Business Breakdowns
· 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.
· James Davolos, Matt Reustle
And so the reason that you can have such extraordinary returns on an incremental invested capital is the ability to control the land and then scale the business. And so it's not the same as how difficult it's going to be to capture if you're going to try to expand oil and gas pipelines. And I think that's another nuance is that the returns here and then the ability to get these systems online and then capture market share is just a completely different universe. I'd say superior to midstream. [00:00:00] S0: Yeah, I mean midstream, especially once we're talking about some of the state lines that they try to cross, is a totally different ball game. The $3.5 billion of capex, is that spread out over a long time period or is that all going to come quickly?
· James Davolos
[00:00:00] S1: So that's just what they've identified in a theoretical standpoint. I don't want to represent that as being guidance, but as an indicative case study of what hypothetically could happen if this really comes to fruition. But to the extent that that does come, I'd say probably five to 10 years that would be spread out over depending on how quickly some of these developments come to bear. But actually something else just popped in my head that I feel we should touch on that I forgot is... So going back to my comments earlier about... So in Texas you have the surface estate, which is the surface, just your fee simple ownership in your house. Then there's the mineral estate, which is the oil and gas. There's essentially eminent domain for the mineral holder where the surface owner cannot prevent you under reasonable circumstances from extracting your oil and gas. And so they can't say no, you can't get a wellbore easement, no, you can't get a frac pad, no, you can't get an easement for a pipeline. There's different university land systems that publish systems around the rates for these things. But in essence there's eminent domain for the oil and gas holder to extract their minerals. Water is not protected by eminent domain, even though it could shut in oil and gas. So a rancher could literally just say, no, you cannot cross my land, hard stop. Or they could ask for some extravagant amount of money. When I say it's getting harder and harder to compete with the incumbent systems, go back to that checkerboard I mentioned of these 640-acre square miles. If you have to go 50 miles and deal with 50 different landholders asking you different rates, I mean that just shows you how difficult it is because there's no protection around giving you egress to get rid of that water, even though it could very literally shut in your operations.
· Matt Reustle
[00:00:00] S0: Yeah, it's interesting just in terms of the nuances of that legal domain and legal rights. So yes, NIMBY rules everywhere when it's allowed to. I wanted to close on one last point just on the capex because again, the 50ish percent EBITDA margins, I understand that capex spend for growth opportunities is spread out. When it comes to maintenance capex, which I know is a dirty word in this midstream infrastructure space, do you have some sense of just the maintenance costs associated with keeping obviously infrastructure that's dealing with very intense saltwater that would I'm sure corrode? Is that a heavy burden on the business?