PITTSBURGH—Steve Schlotterbeck assumed the CEO title at EQT Corp. (NYSE: EQT) and its two publicly traded midstream companies on March 1, and since has wasted no time in his new role.
With Schlotterbeck at the helm, EQT announced June 19 it will pay $8.2 billion in cash, stock and assumed debt to acquire Rice Energy Inc. (NYSE: RICE) in a transaction that consolidates the Appalachian Basin E&Ps into the largest U.S. natural gas producer.
Schlotterbeck succeeded David L. Porges as EQT’s CEO after serving as the Pittsburgh-based company’s president since December 2015. Porges, who retired in March, remains on the board for one year.
The deal, which is targeting a close in the fourth quarter, catapults EQT into the top ranks. EQT will average daily production of about 3.6 billion cubic feet per day (cf/d)—outrunning ExxonMobil Corp. (NYSE: XOM), BP Plc (NYSE: BP) or its independent E&P peers.
RELATED: EQT, Rice Energy $8.2 Billion Merger Creates Northeast Gas Giant
Hart Energy met with Schlotterbeck the day after the deal was unveiled, while editors were attending Hart Energy’s annual DUG East Conference in Pittsburgh. EQT now has “a cool million acres,” and while a lofty number wasn’t the goal, Schlotterbeck admits it sounds nice to say. It’s a round number.
Hart: Who approached who, or did an investment banker bring you the idea? Can you give us some color on how this deal came down?
Schlotterbeck: No details yet, but the proxy will have all that information. What I can tell you is that for the past couple of years, we’ve been working on a consolidation strategy and as part of that, you look at all the opportunities, big and small. Rice from day one was always there; Rice stood out when we were looking at the bigger opportunities that were more of a corporate nature, not just acreage. It stood out because of the synergies. It was always an attractive option, but we had no idea if it was ‘executable’ or not. In big transactions like these, you need both parties to be on board.
Hart: So you looked at other companies too?
Schlotterbeck: In just over a year now, we’ve done six different acquisitions, so we’ve been pretty active. These were primarily acreage deals, although the Trans Energy deal was a corporate one too. So, yes, we’ve been very active, but this transaction was a different order of magnitude. To achieve the objective of delivering synergies, Rice kind of puts it all together for us.
Hart: One analyst wrote that you are an empire builder.
Schlotterbeck: Yes, I saw that too [laughs]. But this was never about scale for scale’s sake. I think there’s the rationale that being the lowest-cost producer will win out. You cannot control commodity prices or service costs, so you have to focus on having the lowest possible cost structure. It’s really around being efficient. The biggest levers we have are longer laterals and more wells per pad, getting our LOE as low as possible and getting our logistics in the field concentrated to have the ability to lower costs.
It’s also about making our G&A costs lower. The operations of both companies were so similar—we have the same business model and our acreage overlays—the whole thing overlays well. It’s an opportunity to get a better cost structure and that’s an advantage in a commodity business.
Hart: Low gas prices are pressuring everyone. Was that also a motivating factor for you?
Schlotterbeck: In a commodity business, the biggest differentiator you can have is your cost structure. We cannot move the revenue lever much, other than which gas markets we access. If you’re going to differentiate yourself, it’s going to be around costs. The commodity itself is always going to be volatile, up and down.
We think that with low costs, the one extra advantage is you know almost by definition, you’re going to survive the downturns.
If you are the first dispatcher of gas to the market, you’ll have an advantage. If you are 4th or 5th or 20th down the list and gas prices go down, you can have liquidity problems.
Now you’ve got all the associated gas, primarily right now in the Permian, which is driven by factors beyond the gas price—that gas is going to come on regardless of the Nymex price. That gas is going to get dispatched first. But we want EQT to be second. You’re going to need at least number two, which will be EQT. So we’re trying to position ourselves for that.
The oil price will move around and that’s independent of anything we can do.
Hart: You never thought about diversifying into an oil play instead, to get a balance between oil and gas?
Schlotterbeck: We thought extensively about that. We’ve looked at consolidation vs diversification. We debated both of those for some time, and ultimately what we concluded was that the benefits of consolidation far outweigh the benefits of diversifying because of all the synergies we could get.
And they mitigate the concentration risks we’re taking on, which are not insignificant.
To diversify and have it be meaningful, we’d probably have to make a deal the size of what we just did, $6 billion to $8 billion, but that means making a huge one-time bet on a different basin, a different commodity than we’re used to, and in an area where we would have no competitive advantage—and it would have meant bidding against other companies that do have a competitive advantage in that basin.
We’ve been in the Appalachian Basin for 125 years. We have a high level of certainty around the geology, the landowners, the reservoirs, the human capital vs. being the new guy on the block. That’s why we chose the consolidation path.
Hart: It makes sense.
Schlotterbeck: Well, we hope it does.
Hart: Were you in part also motivated by the activist investor who in January suggested that EQT should merge with Antero Resources Corp. (NYSE: AR) or Range Resources Corp. (NYSE: RRC)?
Schlotterbeck: Not at all, other than to say we had already embarked on this strategy and he was just saying what we already believed. I think maybe some of the ways he thought it would happen were different than what happened, but for the most part, we were pretty well aligned.
We saw low gas prices as an opportunity because of the strength of our balance sheet. We held up pretty well through the downturn, and we thought we could acquire some assets at pretty favorable prices. We started with Statoil who decided to exit the basin—that was the first one we did. The next few deals were done as the recovery was starting, but again at favorable prices—and we were able to do it at a time when others perhaps had the same strategy, but not the same balance sheet.
Hart: You are taking on a lot of debt here. Any plans for an equity offering?
Schlotterbeck: No. The only equity is the equity we’ll issue to the Rice shareholders. We will refinance the Rice debt. We’ve run our financing plan by all three credit rating agencies and they have indicated we will retain our investment grade rating throughout the process and beyond.
We’ll be issuing 0.37 shares of EQT for every Rice share…in fact, the reason there is $5.30 cash in the deal was our desire to use as much cash as we could and not EQT stock, but also to satisfy Rice’s desires to have EQT stock. That’s why we put cash in. We certainly don’t want to issue new stock—we’re trying to do as little equity issuance as possible.
Hart: In the big picture, you said you want to focus on returns and not growth for growth’s sake. I’m starting to see this concept mentioned by more analysts, who want you to be cash flow neutral.
Schlotterbeck: I think it’s an imperative for our industry to adopt that mindset. Time will tell how pervasive that will become.
The ability to oversupply the market is tremendous and it’s scary the amount of gas the industry can bring on quickly. With set demand growth, the market can really get out of balance quickly. At the end of the day, this is a great market for speculators, but a bad one for companies and their investors who really want to invest their money for the long-term, to help build something sustainable.
I hope this next phase of the shale revolution is about generating excess cash flow and returning it to shareholders and doing it in a routine and predictable way. We intend to be cash flow neutral in 2019 and start returning cash after that. I hope Wall Street will reward that. At this point, if everyone tries to grow by 30% to 40%-plus again, it won’t be long before we’re in another disaster of a bust and that’s not healthy.
I’m not suggesting we go down to single-digit growth, just not the 30% to 40% of the past. I do believe with some time, a slower growth rate will become a more accepted business model. If you have fewer, bigger players, it will accelerate the adoption of that business model.
I realize that for startups, their business model is still going to be built around high growth—there will always be some of that. But if it becomes a feeding frenzy—more consolidation will slow that down and bring some sanity to the industry
Hart: It sounds like you’re talking about what the majors do, the way they spend money and plan their business model to go more conservatively.
Schlotterbeck: It is somewhat like that. The majors are much more vertically integrated, more diversified, but in terms of matching growth with returning cash to shareholders, we are talking about similar business models.
Hart: What challenges do you see for the integration of EQT and Rice?
Schlotterbeck: We probably have about five months before closing at year-end, so that will be a big, big task. However, because of the similar nature of the companies and the direct overlap of our operating areas, we're hoping to make the transition as seamless as possible. That said, integrating the IT and accounting systems is always a major effort that will take some time on our part.
Hart: To what degree is EQT using big data?
Schlotterbeck: We are huge believers in data and metrics, and we currently have a big effort around—around field operations, rig scheduling, water handling and so on. We recently hired a Ph.D. from Carnegie Mellon to come on board and he’s building some very complex models to help us. It’s been fascinating.
The first thing he did was look at how we scheduled our rigs and frack crews in Greene County [Pa.]. He looked at the way we move rigs in and out, the way we do water sourcing and water disposal, and other similar logistical elements. Historically, we’d move in a rig to the pad, drill the wells, move it off and then bring in the frack crews and frack them all—every time you move a rig it’s a half million dollars. He did a look back and designed an optimal plan, and frankly, it was shocking...he had that rig moving all over the place, many more times than we would have moved it. When I looked at his plan, I said that cannot be possible. But he walked me through it. It’s so expensive to get water to that rig, you’d be better off moving that rig among different areas. Other things he looked at were around making the most of our gathering capacity when producing gas.
This was one very clear, very real use of big data and advanced analytics. I think we are just scratching the surface and it’s a big opportunity for our industry across the board.
Hart: The midstream aspect of your merger is a big deal. You’re picking up a big amount of capacity to get gas to the coast.
Schlotterbeck: Yes, we are tripling our capacity to the Gulf. We also think the Southeast is one of the biggest gas markets. Our Mountain Valley Pipeline is 2 Bcf a day to the Southeast. So a significant amount of our gas will go to those two premium markets. Mountain Valley is targeted to go into service at the end of 2018; the project just received its FEIS (final environmental impact statement) from FERC.
Hart: Do you have any direct contracts to sell your gas to LNG facilities?
Schlotterbeck: We do have two contracts to sell to Cheniere and we have contracts with other end users. We have a contract to deliver ethane to the Shell cracker being built here in southwest Pennsylvania. In fact, I’m going to visit Shell’s construction site in the next week.
Hart: What are your next steps ahead?
Schlotterbeck: We now have a cool million acres in the Marcellus—not all in the core, but that’s a nice round number. It was never a real target, but it’s a nice number to say. We weren’t in Ohio at all recently, but now we will be… it’s nice rock, good returns, and fairly well consolidated, so we can drill long laterals.
Hart: The bidding war for Vantage and Alpha Natural Resources in 2016 sure turned out differently. [Editor’s note: last spring Vantage Energy acquired Marcellus acreage out of Alpha’s bankruptcy for $200 million, outbidding Rice Energy. Then last fall, Rice bought Vantage for $2.7 billion.]
Schlotterbeck: We certainly had talks with Vantage but couldn’t make the numbers work at the time. Prior to that, we had also looked at Alpha; it was us, Vantage and Rice and a couple of others who looked at that. I remember at one point, I congratulated Danny Rice on getting Alpha, but then Vantage came back in the auction room after I was certain they were done and they outbid Rice—so I learned, never prematurely congratulate someone on doing a deal.
But now, with this acquisition, we’re getting Alpha, Vantage and Rice, which we think are the key pieces for Greene and Washington counties in Pennsylvania. We just kind of took the long way to get there.
Leslie Haines can be reached at firstname.lastname@example.org.
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