Devon Energy Corp

NYSE:DVN

Earnings Call Transcript 2021-Q2

[Operator]

Welcome to Devon Energy's Second Quarter Earnings Conference Call. [Operator Instructions] This call is being recorded.

I would now like to turn the call over to Mr. Scott Coody, Vice President of Investor Relations. Sir, you may begin.

[Scott Coody, VP, IR]

Good morning, and thank you to everyone for joining us on the call today. Last night, we issued an earnings release and presentation that cover our results for the quarter and our forward-looking outlook. Throughout the call today, we will make references to our earnings presentation to support our prepared remarks, and these slides can be found on our website. Also joining me on the call today are Rick Muncrief, our President and CEO; Clay Gaspar, our Chief Operating Officer; Jeff Ritenour, our Chief Financial Officer; and a few other members of our senior management team.

Comments today will contain plans, forecasts, estimates and forward-looking statements under U.S. securities law. These comments are subject to assumptions, risks and uncertainties that could cause actual results to differ from our forward-looking statements. Please take note of the cautionary language and risk factors provided in our SEC filings and earnings materials.

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

[Rick Muncrief, President, CEO & Director]

Thank you, Scott. We sincerely appreciate everyone taking the time to join us this morning on the webcast. Devon's second quarter can best be defined as one of comprehensive execution across every element of our disciplined strategy that resulted in expanded margins, growth in free cash flow and the return of significant value to our shareholders through higher dividends and the reduction of debt.

Following our transformative merger that closed earlier this year, I'm very pleased with the progress the team has made, and our second quarter results demonstrate the impressive momentum our business has quickly established. Even today, as we celebrate Devon's 50th anniversary as a company this year, we're only getting started, and our talented team is eager, energized and extremely motivated to win. As investors seek exposure to commodity-oriented names, it is important to recognize that Devon is a premier energy company and a must-own name in this space. We have the right mix of assets, proven management, financial strength and a shareholder-friendly business model designed to lead the energy industry in capital discipline and dividends.

Now turning to Slide 4. The power of Devon's portfolio was showcased by our second quarter portfolio was showcased by our second quarter results as we continue to deliver on exactly what we promised to do both operationally and financially. Efficiencies drove capital spending 9% below guidance. Strong well productivity resulted in production volumes above our midpoint. The capture of merger-related synergies drove sharp declines in corporate cost. These efforts translated into a sixfold increase in free cash flow from just a quarter ago. And with this excess cash, we increased our dividend payout by 44% and we retired $710 million of low premium debt in the quarter. Now, Jeff will cover the return of capital to shareholders in more detail later, but investors should take note, this systematic return of value to the shareholders is a clear differentiator for Devon.

Now moving to Slide 5. While I'm very pleased with the results our team had delivered year-to-date, the setup for the second half of the year is even better with our operations scale that generate increasing amounts of free cash flow. This improved outlook is summarized in a white box at the top left of this slide. With the trifecta of an improving production profile, lower capital and reduced corporate cost, Devon is positioned to deliver an annualized free cash flow yield in the second half of the year of approximately 20% at today's pricing. I believe it is of utmost importance to reiterate that even with this outstanding free cash flow outlook, there is no change to our capital plan this year.

Turning your attention to Slide 7. Now with this powerful stream of free cash flow, our dividend policy provides us the flexibility to return even more cash to shareholders than any company in the entire S&P 500 Index. To demonstrate this point, we've included a simple comparison of our annualized dividend yield in the second half of 2021, assuming a 50% variable dividend payout. Now as you can see, Devon's implied dividend yield is not only best-in-class in the E&P space, but we also possess the top rank yield in the entire S&P 500 Index by a wide margin. In fact, at today's pricing, our yield is more than 7x higher than the average company that is represented in the S&P 500 Index.

Furthermore, our dividend is comfortably funded within free cash flow and is accompanied by a strong balance sheet that is projected to have a leverage ratio of less than 1 turn by year-end. Investors need to take notice, Devon offers a truly unique investment opportunity for the near 0 interest rate world that we live in today.

Now looking beyond Devon to the broader E&P space, I'm also encouraged this earnings season by the announcement from Pioneer on their variable dividend implementation as well as a growing number of other peers who have elected to prioritize higher dividend payouts. These disciplined actions will further enhance the investment thesis for our industry, paving the way for higher fund flows as investors rediscover the attractive value proposition of the E&Ps pace.

Now moving to Slide 10. While the remainder of 2021 is going to be outstanding for Devon, simply put, the investment thesis only gets stronger as I look ahead to next year. We should have one of the most advantaged cash flow growth outlooks in the industry as we capture the full benefit of merger-related cost synergies, restructuring expenses roll off and our hedge book vastly improves. At today's prices, these structural tailwinds could result in more than $1 billion of incremental cash flow in 2022.

To put it in perspective, this incremental cash flow would represent cash flow per share growth of more than 20% year-over-year, if you held all other constants -- all other factors constant. Now while it's still too early to provide formal production and capital targets for next year, there will be no shift to our strategy. We will continue to execute on our financially driven model that prioritizes free cash flow generation.

Given the transparent framework that underpins our capital allocation, our behavior will be very predictable as we continue to limit reinvestment rates and drive per share growth through margin expansion and cost reductions. We have no intention of adding incremental barrels into the market until demand side fundamentals sustainably recover and it becomes evident that OPEC+ spare oil capacity is effectively absorbed by the world markets. The bottom line is we are unwavering in our commitment to lead the industry with disciplined capital allocation and higher dividends.

And with that, I will now turn the call over to Clay to cover some of the great operational results we delivered in the past quarter.

[Clay Gaspar, EVP & COO]

Thanks, Rick, and good morning, everyone. As Rick touched on from our operations perspective, Devon continues to deliver outstanding results. Our Q2 results demonstrate the impressive operational momentum we've established in our business, the power of Devon's asset portfolio and the quality of our people delivering these results. I want to pause and congratulate the entire Devon team for the impressive work overcoming the challenges of the pandemic and the merger while not only keeping the wheels on but re-questioning everything we do and ultimately building better processes along the way. We've come a long way on building the go-forward strategy, execution plan and culture, and I see many more significant wins on the path ahead.

Turning your attention to Slide 12. My key message here is that we're well on our way to meeting all of our capital objectives for 2021. At the bottom left of this slide, you can see that my confidence in the '21 program is underpinned by our strong operational accomplishments in the second quarter. With activity focused on low-risk development, we delivered capital spending results that were 9% below plan, well productivity in the Delaware drove oil volumes above guidance and field level synergies improved operating costs.

While the operating results year-to-date have been great, the remainder of the year looks equally strong, a true test of asset quality, execution and corporate cost structure proves out in sustainably low reinvestment rates, steady production and significant free cash flow. This is exactly what we're delivering at Devon. We plan to continue to operate 16 rigs for the balance of the year and deliver approximately 150 new wells to production in the second half of 2021.

Now let's turn to Slide 13, where we can discuss our world-class Delaware Basin asset, which is the driving force behind Devon's operational performance. During the quarter, our capital program consisted of 13 operated rigs and 4 dedicated frac crews, resulting in 88 new wells that commenced first production. This level of capital activity was concentrated around the border of New Mexico and Texas and accounted for roughly 80% of our total company-wide capital investment in the quarter. As a result of this investment, Delaware Basin's high-margin oil production continue to rapidly advance, growing 22% on a year-over-year basis.

While we had great results across our acreage position, a top contributor to the strong volume were several large pads within our Stateline and Cotton Draw areas that accounted for more than 30 new wells in the quarter. This activity was weighted towards development work in the Upper Wolfcamp, but we also had success co-developing multiple targets in the Bone Spring within our Stateline area. The initial 30-day rates from activity at Stateline and Cotton Draw averaged north of 3,300 BOE per day, and recoveries are on track to exceed 1.5 million barrels of oil equivalent.

With drilling and completion costs coming in at nearly $1 million below predrill expectations, our rates of return at Cotton Draw and Stateline are projected to approach 200% at today's strip pricing. While we've all grown weary of quoted well returns, this is the best way that I can provide insight to you on what we're seeing in real time and what will be flowing through the cash flow statements in the coming quarters. While we lack precision in these early estimates, I can tell you, these are phenomenal investments and will yield significant value to the bottom line of Devon, and ultimately, to the shareholders through our cash return model.

And lastly, on this slide, I want to cover the recent Bone Spring appraisal success that we had in the Potato Basin with our 3-well Yukon Gold project. Historically, we focused our efforts in the Wolfcamp formation in this region, and Yukon was our first operated test of the second Bone Spring interval in this area. Given the strong results from Yukon plus additional well control from non-operating activity, this will be a new landing zone that works its way into the Delaware Basin capital allocation mix going forward. This is another example of how the Delaware Basin continues to give. This new landing zone required no additional land investment, very little incremental infrastructure, and as a result, the well returns have a direct path to the bottom line of Devon.

Moving to Slide 14. Another highlight associated with the Delaware Basin activity was the improvement in operational efficiencies and the margin expansion we delivered in the quarter. Beginning on the left-hand side, our D&C costs have improved to $543 per lateral foot in the quarter, a decline of more than 40% from just a few years ago. To deliver on this positive rate of change, the team achieved record-setting drill times in both Bone Spring and Wolfcamp formations with spud release times and our best wells improving to less than 12 days. Our completions work improved to an average of nearly 2,000 feet per day in the quarter. I want to congratulate the team, and I fully expect that these improved cycle times will be a tailwind to our results for the second half of the year.

Shifting to the middle of the slide, we continue to make progress capturing operational cost synergies in the field. With solid results we delivered in the second quarter, LOE and GP&T costs improved 7% year-over-year. To achieve this positive result, we adopted the best and most economic practices from both legacy companies and leveraged our enhanced purchasing power in the Delaware to meaningfully reduce costs associated with several categories, including chemicals, water disposal, compression and contract labor. Importantly, these results were delivered by doing business in the right way with our strong safety performance in the quarter and combined with company delivered some of the meaningful environmental improvements over a year-over-year basis.

And my final comment on this slide -- on the chart to the far right, the cumulative impact of Devon's strong operational performance resulted in significant margin expansion compared to both last quarter and on a year-over-year basis. Importantly, our Delaware Basin operations are geared for this trend to continue over the remainder of the year and beyond.

Moving to Slide 15. While the Delaware Basin is clearly the growth engine of our company, we have several high-quality assets in the oil fairway of the U.S. that generate substantial amounts of free cash flow. These assets may not capture many headlines but they underpin the success of our sustainable free cash flow-generating strategy.

In the Delaware Basin, cash flow nearly doubled in the quarter on the strength of natural gas and NGLs. our Dow joint venture activity is progressing quite well, and we're bringing on the first pad of new wells this quarter. The Williston continues to provide phenomenal returns and at today's pricing, this asset is on track to generate nearly $700 million of free cash flow for the year.

In the Eagle Ford, we have reestablished momentum with 21 wells brought online year-to-date, resulting in second quarter volumes advancing 20%. And in the Powder River, we're encouraged with continued industry activity and how -- and evaluating how we create the most value from this asset. We have a creative and commercially focused team working with this asset, many of which bring fresh set of eyes on how we approach this very substantial oil-rich acreage position. Overall, another strong quarter of execution and each of these asset teams did a great job delivering within our diversified portfolio.

And lastly, on Slide 16, I want to conclude my prepared remarks with a few thoughts on the environmental performance targets we recently published. The team here at Devon takes great personal pride in delivering affordable and reliable energy that powers every other industry out there as well as the incredible quantity and quality of life we appreciate today. We absolutely believe that in addition to meeting the world's growing energy demand, we must also deliver our products in an environmentally and commercially sustainable way.

As you can see with the goals outlined on this slide, we're committing to taking a leadership role by targeting to reduce greenhouse gas emissions by 50% by 2030 and achieving net zero emissions for Scope 1 and 2 by 2050. A critically important component of this carbon reduction strategy is to improve our methane emissions intensity by 65% by 2030 from a baseline of 2019.

This emissions reduction target involves a range of innovations, including advanced remote leak detection technologies and breakthrough designs like our latest low-E facilities in the Delaware Basin. We also plan to constructively engage with upstream and downstream partners to improve our environmental performance across the value chain. While it's a journey, not a destination, environmental excellence is foundational to Devon.

With that, I'll turn the call over to Jeff for the financial review.

[Jeff Ritenour, EVP & CFO]

Thanks, Clay. My comments today will be focused on our financial results for the quarter and the next steps in the execution of our financial strategy. A great place to start today is with a review of Devon's strong financial performance in the second quarter, where we achieved significant growth in both operating cash flow and free cash flow.

Operating cash flow reached $1.1 billion, an 85% increase compared to the first quarter of this year. This level of cash flow generation comfortably exceeded our capital spending requirements, resulting in free cash flow of $589 million for the quarter. As described earlier by Rick and Clay, our improving capital efficiency and cost control drove these outstanding results, along with the improved commodity prices realized in the second quarter. Overall, it was a great quarter for Devon, and these results showcased the power of our financially driven business model.

Turning your attention to Slide 6. With the free cash flow generated in the quarter, we're proud to deliver on our commitment to higher cash returns through our fixed plus variable dividend framework. Our dividend framework is foundational to our capital allocation process, providing us the flexibility to return cash to shareholders across a variety of market conditions. With this differentiated framework, we've returned more than $400 million of cash to our shareholders in the first half of the year, which exceeds the entire payout from all of last year.

The second half of this year is shaping up to be even more impressive. This is evidenced by the announcement last night that our dividend payable on September 30 was raised for the third consecutive quarter to $0.49 per share. This dividend represents a 44% increase versus last quarter and is more than a fourfold increase compared to the period a year ago.

On Slide 8, in addition to higher dividends, another way we have returned value to shareholders is through our recent efforts to reduce debt and enhance our investment-grade financial strength. In the second quarter, we retired $710 million of debt, bringing our total debt retired year-to-date to over $1.2 billion.

With this disciplined management of our balance sheet, we're well on our way to reaching our net debt-to-EBITDA leverage target of 1 turn or less by year-end. Our low leverage is also complemented by a liquidity position of $4.5 billion and a debt profile with no near-term maturities. This balance sheet strength is absolutely a competitive advantage for Devon that lowers our cost of capital and optimizes our financial flexibility through the commodity cycle.

Looking ahead to the second half of the year, with the increasing amounts of free cash flow our business is projected to generate, we'll continue to systematically return value to our shareholders through both higher dividend payouts and by further deleveraging our investment-grade balance sheet.

As always, the first call in our free cash flow is to fully fund our fixed dividend of $0.11 per share. After funding the fixed dividend, up to 50% of the excess free cash flow in any given quarter will be allocated to our variable dividend. The other half of our excess free cash flow will be allocated to improving our balance sheet and reducing our net debt.

Once we achieve our leverage target later this year, this tranche of excess free cash flow that was previously reserved for balance sheet improvement has the potential to be reallocated to higher dividend payouts or opportunistic share buybacks. should our shares remain undervalued relative to peers in the broader market.

So in summary, our financial strategy is working well. We have excellent liquidity and our business is generating substantial free cash flow. The go-forward business will have an ultra low leverage ratio of a turn or less by year-end, and we're positioned to substantially grow our dividend payout over the rest of the year.

With that, I'll now turn the call back over to Rick for some closing comments.

[Rick Muncrief, President, CEO & Director]

Thank you, Jeff. Great job. I would like to close today by reiterating a few key thoughts. Devon is a premier energy company, and we are proving this with our consistent results. Our unique business model is designed to reward shareholders with higher dividend payouts. This is resulting in a dividend yield that's the highest in the entire S&P 500 Index.

Our generous payout is funded entirely from free cash flow and backstopped by an investment-grade balance sheet. And our financial outlook only improves as I look to the remainder of this year and into 2022. With the increasing amounts of free cash flow generated, we're committed to doing exactly what we promised, and that is to lead the industry in capital discipline and dividends.

And with that, I will now turn the call back over to Scott for Q&A.

[Scott Coody, VP, IR]

Thanks, Rick. We'll now open the call to Q&A. [Operator Instructions] With that, operator, we'll take our first question.

[Operator]

Your first question is from Doug Leggate with Bank of America.

[JohnAbbott]

This is John Abbott for Doug Leggate. Our first question is on M&A. There has been some recent press speculation out there that you are the potential bidder in a process. Now recognizing that you probably won't comment on any ongoing potential transaction, could you just sort of discuss in general what you would see as the benefits to Devon of a large-scale acquisition given the running room that you already have from legacy Devon and from WPX?

[RickMuncrief]

John, thanks for the question. It's a great question, great perspective. And just fundamentally, we continue to have a very, very high bar, and we have a wonderful business post-merger. And so for us, the way we think about it is anything we evaluate, and that's really on the buying or selling side, it's got to be immediately accretive. It's got to have compelling industrial logic. And we have tried to be really clear on this, but it absolutely has to feel within our investment framework and makes us even better, even stronger.

And I'll just go back to just a fundamental message today. It's got a -- anything we have to consider has got to help us get stronger on an outlook that says, look, if we just keep volumes flat, we're going to add an additional $1 billion of cash flow next year. And then when you look at that on a cash flow per share base, that's 20% growth, '22 over '21. So that's really how we view it, and that hasn't really changed. We've got a tremendous inventory. We've got a tremendous business, and we continue to have a very high bar. And we're going to be very, very disciplined in anything we do.

[JohnAbbott]

Appreciate it. And then for our follow-up question here, its on your hedging strategy going forward here. I mean you've historically had a systematic component to your hedging strategy. How are you thinking about hedging going forward from here?

A -RickMuncrief

I'm going to have Jeff answer that. Go ahead, Jeff.

[JeffRitenour]

Yes. This is Jeff. Yes, happy to provide some color on that. As you probably saw in our prepared materials and what we disclosed last night, we've not added any material incremental hedges since our last call, since last quarter. Going forward, we don't expect that to change. Given where we are in the cycle, given where we are with our business, the balance sheet, the great shape that we have the balance sheet in, the low reinvestment ratios that we've talked about, which we expect to continue going forward, and frankly, just the low-cost structure and breakevens that we have, it's created a margin of safety for us in our business that allows us to be less aggressive on the hedging front.

And so we really don't feel the need to add any incremental hedges at this point in time. We'll obviously monitor that, and we certainly talk about it and debate it on a weekly basis here within the walls of Devon and could certainly change our view at some point in the future. But where we sit today, given the strength of our business and projected business and the balance sheet, we really don't feel like we need to add any incremental hedges in the near term.

[Operator]

Your next question is from Brian Downey with Citigroup.

[BrianDowney]

Jeff, it sounds like from your prepared comments raising the 50% excess free cash flow payout cap may be considered at some point, given the leverage and maturity schedule outlook here. You mentioned it, but share repurchases are still listed at the bottom of your free cash flow priority slide in the appendix. Has that repurchase appetite changed much at all on the margin given the recent equity performance versus commodity price and Devon's forward yield on offer? And if you were to consider repurchases, do you anticipate that being more systematic or opportunistic?

[JeffRitenour]

Yes, Brian, I appreciate the question. I would say the share repurchases is certainly moving up the list of options for us, potential options for us as we move through the back half of this year. I talked about it in my prepared remarks, and we've talked about it for a couple of quarters now. Our first focus is on reaching our leverage target, which you all have heard me speak to in the past. We really think about that on a $55 oil price.

And so if you do the math on $55 oil, in our current oil production, you get to somewhere around $4 billion, $4. 8 billion, $4.5 billion, $4.8 billion EBITDA. We currently have $6.5 billion of gross debt, cash balance of $1.5 billion. We need a couple of hundred million more dollars of cash to get us to that net debt of kind of a 1x ratio. I really expect that's going to happen in this quarter.

And as I mentioned in our prepared remarks, that puts us in a position to think about other ways to return more of that excess free cash flow to shareholders. And so things on the table are absolutely an increase in the variable dividend percentage. We're going to maintain the framework that we've outlined and don't expect that to change going into the future, but we could absolutely supplement it with some incremental variable dividends and potentially some incremental share repurchases. I think the other thing we'll look at as we get further into the year and probably into 2022 is the potential to increase the fixed dividend as well. So those are all the things that we'll be considering with our Board as we move into the back half of this year.

[BrianDowney]

Great. And then maybe one for Clay. Clay, in the Anadarko Basin, you mentioned bringing online a half dozen or so legacy Meramec DUCs. Anything you're seeing from those production results, completion costs, or early days of the drilling JV that maybe changes your view of Anadarko returns or how it ultimately fits within the portfolio?

[ClayGaspar]

Yes, Brian, just between you and I, I'm actually pretty positive on the Anadarko Basin. I have been for quite a while. I think it's underappreciated, generally speaking. But it's a pretty tough hill to climb to compete in our investment portfolio. So I think the team there is taking exactly the right approach. We've entered this joint venture. We've got some promoted money. It allows the investments to compete, feel really good about the investments that we're making. And then meanwhile, we're doing exactly what you're asking about is we're getting a modern look at today's well cost, today's completion designs and the well results that we're generating.

So still pretty early days on the well results. But I'm very encouraged. The Miller pad is the one we're bringing on this quarter. That's the first one that we've drilled this year, bringing on -- that's really exciting. Looking forward to those opportunities, both Woodford and Meramec opportunities. But I can tell you this, the well costs are phenomenal. Really excited about that. And as you know, $1 saved on well cost is a direct dollar to present value. So it's a holistic look and we look forward to seeing more from that team.

[Operator]

Your next question is from Nitin Kumar with Wells Fargo.

[NitinKumar]

Rick, I appreciate the, I guess, the early look into 2022. But if I can, what is your planning deck, the commodity price deck for 2022? And should we expect, given the efficiencies in the Delaware for that to still be the workhorse in terms of the capital program?

[RickMuncrief]

Yes. I want to have Jeff weigh in and help me on fielding the question, and appreciate them. Yes, I think Delaware is going to continue to be the workhorse in our portfolio. I don't see that changing. As Clay just talked about, we've got some great investment opportunities in our other basins. But the reality is the Delaware is really, really hard to compete with internally. And so you'll continue to see the lion's share of our capital program being allocated to the Delaware Basin. I don't see that really changing anytime in the near future.

So Jeff, you maybe want to talk about commodity price assumptions that we have?

[JeffRitenour]

Yes. I appreciate the question. And we -- as you might guess, we look at multiple sensitivities and evaluate different scenarios and price decks that might come at us. I would say foundationally though, we really think about $55 oil as kind of being a normalized price and then try to manage our business around that. We're in a position today with the low breakeven that we have in our business, even at $55 oil, we can accomplish all of our financial objectives and then some. So we feel like we're in a really good spot. But we certainly do evaluate the strip and even higher and even lower price scenarios as we work through our budgeting process with our Board.

[NitinKumar]

Great. And my follow-up, you were 9% below expectations on capital spending in the second quarter. We're expecting an improvement through the rest of the year, but you left capital budget for 2021 unchanged. If I could, is that a function of any inflation that you're seeing? Or could you just help us understand the math there?

[ClayGaspar]

Yes, thanks. This is Clay. I'll respond to that, Nitin. I think the idea is that we've set a course for capital. I think we're still very much inside the planned activity levels. In fact, we've accelerated a little bit just from drilling faster. We're not going to drop rigs and balance activity because of that. And so what it does is it draws a little bit more natural activity into the fourth quarter. But that said, I think it's -- I think you can kind of continue to see a very line of sight runway. I think there will be some continued improvements. I think we will also see some headwind from inflation start to creep in. I think on balance, I still feel good -- really good about reiterating the '21 capital plan. And we'll see how the team continues to perform throughout the year.

[Operator]

Your next question is from Neil Mehta with Goldman.

[NeilMehta]

The first question that's just is more tactical. As we think about Q3 and all the moving pieces with first of the quarter at this point done from a realized price perspective, how should we think about the dividend, the variable dividend, recognizing it as a board decision? But can you talk about the moving pieces around price realizations, gas NGLs and then capital and cost. Should we -- based on what we know now, is it fair to assume that the variable dividend is likely to be higher next quarter than it was this quarter?

[JeffRitenour]

Yes, absolutely, Neil. That's exactly right. I mean given the strength that we've seen in pricing thus far. And as Clay mentioned earlier, the capital efficiencies that we've seen and continued cost reductions, you marry that with the fact that we've got incremental hedges rolling off into the third and fourth quarter. All those are going to be tailwinds to our free cash flow in the quarter. And my absolute expectation is to see a higher variable dividend in the third quarter on a relative basis.

[RickMuncrief]

Neil, this is Rick. I'll augment that a little bit. I think we need to just remind everyone that we were about 50% hedged on crude this year, but the profile of that is about 60% first half, 40% in the second half. And currently, we're about 20% hedged as we look into '22.

[NeilMehta]

That's great, Rick. And just a follow-up here is, as you guys think about the payout, which right now is 50%, I think you've -- the breadcrumbs will indicate that you think there is a pathway to move that higher. Can you just talk about what the milestones we should be watching for to see when we should start to think about taking up that payout ratio from 50% to something higher, and any sense of what the ultimate destination would be in the dream world of what the right payout ratio could look like?

[JeffRitenour]

Yes. No, this is Jeff again. Again, as I mentioned earlier, that's something we're absolutely going to debate and talk about with the Board as we move into the third and fourth quarter. Again, I want to reiterate, we want to make sure we get to our debt target that I mentioned earlier, that 1x turn, which I fully expect, given where prices are, we'll accomplish that here in the third quarter. But as we move into our discussions into the fall with our Board around the budget for 2022 and the potential outcome around share repurchases, the fixed dividend and incremental variable dividends on top of the 50%, I think those are all things we'll talk about here over the next, call it, 3 months and would expect to give you all more color as we move through the year.

[Operator]

Your next question is from Matthew Portillo with TPH.

[MatthewPortillo]

This one might be for Clay. Just wondering if you could talk about some of the strong results you're seeing in the Bone Spring around Stateline and how that may impact your future inventory and development plans going forward?

[ClayGaspar]

Yes. Thanks for the question, Matt. It's really exciting. So we -- the original acquisition was based on really the Wolfcamp A. We knew there was additional upside, but really pending the acquisition economics and the forward plan, it was really on kind of that Greater or Upper Wolfcamp landing zones. And that's been amazing. The homerun is really where you get these additional landing zones essentially for free, right? And that's what was so intriguing about the original entry into the Delaware. And as I mentioned in my prepared remarks, just the continued dividends that are paid from it.

So we there was opportunity in the second Bone. We had drilled some early wells. But as we've refined the petrophysics and really dialed into the proper landing zones, we've been very encouraged, at least 3, maybe 4 landing zones in the Bone Spring. And the real questions have been and what we've been working on is proper spacing come laterally, but also in a vertical sense. How much of this is in hydraulic communication. And we're starting to kind of nail that down, and now you're starting to see us move into the development mode, which is just significant upside on that -- the incredibly rich infrastructure right there.

And I talk about infrastructure, it's everything from owning the electrical infrastructure, water disposal system, our partnership with Howard Energy to relever all of those benefits. And then also recall that we purchased 15,000 surface acres over this whole area. And so again, as we continue to rediscover refined new opportunities kind of little exploration under our own feet, this is some of the most accretive value creation for the organization, without question.

[MatthewPortillo]

That's great. And then maybe just another follow-up on the operational side. The WPX team was working to widen spacing designs in parts of the Delaware before the merger with Devon. I guess, with both of the teams now combined, could you talk about what you've learned so far from a completion and spacing optimization perspective and how that might influence your results moving forward?

[ClayGaspar]

Yes. This is one of the kind of the hidden wins of what we talk about synergies. We can put a number on so many things, and we've ascribed this $600 million, which, by the way, I feel very confident in achieving by year-end. But I think these are the kind of things that are synergistic in nature. You've got 2 really, really smart teams that have been trying to solve this problem independently now have the opportunity to really learn together, share data, share resources, share lessons learned, wins, losses along the way, and it really kind of supercharges that.

So I don't know that we've moved dramatically in any one area around spacing, but I think what's really interesting is to watch the continued improvement on the cost side of the equation. We're drilling wells in 12 days, 2-mile laterals in some pretty challenging areas. That's phenomenal. That adds incredible efficiency on the front end of the economics. The capital and the design associated with the completion is really where these wells will start to separate, and that's well placement stimulation design and all of those attributes that go in.

We're testing -- we're turning a lot of knobs in that space. Too early to call on kind of what is the go-forward consistent plan across the whole Delaware Basin. My intuition will tell me that it's multiple go-forward plans in different areas. We'll continue to learn. We're looking at a lot of new technologies, and at the same time, continuing to get better from an ESG front. And I can tell you that's another one of the hidden wins from synergies, we're making great strides on that. And I think it's a very much a beneficial symbiotic relationship there as well.

[Operator]

Your next question is from Neal Dingmann with Truist Securities.

[NealDingmann]

Two questions that's kind of both been asked, I want to ask in different ways. Maybe, Rick, first for you, just first question is maybe on free cash flow allocation. I guess my question around that is, obviously, you're doing a great job on the variable dividend than the first out of the gate. But I'm just wondering, one, do you think you're being appropriately rewarded for that variable and just the total bills in general? And to me, kind of combined with that, what appears to be your stock trading at a discount to NAV, maybe why not do some more buybacks near term given that discount?

[RickMuncrief]

Yes, Neal, that's a question that we all debate here internally. And I'm not convinced that we've seen that yet. I think there's a question around the variable dividend about consistency, and you get quarter after quarter of some really nice dividends. I'm encouraged by the actions of our -- some of our other industry peers. And I think what you're going to find is that now Devon is not just being treated as a one-off, it's truly a movement within our sector of getting more cash back to shareholders. And I think that's a good thing. So when you look at it from that perspective, I think we will start seeing better equity performance. But if not, certainly, the discussion we had about share repurchases really comes to light and it's great to have optionality. So you heard Jeff a while ago talk about the ability to ratchet up the variable dividend with the stronger cash flows, we also would -- from an opportunistic standpoint, have the ability to certainly repurchase the equity.

And the third thing, I think that when we think about capital allocation, it's a little more longer term. But we don't have any near-term debt maturities. We do have a couple of hundred million due, I think, here in 2023. But we have an incremental $800 million of callable debt in the next 24 months. And so we have options. And Neal, that's what I love about our portfolio, our strategy, the optionality, strong balance sheet. All that is going to, I think, really make for an exciting story over the next few years and something I'm very, very pleased with how it's come together with the merger. So I think suffice to say, if we don't see the equity performing to the level that we feel it should be, it's going to be a really good discussion with our Board. And I think they'd be very supportive of us pursuing opportunistic share repurchases.

[NealDingmann]

You all have really been the pioneer of this variable dividend. Great to see the options. And then secondly, just on my question on the capital allocation. Clay, obviously, the Delaware sort of speak from self what you're dealing with that Stateline development, Cotton Draw, et cetera. It just seems like every quarter efficiency are getting better. So I'm just wondering, when you think about -- I mean, you mentioned your excitement in Powder River, and obviously, you've got that Eagle Ford, et cetera. Could you talk about how you think about the capital allocation? Is it always sort of that -- as you said, the workhorse will probably continue to be the Delaware. But how do you think about allocating the capital because you've got obviously a lot of other exciting areas.

[ClayGaspar]

Yes. Thanks for the question, Neal. So set Delaware aside because it's just -- it's kind of first in line, takes the lion's share, is the growth engine, dot-dot-dot, you know the story there. I think thinking about the other assets, the Williston Basin, I have more familiarity with, more history with. And you've seen the phenomenal returns year after year after year there. We've been 100% transparent that we're just short on inventory. And so it just doesn't command a whole lot of capital today.

As we think about the other assets, I mentioned the JV we have in the Mid-Continent area. That's a wonderful investment, but it is of a certain scale, right? It's -- in time, if it's very successful, we could scale up in time. If we want to do something different, we could certainly scale down. There's even a scenario where if in the best success case, it really competes that well, we can continue to drive the -- invest in the asset on a heads-up basis.

As I move to places like South Texas, we have a partnership there with BP. And so there's a dance we have to do together to mesh up our expectations on capital investment along with theirs. I can tell you, it's a really phenomenal asset. We're really pleased with the returns. And we're really pleased with our partnership there we have with BP. I think the teams have both worked very well together to make sure that they are working well in advance. And so there's no surprises on either end. And so that is something that's kind of almost prebaked as we started thinking about some of the activity.

The Powder River Basin, I think as I mentioned in the prepared remarks, I'm very encouraged by the continued industry activity. So really Tier 1 players in the area that are excited. There's lots of opportunity. As we know, when you really do a thorough post appraisal, it's just been challenged. And so I think taking a real commercial opportunistic look at how we create value there is a multistep process. We're just -- like I said, we kind of refresh part of the team, and I think that that helps kind of, one, bring some new questions and challenges to the asset. But it's also a new way to kind of bring some more life in and think about how do we energize that asset to create value and ultimately compete for capital in the portfolio.

[Operator]

Your next question is from David Heikkinen with Pickering Energy Partners.

[DavidHeikkinen]

Most of the questions were asked. I was trying to think through the combination of the new sustainability report for 2021 and your methane emissions targets. How do you think through where merged company will be and then what that's going to be, a little bit of an early look as you start thinking about the outlook for the company?

[JeffRitenour]

Thanks. I appreciate the question. I think it was very important to us not to just set a very long-range target and say, trust us, we'll get there. So we said intermediate kind of ranges goals as well. And so we have intermediate steps around 2025 and 2030 that are peppered throughout the document. And I can tell you we're well on our way. I mean just to point to some of the areas I think about one of the most important is around greenhouse gas emissions. And I think of the Southern Delaware, which is the legacy WPX asset, we were about 5% a couple of years ago. We averaged about 2.5% last year. State-of-the-art today, last probably quarter, we are somewhere between 1% and 1.5%.

And so that's very encouraging. There's a lot of meat on that bone, because when you compare it to the legacy Devon asset, just across the border, they've been running about 0.5%. And so we see line of sight to where that Southern Delaware needs to go. We just need to do a little bit more work on some of the infrastructure, some of the cultural mindset about how we flow back what we're going to do, flow back and build the infrastructure and how we manage the wells themselves.

I think about the other areas, both South Texas and Mid-Continent are phenomenal in that regard. Powder is a little bit more challenged. The big challenge is the Williston. And for all the Williston players, you hear the same story. It is a real challenging infrastructure asset. That has continued to be the case. I can tell you we are pushing really, really hard on that. We've dropped the emissions by about 1/3 over the last year, but it's still nothing to brag about, okay? It's still about a 10% number, which we need to continually improve on. We're investing in that. We're leveraging all of the relationships we have to continue to drive that down. And we will achieve our '25 and '30 targets as we've set out, but there's a lot of work to do between now and then.

[Operator]

Your next question is from Paul Cheng with Scotiabank.

[PaulCheng]

Two questions, please. I think first is maybe for Jeff. At $70-plus oil I think in the past that you guys talking about you won't be a cash taxpayer and Tier 2 with the latter half of the decade. Just want to see that how that progression is may or may not have changed? And also, can you talk about the earnout accounting, look like with today's pricing that you should get the earnout money on that. So that in terms of the cash flow and on the P&L accounting, maybe that you can help us understand a little bit better on that.

The second question, I think it's for Clay. Can you talk about the inflation, whether -- I mean how much inflation that you're seeing, particularly in the terminal? And then finally, I just want to make a comment on the hedging. I appreciate that you guys maybe the shipping down the activity level. And quite frankly, with the Shell 3.0 business model, if we are serious on that, I'm not sure that why you need hedging at all. I think your shareholders will actually be better off without it, given the industry pool record in terms of hedging in the long run, that seems like we all lost money every single company.

[JeffRitenour]

Paul, I appreciate the thoughts and the questions. That was a mouthful. I think we got the second half of the question. If you wouldn't mind, could you just refresh us on that first question, just so we get to what you're asking.

[PaulCheng]

For $70 of oil prices, Jeff, that when -- in terms of the cash tax paying, if that trajectory has been changed from what you have said in the past?

[JeffRitenour]

Yes, Paul okay. I'm with you. Yes, really short answer is no material change from what we talked about on the previous call. If you'll recall, what we -- current projection, we think we'll enter into next year with probably over $3 billion of federal NOLs. So that puts us in a pretty good position to shield ourselves from taxes in the near term. Obviously, price deck is, as you highlighted in your question, can have a material impact to that. Our current expectation, though, given the NOL position that we have and our current projections, even at these higher prices, we really don't expect to be a material cash taxpayer for a number of years. So again, that's going to be consistent with what we talked about in the past and no material changes there.

Obviously, one of the things that we're evaluating and thinking about in the broader macro specific to the tax -- our specific tax position, and then just more broadly is any changes that the administration may make as it relates to IDC or any of the other specifics around how we would calculate our tax position. Again, no new news on that front. We've not gotten any better clarity as to the direction of the administration where they may head on that front. But we've certainly been running the sensitivities and evaluating the potential outcomes. Again, given our tax attributes today, we really feel like we're in a good spot and don't expect taxes to be a detrimental impact to our free cash flow story for a number of years.

[ClayGaspar]

Yes, Paul, I'll pick up. This is Clay on the inflation question. Was there something else first?

[PaulCheng]

Yes. And then how about the earnout accounting, given your commodity prices that you should be able to get some money from the earnout?

[JeffRitenour]

Paul, I think you're asking about the contingent payments specific to our Barnett transaction? Yes, absolutely. So we -- the one item you probably saw in the quarter as we adjusted our expectation there, given the higher prices. And so as we look at -- again, this is -- I'm going to use the forward strip as the baseline here. But as we look at 2022 -- or excuse me, 2021 in the results and the prices that we've seen to date, we would expect to receive a contingent payment on our Barnett transaction. It could be in the ballpark of $40 million. So that would be incremental cash that would be coming in the door to us as a result of that transaction.

[PaulCheng]

And does you have any P&L impact?

[JeffRitenour]

P&L impact? Yes. No, we've adjusted that contingent payment in our results for the second quarter, so you shouldn't see a big impact going forward.

[ClayGaspar]

And Paul, it's Clay. I'll pick up on your original question 2 around inflation. My belief is inflation is real. I appreciate the Fed Chairman saying there's some transitory things happening in the macro sense. But I think you go anywhere, talk to any business owner, and there is -- there are struggles to get employees and things working, even trying to buy relatively routine thing.

So I think there's one level of inflation kind of in a macro sense. And then specific to our industry, higher commodity price obviously is driving some increase in activity. The question I have, and I think is still yet to prove out is the historical correlation between commodity price and rig activity is disconnected. And that's a good thing from the sense of our industry discipline.

And so I think what we need to do is not necessarily focus on the commodity price, but it's more of the resulting activity. Certainly, some of the private folks have picked up more rigs differentially relative to the larger publics. I think as the larger publics continue to hold the line on disciplined cash flow returning sustainability in that regard, I think we'll continue to see moderate growth on activity.

So what that means to us is summing those 2 things up, certainly, we will see some inflation. We're seeing it now. We have certainly baked that into our '21 expectations guidance. I have a lot of confidence in, again, being able to meet our guidance for the balance of the year. As we start to look forward and really trying to hone in on '22, I think there's still some questions out there.

Clearly, we expect to see some inflation. I'm not ready to prepare and put a number on to it today. We're just starting our really deep conversations in a long-term sense with the Board as we work through capital investment levels, some of the things we've talked about on this call and certainly an incredibly important part of that math is inflation. So we see it coming. We're prepared for it. We're working to mitigate as best we can.

We believe our relationships and the partnership that we can offer from a very consistent and robust program with a company that does what it says it's going to do, I think, offers a lot of value to our service company partners. And end of the day, we will see some higher costs, but not prepared to really point to a number just yet.

[Operator]

Your next question is from Scott Hanold with RBC Capital Markets.

[ScottHanold]

My question is, when you step back and think about Devon's strategy in how you return cash to shareholders, do you all have a sense on how you view the best way to give value back to investors is? Meaning, do you think it's higher -- the highest dividend yield. Is that the real way you think long term you're going to create value? Or is it [Indiscernible] ways to use that free cash flow to over time generate incremental more free cash flow? Is that -- do you all have a certain thesis or strategy at this point?

[RickMuncrief]

Yes, Scott, one thing -- this is Rick. One thing that we constantly try to keep a pulse on and that is investor preferences. And that's not always easy. Depends on who you ask sometimes. And so from our perspective, we think a balanced approach is a pretty good way to look at it. And you may be a little cross-threaded 1 quarter or 2 quarters, but over time, we think that's the best way to do it. And that's why you heard us talk about optionality.

I think more near term, I think the higher dividends show me the money now has been, I think, the lion's share of the feedback that we've been hearing from shareholders. And I think that as we look at our shareholder group, we think that it's continued to strengthen as we're getting really some nice shareholders across the line, and really pleased with that.

Now I think you'll also hear over time, maybe more comments and more perspectives on a little longer term approach. And I think that's an outcome of maybe some more stability in some commodity prices. And when I think commodity prices, I'm thinking about not only crude oil, which drives most of our revenues, but I can tell you, NGLs are -- we have some really, really nice exposure to the NGLs from basically all three of our basins, nice place to be.

And so that -- if you get into a situation where even with your best efforts of getting cash back to shareholders, significant amount of cash to shareholders, if you still think you're being not rewarded properly with your equity performance, that really sets you up for some opportunistic share repurchases. And that's something that even though there were a 20% growth next year on the cash flow per share, you were on both the numerator and the denominator, not a bad way to go. And that's how you can deliver some growth, because I think the broader market continues to reward growth. Our sector, we just can't -- we're not going to get rewarded for growth right now, as we've all talked about for the last year or so. So how can you do things opportunistically both on the numerator and denominator.

And then the third option is just is on the balance sheet, just continue to have a fortressed type balance sheet, which we have a wonderful balance sheet. It's getting stronger every quarter. But at the end of the day, we also have some callable debt that we'll have to think about over the next couple of years, the way we pull the trigger on that or just treat it as a net debt type exercise.

So really a good spot to be in, and that's really how we view it. We really -- in summary, we just try to do the best job we can day in, day out and trying to keep a good pulse on what investors are looking for. And I do think in this day and time, as we said in our opening comments, when you have a near 0% interest world that we're in right now, these yields are really, really compelling. I mean we're all shareholders, and we love those quarterly dividend checks I can tell you. Those are really nice. So that's really how we're looking at it. So hopefully, that's some color that can help you. So

[ScottHanold]

Yes. No, it's very appreciated. And just a quick last question here. Clay, I think you kind of alluded to this already, but obviously, with your greater efficiencies and you guys continue to outperform, I guess, even your expectation on your quarterly production guidance and look on pace to be there for the full year. It doesn't sound at least like this year, you're going to probably taper activity much. Is that sort of the concept that we should think about as we think about 2022, if you guys are still running a little bit more efficient. You're going to kind of maintain that activity and maybe grow into that 5%, I guess, kind of cap rate that you have out there?

[ClayGaspar]

Yes, I think it's a great question, and I appreciate the clarification. Because obviously, as we run a constant rig program and those rigs become more efficient, you just draw more capital into the calendar year. That's a normal thing we've seen before. We love that kind of win. Those are always beneficial, ultimately, investments that we're making, right?

The challenge can be your capital constraint during the calendar year, which is obviously how we guide. I feel very comfortable on being able to deliver our capital during the year even with the efficiencies. How that manifests into '22, yet to be determined. But here's kind of what it could look like in my mind.

If we find that 12 rigs in the Delaware can do what we were doing with 13 and that achieves our goal, we can run 12. What I don't want to do is drop to 12 or 11 or 10 and try and scale back up in a couple of months, just to try and kind of gain the capital for the calendar year. I can say that it's value destructive to the asset teams and it's value destructive to our service companies. And so I think that consistency approach is very, very important, and what you'll see us do is kind of run through. Now when we make a move to more or less rigs, hopefully, we're very steady in that regard as well and predictable and deliver on what we said we were going to do.

Scott Coody

All right. Looks like we're at the end of our time slot today. We appreciate everyone's interest in Devon. And if you have any further questions, please don't hesitate to reach out to the Investor Relations team at any time. Have a good day.

[Operator]

This concludes today's conference call. Thank you.