Indigo Natural Resources Executive Q&A: Cruising Altitude

[Editor's note: A version of this story appears in the February 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]

In the past three years, Indigo Natural Resources LLC net production grew at an astonishing 80% per year, from 160 million cubic feet of gas per day (MMcf/d) in 2016 to approximately 1 billion cubic feet per day (Bcf/d) presently, becoming the fourth largest private producer in the U.S. in the process. The ramp up was led by CEO Frank Tsuru, who joined the company in 2016 as it made a transition from a single-horizon focus—the Cotton Valley—to targeting multiple pay zones: the Haynesville Shale, Bossier and Holly Vaughn.

Houston-based Indigo was one of several private-equi­ty-backed E&Ps that took advantage of the “second wave” of the Haynesville renaissance following a sell-off by many of the earlier prominent public players. But it wasn’t a new entrant to the region. First formed in 2006 by Bill Pritchard, currently chairman, to exploit the Cotton Valley, Hosston and Austin Chalk, that iteration was sold to Encana Corp. and Chesapeake Energy Corp. for a combined $611 million in 2009, a year after the Haynesville Shale made its debut.

By 2016 the company had re-established a sizeable position in North Louisiana. It was then that it received a $375 million recapitalization infusion in conjunction with the acquisition of Bridas Energy USA’s Haynesville position, when Pritchard came calling Tsuru.

Pritchard and Tsuru had been partners for 13 years by then through Momentum Midstream, which they co-founded in 2004. Tsuru was CEO of Momentum, and Pritchard needed a CEO and CFO to run Indigo at the time.

“He and I were talking about potential candidates,” Tsuru recounted, “and Bill says, ‘Who better do I trust than my two partners (including Momentum CFO George Francisco) that I’ve worked with all these years? Do you guys want to run both? Can you run both?’ We said, ‘Sure, let’s do it.’”

A few months later Indigo announced a $450 million acqui­sition of Haynesville assets from Chesapeake, and it was off to the races. The company queued up to IPO in 2017 before the market fell away.

With the shared management teams, it’s not a surprise that Indigo and Momentum partnered on a joint-venture mid­stream infrastructure build-out on Indigo’s position. In De­cember, M5 Louisiana Gathering LLC, the 50:50 JV entity, sold to DTE Midstream for $2.65 billion, with half of those proceeds falling to Indigo.

Today Indigo, with 180 employees, holds some 237,000 net acres primarily in DeSoto, Caddo and Sabine parishes in Louisiana, or 450,000 “net effective” acres considering its three tar­geted horizons. Proved reserves are 4.7 trillion cubic feet equivalent. The company touts in ex­cess of 1,700 core horizontal locations.

Indigo is backed by a basket of sponsors in­cluding Yorktown Partners, Ridgemont Equity Partners, GSO and Trilantic Capital Manage­ment, along with family-owned Martin Com­panies and Bridas Energy, an Argentinian company.

Tsuru graduated from the University of Kan­sas with a degree in petroleum engineering in 1982. He also serves as the president of the National Eagle Scout Association, and is him­self an Eagle Scout.

Investor: Why did you decide to sell the mid­stream interests now?

Tsuru: We decided to sell the midstream be­cause of where it was in its development. We felt it was the right time. The midstream sys­tem buildout was largely complete and the system was approaching capacity, driven by Indigo’s strong production growth over the past few years. Given these factors, we felt we could present a compelling story to potential buyers based on actual throughput and cash flow. The asset was relatively mature, and the buyers wouldn’t have to rely on a huge pro­spective volume ramp to get their return.

And it actually was very, very good for In­digo. It was transformational for the company.

Investor: How did the sale impact Indigo?

Tsuru: Indigo will receive $1.1 billion of pro­ceeds from the sale with the majority of the proceeds already received in December of 2019 and a portion to be received in the second half of 2020. We used the proceeds received to date to reduce leverage and strengthen our balance sheet and plan to do the same with the deferred portion in 2020. Pro forma for the asset sale, we expect our leverage ratio to be below 1.5x throughout 2020, which is among the lowest leverage relative to our public natural gas peers. That is a big reason why we did that sale. This positions us for success in today’s challenging natural gas price environment.

Investor: As a private-equity-sponsored company, did you feel an urgency to have a monetization?

Tsuru: No, we didn’t. We have a very patient investor base—our early investors made a strong return in the asset sales in the first wave of the Haynesville and our more recent inves­tors are early in their investment horizon. They also participated on this midstream sale and did very well.

Investor: Did you have a need to monetize related to the debt? Were there near-term ma­turities?

Tsuru: We were fine even without it. We had no near-term maturity issues—the earliest ma­turity of our debt at the time of midstream sale was in 2024. In addition, we had relatively low leverage at the time of the sale—around two times—so we were not driven by a need to re­duce overinflated debt levels.

But it did make our balance sheet very strong. It made the company durable. We have zero balance on our reserve-based loan. We’ve got plenty of liquidity. We are in a much bet­ter position today following the sale with a stronger balance sheet and reduced interest ex­pense. It took us to a point where it allows us to withstand this terrible gas price environment.

Investor: How has Indigo’s overall strategy changed considering the depressed gas price environment? Or has it changed?

Tsuru: In 2016, when we began aggregating Haynesville acreage, our strategy was to grow at a huge clip—80% per year—and create a company with substantial scale. And we have achieved this. Since 2016, we’ve gone from 160 MMcf/d of net volume to 1 Bcf/d.

We decided that we’re at a good place scale-wise, and we’re going to level off our growth. Our company looks at three things right now very carefully: conserve capital, reduce our costs as much as possible, and focus on free cash flow. Also part of that is to moderate growth. We’re going to look at a growth rate of around 10% to 15%.

Investor: Why did that change?

Tsuru: Because right now in this environment it’s not wise to continue to grow at 80%. We’re going to be growing at a very moderate rate, and I think that provides a clear window to free cash flow—if I watch my costs and watch my capital.

Investor: Public companies talk a lot about be­ing free-cash-flow positive with their investor base these days. As a private company, how important is it to be free-cash-flow positive?

Tsuru: Like public investors, our investors pre­fer a moderate pace with predictable cash flow on an annual basis. And so that’s our plan. If gas were $3 or $4 an MMBtu [million British thermal units], we’d probably be doing some­thing different than at $2.20.

Free cash flow is very difficult to attain at $2.20. Very difficult. We work hard to be free-cash-flow positive, but at this point in time it’s harder. That’s a very important target on the wall that we are always focused on.

Investor: How are you then achieving that at $2 gas?

Tsuru: Our wells are strong: We bring on 30-mil­lion-cubic-feet-a-day wells—choked back at 5 to 10 psi pressure drop per day. We’re reducing our costs all the time. In the Lower 48, the slow­down is resulting in reduced rig costs, reduced services, reduced pressure pumping, all those. Similarly, we’re looking at reducing costs inter­nally within our wells.

Investor: What does a well cost now?

Tsuru: Across our field, from the more shallow to the northwest to the deepest in the southeast, it’s $10.5 million in the shallowest, up to $13-plus million in the deeper parts, and the deeper parts are where we have temperature issues.

Investor: With all the gas coming from the Northeast and all the associated Permian gas, can the Haynesville be economically compet­itive then?

Tsuru: The Haynesville is the most econom­ically competitive natural gas basin in the whole of the United States due in large part to the proximity to LNG and petchem demand along the Gulf Coast. While it can cost 50 cents to a dollar for Northeast gas to access the Gulf Coast market, it only costs us 25 cents. And that makes it the most profitable right off the bat. The cost to transport gas to market is cheaper than anything from the Northeast, the Permian or the Midcontinent. Nothing can be compared to the Haynesville.

Investor: Are you just putting your gas into a pipe and selling it at the wellhead, or do you have contracts with LNG or other end users?

Tsuru: We have a very thoughtful forward sales program where we pair transport with forward contracts with buyers at various pricing points. Right now we send our gas to different markets—to Perryville near the LNG corridor and to Carthage in South Tex­as among others. And in each case, we have a market already supported by forward sales contracts. We don’t just dump our gas off at Perryville or Carthage.

When our gathering line gets down to Gillis, La., in the fourth quarter of this year, our gas will be going directly to the LNG markets. We have forward sales contracts in place for these volumes with certain LNG producers.

“Free cash flow is very difficult to attain at $2.20. Very difficult. That’s a very important target on the wall that we are always focused on.”

Investor: What’s your average realized price?

Tsuru: It’s different because we’ve got a very strong hedging program. Seventy-five percent of our 2020 volume is hedged and about 50% of 2021—at a very attractive number that I’d rather not say. That’s why I’m breathing a lit­tle easier than maybe someone else that’s not hedged at 75% of their 2020 gas volumes.

Investor: Do you only hedge at high numbers, or do you hedge consistently regardless of price?

Tsuru: Historically, we’ve consistently and dispassionately layered on hedges. Our wells are economic down to the low $2 range, which gives us a lot of flexibility. However, adding hedges in today’s market is a little tough given the current low natural gas tape. We will op­portunistically hedge and layer on some more when prices spike a little bit. But we are mind­ful not to hedge ourselves into mediocrity. Luckily, we have a strong hedge book with a high percentage of near-term volumes hedged.

Investor: What is your view on natural gas demand and pricing going forward? Is there upside hope?

Tsuru: I really think there is. I really do. I think what’s happening right now gives us upside.

There are three components to natural gas price we think are important.

On the supply side, what’s the best thing to do to get out of low prices? Low prices. Opera­tors stop drilling. The capital’s not there. Drill­ing rigs get laid down, and the supply starts reducing. Low gas prices paired with restricted access to capital, and the industry’s focus on free cash flow, are all putting pressure on pro­ducers to reduce rig count.

And it’s happening. We are seeing a tre­mendous number of rigs being laid down in the Northeast and throughout the U.S. We expect this will start putting some downward pressure on supply growth. I always say that the best thing for low prices is low prices. It’s going to show.

On the demand side, you have petchem and LNG coming on, and we are well-positioned in the Haynesville to benefit from these trends along the Gulf Coast.

Finally, you have weather, which is less pre­dictable and has not shown up in a positive way recently. We have not had a winter, and I think this may be masking the supply drop.

Investor: I’ve heard that mantra for a while that low prices cure low prices, from $7, to $5, to $3—and now we’re pushing $2.

Tsuru: Yeah, but those are not low prices. You’re economic at five bucks and three bucks, very economic. Very few companies are eco­nomic where we are now. We’re okay because we’ve proactively protected ourselves, and we’re closest to the takeaway point.

Investor: Is it your mission to be a long-term producer, or do you need or desire an exit eventually?

Tsuru: As a private-equity-backed company, we would like to see an exit. Given our substantial scale, deep inventory of economic locations, strong balance sheet and move to free cash flow this year, we think we will be an attractive can­didate in the right market to a buyer or to the public markets.

In addition, ESG is a big deal now, and ma­jor companies are looking to reduce their car­bon footprint, to reduce their oil production as compared to natural gas. And so we might be a good target for a company to increase its dry natural gas portfolio.

Investor: Would you look for a merger oppor­tunity?

Tsuru: If the opportunity is right. We’re a good target for a merger because we have such a low debt level. Our metrics are good.

Someone may want to enter the Haynesville or consolidate gas assets, and we are one of the big producers. So that might be another way to exit. But it’s not a goal.

Investor: Are you still considering an IPO as an exit?

Tsuru: Right now we’re not pursuing an IPO, but again, if the markets come around and decide that the multiples of our EBITDA are better than they have been, then we would consider the public route, but we’ll let the cap­ital markets tell us which way we’ll go.

Investor: Are you looking to be the consolida­tor of assets?

Tsuru: We don’t really see ourselves as ag­gregators. We’ve spent a lot of time and effort with our current acreage and balance sheet to position us to the best ability to weather this storm—we’ve been careful not to extend our­selves, keep our debt down, keep our volumes steady, maintain our hedge book, watch costs and target free cash flow.

We are very satisfied with what we have right now. We’ve got decades of drilling in­ventory in the core and we just don’t think we need to add anything or do anything to make our story better.

However, if there is an especially compelling opportunity that fits us like a glove and allows us to maintain our strong balance sheet, we would definitely look at it.

Investor: What’s your operational plan going into 2020?

Tsuru: To continue drilling with four to six drilling rigs, and one to two completion crews. We expect to drill upward of 48 to 52 wells for 2020 with growth of 10% to 15% over 2019.

Investor: In 2018, you were running eight rigs. Are you purposefully slowing down?

Tsuru: In 2018, we brought online 52 wells, and in 2020, we plan to bring online 48 to 52 wells, so we are maintaining a fairly consistent pace. We’re seeing some areas of greater effi­ciency, so the number of rigs, really, doesn’t equate to activity levels.

One has to be careful counting the number of rigs, the number of wells turned in line, as to what you perceive as the company’s cadence or growth. That’s not always the same. We’re growing at a modest rate, just not at a clip that we had before.

Investor: What are your primary targets? At what percent?

Tsuru: Haynesville and Bossier are our primar­ily targets and where 95% of our 2020 capital will be spent.

Haynesville and Bossier wells are very simi­lar. They are only 200 to 250 feet apart. Some­times Bossier is a little bit more challenging because the Bossier has some difficult zones. Haynesville’s a little bit deeper, so you’ve got more temperature. Both targets make great wells. In some areas we drill stacked Haynes­ville and Bossier targets.

While a smaller part of our capital budget, we also drill the Holly Vaughn, a Cotton Val­ley target with 2.1 Bcfe EURs per 1,000 feet, which has lower capex and has liquids with it. It’s very competitive with Haynesville and Bossier wells, and that’s what we love about it. We have three horizons that we can pro­duce and tap, and that’s what gives us such a huge inventory.

Investor: How long are your laterals going these days?

Tsuru: We’re drilling between 6,500 and 10,000 feet. The sweet spot is probably 7,500 feet.

Investor: You’re not drilling super laterals?

Tsuru: No, we don’t. We see that cost/risk-re­ward of going out to 10,000 or 15,000 feet as very, very limited. That last 5,000 feet is the cheapest that you can drill, but it’s very hard to get a work string to drill out plugs. You’ve got to pump plugs all the way down, and then if you sand out, coiled tubing is almost impos­sible to get down to that depth. We just don’t see it.

Also, 7,500-foot laterals are more efficient—the rigs do not become a monument onsite drilling super laterals for months and months.

Investor: What does a typical Indigo comple­tion look like today?

Tsuru: Typically, we will frac wells with five to seven clusters spaced 140 to 100 feet. Sand in­tensity will be roughly 3,800 pounds per foot, going in with 100 mesh and 40/70 at a 50:50 blend.

Investor: Can you talk about your refracking program and what you’re doing there?

Tsuru: We have found that standalone refracs, although they’re economic—they have a posi­tive return—they’re just not the return that we see with our other dollars going into a well.

We are focused primarily on what we call protective refracs, or a refrac of a legacy parent well offset to modern wells we are complet­ing. These protective refracs generally provide the same return on investment as our drilling program. Parent wells that were producing 100 Mcf per day or 150 come on at 10 or 15 million a day. What you see is repressurization of that hole and fracking new reservoir.

In addition, we see better results on the modern child wells with protective refracs—increasing the pressure in the parent well pre­vents a pressure sink and ensures the modern frac job is focused in the right place around the modern child well.

We have a couple of protective refracs planned in 2020, both offset to modern com­pletions in our drilling program.

“The Haynesville is the most economically competitive natural gas basin in the whole of the United States due in large part to the proximity to LNG and petchem demand along the Gulf Coast. Nothing can be compared to the Haynesville.”

Investor: What’s next for Momentum?

Tsuru: Momentum is working hard right now to find the next new project. We’ve got an ex­ceptional business development team. There have been five iterations, and Momentum 6 is going to be successful too. At this point in time we have $500 million committed.

Investor: What words of wisdom might you have for other natural gas operators in today’s environment?

Tsuru: Get your balance sheet in a good po­sition and focus on free cash flow. Capital is precious—use it very wisely.

Investor: What is the significance to you of be­ing an Eagle Scout?

Tsuru: Not only did I get to establish lifelong friendships, but the architecture of scouting molds boys into our future leaders. It com­pletely prepared me for the leadership and problem-solving skills I use today.

I landed my first job as a petroleum engineer because of my Eagle Scout award. Of the sev­eral entry-level petroleum engineers being con­sidered, I was the only candidate that was an Eagle Scout—and that is why I got the job. I have a framed display of scouting patches, giv­en to me by my parents at graduation, which has followed me all over the oil patch. It now hangs prominently in my office on the 56th floor of the tallest building in Texas. I keep it to remind me of how I got my start in the industry.

Without a doubt, I have a great passion for the BSA organization.