Western Midstream Partners LP

NYSE:WES

Earnings Call Transcript 2022-Q2

[Operator]

Good afternoon. My name is Rex and I will be your conference operator today. At this time, I would like to welcome everyone to the 2Q 2022 Western Midstream Partners Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I would now like to turn the conference over to Daniel Jenkins, Director of Investor Relations. Please go ahead.

[Daniel Jenkins, Director of Investor Relations]

Thank you. I'm glad you could join us today for Western Midstream's second quarter 2022 conference call. I'd like to remind you that today's call the accompanying slide deck and last night's earnings release contain important disclosures regarding forward-looking statements and non-GAAP reconciliations. Please reference Western Midstream's most recent Form 10-Q and other public filings for a description of risk factors that could cause actual results to differ materially from what we discuss today. Relevant reference materials are posted on our website.

With me today are Michael Ure, our Chief Executive Officer; Kristen Shults our Chief Financial Officer; and Craig Collins our Chief Operating Officer.

I'll now turn the call over to Michael.

[Michael Ure, Chief Executive Officer]

Thank you, Daniel, and good afternoon everyone. Yesterday, we reported another quarter of strong operational and financial performance at Western Midstream. Our second quarter financial success was primarily driven by increased throughput across all three products in the Delaware Basin and higher distributions from equity investments, partially offset by higher operation and maintenance expense. We also achieved several records in the quarter including record natural gas throughput in the Delaware Basin, processing 1.5 Bcf of gas per day, record produced water throughput in the Delaware Basin, gathering 864,000 barrels per day and record adjusted EBITDA for the second straight quarter, generating substantial free cash flow.

We have also delivered on our plan to accelerate the return of capital to our stakeholders. Specifically through July 29th, we have repurchased approximately 7.1 million units in the open market and 10 million units from Occidental under our $1 billion unit buyback program. Since announcing this program in February, we have repurchased $425 million of units at an average price of approximately $24.85 per unit.

Additionally, through our unit buyback programs and including the Anadarko note exchange, we have now retired 59 million units or approximately 13.2% of the unaffected common unit count since becoming a stand-alone organization at the beginning of 2020. We also retired $504 million of senior notes during the quarter. Inclusive of the previously mentioned unit repurchases we have reduced our debt to trailing 12-month adjusted EBITDA ratio below our year-end leverage threshold of 3.4 times, and we have now retired just over $1.65 billion of senior notes or 20% of the aggregate debt balance since our January 2020 senior notes issuance.

As of July 29th on a per unit basis, we have now returned $6.53 through debt retirement and unit repurchases and $3.97 in distributions for a total of $10.50 returned to unitholders since our January 2020 senior notes issuance, which excludes any market driven appreciation in our current unit price.

We are very pleased with our recent efforts to accelerate the return of capital to our stakeholders through debt retirement, unit repurchases and maintaining a strong base distribution. Considering our debt-to-EBITDA leverage ratio is already below our year-end net leverage threshold of 3.4 times gives us financial flexibility to evaluate other opportunities to return additional capital to our unitholders whether through additional buybacks or an enhanced distribution. The decision to pay an enhanced distribution will partially depend on our financial performance in the second half of 2022.

Additionally to the extent we fund unit repurchases with revolver borrowings or if we refinance those borrowings with more permanent debt capital those transactions would be excluded from the computation to potentially pay an enhanced distribution. Said differently, we only intend for permanent reductions in outstanding debt and equity in the aggregate to be considered in the enhanced distribution calculation.

Turning to ESG. We released our annual sustainability report this week. The report details how we are working to support sustainable environments focus on people and operate responsibly. We are very proud of the unique culture we have built at WES. Our people have worked tirelessly to focus on minimizing our environmental footprint and to work with others to find creative solutions to some of today's energy and climate challenges. This approach to advancing energy and our expertise in handling and transporting natural gas are reasons why we feel we are playing a key role in the energy transition.

We will talk more about our ESG efforts later in the call. The work of our people, health of our balance sheet, and our strong operational execution, all give us confidence that WES is well positioned for continued success, even in light of the recent market volatility and economic concerns. Over the past few years, the Midstream sector has been focused on utilizing existing capacity, prudent capital allocation, and improving the health of its respective balance sheets. This discipline has made our sector increasingly more attractive to investors.

WES has been a leader amongst our peers by being the first in the industry to focus on free cash flow, meaningfully de-risking the enterprise and creating value for our unitholders through the return of capital. The actions we have taken have increased our financial flexibility and we are well positioned to capitalize on these market dynamics and to continue returning capital to our stakeholders.

With that, I will now turn the call over to Kristen to discuss our second quarter financial performance. Kristen?

[Kristen Shults, Chief Financial Officer]

Thank you, Michael, and good afternoon, everyone. During the second quarter, we generated net income available to limited partners of $300 million, and another record-breaking quarter of adjusted EBITDA that totaled to $548 million. The sequential quarter increase in adjusted EBITDA was driven by increased adjusted gross margin, partially offset by increased operation and maintenance expense.

Our adjusted gross margin increased by approximately $51 million on a sequential quarter basis, due to increased throughput across all three products in the Delaware Basin, and increased natural gas throughput in the DJ Basin.

Distributions from equity investments also increased on a sequential quarter basis, which we do not expect to reoccur in the third quarter. Additionally, our strong plant performance in the second quarter and elevated commodity prices resulted in incremental gross margin associated with the retained excess natural gas liquid volumes under our fixed recovery contracts.

Our operation and maintenance expense increased by approximately $39 million, on a sequential quarter basis, primarily due to increased costs, associated with higher utility expenses and increased maintenance and repair. We expect O&M to further increase in the third quarter, as we perform expected plant maintenance and complete a one-time $10 million field level project to support our transformation effort.

After the third quarter, we expect O&M expense to be more in line with our second quarter results. While utility costs should decrease as prices and usage decline during the winter months, we expect to incur additional service use fees as our produced-water throughput increases.

Turning to cash flow, our second quarter cash flow from operations totaled $467 million, which was a material increase compared to the prior quarter due to our strong adjusted EBITDA performance and positive working capital changes from normal course of business.

Free cash flow totaled $372 million and free cash flow after the increased first quarter distribution payment in May totaled approximately $166 million. Finally, we recently declared a second quarter cash distribution of $0.50 per unit payable on August 12. The distribution is equal to the prior quarter's distribution and is consistent with the previously announced annualized base distribution target of $2 per unit.

Looking to the second half of the year, we expect throughput to continue to increase throughout the year and into 2023, due to continued strong producer activity levels. With that said, as throughput increases in the Delaware Basin, we expect to experience slight compression in our natural gas adjusted gross margin per Mcf as we further utilize our recently executed offload arrangements.

Despite the headwinds associated with expected lower distributions from equity investments and higher O&M expense, we remain comfortable with our previously announced 2022 guidance ranges for adjusted EBITDA and free cash flow.

Finally, our remaining capital budget focuses on the organic expansion of our existing asset base and the construction of Mentone Train III, so we can provide flow assurance for our customers' volumes in 2023 and beyond. In the meantime, we're utilizing excess capacity in the Delaware Basin through offload arrangements that will bridge us to the expected completion of Mentone III in the fourth quarter of 2023.

I'll now turn the call over to Craig to discuss our operational performance. Craig?

[Craig Collins, Chief Operating Officer]

Thank you, Kristen. On a sequential quarter basis, natural gas throughput increased by 5%. This increase was primarily driven by increased volumes in the Delaware Basin and increased volumes in the DJ Basin attributable to new processing on load volumes. We also saw an increase in natural gas throughput from our equity investments.

Our crude oil and natural gas liquids throughput decreased by 1% compared to the prior quarter. Expected declines in the DJ Basin and reduced liquids throughput from our equity investments were partially offset by increased throughput in the Delaware Basin. Produced-water throughput increased by 15% compared to the prior quarter due to increased volumes at the DBM water system.

Our per Mcf adjusted gross margin for our natural gas assets increased by $0.02 compared to the prior quarter, primarily due to changes in our contract mix and increased throughput at our West Texas complex, which has a higher per Mcf margin as compared to our other natural gas assets.

In addition, continued strong plant performance coupled with higher commodity prices benefited our margin in the second quarter. Our per barrel adjusted gross margin for our crude oil and natural gas liquids assets increased by $0.13 compared to the prior quarter. This was primarily driven by two factors; increased throughput at the DBM oil system, which has a higher per barrel margin as compared to our other crude oil and NGL assets, and higher distributions despite lower throughput from equity investments.

Our per barrel adjusted gross margin for our produced water assets decreased by $0.10 compared to the prior quarter primarily due to decreased efficiency fees and changes in our contract mix as throughput increased. We expect that the anticipated increase in throughput in the Delaware Basin in the back half of the year will be partially offset by expected volume declines in the DJ Basin.

Regardless, we're maintaining our previous 2022 throughput exit rate expectations of mid single-digit percentage growth in natural gas volumes low single-digit growth in crude oil and NGL volumes and low fixed percentage growth in produced-water volumes. In the Delaware we expect 202 wells to come online in the Basin during the second half of this year, which is approximately 65% of the total 2022 expected well count.

In the DJ, we expect our natural gas decline rate to slow down as we enter into 2023 as legacy wells enter a more mature phase of the production type curve. Third-party on-load volumes continue to flow onto our system and through continued activity in the Watkins area of the Basin.

From an oil standpoint, we would expect the current decline rates to continue until additional rigs return to the acreage we service. We are also encouraged by some positive momentum in the permitting process with the COGCC. Several permits that contain multiple pad sites each in Weld County have recently been approved and it appears that producer optimism is growing, as they gain clarity on the permit approval process.

Finally, from a supply chain and inflation standpoint, prices for most parts and services remain relatively consistent to those in the prior quarter. This year we will benefit from preordering a large portion of the steel pipe needed for organic expansion and well connects, but we have seen price increases for steel and other major items such as chemicals and lubricants. Despite these recent challenges, we continue to actively manage our supply chains and inflationary cost pressures all of which were already contemplated in our revised 2022 guidance from last quarter.

I'll now turn the call back over to Michael.

[Michael Ure, Chief Executive Officer]

Thanks Craig. As I mentioned in my opening remarks we released our annual sustainability report this week. I will highlight a few of our achievements here, but I encourage you to take some time to read the report. We are very proud of our accomplishments addressing ESG issues since becoming a standalone organization.

This year these achievements include a reduction in Scope 1 and 2 gross GHG in 2020 installation of new technologies to enhance leak detection efforts, further reduce emissions and expand electrical compression in the field. The expansion of our diversity equity and inclusion efforts, which include 56% of our senior leadership and 30% of other managers who are female or racial or ethnic minorities and an extremely successful first year of our volunteer program, which saw 62% of our employees volunteer in the community and donations to nearly 200 causes.

For such a young organization, the heart of our people is such an awesome quality of WES, one of which I'm personally most proud. Thank you to all of our dedicated employees who have played such an integral role in reducing emissions and giving back to the community. Our track record in under three years of operating as a standalone organization is further evidence of our commitment to reducing our overall carbon footprint and developing a great culture at WES. We look forward to building on this momentum in the years ahead, as we continue to advance energy by enhancing the sustainability of our operations.

To recap, we're very confident that WES is well positioned to service the growing needs of our customers. We're pleased with the sustainability of our operations thus far, as well as our financial track record of prudent capital allocation, operational efficiency and strong returns to unitholders.

I'm also proud to say that WES has been a leader in returning capital to stakeholders amongst our publicly traded midstream peers. WES maintains one of the lowest debt-to-EBITDA leverage ratios and continues to be a leader in proportional debt reduction and total units repurchased since early 2020 relative to our publicly traded midstream peers. As all of our peer group reports second quarter earnings, we will post an updated slide deck which we believe will continue to demonstrate WES's comparative leadership in these regards. Thanks to the hard work of our employees and contractors, our operational and financial performance through the first half of the year, has been excellent and we look forward to what's ahead in the second half of 2022.

With that, we'll open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Gabe Moreen. Your line is open.

[Gabe Moreen, Mizuho Securities]

Hi. good afternoon, everyone. Kristen, I have a follow-up question just in terms of the unit repurchases. It seems like you were pretty aggressive and opportunistic around things on the unit price pulling back here, in the last couple of weeks. Can you just talk about kind of I guess, what you feel like the gating factor is at this point? I think you've talked about 3.4, being your year-end leverage target. I just want -- and you're basically close to 3.2 on an LTM, basis right now. I just want to confirm, that you still you feel you have room to be opportunistic for the rest of the year, considering kind of where your leverage targets are right now when it comes to unit buybacks?

[Michael Ure, Chief Executive Officer]

Thanks for the question, Gabe. Yes, we definitely will continue to utilize that program as we see opportunities to do so. Again, as we think about the leverage target as it relates to an enhanced distribution, the construct for that was whether or not we had other opportunities to utilize that excess free cash flow, and to try and do that under a prudent way. We still have $0.5 billion left or a little over $0.5 billion left in the buyback program.

And if there's opportunities to do that, then we will intentionally utilize the buyback program, in order to repurchase units opportunistically in that regard. And we'd certainly, like to be in a place to be able to pay an enhanced distribution. But if there is -- if there are other opportunities including other opportunities to buy back additional units, then we'll continue to utilize that program for sure.

[Gabe Moreen, Mizuho Securities]

Thanks, Michael. And then maybe, I can ask a follow-up to that. I'm just curious, to what extent getting that one extra notch to get to investment grade, really is a factor in terms of, the unit buybacks or not. I know a little bit -- getting to IG is quite a bit out of your control. But I'm just curious, from a capital return standpoint, how you balance those things?

[Michael Ure, Chief Executive Officer]

Yes. As it relates to leverage, we're certainly from a metric standpoint, well within the ranges that have been established from the agencies, in order to be in investment-grade territory. With frankly, a fair amount of leeway, relative to the metrics provided. And so, we would still have a comfort level to be able to do that, from a rating agency perspective. As you noted, the constraint from that standpoint, isn't necessarily the metrics, that we're currently working under. I don't know Kristen, if there's anything else to add there.

[Kristen Shults, Chief Financial Officer]

No. I think just in general, the conversations we've had with the rating agencies, have been really positive, before we put our balance sheet, but I don't see for anything changing that’s not already there.

[Gabe Moreen, Mizuho Securities]

Great. And then maybe, Kristen, if I can follow up just on some of your O&M commentary, just kind of understand here exactly, what is seasonal versus structural versus maybe inflationary, if that all makes sense? So maybe you can just kind of recap, what you're seeing on O&M it sounds like it's currently a little bit higher, but scaling back also a little bit in 4Q and beyond?

[Kristen Shults, Chief Financial Officer]

That's, right. So -- just to take a step back our Q1 O&M, was a little bit lower. There is some seasonality on the utility side. We use more from a utility perspective, during the summer months. We've also seen increased pricing on the utility side. So that's coming out, in the second quarter, and we expect that to continue into the third quarter as well. The second quarter, is probably a better run rate going forward, with the exception that in the third quarter, we're expecting to spend around $10 million, on a field level project, that's working with our transformation effort allowing us to be more efficient and proactive on the maintenance and repair side. So expect a little bit of an uptick in the third quarter, and then returning back to the second quarter level, when we get into Q4.

[Gabe Moreen, Mizuho Securities]

Good. Thank you.

[Operator]

Your next question comes from the line of Jeremy Tonet. Your line is open.

[Jeremy Tonet, JPMorgan]

Hi, good afternoon.

[Michael Ure, Chief Executive Officer]

Hey Jeremy, how are you?

[Jeremy Tonet, JPMorgan]

Good. Just wanted to slice the buyback question slightly differently if I could. And I was just wondering when you guys think about unit repurchases is it more driven by kind of unit price at a point in time or balance sheet capacity or other considerations such as trying to maximize or hit a certain level of free cash flow return to unitholders?

[Michael Ure, Chief Executive Officer]

Jeremy, all of those factors come into consideration as we execute on the buyback program. Again, so when we talk about opportunistic those are definitely many of the factors that are under consideration. Are we seeing weakness out there and therefore seeing an opportunity to be able to repurchase; balance sheet free cash flow and ability to potentially pay an enhanced distribution all of those certainly are factors and we definitely saw in the second and into the third quarter a meaningful opportunity in that regard to be able to utilize that program.

[Jeremy Tonet, JPMorgan]

Got it. Thanks for that. And then just wanted to touch base on the CCS side and Oxy obviously has big plans there. I'm just wondering your thoughts if Ira, kind of changes things a bit. And is there a role for WES to play here alongside Oxy in these initiatives?

[Michael Ure, Chief Executive Officer]

Yes it's a great question. We have frequently active dialogue with Oxy with regards to opportunity there. The legislation is currently being proposed obviously does provide incremental opportunities for everyone out there. And I’d argue that Oxy is clearly a leader in that regard. And so -- our close relationship with them has resulted in frequent and active dialogue around ways that WES will be able to participate.

[Jeremy Tonet, JPMorgan]

Got it. That’s helpful. I will leave it there. Thanks.

[Michael Ure, Chief Executive Officer]

Thanks Jeremy.

[Operator]

Your next question comes from the line of Neel Mitra. Your line is open.

[Neel Mitra, Bank of America]

Hi, thanks for taking my question. Just wanted to bridge the guidance raise given on the last quarter and also maybe what changed regarding O&M versus when you put out the guidance in Q1. What was expected and what was unexpected going forward structural versus inflation? And then second, it was mentioned that the G&P rates will decline going forward as you use offtake agreements. Was that anticipated? And how long will that persist? Will it be till Mentone III comes online?

[Kristen Shults, Chief Financial Officer]

Yes. So a couple of pieces in there. When we announced the revised guidance last quarter it took into account everything that you're seeing in Q2 and then it's still -- we're maintaining that right now. And so, the G&P rate gross margin per unit that's as expected and was part of that revised guidance and still holds true today the O&M expense and the uptick that we were seeing that was also part of that and expected as well. So, I think most of what we were expecting from an inflation standpoint from just activity standpoint, spending standpoint is right in line when we're seeing actuals right now and when we're looking into the second half of 2022.

[Neel Mitra, Bank of America]

Okay. Great. And then as a follow-up just with the activity from the E&Ps in the Delaware and the announcements of new processing capacity by your peers. Are you looking past Mentone III? And when do you think you would need a new processing plant beyond that given just the increasing volumes in the Delaware? And then on the other side, how do you see DJ volumes trending over the next year or so?

[Michael Ure, Chief Executive Officer]

Yes. So, we are absolutely constantly monitoring growth is additional capacity necessary from our standpoint. That went into consideration of authorizing the incremental capacity at Mentone last quarter. It's been frankly continues, to be just as positive if not stronger in terms of expectations going forward. You probably keyed on the announcement that Oxy mentioned yesterday with regards to the Ecopetrol JV that will be transitioning on to WES acreage.

That will likely increase activity levels in a pretty meaningful way for us going into 2023 and beyond. And so, as we need to take into consideration as we look at potential incremental capacity, but as it sits right now there's nothing that we look at and see would be required as we sit here today. Craig, I don't know if you want to reiterate the commentary on DJ as it relates to volumes or anything to add there on the capacity side?

[Craig Collins, Chief Operating Officer]

Yeah. I mean, we obviously continue to have more than sufficient capacity in the DJ. We've done a really good job I think of bringing additional gas onto the system both from producers as well as from some of our peers, and we'll continue to look for those opportunities. I think we're getting to a point here pretty quickly, where the rate of decline of those volumes is going to start to flatten out a lot more than where it's been just based on the where the production the base production is on the type curves up there. And so we see that starting to slow down in terms of the rate of decline going forward but still be on decline and continue to look for opportunities up there in the DJ. But nothing, further to add to Michael's comments on the Delaware. I think that summed it up well.

[Neel Mitra, Bank of America]

Okay. Great. Thank you very much.

[Operator]

Your next question comes from the line of Michael Cusimano. Your line is open.

[Michael Cusimano, Pickering Energy Partners]

Hi. Good afternoon, everyone. How much of your margin goes through the cost of service adjustments at year-end? Maybe hoping like you can frame out either by basin or by commodity because we just we've gotten feedback where some investors assume all of your fee goes through that adjustment and I think you've broken it out somewhat before in the past.

[Michael Ure, Chief Executive Officer]

Yeah, so we actually talk about the percentage of our contracts that are covered by either cost of service or minimum volume commitments. And it's around the 81% gas, 96% oil and 100% water that at least has some coverage from that perspective. We don't actually break out what proportion of that is cost of service versus fixed fee or minimum volume commitment. But to be very clear, there is most definitely a portion of that that is fixed fee-oriented and not all is cost of service.

[Michael Cusimano, Pickering Energy Partners]

Got it. Okay. And does it depend by commodity stream as well, or is it across all three where you maybe reset rates every year?

[Michael Ure, Chief Executive Officer]

We do have cost of service contracts on all three commodities: gas oil and water again different proportions of each of those. But there are cost of service elements on all three commodities.

[Michael Cusimano, Pickering Energy Partners]

Okay. And then to follow up on that I believe into this year the DJ rates had some downward pressure because the expectation was a steep volume ramp that may not materialize with some of the permit issues that Oxy has been having. So I guess I'm wondering is it wrong to think that DJ rates could possibly improve every year with that not materializing?

[Michael Ure, Chief Executive Officer]

Yeah, it's too early to tell at this stage. It's a great question but it's too early to tell what the potential impact on rates are going to be. As Craig mentioned in his prepared remarks, we're starting to feel a little bit more optimistic as it relates to activity levels on the DJ side as more producers have continued to work through that process and gotten a little bit more familiar with the means necessary in order to achieve permits.

And so a lot of obviously will depend on what our rates will be expectation of when and at what time and to what extent volumes would come through the system out in the DJ.

[Michael Cusimano, Pickering Energy Partners]

Okay. That's all for me. Appreciate the f

[Operator]

There are no further questions at this time. Mr. Ure, I turn the call back over to you.

[Michael Ure, Chief Executive Officer]

Thank you everyone for joining. Look forward to the future. I appreciate your time.

[Operator]

This concludes today's conference call. You may now disconnect.