CNX Resources Corporation (CNX) Q4 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the CNX Resources Fourth Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this even is being recorded. I would now like to turn the conference over to Tyler Lewis, Vice President, Investor Relations. Please, go ahead.

Thank you, and good morning to everybody. Welcome to CNX fourth quarter conference call. We have in the room today, Nick DeIuliis, our President and CEO; Don Rush, our Executive Vice President and Chief Financial Officer; and Chad Griffith, our Executive Vice President and Chief Operating Officer. Today, we will be discussing our fourth quarter results, and we have posted an updated slide presentation to our website. To remind everyone, CNX consolidates its results, which includes 100% of the results from CNX, CNX Gathering LLC, and CNX Midstream Partners LP. Earlier this morning, CNX Midstream Partners, ticker CNXM, issued a separate press release, and as a reminder, they will have an earnings call at 11:00 AM Eastern today, which will require us to end our call no later than 10.50 AM. The dial-in number for the CNXM call is 1-888-349-0097. As a reminder, any forward-looking statements we make or comments about future expectations are subject to business risks, which we have laid out for you in our press release today, as well as in our previous Securities and Exchange Commission filings. We will begin our call today with prepared remarks by Nick, followed by Chad and then, Don, and then we will open the call for Q&A. With that, let me turn the call over to you, Nick.

Thanks, Tyler. Good morning, everybody. Thanks for joining. I'm going to start on slide three of our slide deck, where we showcase some of the highlights of the company. As you may have seen, we announced simplification transaction with CNX Midstream this morning. I'll go into more detail in the next couple of slides and what it means for both CNX and CNX Midstream. Suffice to say, for now, that CNX Midstream, which was already a strategic part of the CNX business model, has become a clear differentiator for CNX with this transaction and it's going to remain so in the coming years. On the operations side, we continue to see strong well results in the fourth quarter. We came in at the high end of our production guidance range. For capital, we came in nicely below our guidance range; while posting costs, we were in line with our prior expectations. So there's many factors that drove the reduced capital intensity, the strong production and the cost structure. They all boil down to a focus on the things that allow us to optimize the intrinsic per share value of CNX Resources. The fourth quarter's strong results, there is a prelude to the theme for 2020. And the theme is that the team here continues to proactively manage the drivers of the business through the commodity cycle. We've taken control of the things within our control across all of our business segments. So, for instance, we've made the difficult but prudent decisions to remove SG&A costs from the business and that's created a best-in-basin SG&A level that allows for prudent, profitable and, what I'll call, scalable growth. We redefined our activity set, that's in line with our best-in-class hedge book, that ensures attractive cash margins. Our balance sheets, they're very topical, given where the commodity is. And fortunately, we positioned ourselves with a great deal of strength on that front. Our hedge book helps drive and maintain a strong balance sheet, which also benefits from our minimal FT strategy to limit those off-balance sheet liabilities. Our leverage ratio is going down, when you look at 2020 and 2021. And we believe that our nearest-term maturities, the 2022 notes, they're easily manageable. Last, we've updated guidance for 2020 and 2021. They generate substantial free cash flow by allocating prudent capital into our asset base at high rates of return. The 2020 and 2021 guidance, unique, given the commodity environment that we're operating in, that's a key piece of the game board to further strengthen an already strong balance sheet. I want to jump over now to slide four, and that really highlights that our philosophy has remained unchanged. And I know we always say it, but because in this industry the landscape is constantly changing and because it differs from our peers, please allow me to say it again. All of our decisions, resources, tactics and focus, they all concentrate on optimizing the NAV per share of the company. Our decisions are based on making risk-adjusted returns. They use a hurdle rate for these decisions. We've reduced our share count meaningfully since the inception of our share buyback program that started back in 2017. And for the fourth quarter of 2019, we didn't retire any shares, but instead, our focus was on addressing our 2022 notes with free cash flow that we expect to generate. It's what the math and the logic dictate. And again as capital allocators these decisions are fluid and in a commodity business, you have to have the flexibility to adapt as variables change and you have to have discipline to stay true to your values and what you are ultimately solving for through the up and down cycles. All that being said, we see a tremendous long-term opportunity to retire meaningful number of shares in the future. Slide 5 provides specifics on highlights in the context of a tough macro environment. We're now forecasting $250 million in total free cash flow per year in each of 2020 and 2021, which includes approximately $50 million in asset sales each year. $0.5 billion of free cash flow over two years is an impressive feat by itself. But what makes it more impressive are two details associated with the guidance. First, we're highly hedged on NYMEX and basis for 2020 and 2021, and that of course insulates us from the threat of prolonged or further depressed pricing. Second, the $0.5 billion in free cash flow assumes around $100 million in cumulative asset sales over those two years. That's a very manageable asset sale target with much of it driven by things like surface acres and rights-of-way sales, things not nearly as challenged as undrilled acreage in a tough macro environment. And I want to spend a couple of minutes on the recently announced CNX Midstream simplification transaction and really what it means for both parties. But first, I'd like to provide a brief history of the MLP, and that is shown on slide number 6. Like CNX Resources, we have been thoughtful, disciplined and focused with CNX Midstream through the ups and downs of both the commodity cycles and the MLP markets. And as you can see since the IPO, the Midstream company has performed phenomenally and CNX has worked hand-in-hand with them. Through score transactions, we've built a best-in-class Appalachian midstream company. It's grown tremendously and is projected to continue to do so in the future. Our transaction track record, coupled with the Midstream team's smooth execution, help drive 2019 -- I'm sorry, help drive not just 2019 results, but also 19 consecutive quarters of 15% distribution growth, which in turn, sets us up for an IDR transaction to strengthen both companies in a big way. All these things create a really exciting future. Slide 7 shows the details of the transaction. In short, CNX Resources received 26 million regular common LP units, 3 million Class B units that convert automatically to common units in 2022, and finally $135 million in cash over three annual installments. This deal transaction simplifies our capital structure. It reduces CNX Midstream's cost of capital. And it further aligns CNX equity Interest with common unitholders and finally removes a key overhang expressed by the investor base. If you move to Slide 8, it's just simply highlights why we're so excited to be a majority owner in this Company. The historical and forecasted EBITDA growth rates for CNX Midstream, they are tremendous and they compare favorably to any industry. And the cash flow CNX receives from the distributions are material to the company and growing over time. We view the sponsored MLP as a strategic advantage going forward, as we look to navigate downturns and position both companies for the upturns. Case in point, no peer has the flexibility that we have to combine midstream and upstream teams to unlock synergies, savings and efficiencies like we can. I'll reiterate, we're very excited for the future of CNX Midstream. Before I hand it over to the team, Chad and Don to discuss the quarter in more detail, I just want to reiterate a few key points that underlie the strong strategic position we find ourselves in, as we and our peers look down the barrel of a very challenging 2020. Our costs are among the lowest in the basin. Our SG&A spend is among the lowest in the basin. And we're building additional contingency optionality and liquidity to maintain a strong balance sheet capable of withstanding a worsening macro environment, but we're not going to take our foot off the pedal in 2020 or beyond. We'll continue to push on costs and SG&A, so that we define best in class in those areas. We'll continue to focus on efficiencies and simplification across the business, and we will never stop setting the bar higher. While other struggle to tread water through the next year and perhaps beyond, we'll be ready to take advantage and continually assess strategic opportunities that have the potential to advance the business as they arise. And with that now, I'm going to turn it over to Chad and he is going to discuss our operational results.

Thanks, Nick. As you can see on Slide 9, 2019 was a strong year in terms of our financial and operational performance. Looking at some of our major metrics, we finished 2019 around 539 Bcfe, which is at the top end of our guidance range, while adjusted standalone EBITDAX finished above our guidance range. And finally, total E&P capital finished below the low end of our 2018 guidance range. As a result, we finished 2019 nearly free cash flow neutral when including the $45 million in asset sales that we completed during the year and the distributions we received as part of our ownership in CNX Midstream. We had a very active year and drilled 66 wells, completed 50 and turned-in-line 51, which was all in line with our prior expectations. We also had several operational successes in the year, some of which we've already discussed during prior calls. A new example from the quarter was our Richhill 71 Pad in Southwest PA. During 2019, we drilled and completed six Marcellus wells on this pad for a total of just over 95,000 lateral feet. One of the wells in that pad, the Richhill 71B well for the Pennsylvania State record for the longest lateral, just shy of 20,000 feet. The pad averaged just under 16,000 feet of lateral per well, which drove capital efficiency on this pad down around $800 per lateral foot. Slide 10 highlights some additional capital and operations improvements that we saw throughout the year. We have continued to focus on driving capital costs lower by attacking it on multiple fronts. We've become much more deliberate with completion designs, customizing each well's completion design based on the reservoir characteristics of each well the production resulting from those changing designs and selecting the design that generates the best rate of return. On cycle times, while tremendous progress has previously been made improving the productive time, we made additional gains in 2019 by studying the non-productive time, preventing downtime from happening and reducing it when it does. Similarly, we've made improvements on how quickly it takes our fleet to move from one well to the next and are incentivizing our service providers to deliver on much more aggressive mobilization targets. Operating expense continues to improve and many improvements continue to be driven by our real-time operating center. What was formerly a split Midstream team and upstream team has been integrated and cross-trained, now handling control and field service dispatch on a correlated basis. We also expanded our control room by adding around the clock water dispatch desk that monitors and manages our water assets. Finally, we finished a number of one-time infrastructure projects during 2019, which we expect to pay dividends for years to come. We expanded our water system materially by adding the Ohio River waterline and significantly expanded our water storage capacity. We also built and commission the greenfield midstream system in our waste town area. Slide 12 covers the blending strategy we are executing on our Richhill field. As part of that blend strategy, we expect to turn in line around once with the dry Utica pad per year during 2020 and 2021, we had a few of these wells come online during 2019. And while the results have varied, the economic benefit they provide to the day Marcellus still supports these wells on a rate of return basis. The SWPA Utica continues to serve an integral economic purpose in our investment portfolio, which again is primarily the blending strategy, and that purpose will continue to provide opportunity for continual reservoir productivity optimization in 2020 and beyond. I'll end on Slide 14, which highlights our trailing 12-month production cash costs compared to our Appalachian peers. As you can see CNX's top tier cost structure provides a huge competitive advantage, especially in the weak -- in the current weak natural gas pricing environment. We believe strongly that in a highly competitive commodity market, the low-cost producer wins. We will continue our laser focus on driving costs lower. With that, I'm going to turn it over to Don.

Thanks, Chad. And good morning, everyone. Just to briefly echo next remarks, all the work we've put in over the past few years is beginning to pay dividends and has set us up to get even stronger over the next few years, even as the macro conditions around us get worse. We're prepared for what lies ahead as we continue to differentiate ourselves from our peer group. Now, let me start on Slide 15 by hitting on a couple of the results that Nick and Chad already touched on. As you all know, gas prices have gotten significantly worse since our Q2 call six months ago with 2020 NYMEX futures falling from $2.55 per MMBTU to under $2.10 recently. And despite the worsening macro backdrop, CNX's fundamentals and forward-looking business plans have improved once again. Our expected capital through 2019 and 2020 versus the midpoint of guidance at the time of our Q2 call has come down by approximately $144 million, while our EBITDAX over that same time frame increased by approximately $20 million, quite an accomplishment by our internal teams. And as Nick mentioned, we permanently reduced our annual SG&A run rate by approximately $30 million going forward. If we turn to Slide 16, you'll see more detail on our updated 2020 guidance, along with some preliminary guidance for production and free cash flow in 2021. As you can see, for 2020, we are lowering capital guidance increasing EBITDAX plus distribution guidance and increasing our organic free cash flow expectation to approximately $200 million. In 2021, we expect moderate production growth of around 5% and another $200 million of organic free cash flow. And as you can see in the footnote, when including modest asset sales, we expect to generate approximately $250 million in free cash flow each year. And it's important to note that our assumed 2021 capital program used to get to our free cash flow guidance will set up both production growth and more significant free cash flow generation in 2022. These guidance numbers clearly showcase what we have been saying for some time now. We've built a company that is very efficient, flexible, and able to produce substantial free cash flow at the current strip. Slide 17 shows the production cadence for the year, which is fairly even with some slight growth as we head into 2021. Our hedge book supports this production and our MLP CNX Midstream works very well with this level of activity. Slide 18 is another reminder that we build our hedge book methodically over the last several years and it is turned into a distinct differentiator now when you scan the rest of the E&P space. As you can see, for 2020, we are almost 100% hedged and assuming the 5% production growth guidance for 2021, we are approximately 83% hedged next year. If we were to hold 2021 production flat into 2022 and 2023, we are significantly more hedged than any of our peers thereto. Our hedges strengthen our balance sheet, give us dependable future cash flows, and lock-in our forecasted capital returns. And as we have been saying for some time now, hedge books and FT commitments are important when it comes to evaluating balance sheet strength. And with the current downturn we are all living through, you are seeing CNX's philosophy at work with our balance sheet and metrics improving, while our peers are deteriorating. Slide 19 showcases our balance sheet and how we expect it to get even stronger moving forward. Using our assumed total free cash flow in 2020, we are forecasting our standalone net debt to be around $1.78 billion by year end, which produces a leverage ratio of around 2.25 times. And on the right side of the slide, we provide a scenario where we use our CNX Midstream units as an equity offset to our net debt balance. And with our IDR transaction, we now own 50.7 million units worth approximately $780 million. Looking at it this way would result in a leverage ratio of 1.3 times, clearly, best-in-class. That being said, we see substantial value in our Midstream interest and have no planned sale of the units, but rather want to highlight the layers of optionality we have built into our business model, especially as it relates to liquidity. And as you can see on slide, we expect our leverage ratio to be reduced even further in 2021. Slide 20 expands on our balance sheet strength and provides additional context as to where CNX stands going forward relative to peer consensus estimates. And remember, our metrics are more reliable because we are substantially hedged through 2021. Our peers with smaller hedge positions are exposed to considerable balance sheet risk if gas prices are further pressured. Slide 21 highlights some additional balance sheet metrics that CNX also screened well on. And on slide 22, I will round out the last piece of our balance sheet management, addressing our notes due in 2022. Even though we still have ample time to address them, we have taken a proactive approach to them. This started early last year when we launched a $500 million notes offering, $400 million of which went to extend the maturities of the 2022 notes. And as you can see on this slide, we have a clear path to easily address the roughly $900 million of notes coming due. As we have stated, we expect to generate approximately $500 million in total free cash flow over the next two years, which will take care of more than half of it. Another option we have hinted at in the past is our ability to access the project financing market, utilizing our vast array of assets we own. As such, we have been working on this front with large like-minded long-term focused strategic partners. This leaves $195 million left to address, which is easily handled by incremental free cash flow or by using a small piece of our substantial $2 billion in liquidity, which by the way, we can get right back utilizing the free cash flow we expect to generate in 2022. So in summary, given our free cash flow generation, our hedge book and our substantial liquidity position, any perceived 2022 maturity risk has been successfully mitigated. So what lies ahead in 2021 and beyond? Slide 23 tackles this question. Very simply, we expect modest growth in 2021, along with approximately $250 million in free cash flow. We expect our leverage ratio to decline and have a base level 2021 activity set that grows production into 2022 with the optionality to grow more if the conditions warranted. If not, we have the flexibility and optionality to maintain a slow and steady plan that provides significant free cash flow under the current strip. This is not the same situation most of our peers find themselves in. For the majority of our peer group, the expectation under the current strip is for peer production to be flat or declining, peer free cash flow to be minimal or negative, with peer leverage ratios and balance sheets deteriorating. This could open up interesting opportunities for CNX and will likely lead to an improved long-term gas price environment as well. The bottom line is that CNX is getting stronger in a down commodity cycle. And we will be best positioned to take advantage of any opportunities that may arise during the downturn and be best positioned to move quickly in any gas price recovery scenario. With that, I'll hand it back over to Tyler for any questions.

Thanks, Don. Operator, if you could open the line up for questions at this time, please.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Holly Stewart with Scotia Howard Weil. Please go ahead.

Good morning, gentlemen. Maybe, first Nick for you, just -- you mentioned I think at the end of your prepared remarks that CNX is now in a position to assess strategic opportunities. And I'm sure if probably asked you this in the past just -- but the market is very dynamic and continues to change, so can you just talk about what type of assets you would see as a good fit to add to your portfolio? And then maybe what metrics or benefits that you guys would want to see as immediately accretive or maybe even just accretive over the near-term?

Sure. I think, Holly, the two most immediate assets that come to mind when I think of it is our debt and our own equity ironically or interestingly and again as capital allocators, those are typically the first two we look towards, the third being of course reinvesting into the drill bit with the asset base we control. Downstream from those would be more of the traditional right M&A asset acquisitions or packages. It seems like the entire basin in some way shape or form is for sale, and I want to comment on any of that news or developments that are out there beyond that, but I put that fourth on the list. Right now, it is -- to say, it's a target rich environment when it comes to our debt equity and that incremental well on either the Marcellus or Utica side is an understatement. So the free cash flow and the liquidity and the optionality we've got now with where we're looking at 2021 and with where our holdings are with CNX Midstream, I think, put us in a good position to take advantage of those first three in particular.

Okay. That's helpful. And then maybe for Chad or Don just talk about the volume cadence in 2020 is, it seems like the exit implied is a bit of a decline. So how do we offset that with growth in 2021? Can you just help us bridge that gap?

So there is a chart that's actually in the slide deck that shows a little bit what the production profile looks like. As Don already mentioned in his prepared remarks, it's a little bit of a dip during the middle of the summer, and then it picks back up as we head into the exit of the year. I don't have the exact year-over-year -- the exit rate year-over-year, but I really be surprised to see a decline Holly. It's a little bit to do with the turn in line cadence. We've got several TILs here in the first half of the year. There's a little bit of a gap in the summer, and frankly that lines up well with what we think could be particularly stressed sort of macro commodity market in middle of summer. So, we've got a little bit of gap in the TILs. We got a little bit of drop in production during the summer, and then we get back on the TILs as we exit the year and that production rate comes up as we exit the year.

And it's typical to our Q3 kind of cadence falls in line, as we get things closer to the winter cycle and the gas prices here. And Slide 17 kind of gives you a visual of the cadence and the exit on total production for the business does end up going up at the end of the year versus beginning of the year.

So assuming that modest amount of growth in 2021, does that mean like the TILs would then increase in 2021? Is that the way you will have it modeled?

Yeah. And we've -- if you remember, we've talked to the 540 production level, needing a $400 million kind of all in capital level. So as far as the TILs necessary to support that, we've also talked to 35 or so TILs here across the business. So just goes to show the impact and the performance of our wells and really how little activity we need to do to grow.

Okay. And then maybe just one final one for me, Don. We had a window -- a slight window, I guess, open here in the high yield market. I think you talked about on Slide 22 maybe, the approach to taking out that maturity. Maybe just talk a little bit about what you're seeing in that market today and maybe how comfortable you are just leaning on that revolver any further.

Yeah. I mean, I think the credit markets have been challenged for E&P companies. Fortunately, for us, we've built the business in the balance sheet to take a disciplined patient approach. We're constantly engaging and interacting with all the pockets of capital around the ecosystem on the credit side, the equity side. And like I mentioned, some of the banking project financing arms that we're looking at here. So our standpoint is to kind of try to do it slow and steady, not rush into anything and keep our eyes open and if there is opportunities, it makes sense to go ahead and kick some back, okay. If not, we have a pretty easy path to just handle it the old fashion way and pay it down.

Okay. That's helpful. Thank you, guys.

The next question is from Sameer Panjwani with Tudor, Pickering, Holt. Please go ahead.

Hey, guys. Good morning. So even talking down activity and growth in 2020 on these most recent conference calls and that's been a response to repricing, but it seems like you're looking for 5% growth in 2021 and an additional growth in 2022. So, I guess from a higher level standpoint, what gas price signal do you need to allocate capital beyond either our maintenance level, our volumes covered by hedges? And would it be fair to think that spending and growth for 2021 could be by lower if pricing continues to remain weak?

It's gas pricing and whether it's a short-term gas price improvement or long-term forward strip gas price improvement that we can hedge, coupled with kind of the hand-in-glove relationship with our Midstream company. So we do have what we call, and we don't really think so much, we did -- we do give information around kind of our flat case 540 for maintenance capital case. But as we've mentioned historically, we kind of look at our business a little differently on foundation cases and what's the well commitments at the Midstream level, what's the right water balance to kind of hold and how do you think about flex and delaying across the year to shape production profile. So it's a more complicated analysis than simply gas prices going up or down $0.20 that leads us to the ultimate decision. The big thing to recognize and I think we've shown is, we have the ability to change as conditions change. So as gas prices have weakened, you've seen us slide back and as we've handed it out and showed, and hence we've proven in the past, if gas prices warrant, we have the ability to quickly ramp back up. So having that flexibility is important to us. And keeping track of all the moving pieces, we'll make decisions as they change.

Just to add to what Don said, we've said in the past, we'll continue to do so. Moving forward, we follow the math. We look at the rate of returns associated with the various capital allocation options we have, whether it's debt, whether it's other opportunities, whether it's a drill bit and seeing how those rates of return change as the change in commodity markets and changing capital markets.

Okay. That's helpful. And then how should we think about the IDR simplification impacting the timing or ability to conduct dropdowns to CNXM. And do you see CNX as a long-term holder of the units, or is there potential for a separation or sell down over time?

So on the first front, I mean, I think we have shown that we're able to structure and execute lots of different types of transaction with CNX Midstream if you go back to the milestone chart that Nick put together. So I think going forward, it hasn't changed. I mean, we have the ability both upstream and midstream to fund different types of either drops or organic build-outs. And we will work collaboratively here to figure out the right structure timing when it make sense, but it's important to note that both companies, midstream is an upstream. They have base plans that worked very well without any of these. So they're really only value-adds for upstream or midstream, if and when they would occur. So, very comfortable there. And to the second part as Nick mentioned, we really like the business. We like the cash flow generation profile of the business. We like the synergies that does – that do come in Appalachia with having the hand-in-glove relationship with your Midstream counterparty. So right now, that's a fit, we like and we enjoy, and we're looking forward to – now that another overhang is removed from the midstream company to see, its performance, hopefully, gets more in line with the cash flow generation potential of it.

Okay. Thank you.

The next question is from Welles Fitzpatrick with SunTrust. Please go ahead.

Hey, good morning. The – if we look on slide 22 to kind of follow-up on Holly's question, it seems like the focus for the free cash flow is on the 22s. But with that high-yield window cracking open, is there any temptation to go after the deeper discounted 27s or even to be more aggressive on the buyback side?

Basically, we're always assessing these like we've said over the past. I don't know how many calls here. These are analysis that, we run on a pretty continual basis and we try to follow the math. And the way we talk to is goal number one is keep a healthy strong balance sheet and then incremental dollars after that can chase incremental activities. And part of the healthy balance sheet is part of the liquidity balance, coupled with the maturity extensions versus we have on the revolver. So these are pieces we take into account across all the board here. And as we go forward, those options will still all be on the table for us, and we'll take a risk-adjusted approach and kind of choose where the dollars go wisely.

Okay. Perfect. And obviously, you guys have over a decade of core inventory left, but how many locations do you all have left in the Richhill and Marcellus? And can you remind us if you have any commitments that you need to meet on the Dry Ridge facility?

Yeah. So the midstream commitments, they're actually – it's in the midstream deck that is posted and we'll have that call later. I don't recall the number.

It is – the well commitments and the Richhill area, that would flow predominantly the Dry Ridge station, is all laid out pretty well and a lot of detail in the midstream deck as Don mentioned. So the way that work is Dry Ridge as part of the McQuay system area. And so, the well commitments associated with Dry Ridge are all part of the McQuay system area working in it.

If you look at slide 38 in the appendix, it's just a reproduction of the core acreage position that we posted previously with the locations remaining and doing the math here. Again, we've tried to highlight that our math is basic. It doesn't assume that we leased anymore acres. It's just acres we own divided by how many acres you need for a well, gets you 427 locations in that Southwest PA, Central area, which encompasses Richhill and the surrounding acres around it.

Okay. Fair enough. Thank you.

The next question is from Leo Mariani with KeyBanc. Please go ahead.

Yeah. Hey, guys. Just want to follow-up a little bit here on 2021. Certainly, get the fact that you guys exiting 2020, it sounds like at the high rate for the year, but just wanted to get a sense to start kind of posting the growth in 2021, do you guys think you'd have to maybe add a rig or half a rig for the year to sort of get up there or would you be able to maybe tweak the timing of some of the completions or reduce any of your DUC inventory to kind of put that higher growth in 2021?

Yeah, thanks for the question. So really what we look at 2021 and soft guidance we've given in 2021, that's really assuming a fairly consistent rig activity pace and completions activity pace throughout those two years. We wouldn't be cheating in the DUCs. We're maintaining a sort of healthy DUC level. The total DUC maybe comes down, but that's really just related to the fact that our activity sets narrowed slightly. So we don't need as much working inventory sitting there, but we're not going to be short DUCs. We still have a really healthy sort of working inventory that will be available for -- if commodity markets start improving, we will have those wells sitting there ready, we can accelerate activity on. And the point is, as we look into 2021, there's a lot of optionality there. So we're going to closely monitor the commodity markets, what we see happening there and will be positioned to modify our plans as the rates of return justify.

And as we showed on slide 38, I mean 40 wells a year grows the business, grows the company and that's -- you can accomplish that with the current fleet that we have running through 2020 as we look into 2021.

Okay, that's good color here. And I guess just with respect to this project financing piece you talked about in 2020, I was hoping to get maybe a little bit more color on that. Is that going to just be related to the E&P side of the business, where is it sort of a JV or a Drillco or something like that on part of your asset base, is that high level sort of what you guys are thinking here?

Yeah. So we circle this up just for -- in the CNX call for the CNX standalone. And this just really highlights. I mean, we've obviously spent a lot of money over the last decade, creating an asset and been a 150-year old company, we have a lot of assets out there to use this kind of product for. So water infrastructure, some of the E&P-only kind of midstream infrastructure, compressors, GPUs. So there's just a lot of assets that are readily available to use in a kind of project financing matter, and like I mentioned in the script here. I mean, these kind of situations are more, I guess, give us a better ability to sync up with some like-minded long-term focus folks to really establish kind of platforms and just different diversifications on how we access capital across our businesses.

Okay, that's helpful. And I guess you also talked a little about some of the variability you've seen in some of the Southwest PA Utica, just wanted to see if there is just kind of any update look now that 2019 is over, as you kind of looked at the well results, have you kind of been able to maybe target some areas that are a little bit less variable, just any kind of change in that variability recently versus maybe where you were a year ago?

We just bought a number of SWPA Utica wells online during the year and it's still early. We'll need to see -- the really critical time is when those wells hit line pressure and they're not there yet. So we'll have to see how those wells produce once they hit line pressures. But regardless what we've seen so far from those wells is a continued to deliver the rate of returns that are in excess of our cost of capital. And when you look at them from how -- what they do for blend of our damp Marcellus and how they help us on water reuse. Now we haven't updated the type curves really since March of 2018. Those are obviously dated and when you update it. But generally speaking in SWPA, the wells are performing at or below its type curve. Swift is performing in line with its type curve and CPA up in our Central PA area, this well is performing at or above their type curve.

Okay, thank you guys.

The next question is from Jane Trotsenko with Stifel. Please go ahead.

Good morning. My first question is on new transportation contracts that you mentioned in the press release and then CNXM fees. Maybe you can expand a little bit on those? And also I'm kind of curious what's driving the improved basis differentials for CNX in 2020?

So the FT line item, we went up maybe $0.10 year-over-year on what on the processing, gathering and transportation line item. That was largely driven by two new FT contracts that came online at the tail-end of 2018 and early 2019 that would be our extra contract or our MSP contract. And we also had sort of another line item of really low FT that expired. But really, even though it's cheap FT, it really -- it still wasn't even in the money. It was sort of local FT. So the net effect of those three changes really drove that the GP&T lineup. And I think the CNXM fees were changed predominant -- most of the change there is driven by just the annual escalation and maybe a little bit on the margin by wet/dry blend mix.

Okay. Got it. And then basis differentials for CNX better year-over-year, is there something that you see in basin that's driving that?

So, those are basically mark-to-market off the forward strip, right. So, we're not really providing a view. We're not on what that forward basis looks like. We're really just producing our market mix and looking at what the forward strips are for basis and coming up with what that basis range should be.

Okay, got it. And then the second question, you guys are 100% hedged for 2020, and I'm curious what exactly drove your decision to reduce production lower?

Some of the incremental production that we've kind of laid down is really just thinking about the ordering and whether it wants any spot activity in 2020 versus going ahead and rolling it in 2021. As we've said, we do have flexibility in the plan. We'll pay attention as the gas price unfolds throughout 2020 and 2021 and what the forward strip looks like. And if it warrants that -- we could add some more if it warrants it. So we have the ability to stay disciplined, stay steady and make small adjustments as conditions change.

Okay. Got it. And the last question if I may, on 2021 and 2022 consolidated CapEx. So, my understanding is it's going to be relatively flat year-over-year. Is it the right way of thinking about it?

I'm not sure about the question. So, you're asking for the capital -- which capital in 2021?

Yeah. So consolidated -- consolidated CapEx that includes Midstream part as well. Is it going to be relatively flat year-over-year, the way you think about it right now for 2021?

Yeah. On the Midstream, the CNX Midstream capital, we give 2021 numbers that is going down. So the range was 92 -- $80 million to $100 million, $90 million is the midpoint and we gave a $55 million directional guidance for 2021 in Midstream. For CNX Upstream, we haven't given 2021 guidance for capital.

Okay, got it. Thank you so much.

The next question is from Joe Allman with Baird. Please go ahead.

Thank you for the comments. A couple of questions, one in terms of the CNXM transaction, could you talk about the analysis that went into the final terms of that transaction? And was there any consideration to converting CNXM to a C-Corp?

Yeah. So we haven't ran -- we've talked about looking at different things. This transaction we kept very simple, it was to remove the IDR overhang that's been expressed by the Group here. The focus really was getting CNX Midstream to that capital structure that the MLP investors wanted to get into and figuring out a fair way that works for both parties. So, when we looked at it, we looked at it really two different ways. One, cash flows and how much of the near-term and long-term cash flows we expected from the IDRs. And two, the percent of the cash flows, the IDRs were expected to receive going forward versus the cash flows we are now expected to receive from the business. And that kind of was our guidepost on trying to sort out of a fair trade to just get the Midstream unit into a structure that work for both parties.

Okay. That's helpful. And then on the operations front, in 2020, do you expect improved capital efficiency versus 2019 or do you expect capital efficiency to be relatively the same?

We do expect improved capital efficiency in 2020 over 2019 for a couple of reasons. First and foremost, -- first, we continue to improve on our lateral lengths. We're not sort of making a huge leap in those because longer laterals certainly introduce elevated levels of risk and complexity. So for us, the lateral length question becomes one of optimization, right. And so, as we've gotten better, state-of-the-art improves, that state-of-the-technology has improved. We have found that the optimal lateral length delivers the optimal rate of return, risk-adjusted return has increased incremental year-over-year. That helps drive down our capital -- or that helps improve our capital efficiency on our D&C. Second thing is, as we expect improvements in some of our service costs year-over-year, I think our balance sheet, our hedge book has certainly highlighted to many of our service providers that CNX is here to stay. We are reliable counterparties and a company that folks want to do business with. So that's really helped our supply chain team with the negotiations with some of our service providers. I already highlighted in the deck in the prepared remarks, some of the things we're doing on the completion design. We expect to continue to improve on that moving forward and similarly, continue to focus on NPT, non-productive time and really trying to get from one well, the next as quick as possible, eliminating downtime, getting back at it. If you do have downtime and I think all of those factors will continue to contribute to improve capital efficiency going forward.

That's very helpful. And then the last quick one for Don. Don, in terms of hedging in, say, 2022 and beyond, are you just holding off until the prices improve because I think the average NYMEX gas for 2022 somewhere in the 230s?

Yeah. Again, we're very happy on the proactive approach. We talk to getting a nice big hedge book built underneath of us like we try to talk to -- guessing gas prices is a different game with smart box in moving pieces. So we try to strike a balance of chipping away at some programmatically. As you've seen from the last quarter, we did continue to kind of chip and build a hedge book slow and steady over time with a weighted dollar average cash -- dollar cost averaging kind of the methodology. But as you've seen over the last few years, we do kind of manage that actively with adding some more or less as we deem appropriate. So in summary, we do want to continue to have cash flow visibility, cash flow production. We are I think, one of the few companies that can generate returns still with our asset quality in our cost structure on the forward strip. So I'm optimistic in 2022 and beyond that gas prices should be better, simply because most of the E&Ps dry gas space cannot exist as a go-forward concern -- going forward business under the current strip. So got optimism, but like I said, we try to take the disciplined, steady prudent approach. It's always easier to add activity when gas prices go up. But you can't unspend capital that you spent if gas prices go down. So we try to take a steady disciplined approach over time and just be ready if gas prices go up to add more activity, but we're still very interested in keeping downside protection.

Great. That's all very helpful. Thank you guys.

The next question is from Jeffrey Campbell with Tuohy Brothers. Please go ahead.

Good morning. You sort of touched on this before, but I just wanted to see if this bank would break out any different color. The press release said that use of cash, free cash would be to reduce debt or go into D&C investment. I'm just wondering if you could add some color on the process of determining to invest in D&C over debt reduction.

Primarily, it will come down to rate of return math for the two and that has some obvious metrics and drivers on the incremental D&C side, many of which we just spoke about through the call and the Q&A and everybody knows what those are. The debt side also has some what I'll call quantifiable metrics, but also some qualitative decision-making about strength of balance sheet, leverage ratio and free cash flow. And those certainly have been bigger drivers to sort of justify rate of returns with respect to that avenue of capital allocation and barring a significant change with respect to forward prices or debt markets, et cetera, I suspect that's going to continue to be a very attractive avenue for us in the near term.

Okay. Great. I appreciate that. And earlier in the call, you voiced confidence in your ability to execute asset sales in '20 and '21. Can you discuss why you expect these assets to sell even as industry activity appears to be flatlining or may be even declining during that period?

Yes. So I'll take it. One easy data point to point to is we sold almost $50 million in assets in 2019. And I'm not sure if anybody even knew we did it. So, I mean if you look at the history of CNX in the last five, six, seven years, we've clearly demonstrated the ability to sell assets appropriately at strong valuations and prices. So, it's one of these situations where we don't have to get anything done. But if you look historically, it's almost impossible for us to not sell anything in a calendar year just due to all the surface acres that we own and the right away is that folks need across our properties and things we have in other people's areas. So, it's almost a steady state going concern running model just due to the 150-year asset -- legacy assets the Company has built up over time, so, nothing monumental there. I mean, we're always looking for every possible outcome and when we look at these things, but it's a pretty, pretty simple steady state to have that kind of run rate.

Okay. Great. I appreciate that color.

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Lewis for any closing remarks.

Great. Thank you. And I'd like to thank everyone for joining us here this morning, and we look forward to speaking with you again next quarter. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.