Ovintiv CEO McCracken: Magnifying Margins

From its early roots drilling the first natural gas well in Alberta, Canada, Ovintiv has grown into one of the largest multi-basin producers in North America.

Known as Encana before the Calgary-based company reorganized and moved to Denver in 2020, Ovintiv still holds strong ties to Canada. The company traces its origin back to the late 1800s, when Canadian Pacific Railway workers discovered natural gas while drilling a water well.

Today, Ovintiv’s Canadian footprint extends across 1.2 million net acres, including around 861,000 net acres in the gas-rich Montney play in northeast British Columbia and northwest Alberta.

Ovintiv also wants to get in on the ground floor of the nascent Canadian LNG space. Brendan McCracken, who took over as president and CEO in 2021, told Hart Energy that the company is in talks with every LNG developer on Canada’s West Coast.

But the company has also expanded massively south of the Canadian border. U.S. operations accounted for two-thirds of its upstream production revenues as the end of 2022.

And like other large-cap E&Ps, it’s putting a lot of capital to work in the Permian Basin, the top oil-producing region in the U.S. Lower 48. Just this summer, Ovintiv closed a whopping $4.275 billion cash-and-stock acquisition of assets in the core of the Midland Basin.

The deal with EnCap Investments portfolio companies Black Swan Oil & Gas, PetroLegacy Energy and Piedra Resources included 1,050 net locations and 65,000 net acres—mostly undeveloped land near Ovintiv’s existing Midland operations.

As part of that transaction, Ovintiv also sold its position in the Bakken to EnCap portfolio company Grayson Mill Bakken for $825 million. McCracken said divesting its Bakken footprint and bulking up in the Permian gives the company a deeper pool of premium drilling locations for the future.

Chris Mathews, Hart Energy’s senior editor for shale and A&D, spoke with McCracken in August to learn more about Ovintiv’s plans—from Midland all the way up to the Montney.

“I always say if you could choose the rock, you would choose the Montney. But if you could choose the market location and the market access, you would choose Texas.”
—Brendan McCracken, president and CEO, Ovintiv

Chris Mathews: What kicked off the effort of growing in such a big way in the Permian Basin?

Brendan McCracken: Everything that we’ve been doing for the last several years has been aligned with what we call our durable return strategy. The premise of that is that the returns that we’re generating in the business today are phenomenal. You can see that in the free cash generation, in the [return on equity] that we’re generating. The idea is, what’s really valuable is to be able to generate those returns over a long period of time.

We’ve really identified a three-part recipe to doing that. The first piece in that recipe is having access to the best rock—capturing a deep, what we call premium-return inventory in the very best parts of the best basins in North America, and indeed, the world.

The second part of the recipe is to have the culture and the expertise to convert that resource to free cash flow at a really high return on invested capital. Various people measure that differently, but you can look at it through the ROIC itself or through our capital efficiency. But the idea here is that it’s really the culture and the expertise of the individual company that determines the efficiency of that conversion.

We always find it interesting in our business that there are many competitors on the playing field. I would say it’s probably second only to agriculture as an unconcentrated industry in the world. There’s no intellectual property or trade secrets, really. It ultimately is that culture and that expertise part, so you’ve got to create that.

Then the third part of the recipe is really capital discipline. We know that in a shale business, if you stop investing, your production declines next year. So, therefore, your revenue declines next year at a pretty   healthy margin—something in the 30s. That just makes the business very capital intense.

It means when we invest capital, it has to make a return or otherwise you create this dilutive effect and your returns are eroded. You have to have the best rock, you have to be incredibly great at converting it, and then you have to be very disciplined with your capital and not let it leak away. That’s been the strategy that we’ve been following. With the Permian acquisition this year, it’s very much aligned with that durable return strategy.

We saw it as a unique opportunity to cement our inventory depth and the inventory quality for a long time. We saw the asset was incredibly unique from an undeveloped perspective—over three-quarters undeveloped in some of the best rock in the Midland Basin. It was offsetting acreage we already execute and operate on, so we’re very familiar and understand the geology and the resource there.

We were able to get a very compelling valuation that became immediately accretive to free cash flow and returns for our shareholders. We saw it as just an especially unique acquisition to be able to deliver on the pre-cash accretion, the return accretion and the inventory life extension.

CM: How do you think about the runway of your Permian acreage? Does Ovintiv have everything it needs there?

BM: I think we’re in a phase where innovation is really driving big differences in return generation from operator to operator. We can see that in the performance data. It’s always amazing to see the spread of returns being generated in relatively adjacent acreage positions. The Permian’s probably the easiest place to see that, just because it’s such a big play and there’s so many operators and different strategies being deployed.

We’re really seeing the advantage swing to operators that can do cube development. That’s this notion of developing the whole stack of resource at once and not cherry-picking just a bench here or there. We’re seeing that that’s really generating leading returns, but also really importantly, advantaging operators on the durability of those returns, because the infills are underperforming. We’re seeing operators that are pursuing an infill strategy instead of a cube strategy run out of that greenfield acreage to pursue that strategy.

You can see that in our numbers. The year-to-date results have been tremendous. With our second quarter, we raised our production guidance and lowered our capital guidance. The biggest contributor to that was significant outperformance from our Permian cubes this year and what we’re doing with completions. I think that’s what’s really driving the dynamics of the play today, and that’s how we’re thinking about creating value there.

CM: How competitive was the landscape for M&A in the Permian?

BM: I think the landscape for unique opportunities like this with the scale and the undeveloped nature of the assets we acquired in the Permian is really rare. Our study and judgment of the basin is that is a very rare thing.

I can’t comment on the competitiveness of the process because, of course, we were participating as a buyer—the sellers would have to offer commentary there. But I’m sure that others like us saw the potential.

What we were thrilled about is acquiring it at such a compelling valuation. Whether you look at it on a net asset value basis or a multiple basis, we feel like we got the deal done at a very compelling valuation.

CM: Part of the Permian acquisition included Ovintiv shedding its Bakken position. Why did that move make sense for the portfolio?

BM: The Bakken asset for us was a really quality asset for a number of years. We had very successfully drilled wells there with high returns and delivered free cash flow from the asset. In fact, we had been growing the Bakken asset over the last couple of years, pretty meaningfully.

But the characteristics of our position there was it was relatively small and relatively more mature than the other assets in our portfolio. Our judgment was, especially in a time we’re running a load-leveled program, [that it] creates that capital efficiency and helps with that conversion of resource to free cash flow at a high return.

It was more challenging for us to do that in the Bakken because it was subscale and we couldn’t run a consistent program there year after year. We were starting to see the potential for inventory depletion.

The trade-off of exiting the Bakken—while there was a high quality asset and the team had done a fantastic job creating value there—the timing was right to move on from the Bakken and deepen that position in the Permian and really cement that Permian position for us.

Grayson Mill was the adjacent operator in the Bakken, so they were effectively bulking up in the Bakken. Then we bulked up in the Permian. The reciprocal rationale made sense on both sides.

CM: How does Ovintiv’s position in the Anadarko compete for capital?

BM: The Anadarko assets [have] been performing tremendously for us. It’s our largest free cash flow generator today in the portfolio. The team’s done a tremendous job there, both on completion design and generating really strong type curve performance, but also lowering our base decline.

We’ve gotten our base decline in Anadarko down to 20%, which is probably one of the lowest base decline shale assets that I know of. A lot of credit to the team there on that work.

It’s playing a really important role for us. Our Anadarko production is about one-third oil, one-third NGL and one-third gas. It does, just in and of itself, create a lot of optionality on the commodity mix. We think it’s been a great performing asset for us, and the team’s done a really nice job creating value with it.

CM: Let’s move north to the Montney play, where Ovintiv also has a large footprint. How does the

company see upside in the Montney?

BM: I think many people don’t realize the Montney’s an oil play, too. Our numbers have it as second only to the Permian on remaining premium oil resource. It is the biggest remaining premium gas resource in North America. It’s high quality. These are, for us, $4.5 million wells. Very attractive well cost.

We illustrated, in our most recent second-quarter materials, these are wells that can make up to half a million BOEs in the first 90 days. They’re very prolific and high return.

I think that the Montney’s just a little bit off the radar screen for many U.S. industry players and investors, and one that has been a high-performing asset in our portfolio and looks to be continuing to do that going forward.

CM: Why has the Montney been overlooked by operators?

BM: I think the simple story there is market access. I always say if you could choose the rock, you would choose the Montney. But if you could choose the market location and the market access, you would choose Texas.

What that means is there’s a huge advantage to incumbents, because we have a legacy market access

position that is really hard to build from scratch.

If we focus on the gas side of things, the market access for gas, whether you’re producing an oil well in the Montney or a gas well in the Montney, you’ve got to find a way to sell the gas.

We sell all of our gas outside of Western Canada. That’s a combination of a huge physical transportation portfolio and long-term basis hedges that we have in place. We’ve been able to build that portfolio of market access over time, and it’s just a hard piece to duplicate. For newer entrants, it does create a barrier to entry in the Montney.

But for the incumbents, it’s a huge advantage and allows us to generate those outsized returns as a result.

CM: Where does Ovintiv see opportunity for the Montney when it comes to LNG?

BM: I think it’s a huge thing here because the world needs Canadian LNG. The first project is slated to be onstream in 2025. Then there are several projects trailing in behind that that are in various stages of development.

The strategy we’re pursuing is tightly linked to that market access story that we just talked about. We believe that the next logical market access step for us is to get some LNG exposure in our portfolio.

We’re engaged with each of the LNG projects that are in development on the West Coast of Canada. We’re not going to take an equity interest, but we do think it makes sense for us to try and find a way to get that LNG exposure in the portfolio. That’s the process we’re engaged in pursuing today.

Then, as a side benefit, that has the ability to grow the market for our Canadian production as well. That’s an ancillary benefit for us.

CM: It will certainly be interesting to watch the Canadian LNG space develop over time. Maybe making some people with projects nervous down on the Gulf Coast?

BM: Well, I think the world needs all the energy it can get. I think that’s the dynamic we’re in: I think the world is going to need it all.

I think there’s a natural synergy there for us on both the associated gas we produce in the United States as well as in Canada.

CM: Do you see opportunity in accessing LNG on the U.S. Gulf Coast, given the growing number of projects happening there?

BM: It certainly could be down the road for us. Today, we’re further down the path on the Canadian side of things. But we’ve certainly evaluated and looked at options on the Gulf Coast as well.