Continental Resources Executive Q&A: Continental Shift

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Continental Resources Inc. has long made a name—and lots of money—as a stalwart of Oklahoma and the Bakken. Then, in a move that surprised many analysts, the company turned unexpectedly to the south, buying up Pioneer Natural Resources Co.’s Delaware Basin assets for $3.2 billion. The company had also recently made acquisitions in the Powder River Basin.

And the company isn’t finished. It’s prepared to spend in excess of $300 million on additional deals, all while continuing to raise dividends and lower costs.

With some of the dust settled, Oil and Gas Investor spoke with Continental CEO William Berry about the company’s strategy and the rationale for its expansion.

UPDATE:

Continental Resources to Buy Chesapeake’s Powder River Position

Darren Barbee: Given how sensitive the markets are to pandemic news and the fact that Wells Fargo recently described you as a ‘combo player’ with oil and gas production, how do you strategically balance business decisions?

William Berry: It always starts off with what one’s company’s perspective is on the fundamentals and where you think those are going. At Continental, we’ve described for the last couple of years that we think there are a couple of things going on. One is that oil supply and demand was not in balance, and that’s why in February of 2020 we went out and said that we need to start paring back production growth. We think it’s inappropriate to overproduce into an oversupplied market, specifically on the crude side.

If you look back to that time period, there were a lot of folks that were starting to worry that it must be a company inventory issue, the reason these guys are slowing down. A few months later, of course, COVID hit and grabbed everyone’s attention, and then we started hearing more people say, “Maybe we should start slowing down.”

“We are foundationally built on strong exploration and geologic skills and subsurface capability, and we’ve got a really good understanding of the basins we’re in and basins we’re not in.”

There was a worldwide crude inventory overhang that was significant. We’re talking about approximately 1 billion barrels that were out there. And then there’s a production capacity side, and there was a real significant overhang on that as well. It was probably in the 7 million barrels a day range.

What’s happened since February of 2020 is that, that inventory has been gradually worked off, and the pundits are throwing numbers out, Q1, Q2; somewhere in 2022, you’re going to see, probably in the first half, that we’re starting to see supply and demand balance. That’s our expectation on the oil side. I think you’re seeing that manifest itself with Biden’s comments where he went out and asked OPEC and Russia to increase their production.

As you may have seen, Harold Hamm did an interview where he suggested that Biden could accomplish the same thing by not even having to make those long-distance calls; he could make a local call by just calling us. That’s kind of our hope is that the Biden administration realizes, acknowledges and supports the essential role the American petroleum industry plays in underpinning the strength of the United States.

All that to say, I think we’re going to see strengthening supply and demand fundamentals through ’22 on the oil side.

Now switch to gas, and that’s kind of a reflection of what you see with the Wells Fargo combo (oil and gas) company comments. We actually described ourselves that way, and Wells Fargo wrote about us that way. Last year we ended up saying we think that the gas actually was on the other side. It was going to be a little bit tight, and we intentionally shifted the majority of our drilling from oil to gas.

We had a couple rigs running up in the Bakken because even under COVID oil prices, we said we just need to keep up activity, keep the service industry busy, keep it active and keep supporting them as we go out and do a little bit. And so we slowed down considerably in 2020, but we put the marginal additional rig on gas.

It was our expectation that the supply/demand balance in gas was going to be very constructive and supported actually putting more drilling on gas. We did that, and we did see gas prices strengthening. We articulated that through the words of commodity optionality. We really liked that. We continue to like that optionality.

DB: We’re seeing in the U.K. speculation of another lockdown there. As you approach 2022, are you feeling like you have to be extremely conservative and very nimble as these things move, or do you rely on a conservative production plan?

WB: I think you would describe it as conservative. We’ve said, and particularly with respect to crude, that we see no reason for companies to be overproducing into an oversupplied market and no reason to be growing more than low single digits. So 3% to 5% production growth are probably reasonable numbers as we go into looking at what the world probably could use [this] year. As we all know, with this coronavirus, there is so much ignorance in the world, and that’s not a negative statement. It’s a statement of fact that we’re all learning, the medical profession especially, and so whether your glass is half full or half empty, Omicron is going to be widespread but not as deadly. The good news is that the longer we go, the higher percentage of the world population is vaccinated, the less capability for the virus to mutate because it has less laboratories to mutate in, meaning bodies, and the more people that catch it through natural immunity that this thing hopefully will temper itself.

As we have said, hope is not a strategy. So, you do have to plan that it could go the other way. The word you used is the word we often describe ourselves with: nimble. We have a very nimble organization. It’s a function of the, if you will, secret sauce of how we run our business and also the function of our ownership structure that we can make quick decisions and move on a dime as we see opportunities present themselves.

DB: Continental has made some interesting deals lately. I am curious what made the company decide it was the right time to step out with the acquisitions you made, both with the Powder River Basin acquisition and the much larger Permian deal.

WB: I’d probably start at the high level and say that we view it as a positive and maybe even as a compliment that this was a surprise to the market. When you talk about M&A or A&D, the way to be successful in that is to be confident in how you’re approaching things. If companies go out there with a well-described M&A or A&D strategy, quite often it’s difficult to execute.

We are foundationally built on strong exploration and geologic skills and subsurface capability, and we’ve got a really good understanding of the basins we’re in and basins we’re not in. I know when we bought the Samson acreages (in the Powder River Basin), we did hear from folks asking why we were entering a new basin, and then again when we made the move into the Permian.

And so just to put it into context our first transaction that we looked at in the Permian, we almost completed, was at the turn of the century, so over 20 years ago. When you think of the Permian Basin, most people don’t think of Continental Resources. We actually came really, really close back around 2000 to putting a deal together.

Geologically, we studied it, understood it, and as you know, the case for any type of activity around the country is having a good understanding of the rocks, and this team has a really, really good understanding of the rocks.

The definition of success is when opportunity meets capability, and we feel both in the Powder and the Permian that probably describes us. We had this opportunity meeting our capability, and we’re really comfortable that they’re going to be good successes for the company.

The other benefit is that there was a little bit of, if you will, an indication of what we were looking at in probably Q1, Q2 of 2020, maybe Q3 also. My comments on the earnings call was we’d be interested in a third leg of the stool, and so looking for other opportunities.

Part of that is because the only way you can manage political risk is through diversification and, of course, everybody saw what was going on with [Dakota Access Pipeline] and the issues there. By having geographic diversification and geological diversification and commodity diversification, that provides you with optionality. We strongly believe that’s a strength, that’s something that we subscribe to, and I think that’s a little bit of what you’re seeing with our activities.

DB: Should these acquisitions tell us anything about the Bakken?

WB: The question that’s begged is what do these acquisitions mean for the Bakken? A couple of things just for some data points to help put it in perspective, for probably the last couple of years, we’ve gone out, again we mentioned this on our earnings call, and Jack Stark, our president, has done a really good job on describing them to the market. He said that we have an inventory, and this would just be the Bakken and Oklahoma, that’s adequate to grow this company 5% per year for the next 10 years and still have significant inventory left over.

There’s not an inventory issue with the existing assets we have. If you look at probably the best reflection of inventory and inventory capability is the drilling activity, and in the Bakken right now we’ve got nine rigs running. We’re three times the activity of our next closest competitor up there.

So there’s still a lot of good inventory in the Bakken, and it’s still a key part. The other attribute, and I’ll call it enabler if you will, is the reason we were able to do things like going into the Powder and into the Permian is because of the strong cash flow generating capabilities of the Bakken and Oklahoma. Oklahoma is also a pretty significant driver of this company. We’re the No.1 producer in each of those locations.

DB: We saw a lot of Permian transactions in 2020 where the buyer didn’t ascribe much value to the undeveloped reserves. Here, I think we saw some upside ascribed to that. As you worked through this deal, did you evaluate it from an inventory perspective or cash flow, repeatability, inventory? Whatever metrics were important to you?

WB: Yeah. A little bit of scene setting. We actually in advance of this had identified this area geologically as something that, again, is the definition of success where we think that if an opportunity presents itself, matching up with our capabilities, which we thought were transferable from an operational basis and geological basis. This is a deep oily area. It’s one that’s hand-in-glove with the things we’ve demonstrated with our capabilities in the Oklahoma area.

We have a strong desire to have assets where we have the ability to drive the performance. This is 98% operated area. It’s 90% held by production. As you know, it’s got 50,000 acres of royalties, which drives your NRI [net revenue interest] up to about 80%. It’s also got surface acreage and good, extensive water infrastructure. All those together pretty much describe our other assets, if you look at where we are in North Dakota, you look at Oklahoma, we have really strong water assets, which drives your operating cost because you’re in control and you’re able to make sure you’re operating at maximum efficiency.

We’ve got relatively good NRIs but, again, it’s in a significant working interest and a significant operator lead position. All that really fits hand-in-glove with where we are. Then it all starts and ends with the rocks. We like the rocks.

DB: Pioneer Resources CEO Scott Sheffield has made it clear his preference is to be the Midland Basin. Did you get a sense of how they viewed the asset during negotiations?

WB: I’m not sure what drove Pioneer’s perspective on deciding to sell this really good asset. We’re seeing this year all over the world, people sometimes have different needs for different reasons versus cash, versus geological perspective, and we’ve all seen over and over again, if you want different geology, get a different geologist. That’s kind of how the world works.

I remember early in my career, we were exploring in Norway, and this is when everybody said there’s no oil and gas in Norway’s offshore continental shelf. Sure enough, folks came in and had the first discovery in 1969. As you’ll recall, when Harold [Hamm] went up to the Bakken, there was a lot of discussion about there is no way you can produce oil from shale and, fortunately, Harold didn’t read that book, and said, “Well, let’s go figure it out.”

Like I said, this is a company that’s always been based on strong geologic capabilities. You see it today. I’ve had a chance to work with a lot of companies, either working for or with through my 40-plus-year career, and the subsurface team here is as good as any in the industry.

DB: Continental has also discussed spending perhaps $350 million to $375 million in other deals, and some analysts have said they were confused or unclear what your strategy was for M&A. Is there something that needs to be clarified? What is the strategy that you guys are looking at? Are you looking to block up additional areas in these two acquisition areas or even in the Bakken?

WB: There’s some clarity and some lack of clarity that is probably beneficial in answering that. The clarity is that there’s a strategy. The strategy part that we have articulated is we’re in some areas where we’re the No. 1 producer in Oklahoma [and] the No. 1 producer in North Dakota. We think that brings strength to us [and] capability to us because we’re transferring operating efficiencies across the basin. Clearly that’s something that we focus on to have that kind of materiality. A strategy of materiality is definitely key, and you’ll see that manifest itself in how we do our business.

The other strategy is that, again, we’re real subsurface focused, and so there probably will be things we do that from an asset basis may surprise people. We may build some acreage positions before we come out with a declaration of those positions, people will say, “Oh, we didn’t know they were doing that” and, “What are they doing?”

But you pretty much have to do it that way in this business. Like I said, if you show all your cards, you’re at a competitive disadvantage, and we’re pretty good about keeping close to our vest or at least we try to.

DB: On the Samson deal, which you’ve closed, are you already seeing the fruits of that acquisition? How is that progressing?

WB: I’m going to probably just share with you that what we’ve seen so far is meeting our expectations. We have actually closed on a follow-up transaction there. We now have approximately 215,000 acres that we’ve ended up with in the Powder River.

DB: How do you view the results there so far?

WB: The Powder is in early innings. People are still trying to understand it. Again, for competitive reasons, I think the best way to describe our thoughts on this is that it’s consistent with our expectations.

DB: You already mentioned your inventory in the Bakken and Anadarko Basin. You’ve reported consistently lower operating costs and an increase in shareholder dividends. What is the main way you have been able to squeeze more production out of fewer dollars?

WB: I’ll share with you a conversation I had with Harold when I first joined the board about seven years ago and started looking at the company. I told Harold that he had created something really special here. It’s a culture that is a combination of very, very strong cost stewardship and caring. Putting both of those in one package is pretty rare in a company. You get companies that care a lot, and they’re not real frugal. We get companies that are real frugal that don’t manifest that they really care about their employees.

He has just really created something special here. It’s unique. That frugality and, again, it starts with the founder and that’s kind of how it was built, “Hey, this is something that we’re going to look at every penny.” You know, a penny on our lease operating cost per barrel, that’s a million dollars. That’s a lot of money. What you have when you have a culture like that, people are proud of it [and say], “Hey, look what I did to be frugal, look what I did to be frugal.”

Once you have that culture, it’s easy to perpetuate. I’ve been associated with companies that have the opposite culture. It’s hard to change. A lot of that is frugality and capability. There’s a really, really strong technical team here that runs the operations, and they’re looking for every single thing they can do. That said, it starts and ends with safety and keeping people safe. We’re really pleased with the safety performance that we’ve actually been able to deliver. We set a record last year. Knock on wood, we’re on pace to set an additional record this year.

DB: You recently announced your third consecutive quarter of the dividend going up. Do you see that continuing?

WB: This company is more aligned with its shareholders than any other company in the industry. We’ve got four of the Top 20 owners that work for this company. We focus every day as much as anyone on what is the right way to steward this company for the benefit of our shareholders, and shareholder return is a big part of that.

As you look at what’s out there, philosophically, we’ve described we want to be competitive on the fixed dividend side of things. The share buyback is a big part of it. We had a billion-dollar program that was put in place a few years ago by the board, and we still have about $600 million to go on that. We think share buybacks are a very appropriate vehicle.

There are other things, the arrows in the quiver, so to speak, that could be used and all of those are on the table. We talk and discuss those all the time. The capability of the company to be able to deliver that dividend, I think that’s where you’re really focusing the question is, the sustainability of it. We introduced it, and then we had to pause it during COVID. That was a lot of the angst on our part going through that as to whether that was the right thing to do. But our philosophy on dividends, and most companies are this way, is that you put in a fixed dividend, you want it to be sustainable, and that’s where we are. Sustainable and competitive is our approach to dividend and shareholder return.

You’ve seen us talk about reinvestment rates of 65%, 75%. I mean, that’s a mid-cycle number, and we’re well, well below that with where we are with the commodity prices right now.

DB: How does that tie into what the company is doing regarding ESG?

WB: We’ve been trying to do the things that I think everybody in the industry is trying to do the right things on and from an ESG perspective. We’ve actually reduced our methane emissions since 2016 by 59%. So a lot of companies are out there talking about reducing by 50% by 2025, 2030. We’re already there, and we’re looking at taking it further.

In both the major basins that we operate, so Oklahoma and North Dakota, we’re the No. 1 gas capture company and continue to try to look for ways to do that. We wholeheartedly do not subscribe to routine flaring. All that comes into perspective. For example, this year, we have basically deferred $40 million worth of production—and this is oil and gas production—that could have been produced, but it didn’t meet our operational threshold for ESG. So in other words, we could have produced it within regulatory footprints that were out there, but we would have had excess flaring that did not meet our standards, so we deferred that production and revenue.

It’s real dollars that we’re putting into not only spending but also revenue deferral to make sure that we’re not in excess of a flaring “goal.”

We were honored to be recognized by Hart Energy this year with the Energy ESG Top Performer Award. We appreciate you recognizing the efforts companies like ours are taking to be leaders in this space.

DB: ESG is top of mind for the industry, but there’s also been a lot of discussion regarding carbon capture. Is that something that you’re looking at?

WB: Yeah. If you’re in the methane business world, you really are in the electron business and in an electron world, you need to understand what your competition is, meaning all the types of ways to generate electricity. And if you’re in the methane world, you have to look at your waste byproduct, and that’s CO₂.

I’m ecstatic that the industry is doing a robust and thorough review/analysis, actually activity, to see some things going on in the space of carbon capture. Yes, we look at it and consider it every day as to what’s the right vehicle, what’s the right approach for us and the industry.

I do believe that carbon capture is going to be an essential and integral part of the energy future for the petroleum industry.