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Text: A replay for today's call will be available on our website for a seven day period beginning this evening.
Today's call may also contain non-GAAP financial measures.
Since we last reported in July, we have seen a fundamental shift in the natural gas market.
Current world events demonstrate the critical importance that natural gas will play in our energy future.
Natural gas futures for 2022 through 2026 have rallied approximately $0.75, which has translated to a meaningful increase to our near-term free cash flow projections.
World events have underscored the important role that natural gas plays in the world's energy ecosystem, not only in reliability and costs, but in meeting our global climate goals.
What we are witnessing in Europe and Asia is a crisis borne out of an undersupplied traditional energy sources, one that highlights the dislocation between the perceived good intentions of addressing climate change through policies of elimination and how these policies play out in the real world.
We are unfortunately seeing the predictable outcomes of an underinvestment in traditional energy resources with both continents having to ration energy in hopes of maintaining sufficient supply to make it through the winter.
While defenders of these policies may claim that these events are isolated in transitory, we believe they are chronic symptoms due to a structural underinvestment in traditional energy resources.
And unfortunately, but yet predictably, we are seeing the adverse environmental ramifications of this, as just a couple of weeks ago, China has announced that it's rethinking the pace of its energy transition and ramping up coal production.
This is not the way to address climate change.
As one of the largest exporters of natural gas, the United States needs to recognize the role it plays, not only in the solution, but also the problem.
The solution is American shale.
We are fortunate to be one of the few countries in the world that has an abundance of energy resources and more so in abundance of the lowest cost, lowest emissions energy resources that is exportable, namely Appalachian natural gas.
During the shale boom, technological breakthroughs, investor support and the innovation and efforts of American natural gas workers translated American shale into low-cost, reliable, clean power, replacing high emissions coal and laying the foundation for solar and wind to play a supporting role with the results being the U.S. leading industrialized countries in emissions reductions.
This model is replicable on a global stage, but only if the United States takes on a leadership role.
For example, if we were to replace only China's new build coal power plants with natural gas, we would eliminate approximately 370 million tons of CO2 equivalent per year.
That number is roughly equivalent to the emissions reduction impact of the entire U.S. renewable sector, which leads to the problem.
The problem is that the United States and advocates for policies of elimination have failed to understand the key role that American shale plays in the global energy ecosystem.
The United States represents about 1/4 of global natural gas supply.
Appalachia alone represents almost 10%.
What that means is that global demand has looked all around the world and, instead, we need almost 1/10 of our natural gas coming from Appalachia.
Regrettably, we've canceled multiple pipelines in the last several years, LNG facilities have stalled, capital has been pulled out of the system, all the while demand has grown, and now we're seeing the results.
U.S. natural gas and more specifically, Appalachian natural gas has the opportunity to provide affordable, reliable, clean energy to the world.
But to do that, we need support in building more infrastructure.
A failure to support pipeline and export infrastructure would effectively advocate the leadership role that the United States is poised to play in addressing global climate change to countries that likely do not have the resources or political desire to do so.
Now to talk more about the gas macro specifically and how it is impacting our business.
There are a number of bullish trends for the global natural gas market that we believe underpin a long-term structural change of the curve.
First, severe underinvestment in supply across all hydrocarbons and associated infrastructure over the past few years has contributed to a global scarcity of accessible traditional energy sources.
Second, Solar and wind have reached enough scale in global power markets that their intermittency is driving structural volatility, driving demand for reliable energy sources like natural gas to stabilize the grid.
Third, environmental pressures and governmental regulations on infrastructure have limited the ability for energy to go where it is needed most, creating market inefficiencies and restricting investments across the space, limiting the ability of producers to react to supply demand imbalances.
And fourth, a continued focus on low-cost, reliable and clean energy sources has increased the prominence of the role of coal-to-gas switching as one of the most impactful, actionable and speedy opportunities for significant progress in reducing global emissions.
These are the main reasons that global natural gas prices rose over $20 per dekatherm during the quarter, with the back end of the futures curve having also revved nearly $1 in the past six months.
They are also why we see structural change in the curve sticking.
While we have been vocal about our bullish view of natural gas prices for some time, the speed of the current price escalation came sooner than we anticipated.
Our reasons for hedging 2022 production at the levels we did while continuing to keep 2023 exposure open is simple: We believe that regaining our investment-grade rating and reducing absolute debt levels best positions EQT shareholders to fully capture these thematic, long-term tailwinds in the commodity.
As you look across the energy sector, it's clear that traditional energy companies are being valued at a steep discount.
We believe this is principally a result of views on a long-term sustainability of traditional energy sources impacting terminal value.
We believe that markets have overshot in this regard, especially so as it pertains to natural gas.
And that events like the current global energy crisis, in particular, as to how they are contributing to a step backwards in our efforts to address climate change, we will make this readily apparent to policymakers and investors alike.
And we believe that at that time, there will be a rerating within the sector, principally concentrated on companies like ours that are differentiated in their sustainability, both financially and on an ESG basis.
Now I'd like to give an update on our free cash flow projections.
The structural shift in the commodity curve, along with some hedge repositioning in 2021 and 2022, have had a positive and material impact on our free cash flow projections.
In 2021, we are now expecting to deliver approximately $950 million in free cash flow generation.
In 2022, our preliminary estimates are $1.9 billion, with 65% of our gas hedged.
As our hedges roll off in 2023, we see free cash flow generation potential growing even further to approximately $2.6 billion, equating to an approximate 30% free cash flow yield for a company that expects to be investment grade, highlighting how robust the free cash flow generation is from our business.
In addition to the shipping commodity market, we have several other factors driving improved free cash flow generation, including our contracted gathering rate declines, more efficient land capital spending, shallowing base declines and FTE optimization, which we have just announced.
As such, we are updating our 2021 through 2026 cumulative free cash flow projection to over $10 billion, a 40% increase since our July estimate and materially above our current market cap.
This extensive free cash flow generation provides us with the ability to return a substantial capital to shareholders while simultaneously enhancing our balance sheet.
And as previously mentioned, we think there is still running room.
Further, this structural gas price improvement has solidified our execution of shareholder-friendly actions in 2022, which we intend to formally announce before the end of 2021.
While we are acutely aware of the investor appetite for return of capital, one of the key considerations as we finalize our plans is leverage management.
However, we want to be clear that attaining investment grade or a certain leverage target is not a precondition to initiating shareholder returns.
With our hedge position and strong free cash flow, we can accomplish both debt reduction and shareholder returns as we create our debt retirement glide path.
This business is capable of returning tremendous amount of capital to shareholders while maintaining optimal leverage.
Bottom line is we are projected to have approximately $5.6 billion in available cash through 2023.
And if 100% of that cash was allocated to shareholder returns, we would still be left with leverage of sub 1.5 times.
Those are some very compelling stats, and we look forward to executing on this robust capital allocation strategy in the very near term.
I'll briefly cover our third quarter results before moving on to some strategic and financial updates.
Sales volumes for the second quarter were 495 Bcfe, at the high end of our guidance range.
Our adjusted operating revenues for the quarter were $1.16 billion.
And our total per unit operating costs were $1.25 per Mcfe.
During the third quarter of 2021, we incurred several onetime items totaling approximately $116 million, which impacted our financial results and free cash flow generation.
First, we purchased approximately $57 million of winter calls and swaptions to reposition our hedge book to provide upside exposure to rising fourth quarter '21 and all of 2022 prices, which I'll discuss in more detail in a moment.
Second, we incurred transaction-related costs, mostly from Alta of approximately $39 million.
And finally, we incurred approximately $20 million to purchase seismic data covering the area associated with the Alta assets, which hit exploration expense.
Our third quarter capital expenditures were $297 million, in line with guidance.
Adjusted operating cash flow was $396 million.
And free cash flow was $99 million.
Rising commodity prices and actions taken to unwind fourth quarter hedge ceilings have resulted in an increase to our fourth quarter free cash flow expectations of approximately $200 million.
But at the midpoint, we expect fourth quarter sales volumes to be 525 Bcfe, total operating cost of $1.25 per Mcfe, capital expenditures of $325 million and free cash flow generation of $435 million.
Turning to some more strategic items, I'd like to discuss the actions taken during the third quarter to optimize our firm transportation portfolio.
First, we successfully sold down 525 million a day of MVP capacity, which when combined with 125 million a day previously sold down, amounts to approximately 50% of our original capacity.
The terms are governed by an Asset Management Agreement, pursuant to which EQT will deliver and sell certified, responsibly sourced gas to an investment-grade entity for a six year period.
EQT will manage the capacity and retain access to the premium Southeast markets, while the third-party entity will be responsible for all financial obligations related to the capacity.
This transaction meaningfully reduces our firm transportation costs.
Going forward, we believe that retaining our remaining $640 million a day of MVP capacity provides appropriate diversity to our transportation portfolio.
And we do not intend to sell down any additional capacity at this time.
During the quarter, we were also successful in securing 205 million a day of Rockies Express capacity, with access to the premium Midwest and Rockies markets.
As part of the agreement, the parties agreed to significantly discount the reservation rates during the first 3.5 years of the contract, which results in a material uplift to price realization and margins during that period.
In the aggregate, we expect these arrangements to lower our go-forward firm transportation costs by approximately $0.05 per Mcfe, while simultaneously improving realized pricing.
Additionally, we are currently working on several smaller firm transportation optimization deals, which, if executed, are expected to further enhance margins and price realizations.
Furthermore, our RSG program is ramping up.
The six year, 525-million-a-day contract, we believe represents the largest RSG transaction done in the marketplace and highlights the accelerating end market demand for low methane intensive natural gas.
I'll now move on to some hedging activity initiated during the quarter, which effectively unlocked upside exposure to rising prices.
Since the end of the second quarter, we have seen the Henry Hub contract price appreciate, backed by modestly tightening U.S. fundamentals and rising volatility.
Couple that with energy shortages occurring around the world, we believe the U.S. could see extreme price events this winter.
By early August, we have revised our hedge positioning to one that participates in more upside while still locking in the necessary cash flows for progressing back to investment grade.
In essence, we removed approximately 28% and 13% of tax for ceilings for the balance of 2021 and all of 2022 and lowered our floor percentages by 11% and 9%, respectively.
We were able to do this by purchasing a significant number of winter call options at very attractive prices and strike levels that are currently in the money.
These call options maintain our downside protection, capitalize on rising volatility and open our portfolio to increase realizations.
In addition to our winter call options, we also purchased swaps in 2022 by taking advantage of the backwardation in the market to purchase swaps at points on the curve we felt to be undervalued.
This is expected to allow us to capture stronger pricing in 2022 well after we are through the winter.
These actions resulted in a onetime cost of approximately $57 million in the third quarter and approximately $18 million in the fourth quarter, with the current market value sitting at well over three times the execution cost.
For our 2023 hedge book, which sits at under 15%, we expect to hedge with a more balanced and opportunistic approach as we have reduced debt and achieved our investment-grade metrics in 2022.
At a high level, we envision a lower hedge percentage, utilizing structures that enable upside participation to capture our anticipated long-term appreciation of natural gas prices and increased volatility.
Last, we remain relatively unhedged on our liquids volumes for 2022 and 2023 at less than 15%, which represents about 5% of our volumes and 7% of our revenues.
Moving on to a quick update of leverage and liquidity.
Pro forma the full year impact of Alta and the removal of margin postings, our year-end 2021 leverage sits at 1.8 times and is expected to decline to 0.9 times by year-end 2022 and 0 leverage by year-end 2023 without the impact of shareholder returns.
If you add all our free cash flow through 2023, plus the $700 million in current cash margin posting, we are looking at $5.6 billion in cash available for shareholder returns and leverage management.
So we have the ability to retire substantial debt, achieve optimal leverage and provide robust returns to our shareholders.
Stay tune for a more formal framework before year-end.
As of September 30, our liquidity was $1.2 billion, which included approximately $0.7 billion in credit facility borrowings largely related to margin balances tied to our hedge portfolio.
As of October 22, our margin balance sits at approximately $0.4 billion and our liquidity will end October at around $1.5 billion.
With respect to margin postings, we've been able to manage these nicely by working with our hedge counterparties, many of which are also [Indecipherable] revolver.
We continue to make progress on lowering our letters of credit postings under the credit facility, which dropped approximately $0.1 billion during the third quarter to $0.6 billion, and it declined another $0.1 billion through October 22.
From mid-2020, we have effectively cut our letters of credit in half from approximately $0.8 billion to an anticipated $0.4 billion by year-end 2021.
And as a final reminder on liquidity, virtually all margin postings and letters of credit go away when we achieve investment-grade rating.
We are one notch away from IG with all three agencies.
And when combined with the structural gas macro tailwinds and EQT's robust free cash flow profile, we believe it's only a matter of time until we regain our investment-grade rating.
These include: one, the compelling and structural positive momentum driving the gas macro backdrop, setting up robust and sustained free cash flow generation; two, the announcement of a shareholder return framework that is right around the corner; three, an investment-grade rating that is on the horizon, further driving increased free cash flow generation and improved liquidity; and lastly, our modern approach and ESG leadership will continue to drive sustained, long-term value creation for all of our stakeholders in the sustainable shale era.

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qtrly sales volumes of 495 bcfe, at high end of guidance.

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