Business Breakdowns
· Matt Reustle, James Davolos
[00:00:00] S0: Yeah, that's a pretty remarkable deal for Devon to reserve that space. Just thinking that far in advance contradicts a lot of what the producers do in oil world. On the point about the minimum guarantees, should I just think about that as anything that is produced on that acreage is ultimately going to go to WaterBridge? From a water standpoint, it's just a matter of you might only be at the minimum levels for a period of time if the producer doesn't choose to produce more. It's just mostly about the timeline? It's not about somebody else coming in and doing some of that disposal? [00:00:00] S1: Minimum volume commitment, it's just what it sounds like. They might guarantee you 20,000 barrels a day, but to the extent that they could find a way to do it internally or cheaper or go around you, it doesn't guarantee you all that flow. And so that's why the acreage dedication, where there's actually penalties to not using them for some of your disposal on that acreage dedication is much more powerful. And so again, it does make sense to do minimum volume commitments, but acreage dedication is much more attractive long-term. [00:00:00] S0: Yeah, I mean the MVC saved some of the midstream companies, at least for periods of time, but that's an interesting dynamic. I was connecting that all of those were associated with acreage commitments, I guess. How easy is switching in this case? So using an alternative provider, if that were to be the case, is there low friction associated with substituting someone in? Whether it be in that example or at the end of 10 years?
· James Davolos
[00:00:00] S1: It's getting really, really hard to switch because again, this concept of porosity where a lot of these saltwater disposal wells, let's say in West Texas, the acreage tends to be in these 640-acre or square miles, which are sections. So even if you're being responsible with how you're injecting on your section, you have no ability to control what your neighbor's doing, which in some cases could be just a couple hundred meters away. And you're seeing these high increasing pressurization. And so now that you're seeing more discretion around permits for the wells and issues with porosity, it's getting harder and harder to change vendors. Once you add in these longer-haul pipelines that are going to be required, then it's going to be incredibly difficult because A, there's only a few companies that are even in the business of doing longer-haul pipes today. WaterBridge being the most well-known and highest regarded. But I really think it's going to end up being an oligopolistic industry where today a lot of it is controlled by the E&P. So internally Conoco deals with their own water, but they really aren't in the business of dealing with 80 miles of easements. And then you're drilling disposal wells and then maybe commingling some third-party volumes. I'd say the answer is it used to be very easy, now it is difficult. And I think in the future it's getting closer to infeasible than just difficult.
· Matt Reustle
[00:00:00] S0: And in those cases, if you have a transition towards outsourcing, is that come with potential for M&A? Do a lot of these producers that are handling it on their own, do they have infrastructure inside their businesses at this point that would be valuable to acquire? Or is this more likely come in the case of WaterBridge, organically building out the infrastructure necessary to work with them?
· James Davolos
[00:00:00] S1: Probably the former. One of the biggest holders of WaterBridge equity is going to be Devon because Devon said, look, I'm better off contributing this asset to you, letting you run it and then let you handle my growth. In that case, they just contributed that. Aris, which has recently been sold, this hasn't closed yet to Western. One of their biggest holders was Conoco because a legacy Concho system was contributed. And so I think you're going to see more and more operators say, okay, it makes more sense. Let me just contribute my system, let you operate it. Just guarantee me I'm going to get what I need through partnering with you. It's interesting you mentioned that because it wasn't that long ago that conversations were like, hey, the big, big, big integrated players. So mostly Chevron, Exxon, Conoco, they're going to handle it themselves. And now it's actually like, well, when we did deal with them, it was some junior person in the marketing team that deals with their gathering systems and their pricing. Now it's up in the CFO's office because if you're talking four, five, six bucks with your LOE, this goes directly into every decision at this company. So not only has it been escalated in terms of priority for these companies, but now they're saying, look, we're pretty good at handling things when we can do it on our acreage, in our footprint. But once you start adding complexity with geology and easements and multiple landowners, it increasingly makes sense to utilize third parties. So just to close this circle here, I think there's going to be very large market share growth for third parties. Some of what's going to be organic and then some of which is going to be consolidating systems. Some are EMP owned and a few out there are still independent.
· Matt Reustle
[00:00:00] S0: Just a very interesting theme that you mentioned. Anytime you see a decision that moves from inside the operational office up to the CFO office, it's a real thing and it has a real impact. You just have to figure out what type of impact it's going to have in the industry. So interesting to hear. And it makes a lot of sense, I guess, when you think about the pricing. I have a few different frameworks in my head just in terms of value capture relative to the EMP. You can only get a certain portion of whatever oil is selling at, whatever they're profiting from. But you also have to earn a return in terms of whatever your costs are. So if we're going to use the hypothetical dollar per barrel of water, so four per barrel of oil, how does that equate back to their own cost line, their own margin profile? Can you just generalize what that means for them and how much fluctuation there is in terms of that pricing?
· James Davolos
[00:00:00] S1: Yep. So for the produced water, which is really that basic business of you take the water from the wellbore, transport it and dispose of it, they're getting about 78 cents a barrel right now on a run-rate, pro forma basis for handling that water. And that includes a little bit of skim oil. But about 85% of their pro forma revenue is just handling the water. 8% is skim. The remaining is mostly this water solutions business, which is cleaning it up for refracs. But again, 78 cents with an adjusted margin, an operating margin per barrel of about $0.44. So call it about a 56% operating margin on a per barrel basis. The consolidated EBITDA margin of the business on a run-rate where they're just shy of about a $400 million run-rate of EBITDA that's running around 51%. So fairly high-margin business. But to your point, okay, I was referencing dollar rates. And so one of their newer projects is getting water from New Mexico east over the state line on a new pipeline called Speedway into Texas. And this is important because New Mexico is far more stringent in their permitting in some cases, again notwithstanding the newer crackdown on permits. But you could get a Texas well permitted in weeks, if not a month or two. The average permitting time in New Mexico was over two years. Wow. And a lot of people don't realize a huge part of the Permian Basin is in New Mexico. Lea County, Eddy County are juggernauts of U.S. energy growth. So it's easier to build a long-haul pipeline to get that out of New Mexico into Texas. So the big gold mine has been that lower state line. So the southern border of New Mexico Speedway is going to take water east over the eastern border into the panhandle of Texas. So yes, there is a higher incremental capital investment because you're building a long-haul pipeline to get it over that border. But one of the interesting things when talking to them is they've identified about $3.5 billion of capex, which should contribute about a billion of EBITDA on a fully utilized basis. So call it around a 30% unlevered return on incremental invested capital. And as you start having higher pricing power and you start having higher utilization, I would expect these numbers to drift higher.