mentioned, given the merger closed in the beginning of the fourth quarter, the reported third quarter financials for Coterra Energy only reflect the results of legacy Cabot for this reporting period. However, my comments will include key items for legacy Cimarex also. I would specifically like to draw attention to the following financial and operational highlights for the third quarter.

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

The combined Cabot and Cimarex free cash flow for the quarter totaled $387 million, which also included merger related costs of $100 million. Legacy Cabot's production for the third quarter was 2.36 billion cubic feet a day, which was 2% above the high-end of our guidance range for the quarter. Legacy Cimarex production for the quarter was 251,000 barrels of oil equivalent per day, including 81.5000 barrels per day of oil production.

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

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

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

Now a few comments on guidance. Our fourth quarter '21 combined production and expense guidance assumes that we achieve results that meet our previously issued standalone annual guidance. Of note, we are reaffirming our fourth quarter oil guidance, which assumes 30% year-over-year growth as Tom highlighted earlier. Our full year '21, combined capital is expected to be at the high end of the ranges due to increased efficiencies and an acceleration of completions in late fourth quarter. Obviously, due to the timing of these actions, the increase in capital is expected to have no effect on '21 production volumes, but will benefit '22 volumes taking advantage of the strong commodity price environment we find ourselves in.

In the Permian, we are maintaining a second crew during fourth quarter '21 to complete a Leigh County project versus our original annual guidance midpoint which assumed we would drop to one crew in the fourth quarter. In Appalachian, we plan to drill an additional four wells and complete an additional seven wells during 2021. These completions are set to come online near year end.

During the first quarter of '22, we plan to maintain two completion crews in the Permian and average just over one completion crew in the Marcellus. We plan to issue formal '22 guidance early next year. The combined financial strength and free cash flow generation potential of Coterra that was originally envisioned when contemplating this combination is illustrated in these results. And has been further supported by the tailwinds from the improving commodity price backdrop.

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

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Neil Mehta with Goldman Sachs. Please go ahead.

[Neil Mehta, Goldman Sachs]

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

[TomJorden]

Well, Neil, good morning. Thank you for that question. The integration is going very well. The single obstacle are moving trucks. We're still kind of dispersed and flying around to meet with one another, but here as we get into November, December, we'll all be off from one another. And they'll certainly give us a head start. What I am wholly optimistic and I'm optimistic for several reasons. First and foremost and you know my background, [EOI] [ph], I fundamentally believe that the only competitive advantage a company has long run is its culture and the quality of its people. And I have been wholly impressed with the Coterra organization from top to bottom, we have people that are energized, really talented, willing to look at problems anew. And they bring an absolute commitment that's humbling to me, in leading this organization.

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

[Neil Mehta, Goldman Sachs]

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

[Matt Kerin, Vice President and Treasurer]

Neil, this is Matt Kerin here. I'll address the fundamentals and then hand it over to Tom or Scott to discuss hedging philosophy. So currently, we obviously feel very bullish on the fundamentals that we've seen for gas. Obviously, we've seen a pretty big uptick in the forward curve over the last couple of months, which we think will certainly be beneficiary for Coterra going forward, given the lack of hedging in place right now for 2022. You kind of look at the US storage levels currently. We're about 10% below last year's levels and about 4% to 5% below the five-year averages. And more specifically to where legacy Cabot operates in the Marcellus; we see similar trends in both the Eastern and Midwest storage levels. So both for the broader NYMEX benchmark, but as well as local basis, we feel really strong about where we sit entering the winter months and certainly going into 2022.

[Scott Schroeder]

Neil in terms of hedging, again, like Tom talked about the integration, we're coming together, we have a formalized hedging policy. We have yet to kind of sit down at the table and collect our thoughts. But Tom, myself and Jeff Hutton, our legacy marketing person will be part of the hedge committee going forward. As you saw in the release this morning, or in the investor deck, we did add some Cabot hedges around the time of the transaction, as we saw the end followed the path of kind of wide collars. And that's still a great approach. But the positive of the market that's out in front of us that Matt talked about is we have the ability to be very offensive in terms of -- on our front foot around the hedge decision versus being in a defensive posture trying to protect things.

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

[Operator]

Our next question will come from [Matt Portio] [ph] with PPH. Please go ahead.

[Unidentified Analyst]

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

[Tom Jorden, President and Chief Executive Officer]

Well, I that's a great question. It certainly in our toolkit, it's our buybacks, we're going to have tremendous flexibility financially. As we look into 2022, I'm stunned that at how constructive one can be in terms of the amount of our capital that we need to invest, to stay flat, or generally flat. So we're going to have great flexibility with cash, even after our stated commitment of return to cash to our owners. We are going to model it; I'll just say there's going to be one word that will guide us into 2022 and that's discipline. And we're going to be disciplined in our capital, we're going to be disciplined in our capital allocation. And we're going to be disciplined in our use of funds. And we're going to look seriously at buybacks you have to but we're not going to do it, because it's a fad. We'll do it because we think it's a prudent use of our capital. Scott, you want to comment on that.

[Scott Schroeder]

I think you've covered it. And it's been an arrow and the quiver of the organization for a long period of time. And I think, as Tom said, it will be fully vetted, we're in the process of pulling that together, you mentioned the intrinsic value. We need to do that deep dive on intrinsic value. We also have to think in strategically about it because historically, when prices are good, your values are up, even if you're at a discount from your peers, when the prices move down, then all of a sudden, you bought shares at a higher price, all you got to do is look at the average cost of the legacy balance sheet of Cabot as to what that intrinsic value is, of the shares on the balance sheet. So it's also part of the economic decision. The question, the rhetorical question, no answer required is, do you kind of leave that cash on the balance sheet and take advantage of that buyback in more lean times than where we find ourselves today? That will be all part of the discussion, Matt.

[Unidentified Analyst]

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

[Tom Jorden, President and Chief Executive Officer]

Well, Matt, we're very pleased by the Carol elder project. We look at our returns fully burden cleaning all overhead, all associated costs, including legacy land, and we look at that we model the Carol elder as being highly competitive within our portfolio. Now, you mentioned Lone Rock, but we've got a portfolio of opportunities within our Anadarko asset. There's kind of three major areas, Lone Rock being one, the [up-dip] [ph] kind of near the merge, classically is another and then we've got a really nice opportunity on our western fringe. All of those are highly competitive for capital.

You asked about inventory, our team has done a nice job of presenting a really healthy inventory of three mile horizontal well, opportunities. There'll be a slice of that in 2022. I don't at this point, can't telegraph how big a slice, but I'll say it offers tremendous flexibility from a capital allocation standpoint, to have that third basin that has competitive returns. Because as you know, from time to time, there have been market constraints both in Appalachian and in the Permian. And having that third highly profitable area is a tremendous safety valve that we offer our owners. So we're very high on the Anadarko, it's obviously doesn't have the running room of our Pennsylvania or Delaware. Good boy, it's deserves a place in our portfolio.

[Operator]

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

[Josh Silverstein, Wolfe Research]

Thanks. Good morning, guys. I know you want to wait till Jan or February next year to provide a more formal guidance, really to say I guess how winter shapes up. But you just talked about how much flexibility there is in the portfolio to shift capital around for 2022 relative to just the standalone base plans.

[Tom Jorden, President and Chief Executive Officer]

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

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

[Josh Silverstein, Wolfe Research]

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

[Tom Jorden, President and Chief Executive Officer]

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

[Josh Silverstein, Wolfe Research]

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

[Tom Jorden, President and Chief Executive Officer]

I’m going to let Scott handle that one.

[Scott Schroeder]

Yes. Josh, I heard the kind of pre-closing, Tom's desire to pay off the 750. And I fully understand that, as you've known me a long time, I am a debt averse kind of guy. But I know that we have to have some debt in the capital structure. I would put that on a lower checklist be lower check list, lower than stock buybacks. But I think continuing to repay debt is highlighted in the descriptive, Cabot paid it's -- Cabot actually paid 188 million back this year, 88 earlier in the year and 100 million in September. So I think, let us kind of get together and figure out and look out in these next couple years. But I would suspect a portion of that 1.3 will be paid back and a portion will be refinanced. I don't think nobody's looking to go to zero debt in the organization. But maybe my gut, and Tom and I, in fairness have not talked about this but a target level of absolute debt, around 2 billion versus 3 billion kind of feels like it's in the sweet spot.

[Tom Jorden, President and Chief Executive Officer]

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

[Operator]

Our next question will come from Michael Scialla with Stifel. Please go ahead.

[Michael Scialla, Stifel]

Good morning, everybody. I will ask, I guess a couple of operational questions. Tom, you mentioned, Slide 9 seems a little perverse to me, I guess that the industry is treading into wider spacing with oil prices above $80. But obviously makes sense if you can get the same reserves with five wells per section that you can with seven prior. But have you looked at that greater completion intensity with seven wells per section? And I guess, as you optimize that NPV per section, what oil price was that based on?

[Tom Jorden, President and Chief Executive Officer]

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

[Michael Scialla, Stifel]

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

[Blake Sirgo, Vice President, Operations]

Yes. This is Blake. I'll take that one. We're real excited to be training at the low end of the guidance. And that's really driven by operational efficiencies we've had throughout the whole value chain throughout the year, drilling completions, facilities, flow back, it's all a game of ages that's coming together. We do have inflation, we've seen inflation, just like everybody else from seed and steel. We've seen fuel, we've seen labor. We're working right now to try to model that for '22. That will come out with our '22 plan, but we expect continued operational efficiencies to help offset in future inflation.

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

[Operator]

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

[Holly Stewart, Scotia Howard Weil]

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

[Scott Schroeder]

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

So I don't think there was there wasn't an aha moment. Obviously, it's a marriage. And for everybody on the phone that gets married, not every day is a – there are challenges it can be each week, each day or whatever, just from the different push pull on various things. Blake and I have had the opportunity to serve on Seer Co and we've had a lot of great discussions and a lot of things come together to get us where we're at. And like Tom said, the biggest driver right now is we just need to all get together in one location so that we can move this forward. But there was no bright spot aha moment that we said, oh, crap, we missed this.

[Tom Jorden, President and Chief Executive Officer]

Holly, one of the things I've been most pleased about first and foremost, we were on track to achieve our announced G&A synergies and I'm pleased about that. But once we got our operational teams together and really brainstormed on operational synergies, best practices, procurement, and how we might be able to leverage that. There are the others who have a set of ideas longer than my arm. And our chance is going to be under promise and over deliver. And I'm very optimistic. I also want to follow up in case my wife's on the line, I don't know what's Scott is talking about the marriage.

[Holly Stewart, Scotia Howard Weil]

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

[Tom Jorden, President and Chief Executive Officer]

Well, as we've said all along, we're going to have the opportunity and flexibility to take advantage of really good opportunities. We've got our play for right now with a deep inventory of fantastic projects, and plenty of challenges. And it doesn't surprise me that lots of assets are hitting the market. I think anybody who really believes what they say when they talk about discipline has to be really cautious buying assets at this up ticking prices. We've got great organic opportunities. We're developing additional organic opportunities. And if something really made sense, we have the ability to strike but -- yes, use the word appetite. We're not hungry. We've got plenty to do.

[Operator]

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

[David Heikkinen, Pickering Energy Partners]

Good morning, and thanks for taking my question. Really, first things first, Scott and Tom, your comment on counter cyclical building of cash and then buying back stock at low as opposed to high if I could wash, rinse repeat that for every conference call, it would be -- that'd be perfection. So thanks for that statement first.

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

[Matt Kerin, Vice President and Treasurer]

This is Matt Kerin, David. So, we're set up to be able to move volumes in and above the level that we're at today, if we think that the pricing warrants it. But as you know, we have a lot of South project coming online, full end service in December 1, but we've been starting to take certain portions of that capacity leading up to that full end service. So that's going to provide us an incremental opportunities there. But from a gathering system perspective, we've recently inked a new deal with Williams, that's going to continue to expand on what we already have. So throughputs not really an issue. The question is going to be is the pricing and the returns on capital, for the incremental volumes make sense for us up there or we just be long-term cannibalizing existing volumes that we already have in the market.

[David Heikkinen, Pickering Energy Partners]

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

[Tom Jorden, President and Chief Executive Officer]

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

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

[David Heikkinen, Pickering Energy Partners]

Satisfaction without pressing further. That's a good summary of that operation. Thanks, guys.

[Tom Jorden, President and Chief Executive Officer]

David, do you know, we drive ourselves crazy every day. And we'll continue to do so.

[Operator]

Our next question will come from Neal Dingmann with Truist. Please go ahead.

[Neal Dingmann, Truist]

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

[Tom Jorden, President and Chief Executive Officer]

Well, it's all about shareholder return. So we think first and foremost, beginning in about shareholder return. Now we will see, I think we're at a bit of a pivot point with what's happening with energy markets. I think there's been a societal realization that oh, my goodness, maybe fossil fuels are important, after all, certainly all markets have moved up, gas markets have moved up. If we have any kind of a winner. There's going to be a serious call on natural gas in the United States. And, we don't live in a vacuum. Although today, I think, we are absolutely committed to everything we've said that we think growth is probably may call for. But, we wake up every day and we're flexible. So what we don't want to do is get back to this cycle where capital is destroyed by the industry, putting the pedal to the floor when times are high. And then suffering when times are low. We're going to be disciplined. We're going to move prudently. But we don't live in a vacuum, we will adapt to the world we live in and there'll be shareholder pressure that will also adapt to that changing world. So Coterra has great opportunity to be flexible through this changing energy landscape.

[Neal Dingmann, Truist]

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

[Tom Jorden, President and Chief Executive Officer]

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

[Operator]

Our next question will come from David Deckelbaum with Cowen. Please go ahead.

[David Deckelbaum, Cowen]

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

[Tom Jorden, President and Chief Executive Officer]

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

[David Deckelbaum, Cowen]

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

[Tom Jorden, President and Chief Executive Officer]

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

[Operator]

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

[Doug Leggate, Bank of America]

I wonder if I could -- I hit I should turn the question but I would like to read back to a little bit of the rationale for the commotion, less volatility stronger balance sheet. Recognition of a variable dividend is a bit of a subjective call I guess what about the base dividend, if you've got lower volatility out of balance sheet, why not step up and base dividend?

[Scott Schroeder]

Doug, it’s Scott Schroeder. How are you? In terms of the base dividend, let's kind of reset the platform here, Legacy Cabot had a base dividend increase in the spring of 2021. And then on announcement in May, there was a second dividend increase, going from the $0.11 to the $0.125 that was memorialized right now in this first Coterra dividend that was announced. We're firm believers in a plan to rationally grow the base dividend over time. But with having just done two, and knowing that we're in a very robust commodity price environment, let's kind of see how this shakes out. Because we do, as you pointed out, have the ability to continue to return with the variable dividend structure that we put in place. And let me add on that, remember the legacy Cabot one was once a year that Coterra because of the financial wherewithal is going to do that assessment every single quarter, which gets dividends back in the hands of shareholders quicker.

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

[Doug Leggate, Bank of America]

So it's a fair debate, I think the issue is about recognition. [Technical Difficulty].

[Scott Schroeder]

Hey, Doug. You are cutting out of bunch. I mean we are hearing about every other word.

[Doug Leggate, Bank of America]

[Technical Difficulty]

[Scott Schroeder]

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

[Operator]

Our next question will come from Leo Mariani with KeyBanc. Please go ahead.

[Leo Mariani, KeyBanc]

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

[Tom Jorden, President and Chief Executive Officer]

Yes, Leo. That would be correct. Just based on the simple math of what the scenario you laid out. Yes. Leo, I would say, our action this morning to advance our variable dividend a quarter is telegraphing that's our bias, since we, our bias is to lean forward. Now, we want to be careful what we commit to. And but I think as we get quarter by quarter, you're going to see how we behave, and that bias will be clear.

[Leo Mariani, KeyBanc]

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

[Matt Kerin, Vice President and Treasurer]

Hey, Leo. This is Matt Kerin. On the LOE for legacy Cabot, those numbers can move around a little bit quarter-to-quarter, depending on some of the workover projects we have. So we did have an increase in workover. And q3 to kind of cause to become a little bit above the high end of the range, but somewhere in that $0.08 to $0.10 range on a legacy Cabot basis is where we would expect that number to be done on a go forward basis. As a relates to deferred taxes. I'm going to hand it over to Dan Guffey when it comes to that.

[Dan Guffey, Director of Finance & Planning]

Sure. Thanks, Matt. So we gave guidance for 30% to 40% on a deferred tax basis, and we've communicated in terms of 382 annotations and built-in games, we would expect the $1.3 billion of NOLs that were on Cimarex’s balance sheet at 9:30, to be a shield that is ratably spread over the next four to five quarters. As we discussed in prior calls, we would expect that NOLs could be fully utilized during 2022 based on current strike prices.

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

[Operator]

[Operator Instructions] Our next question will come from Noel parks with Tuohy Brothers. Please go ahead.

[Noel Parks, Tuohy Brothers]

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

[Tom Jorden, President and Chief Executive Officer]

Well, we've talked about scale a lot over the years. And, I'm going to repeat what I've said in past calls. The first big ticker on scale are long laterals, if you can get two or three of our laterals, there's tremendous cost savings there. So aggregating your land to be able to do that is critically important. And then, an aggregation so you can most efficiently deploy your infrastructure dollars, both gas gathering and compression software disposal or gathering is also important. think beyond that, certainly, procurement is an important scale topic. But quite frankly, I think scale can be overblown. I think once you check those boxes, and you have a really great operational team, that you're down to very small differences between certainly huge companies and scrappy little companies.

Scale alone where the answer, I think the majors would have the lowest cost structure in our business. And clearly, that's not the case. And so I think scale is important. But it's important to a point. In each of our three basins, we have the opportunity to have the lowest cost structure. And that's our challenge. We don't use scale as an excuse, we think we've got what we need to deliver lowest costs.

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

[Noel Parks, Tuohy Brothers]

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

[Tom Jorden, President and Chief Executive Officer]

Well, yes, we certainly widely aware of the challenges in such as federal and state, its investor pressure, it's everywhere we look. We're committed to be a top tier operator in ESG. As I said in my opening remarks, that doesn't necessarily fall into a commodity preference. We think we can deliver the cleanest barrel of oil and the cleanest MCF of gas and we think the U.S. producer is desperately needed to be both. Coterra will be at the front of the line on that. I don't think it will have any kind of thumb on the scale, on capital allocation decisions, nor necessarily will commodity mix. The beauty of Coterra is, capital is going to flow to its highest, most productive return. And that's what we're going to do. We're going to be disciplined in doing that.

[Operator]

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

[Tom Jorden, President and Chief Executive Officer]

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

[Operator]

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