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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon and welcome to the California Resources Corporation Fourth Quarter and Year End 2017 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 also note this event is being recorded.
I would now like to turn the conference over to Mr. Scott Espenshade. Please go ahead.
Thank you. I'm Scott Espenshade, Senior Vice President of Investor Relations. Welcome to California Resources Corporation's fourth quarter and year end 2017 conference call. Participating on today's call is Todd Stevens, President and Chief Executive Officer of CRC; and Mark Smith, Senior Executive Vice President and Chief Financial Officer as well as several members of CRC's executive team.
I would like to highlight that we will provide our slides in our Investor Relations section on our website, at www.crc.com. These slides provide additional insight into our operations, and fourth quarter and yearend results, plus additional information. Also, information reconciling non-GAAP financial measures discussed to their most directly comparable GAAP financial measures is available in the Investor Relations portions of our website and in our earnings release.
Today's conference call contains certain projections and other forward-looking statements within the meanings of federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ from those expressed or implied in these statements. Additional information on factors that could cause results to differ is available in the company's 10-K, which is being filed later today. We would ask that you review it when available and the cautionary statement in our earnings release.
A replay and a transcript will be made available on our website following today's call and will be available for at least 30 days following the call. Please note, CRC will also be hosting an Analyst Day on October 3 in New York City. We believe that this will be a great opportunity to get an update on our operations and run you through our strategic plans in detail. A mark-your-calendar notice will be sent soon out to you.
As a reminder, we have allotted a similar time for earnings and Q&A at the end of our prepared remarks; would ask that participants limit their questions to a primary question and a follow-up.
I will now turn the call over to Todd.
Thank you, Scott, and thank you to everyone for attending CRC's year end 2017 earnings call. In 2017, we followed the same major tenets of our strategic plan that we have consistently adhered to since the spin. One, we maintain the disciplined approach to developing our world-class assets; two, we focus on projects that offer the best value creation opportunities; and three, we improved our financial position.
Our plan is clearly working. We lived within cash flow since our inception, a rarity in the E&P sector. Throughout 2017, our banks, investors and joint venture partners repeatedly validated the quality of our extensive inventory and demonstrated confidence in our team.
With the closing of our midstream JV with Ares, we believe CRC is well positioned to create and deliver sustainable value to shareholders in a mid-cycle pricing environment. We will achieve this by continuing to prioritize value-added growth, focusing on factors within our control and further strengthening our financial position.
Our team and our assets continue to deliver throughout 2017. I'm pleased to report that our 2017 development program delivered a strong organic reserve replacement ratio of 119% as well as single-digit F&D cost of $6.82 per BOE. In fact, this marks the third year in a row that organic F&D costs have been in the single digits and recycle ratios in excess of two times.
We ended 2017 with 618 million barrels of oil equivalent of proved reserves and 450 million BOE of probable reserves. Additionally, our proved [SEC 10] [ph] PV-10 value alone increase from $2.8 billion to $4.5 billion. We continue to proactively manage our business through the strategic use of JV capital to enhance the value of our asset portfolio.
In 2017 we added two development partners, Benefit Street and Macquarie, in addition into answering into several smaller exploration joint ventures. These partnerships have allowed us to ramp up overall activity, while creating optionality to direct CRC capital to other high value opportunities.
By operating with JV partners, we expect to continue to improve operating efficiencies, maximize capital flexibility and de-risk an even broader inventory of actionable projects just as we did in 2017. Earlier this month, we announced our third major strategic joint venture, this time with Ares Capital Management. We're thrilled to have Ares as a strategic partner, investing in our midstream assets, which includes the Elk Hills power-plant and gas processing facility.
We believe the transaction reflects Ares' strong confidence in CRC and will accomplish two main objectives. First, it helps validate the value of our midstream assets and combine with the Ares investment in CRC equity, speaks to the significant long-term value creation opportunity ahead. It also aids in strengthening our balance sheet.
In accordance with our bank agreement, CRC paid off $297 million of outstanding amounts under our revolver. We intend to deploy the transaction proceeds as a best-value alternative, where that is reinvestment, acquisitions or additional debt reduction to drive long-term shareholder returns.
Financial discipline has been our hallmark. CRC's balance sheet has improved meaningfully, reflecting a significant positive change in our credit position. We successfully completed refinancing last November, along with executing a bank amendment, both of which provide clear runway through 2021 to reinvest in the business above 2017 levels.
While Mark will provide more detail, the important takeaway is that we have received solid third-party validation of the value of our assets, evidenced not only by the refinancing and a bank amendment, but also through the strategic joint venture agreements we have entered into. As part of the due diligence process for these transactions all the parties took a comprehensive look into our assets and management expertise. They voted with their dollars and chosen investment in CRC during a time on capital which is rapidly exiting this sector.
Their actions in partnership affirm not only our strong development inventory, but speak to their confidence in CRC. Looking ahead, under our strategic plan for 2018, we will work to further strengthen our financial position, while continuing to realize the value-driven growth from our world-class assets and drive operational execution to deliver cash margin expansion.
We believe that our recent transactions provide stronger position here to take advantage of the opportunities before us and significantly increase CRC's optionality to prime the pump to recognize our full value.
2018's operational focus, magnified by CRC's core principles, will enable us to realize even more of that value.
From an operational perspective we continue to profitably and sustainably ramp our drilling activity by utilizing JV capital alongside our internally generated cash flow. For example, in the Buena Vista Area the JV provided a lasting value to CRC, while providing the capital flexibility for us to advance important resource capture.
In this area, partner capital was applied to support our infill program and improve operating efficiencies, while organic capital is deployed to expand the extent of the play. This was beneficial as we're able to leverage our geologic learnings from our known areas we thoughtfully step out and retain all of the upside of the prospective area for CRC.
Our team employed drilling optimization and cost improvement, which work to offset the variable performance and preserve attractive project economics. Overall results for this highly prospective area are calculated to achieve a robust VCI of 1.8 on a fully-burdened basis at $55 Brent deck.
In addition, success in the Greater BV Area contributed to incremental 7 million BOE of proved reserves. These strong operating results exemplify the dynamic nature of our portfolio and demonstrate the benefits we reap from our deep value offering and laser focused execution.
In addition to our drilling program, we continue to execute our high VCI workovers with organic CRC capital. Across the company we invested $89 million in workovers that delivered a VCI 2.9 at $55 Brent price deck. As we continue to refine our life-of-field plans, we are expanding our inventory at this high value, low costs, workover opportunities.
This year, thanks to our improving balance sheet, we're poised to begin investing above our 2017 capital investment level. Our 2018 capital plan will be deployed primarily on loaded client crude, while development and delineation projects in Buena Vista, Kettleman North Dome and Ventura. Some of our largest assets including the greater Elk Hills area, Wilmington, Huntington Beach, and Kern Front, we'll see investments focused on new conventional opportunities and expanding waterflood and streamflood projects along with our capital workovers that have already proven to be highly valuable.
We'll begin with $425 million to $450 million capital program that could potentially ramp through the year, as confidence in the current commodity price environment growth. Additionally, we can use our JV capital of flex as plan as needed, in line with increasing operational cash flows to maintain our goal production over the near-term.
Our cash margin performance was to be key focused in 2018. CRC is the large scale value focused entity with operating control over nearly half of oil and gas fields in California. Since we have prolific and diverse assets, we can quickly shift our investments between oil and natural gas assets to manage price volatility. Given current pricing we continue to focus on investment in oil projects.
For 2017, crude oil accounted for 64% of our production mix, and we expect oil-weighted will grow over time towards 72% oil mix reflected in our reserves. The composition of our resource space is the key factor that we believe will aid cash margin expansion along with our ability to grow production and tightly managed production costs.
We look to increased efficiencies, reduced controllable costs, and optimize our integrated infrastructure in 2018 to extract even more value from new and existing production. Our commitment to operational excellence remains high priority across our organization at 2018, while sustaining our strong safety environmental performance.
CRC's continues to help California address at surpassing energy, economic and environmental goals. We've served at the net water supplier to agricultural water districts every year since our formation. In 2017, we again set a company record, creating and delivering 4.9 billion gallons of reclaimed water for agricultural reuse.
CRC's team also won four National Safety Achievement Awards in 2017 from the National Safety Council. As a responsible partner of choice within the state we proactively engaged with regulatory agencies, community leaders, labor groups and other stakeholders to pursue mutually beneficial outcomes and expand opportunities for the communities in which we live and work.
We've been able to achieve this level of operational excellence, thanks to no small part to Bob Barnes. As you may have heard, we started the year with leadership changes at CRC as part of the company's succession planning. As Bob eyes retirement, he will move into an advisory role to continue shaping CRC's future of the as he mentors many in our organization with his vast experience, knowledge and camaraderie.
I'd like to thank Bob for his 40 years of commitment to CRC and its predecessors company. His expertise and judgment helps CRC navigate the commodity price downturn, while getting the most out of our asset base.
At CRC, we're constantly focused on adopting our business model to best generate shareholder value, given market dynamics. Our business opportunities dictate our structure, not the other way around.
To lead the team's operational growth moving forward Shawn Kerns and Darren Williams will focus on production and margin growth as well as resource capture. To help this effort we recently took steps to align our organization in a way that maximizes the value of our assets from cash margin and VCI perspective. While ensuring that teams are working collaboratively, safely, and creatively to achieve operational goals.
In summary, with our strategic plan in place, CRC is rooted in creating and developing sustainable value to shareholders, while maintaining our commitment to invest within cash flow and prioritize value driven growth in 2018 and beyond.
Now I'd like to turn the call over to Mark.
Thanks, Todd. I'm proud, what we've achieved, we've taken several steps to create substantial runway for the future with stronger balance sheet, we are now positioning to capture significant operating leverage as a crude market continues to strengthen and we work to deliver value-driven growth from our operations.
Our stronger financial position results from several actions we executed in the fourth quarter of 2017 and early 2018. In November, we worked to secure an amendment and complete financing that created additional financial flexibility and improved our liquidity.
We repaid the outstanding balance from our 2014 term loan facility and subsequently repurchased a portion of our senior notes to eliminate the related springing maturity provisions in our credit agreements. More recently, we announced our strategic partnership with an affiliate of Ares for our midstream assets, including the Elk Hills power-plant and gas processing facility.
As a result of that transaction, we were able to repay debt more quickly and also provide more capital for operations or other value enhancing opportunities. We have significantly more optionality and improved positioning to take advantage of the strong opportunities before us.
With a bolstered cash position and increased financial flexibility, we now have significant liquidity and nearly 4 years of runway, providing us with the wherewithal to build momentum through 2018 and beyond.
In terms of strengthening our balance sheet going forward, I tend to think about our leverage in terms of debt to EBITDAX. We'll focus on both reducing the numerator as well as increasing the denominator. We'll also continue to work to reduce our fixed charges and simplify our balance sheet over time.
We believe we'll be able to accomplish this as Todd said by allocating capital to the best value alternatives, whether that's investment to grow our business or to reduce debt. In our earnings slide deck, we presented an indifference curve to provide insight into one of the ways we think about these different opportunities, using our disciplined investment approach.
The curve plots our VCI metric on the Y axis and bond discounts on the X axis. Recall that for a project to receive investment at CRC is VCI must be greater than 1.3. If we have resource returns on investments greater than our indifference curve, we believe we are better off investing the money in the ground versus buying back debt in the open markets.
Our planning scenario showed at current or higher oil prices we can strengthen our financial position more effectively by redeploying our cash flows into operations and by paying down debt. However, this is not a standalone exercise, we'll continue to evaluate each alternative's underlying value proposition with a firm commitment to continue to delever. We'll do this by reducing debt in absolute terms as we've done in the past, by continuing to grow our EBITDAX or by some combination of both.
A look back at our 2017 capital program shows the potential of our asset base to delever organically and drive value for CRC shareholders over the long-term. At a $55 flat Brent price deck, our development program had 1.7 VCI on fully-burdened investments. We don't have cycle costs for cherry-picked wells. This analysis includes both good wells and bad wells, and associated infrastructure for those particular projects.
Apply a $65 Brent price deck from 2018 forward, we'd achieve a 2.0 VCI as shown in our slide deck. For reference we've included fully-burdened IRRs on the slide as well. We understand that reinvestment in drilling and work-overs carries the execution risk not found in repurchasing bonds.
By utilizing fully-burdened VCI calculations for actual 2017 program, we seek to provide a forthright look at our potential opportunities. These risk results are well above our cost of capital and we expect will create real value for shareholders. We continue to increase our capital plans to align with commodity prices.
Now, turning to our financial performance for the fourth quarter and full year 2017, I'm pleased to report that we delivered results within our stated guidance range. We produced an average of 126,000 BOE per day in the fourth quarter. This result reflected our gradual increase in activity during the second half of 2017.
The increased activity partially offset the impact of significantly reduced investment through 2016. Our results also include approximately 1,300 BOE per day of negative PSC effects due to higher realized prices compared to those at the time of our guidance, as well as a 700 BOE per day impact for the quarter due to California wildfires that occurred in December.
We expect similar effects to continue in the first quarter. Our first quarter guidance incorporates approximately 1,200 BOE per day negative impact in January or 400 BOE per day for the quarter, due to third party power issues from the fires and mudslides, a 600 BOE per day for PSC effects, as well as results from a significant well that did not meet timing and performance expectations.
While the rise of oil prices was strong during the fourth quarter, the effects from our income statement were tempered due to our hedging contracts, which were first put in place when prices were much lower. However, we continue to benefit from premium Brent based pricing realizations. Oil differentials were healthy, registering a strong 97% of Brent and 92% including hedges.
NGL realizations also remained healthy reflecting tighter domestic supply and strength in the exports. We anticipate these dynamics to continue in 2018. Natural gas realizations continue to see seasonality trends, which were magnified due to limited third-party storage within California.
Production costs for the fourth quarter 2017 were $227 million or $19.64 per BOE, within our stated guidance range. The year-over-year increase was driven by increased activity in line with stronger commodity prices and higher gas and electricity costs.
Adjusted general and administrative expenses were $5.80 per BOE, which were higher than guided as a result with the higher costs of performance-based bonus and incentive compensation plans due to increases in share price. Excluding these effects, adjusted G&A for the quarter would have been $5.44 per BOE.
For the fourth quarter, we've reported a net loss of the $138 million and attributable to our common stock or $3.23 per diluted share. Adjusting for unusual and infrequent items, such as non-cash derivatives losses that are generally excluded from core earnings by investment analysts, our net loss would have been $14 million or $0.33 per diluted share. Adjusted EBITDAX for the fourth quarter was $222 million or 32% from the prior year period, reflecting margin expansion from 34% to 39%.
CRC reported cash flow from operating activities of $23 million in the fourth quarter and it was free cash neutral for the full year, excluding $96 million of the capital funded by BSP. Our results demonstrate the capital discipline that we continue to apply throughout our business.
Todd noted our proved reserve position of 618 million BOE, our enhanced life of field development plans and better than expected well performance and lot us to replace 119% of our production, excluding the effect of price adjustments. Despite to eliminate 2017 capital program, we added 34 million BOE of proved reserves from extensions and discoveries, and 22 million BOE from performance.
We were also able to rebook 49 million BOE due to the increases and prices compared to 2016. Organic F&D costs including price related revisions were $6.82 per BOE in 2017 and produced recycle ratio of 2.1 times. This is the third year in a row that organic F&D costs have been in the single-digits averaging $4.80 over this timeframe.
Additionally, we've grown our probable and possible reserves by 302 million barrels, a 37% increase from the prior year. These additional reserves provided a ready source of projects as our cash flow increases it about current prices, and we'll provide ample opportunity to accelerate further development using our cash flow supplemented by our JVs.
Our slides also show the price impact on our reserve since the spin, we would expect approximately quarter of those to come back at $65 Brent.
Turning to 2018, our capital budget for this year's plan between $425 million to $450 million, this includes approximately $100 million to $150 million of JV capital and represents slight increase for internally funded CRC capital over 2017 levels as we transition to mid-cycle pricing environment.
Our 2018 plans assumes Brent and NYMEX natural gas at about recent levels based on strip pricing. As we stated before, we have dynamic plans and we're strategically used levers such as JV capital remain within cash flow as well as prudently ramp activity.
Please not our current 2018 capital plan is not reflect the use of proceeds from the JV transaction with Ares. To protect against our spending cash flow due to downdrafts in crude oil prices, our hedge program currently covers a significant portion of our oil production portfolio for 2018 as detailed in our earnings release.
Our philosophy regarding hedging continues to target of the 50% of our production in order to provide more certainty and cash flows and underpinned our capital program. Please refer to our earnings release for the details on our hedging positions and counterparty options.
We strengthen our financial position and continue to align our organization for the commodity environment at hand. Our assets are responding and with the support of our strategic JV partners will poise to increase activity, grow cash flow and maximized value creation.
Please note that we've provided detailed analysis of adjusted items as well as key first quarter 2018 guidance information the attachment to our earnings release. We'll happy to take any questions you may have on added information and other aspects of our results during the Q&A portion of this call. Thanks. And then, now I'll turn it back over to Todd.
Thanks, Mark. We are poised to build on the solid foundation we've established in 2017. As we prudently ramp capital investments to a sustainable level in line with available capital from cash flow and JV partners, we will allocate capital to the best value alternative.
With our high level of optionality, we will do as we have always done and flex our activity to meet our discipline and investment criteria. Our resilient assets have a low base decline and low capital intensity that benefits us throughout the commodity cycle.
Importantly, CRC's management team has decades of experience operating these assets with a strong track record of driving down controllable cost and increasing efficiencies. Each time we improve margins more of our inventory achieves our ambitious VCI hurdle. We are excited for 2018 as we look to benefit from the current commodity price environment and continue to build on strong momentum throughout CRC's operations.
Our focus will be centered on showcasing CRC's world-class assets, driving an exceptional operational execution with character, responsibility and commitment and further strengthening our financial position to deliver value for our partners and investors. We now welcome your questions.
We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Doug Leggate with Bank of America Merrill Lynch. Please go ahead.
Thanks. Good afternoon, everybody. Thanks for taking my questions. Todd or Mark, whichever one of you guys wants to take this. When you look at the 2019, looking at Slide 17, there seems to be a fairly substantial step up in your capital plan. Is that - what's the basis of that? Is that living within cash flow as it's using some of the proceeds that you put on the balance sheet? What is your thought process on that step-up in spending as you go into 2019?
That's just - okay, Doug, this is Todd. On the scenario we're portraying there, that's one scenario where we talk about production growth and EBITDAX growth. You've seen the chart from us before and this is the capital that goes along with that. That doesn't mean anything more than that one scenario that could play out. It's not a kind of foreshadowing or giving guidance on a business plan for 2019.
So the things stand today, the plan is still to live within operating cash flow or to use cash on the balance sheet?
At this point in time, we would plan to use operating cash flow, but we might supplement that with other cash flow if the opportunity from a value perspective merits it.
Okay. I appreciate that. My follow-up is also kind of a longer dated question. But when you go back to the very beginning of the company as a standalone entity, Todd, you used to talk about you'd be dead before you got a chance to drill all the drilling locations that you had. But you didn't want to monetize into a fire-sale type situation. But we're not really in a fire-sale situation anymore and I don't really think you've done - you've done some innovative things sure, but not as it relates to the very longer dated drilling inventory. So what are your thoughts in terms of additional monetizations?
And I guess, I've got one final one if I can squeeze it in after that.
Sure, I think it's two-fold. I know from day one of the spin back there in October, was it Halloween of 2014, we talked from day one we needed to bring down our absolute debt level. We understood that. We looked at monetizing different ways the midstream assets and you say us finally do that in a way that we feel like it's most advantageous to ourselves and with our great partner.
On the upstream side, along the way here we have monetized from small amounts of assets along the way. You got to remember, everything we have under our portfolio, we're doing [license deal plants] [ph] and it has to compete for capital. If it's not competing for capital or its long-dated in the current environment, we're going to look to use joint venture dollars or ultimately sell it.
So I think for the right price, really everything here is on the table from an external standpoint. But, yeah, I think you're right, the environment has changed. I think we've underpinned different commodity price environments, so we would look to do that if they made sense that we weren't going to get to things like we talked about that in my lifetime or in the short - or the amount of time that would take for us to either internally or with joint venture investment that kind of assets.
So nothing on the table for now or should we expect to see that change in 2018?
We've had active discussions with numerous folks along the way here during the fire-sale portion that was recurring for some time. But I think we have ongoing discussions both on joint venture partners and with the potential sale of certain assets that just don't compete for capital. And I think the one thing that's lost, we didn't highlight quite so much, we hinted at it, was at the year-end we had 6 exploration wells being drilled with other people's money.
So I think that's important to understand that we could execute on a lot of small joint ventures that are really value additive. And this is real wildcatting. This isn't stepping out to locations from a pud.
All right, thanks, guys. I'll leave it there. Thank you.
Thanks, Doug.
The next question comes from Brian Singer with Goldman Sachs. Please go ahead.
Thank you. Good afternoon.
Hey, Brian.
You reiterated in the press release just the response times and the production profiles on the steam floods and water floods. And naturally, they'd take a little bit more time to provide the uplift. Can you just give us your latest expectations here and how the wells that are showing uplift or mitigated declines are performing relative to or relative to expectations?
I think our overall corporate base decline hasn't changed. It's probably mitigated a little further, as we've talked about kind of very low single digits. And we have parts that clearly that can be lower than that. I think if we talked about individual type drive mechanism, I think there not a lot has changed overall as if the from the company perspective.
I think we - when we looked at and when we talked about the Buena Vista wells and the performance there, those are all wells that are pretty heavy hitting good wells, good - as you saw we - incremental 7 million barrels of proved reserves and that we haven't finished the program there yet.
So I think overall as a company the portfolio effect works well for us. We still have a very low single digit - I mean, double digit base decline for the company.
Great. Thanks. And then, with regards to the quarterly projection trajectory, can you give us a little bit more color on how to look through the year? In the fourth quarter, production had fallen sequentially. Fourth quarter of last year, you highlighted some of the one-off reasons for that, the wildfire, the PSC impact. Can you just talk a little bit more about the - more same store sales momentum and whether you're on a more gross basis and growth mode flat or still declining?
When we look at coming into fourth quarter and the year - and where we started the year, clearly not the way you want to start the year with the mudslide and the fires that occurred. And we had obviously an impact on the company. The positive impact that occurs from a net production perspective is the PSC effect, because that means we're getting higher prices. So that occurs, but that's something you can't really plan around. You just hope to get lower production from lower prices.
And we did have one well that we ended up having to side track the expectations on the timing. It turned out to be an okay well in the end, but the timing didn't come in the fourth quarter. Some of that hangover from the fourth quarter, particularly on the mudslides and the fires carried into January, there is a very, very tiny amount of production still impacted now. But it's more about economics and third-party issues that we are dealing with it on this amount of production.
So the vast majority of what was down is up. So when you look at the trajectory, I think clearly we had a rough January because of that. But I think the rest of the quarter is looking more positive and I think you'll see us bounce back to a more of a trajectory like in the second quarter that looks flattish to maybe moving up a little bit depending on performance through the quarter.
Great. Thank you very much.
Thanks, Brian.
The next question comes from James Spicer with Wells Fargo. Please go ahead.
Yeah, hi, good afternoon.
Hi, James.
I'm wondering if you can just talk a little bit about how much of your total production is coming from joint ventures at this point and talk a little bit about the pace of incremental capital coming in throughout the year in 2018.
So we can't really talk about where it comes from, because remember the two joint ventures currently. Well, I won't talk about the exploration joint ventures. The two upstream development joint ventures, BSP, remember that's a little bit different, that's not a traditional joint venture. And then on the Macquarie side, that will be about 10%, remember of their investment of their production until payout comes to us.
And so, the BSP, we're going to get materially most of the production from the joint venture. So but I don't think we'd disclose that at this point in time. I think it's currently all we can really say is it's less than 2,000, probably somewhere between 1,500 and 2,000 BOE a day.
Okay. That's helpful. And then in terms of the pace of capital coming in throughout 2018?
Yeah, so remember it's in tranches, the BSP joint ventures in $15 million tranches and we are still in the first tranche - first $160 million tranche of Macquarie. So that pace will continue through the year, I think, you will see as probably drive down one more tranche from BSP, as we go through the year. But I think, when you look at our earnings release, you'll see, we've given a little bit of guidance around what we think that will be - at this point in time, plus or minus a hundred is probably a fair number.
Okay. Thanks. And then for my follow-up here, just on the CapEx side. Can you just talk a little bit about - obviously you're seeing on a lot of cash now post the Ares transaction. Can you talk a little bit about priorities in terms of capital allocation there, and whether you - I think, you may be able to supplement that with free cash flow generation in 2018?
Yeah, so I think it's - we have these proceeds gives us an exceptional amount of flexibility and optionality as a company. But for us, having cash in the bank is not what we want, we want actually invest or utilize that to create real value for our shareholders. So when you look at it, I think the priorities as I outlined in my remarks, we are really looking at putting in the ground in some way.
When I say some way, I could mean, could we do an acquisition that makes sense for us, that was accretive from both an operational and financial perspective. Or could we put it in the ground in a way that creates value using our VCI and other metrics from an inventory standpoint. Or as Mark alluded to look at buyback our debt, we have that indifference curve we've outlined, where we talk about where our debt trades. And really we focused on the seconds at this point in time. And they have to meet a minimum threshold discount for us to be able to purchase them.
But looking at that and making sure that is something that creates real value for us. Also understanding that, that when we purchase a debt, clearly there is no execution risk with exception of defining a willing seller, as it is with the executing on drilling inventory or buying something.
So again, we will compensate ourselves from higher VCI perspective, if we were going to execute on inventory or purchasing something that really had to be well in excess of the value perspective we would get from buying in that. Because I think people have to understand that, overarching concept here is, we do want to bring down the absolute amount of debt. But there is no one single way, we're going to do it - we're going to do it kind of an all above the strategy with growing our EBITDA, shipping away of the debt, where it's buying it in at a discount or other creative methods, as we've shown along the way. So I think from that perspective that is, when you look at kind of user proceeds that's how we're looking at it.
And we're not going to see here and wait forever, we're going to turn around and utilize something to create real value for our shareholders here in the near term.
Okay. All right, Todd. Thanks very much.
Thanks, James.
The next question comes from Pavel Molchanov with Raymond James. Please go ahead.
Thanks for taking my question, guys. So your capital program is going to be at a three year high and I suppose the - I go back to some of the commentary you had made back in 2014, 2015 about the drilling permit bottlenecks that had in those days, it's been impeding some of your activity. And I would just pose the question to what extent could that become a hurdle now that you're back at half of the peak rig count that you had in those days?
Yeah, Pavel, we don't see it being an issue for us. We keep very close track of our days of drilling inventory from a permit standpoint, I think, we are a record highs for the company with continue to grow that. We're - our goal is to get out there a year, but I mean, we are not close to that at this point in time. But we're doing very well - really well for ourselves. Could there be one-off issues with particular permits in certain areas. Yeah, there's going to be some delays, but that's what great about having a portfolio like we have - we can displace that within other grade project if necessary.
And so there's a lot of planning that goes into, as you know our life-of-field plans in our portfolio. So again having a very sophisticated process enables us to have alternative projects in case of that. We plan for that in some cases. And we also as I've said many times, here ganshort [ph] and certain project this is going to be long, because you have to get through the permitting processes of California in certain areas, and particularly if it's more greenfield project.
So from our perspective, we plan for that, and we feel like we have a very good handle on it, and a level of detail and the people working on it, I feel better - much better now than I did in 2014, for sure.
Okay. And then sort of along those lines, there are at least anecdotally reports of more and more cities and county governments that are imposing various kinds of drilling restrictions, above and beyond what the state directly may be involved in. Have any of those been impactful at all to your operations? Or is it really just a PR move by those cities?
I think in some cases, the cities, counties whatever local government, you're talking about in some cases are put up to these things by activists and what happened is as a publicity stunt, a fundraising stunt, in some cases. And in some cases, it's various. You saw what happened in Measure Z and Monterey struck down in Court. We weren't involved there, we had some - we didn't have production but we had minerals that was considered are taking from a legal perspective. I think, that sets a precedent for people that want to dabble in this from a local government perspective.
So other than that, I do think that we make a concerted effort to work with communities, we live and work in, and establish what we do, what we don't do the benefits we bring to the communities, we live and work in. So I don't think, it's been much of an issue at all, where we have operations. But we do work very diligently in this with our partners in the community, and with labor and everyone else. Make sure people understand what it is we do and don't do. Because a lot of these initiatives, they are very misleading and they mislead the borders and mislead the people they represent.
Great. I appreciate it, guys.
Thanks, Pavel.
The next question comes from Jason Gilbert with Goldman Sachs. Please go ahead.
Hi, guys, thanks. Most of mine have been answered. But I did want to follow-up on the - on F&D cost. You put up I think for the third year in a row pretty low F&D cost, and you below your DD&A per barrel. So how do we - and below peers also in California. How do we think about the right F&D cost going forward and specifically are there certain low cost activities they are doing now that are maybe finite in nature, that might run off at some point.
I think if you look at - you're right, the DD&A rate is historical lighting indicator of F&D, I think, that's going to trend down over time. And I think when you look at our portfolio in our reserves, you'll see our F&D, in my mind, when I go through and calculate the total portfolio, it's sort of 7 to 10, 7 to 9 range over time. So I think, if you use 10 plus or minus, or 9 plus or minus, I think you would be there. But I would try and do at this point, I think there are over time it's probably going to come down from there, because as we continue to get better and find the project we have and have more exploration successes, which is great for F&D.
Okay. Great, thank you. And just as well I actually want to follow-up, which is a housekeeping item. Cash flow on the quarter looked a little lighter than we had expected. Was there working capital use in the fourth quarter?
Yeah, in November, we pay property taxes in California. That's just you pay them in April and November, you pay the - that's the way - ad valorem is the way you really - the way the fiscal regime works. And it was a - also - as you start ramping activity you have the issue with how account payable and receivables work. But I think, it was about $50 million plus or minus working capital adjustment in the quarter.
Great. Thanks. I'll turn it back.
Thanks, Jason.
The next question comes from Sean Sneeden with Guggenheim. Please go ahead.
Hi, thank you for taking the questions. Maybe just on the LOE guidance, could you talk about that's being sequentially higher is that driven by the mid-stream deal or was that due to the fire and mudslide impact on that as well? Or any kind of thoughts around how we should really think about kind of normalized LOE going forward?
Yeah, I tell you how I look at it, because when you have these one-off impacts, or the PSC impacts that really could affect that either way. It's really the focuses on the absolute dollars being invested and spent here on operating costs. So a little bit of that is PSC effect, a little bit of that is coming into the year, a little rough in the volume being down a little bit. But I think, overall our plan keeps us for the year, the production costs are going to be kind of flat for the year, it's not down overall.
And that's really what our focuses on absolute basis as we grow out of this hiccup here at year-end 2017 coming into 2018 from the fires and the mudslides. I think, you will see us, rate in production to the extent we can, from a gross basis. But obviously, that can be affected by the PSC, but that's really my focuses really looking at the absolute costs. When we do give you a little bit of guidance in there, about how the PSC could affect production at different price levels.
Sure. That's helpful. And just kind of make sure I understand it. For the full-year, you're thinking that absolute dollar should be kind of lower on the LOE side, and perhaps without the PSC effects maybe you'll see that on the unit side as well? That…
Correct. I think, it's going to be about - absolute to be about flat to down. And on absolute basis for the year and that's we're targeting, and that's what we're working on right now. And obviously the PSC effects could move it around and you should see as flattening to growing production as we come out of this hiccup coming into the year.
Okay. That makes sense. I guess, I think you had mentioned, Todd, that we should start digging back to kind of normalized production levels by around Q2, and then we should think about that quarter kind of being flat maybe modestly up? Was that comment that geared around flat to modestly up versus the first quarter guidance or is it versus like more normalized level that you're talking about?
Yes. It's more normalized level, if you took out what happened at year-end and start of this year, if let's assume it didn't happen that would be our goal as where we would be.
Okay. And that's kind of more - closer to like 130,000 a day type of numbers? Is that how we should think about it?
We haven't provided that, but if you look at year-end, look it like the 3Q where we were at in 4Q, where we are at before the fire impact which was about 400 BOE a day, fire and mudslide, and for the quarter. It was higher, obviously, in the month of December, I think, than that would be more of what we think we'd be at.
Okay. That's helpful. Thank you very much.
The next question comes from Jacob Gomolinski-Ekel with Morgan Stanley. Please go ahead.
Hey, thanks for taking the questions and congratulations on the recent transactions, and to Bon on the retirement. Just given the - on the JV side with the power plant, I mean, you've got $750 million in the door and, kind of, if we assume CRC is the only customer for that. Should we assume that your costs go up by call it $71 million a year to fund the cash portion of the preferred dividend and eventually $101 million after two years once the preferred stops ticking? And I guess, I think that translates to about $1.50 to $2 a barrel, using the 130,000 or 120,000 a day of production?
Yeah. You remember, it's a preferred interest, it's not OpEx. I think you've got it approximately right. But also remember as - power plant it's something that we've constantly tried to utilize the power generated there in our operations, because it's cheaper than we could purchase it from the grid. So we continue to expand it to use this internally, around 35% of the power currently is used internally, continue to look to grow or even grow our customer base even outside of CRC. So that we could have this to be more beneficial to us, and to the bottom line our partners in Ares.
You remember, this is something when you look back like I mentioned to Doug, from day one, we are looking at a way to bring down debt to monetized these in place. That would be mutually beneficial, we weren't really interested just monetizing it to someone and trading balance sheet leverage for income statement leverage. This is truly a partnership, and something that takes into account of the important operational aspects of the plan for our benefit. And it gives us a strategic partner that not only is invested in our power plant, but in our equity. So I think it's important to understand that this is a real partnership and not just some kind of classic just business transaction that we're over and done with and move on down the road.
So we're excited about it. It's something we've been working on for some time. Clearly, there are some other priorities given what happened between the spin and now. But we saw this is the right time to start bringing this down and be able to utilize the proceeds to create a lot of flexibility and optionality for us to invest in the business or to buy in debt if it trades at the right discount.
Got you now and I appreciate the fact that you'll maintain operational decision making on there. I guess, I just want to make sure if I'm understanding this correctly. So when you say, it won't be an OpEx item because it's preferred in a JV that you owned, how do you - so is that not taken into account then? Will those cash flows then be sort of in the financing section and not taken into account…?
Yeah, I'll give it to Mark and Mark can explain where it will be in the balance sheet - in the income statement.
Yeah, let me try to add some clarity here. In terms of geography on the balance sheet it will reside between debt and equity. And on the income statement it will come through, the dividends payments will come through. The line item is already there, that's described as net income attributable to non-controlling interest. So that's why it won't run through the operating expenses as we used to say. And it will run through the cash flow statement as a financing.
Got it. Okay.
Okay.
And then, maybe just how to think about it, bigger picture on the JV, because I appreciate that is a partnership. Is the right way to think about it, maybe from a more traditional or more simplistic valuation approach that you basically lease the plant for 10.5 times cash flow or 7.4 times total or like maybe said differently like given the preferred at the JV box is ahead of your equity, is it - I mean, you could - I guess, you could kind of talk of - think of it as like 13.5% or 9.5% whether you use pick or cash financing on those assets?
I mean, you can characterize it however you see fit. I'm sure different holders in the capital stack, whether it will be equity or debt will choose their characterizations how they see fit. But I think from our perspective, we're excited about it. We view it as a valuable investment, a valuable partner. And we think the partnership will grow over time.
Yeah. No, I mean, delevering either way I just was trying to make sure I'm not thinking about it the wrong way though. Maybe just a last question for me. The NGL pricing looking very strong again this quarter, can you talk about what's driving that and maybe if you see that as continuing going forward?
Yeah, I think you got to remember that if you step back at a 50,000 foot level, California has a very big energy deficit in imports. Two-thirds of its oil from outside the States, 90% of it is natural gas. And from a NGL basis, it's also an island. So we don't - we always get a premium to Mont Belvieu. We're not tied into the kind of NGL infrastructure that's there in the Gulf Coast. So you'll see us have strong realizations, the primary markets are in Mexico and Canada for us.
And we did have a little bit of a tail-off over a little bit there. But I think we're kind of back to normal and very strong realizations on our NGL, which if you look at historically it's been that way.
The next question comes from Gregg Brody with Bank of America Merrill Lynch. Please go ahead.
Good afternoon, guys. Just a couple for you. The first one, so the midstream JV, could you talk about what the opportunity set for you to grow that business in terms of organic opportunities and M&A, how you're thinking about it?
So, obviously, we have our portfolio that we could use the proceeds; invest in our portfolio of inventory. Or you look at the assets that could potentially be for sale in the company whether - I'm sorry - in California or elsewhere. We're not - we do have an AMI that goes back to the spin, but I think that we could use the proceeds if it was - that made sense. I don't think most things in North America compete with California when we look at it from a value perspective, especially when you talk about M&A deals.
But we have a competitive advantage from an operational standpoint, from an infrastructure standpoint and really anything that could be for sale. And there has been some things that had a high level of turnover, whether it'd be bankruptcy or other things where assets are being held in California by folks that might not be long-term hands. So that's something we have to balance it off. But obviously, from my perspective the cash is burning a hole on my pocket, so I want to make sure we utilize that.
Instead of getting the miniscule interest we get, we can go out and invest in something that's going to create real value for our shareholders, whether it being in the ground, through an acquisition, or in a ground through inventory or buying back debt at a discount. And that's really what we're looking at really hard right now and losing sleep at night about.
Maybe - I'm sorry, maybe I didn't ask my question clearly. So I appreciate all that. And I didn't mean to make you repeat that. My question was specifically about the midstream. In the midstream power-plant JV, I'm trying to see how you seek raising value at that entity. And where I'm going with that is how much can you potentially grow the volumes there yourself, how much can you do it outside of the CRC system by bringing in other E&P assets, other volumes.
And ultimately, how does that lead to - I recognize there is some structure here that allows for dimensional sale of this asset, 5 to 7 years from now, who knows, maybe sooner. But trying to figure out how you're thinking about the value creation there. That…
Okay. Sorry, Gregg, sorry, I went down the other rabbit hole. But from what we've done and we've been very successful, you got to remember the power here is generated at a small percentage of the cost that what we pay for power in the grid. So connecting new fields or connecting our existing fields that are nearby is invaluable for us, because we're in a power-intensive business. So I think that's very important.
But also, we can connect our other midstream assets or other people's midstream assets or we can bring other people's volumes who might be - who'll have an older outdated plant that doesn't have a good technology or has some requirement from a capital standpoint to meet AQMD standards or something like that. So I think there is a lot of potential synergies here in addition to the complex of assets that exists around Elk Hill. I mean, if you look at within a 10 mile radius of Elk Hill, I think there are three multi-billion barrel of oil field and a lot of smaller oilfields that could be tied in some fashion that has a best stance from a standpoint of gas processing facility west the Rockies, most sophisticated. And then also our power-plant, which we can internally generate the power or sell it to somebody at a discount, but still make a profit for ourself.
So if you think down the road, I mean, I recognize there are much provisions in there to allow for an exit by - for Ares with the sale and IPO. How do you think this is - this JV is going to exit its current financing structure ultimately potentially monetize some more value.
I don't know if I could see 5 to 7 years into the future. But I think at this point in time, I mean, some of those provisions were put in for different reasons other than what a traditional partnership would have. It's more driven by tax or other consideration. But I think at this point in time, we do it as real partnership. And as we get closer to those true decision points for ourselves we'll have to take that into account at that point in time.
But I think at this time we're just very bullish about it, looking to grow the business that were involved in here from both the volume perspective and tying in more existing assets, whether it'd be ours or someone else's that could benefit both parties. So, yeah, it's hard for me to say what will happen in 5, 7 years from now.
Got it. That was - just wondering if would think about an IPO in the near term or medium, but I…
Well, we can think of everything. I mean, there is not a thing we haven't thought about. So we've looked at should we do some of this on our own, should we create our own MLP, should we create with other folks. I mean, there isn't a - I think an opportunity we haven't vetted, but really feel like we hit the sweet spot here with our partnership with Ares.
I appreciate the time, guys, thank you.
Thanks, Gregg. The next question comes from Joseph von Meister with Bennett Management. Please go ahead.
Hi, guys. This is hopefully a quick one. The Q4 guide was for Q1 production of 120 to 125, the Q3 guide was 125 to 130, and the Q2 guide for Q3 was 127 to 132. So in the midst of putting some significant capital to work, production guides have been coming down. I wonder if you could bridge me to what you guys think is normal.
Joe, so when we were coming in - going into last year or through last year, we talked about we reached this inflection point. And I think the hiccups on the fires, mudslides, and we talked about one particular well also, that has enabled us not to kind of bottom out or flatten out at the bottom where we wanted to.
I think clearly we probably have at this point bottomed out, when we look at everything. And we're continuing to focus on investing from a standpoint of - from a maintenance capital standpoint, as we've always talked about and started to flatten. And the decision then comes into play here as we come into this year, as we grow out of this December-January bottom of the production curve.
I think what will be as - whether we best positioned to invest in the business to grow or invest in the business to maintain and utilize excess free cash to buy in debt or invest more in the business to grow, continue growing the business, so I think that's where the real inflection point is now. As we're here and now it's a question of as we invest in this price environment are we going to really look to grow very modestly or maintain flat production and try to buy in debt or pay down our debt with the excess free cash flow.
I think as you saw last year we were still arresting our decline as we guided in. I think we would have obviously bottomed out except for the fires and the mudslides. So at this point in time, I think we're back on the trajectory as I alluded to before. I think by the end of this year and early Q2, you will see us back up to where we should have been and continue to kind of maintain or grow modestly from there.
So do you see an exit rate in Q1 of something closer to 128,000 to 130,000?
No, I think obviously we guided 120,000 to 125,000. I think if you want to think that we should be closer to 125,000, I think that that would be correct thinking at this point in time. But we have PSC effects that work against us also. So that's the wildcard when you think about our net production basis. So if you didn't have any PSC effects, I would say clearly the way we guided out, but again, if we have prices that meaningfully move up from here, it will meaningfully move the production down.
Maybe it'd be good to report your numbers, so that the PSC effects were included.
Yeah, we have done that on a gross basis also. And we do it in the - in our guidance for the next quarter also, the attachment to the earnings release.
Yeah, if you look on Page - this is Mark. If you look on Page 21 of the press release, we give you the pricing effect, the PSC effects, both in terms of production as well as production cost attributable to PSC effects at various price scenarios, $10 up, $55, $65, $75…
So the guidance - the guidance that you're giving, I mean, just to wrap this up and I apologize, but we're at 126,000 in the fourth quarter. We were 128,000 in the third quarter and we're expecting to turn up. Now, you're guiding to 120,000 to 125,000 for the first quarter and the disconnect or the problem that I have with that is that the mudslides only cost you 400,000 barrels a day. So there is obviously something else going on or you're just being very conservative. I don't know.
Now, the 400,000 dollars [ph] a day with the net impact in the fourth quarter just from the December, I think if you look at the effects in January they were higher than that. So when we - we look at going forward. We think there is probably going to be - overall effect is going to be 2,000 to 3,000 barrels a day, plus or minus.
On a quarterly run rate?
Yeah, if you said that the quarter was December, January, February, it's going to be kind of that impact.
Got it. Okay, this goes past and then you're sort of back to normal by the second quarter.
Yeah, that's really what we're talking about. It's that and the PSC effect. If you look at - again, like I said, we still have a very small amount of our production that's offline. But there is a few hundred barrels a day of third-party production that we process at our gas plant in Ventura that was net production for ourselves also, but still offline from the fires.
Got it.
So there are different impacts here going on.
Got it. All right, well, good luck guys, great progress. Thank you.
Thank you.
This concludes our question-and-answer session. I would like to turn the conference back over to Todd Stevens for any closing remarks.
Thank you everyone. CRC is focused on value creation and our plan is working. We're enhancing our resource base to resume production growth while living within cash flow and expanding our margins, deliver long-term value for our partners and investors. These principles will continue to guide us through 2018 and beyond as we deliver much needed energy for California by Californians.
As a reminder, we look forward to seeing you at our Analyst and Investor Day in New York on October 3. We expect to see a save-the-date from our Investor Relations team soon. Thank you and good bye.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.