Andrew Carreon from Emeth Value on Diversified Energy $DEC (podcast #122)

Andrew Carreon, founder of Emeth Value, discusses his thesis on Diversified Energy (DEC; trades in London). Key points include how the company can get such good deals on acquisitions, if the company has an edge in handling asset retirement obligations, and why the company pays such a big dividend. You can find my series on DEC here, Andrew’s first podcast on BSM here, Andrew’s write up on DEC here, and the bloomberg article we refer to here.

Please follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or share it with someone else who would enjoy it (more listeners is a critical part of the flywheel that keeps this Substack and podcast going!).

This podcast is brought to you by Daloopa. Daloopa’s database of over 2,500 models helps clients to construct their own models faster and ramp up on new names more readily. Save time with Daloopa to do more value-added work. No more data errors, no more Excel monkeying, just the fundamentals—all at your fingertips.

Disclaimer: Nothing on this podcast or on this blog is investing or financial advice; please see our full disclaimer here. The transcript below is from a third party transcription service; it’s entirely possible there are some errors in the transcript

Transcript begins below

Andrew Walker: All right, hello, and welcome to yet another value podcast. I'm your host Andrew Walker. And with me - oh! if you like this podcast, would mean a lot if you could rate, review, subscribe wherever you're listening. With me today, I'm happy to have on for the second time, my friend, the founder of Emeth Value Capital, Andrew Carreon. Andrew, how's it going?

Adrew Carreon: It's going well. Thanks for having me back on. I really appreciate it.

Walker: Hey, I've been looking forward to this one for probably 2 months now, but let me start this podcast the way I do every podcast. First, the disclaimers to remind everyone, nothing we're going to talk about here is investing advice. Please do your own due diligence, consult a financial advisor. Diversified is a pretty big company, but the podcast's going to focus on Diversified, which trades International. Obviously, that comes with all sorts of extra risks and concerns and everything, so please consult a financial advisor.

Second, a pitch for you, my guest, this is your second appearance. People can go listen to the first appearance on BSM. I'll include a link in the show notes, if they want a full pitch for you. I mean, BSM was an absolute banger of a podcast. That's been an absolute banger, but look at bottom line, I think you're a super sharp listener, super sharp thinker. Every time I can talk to you, I learned something new and I'm just really excited to have you back on.

All that route away, today we're going to talk about Diversified Energy. The ticker is DEC. They trade in London. I'm just going to stop rambling and ask you, Andrew, what's the Diversified, and why are we so interested in them?

Carreon: Yeah, well, I really appreciate the kind words. It's great to be back on. I'm a huge fan. Yeah, so Diversified is a London listed oil and gas producer. That is actually the largest well-honor in the United States by wild count[?]. They have a footprint of about 70,000 oil and gas wells, primarily natural gas, in Appalachian Basin and what they call the Central Region which is Texas, Louisiana, Oklahoma, and Arkansas.

A little bit unique about Diversified is that they actually do almost no drilling. So a bit different than a typical EMP model where I guess, for the listeners benefit, a typical EMP, maybe you own a couple hundred thousand net acres and you know what? It might be a good location and you're certainly telling your investors, "It's a great location. It's X percent developed," and you're telling your investors, "It's half X developed." Every year you go out and drill however many wells to both offset your embedded declines, and then potentially grow production as well. And so, you're very focused on the drill bit.

Many of these companies have up to hundreds of millions of dollars of drilling program cost per year. So in that model, your Kosta drill, your quality and quantity of future inventory locations, take away capacity, commodity prices, lots and lots of relevant factors. On the other hand, what Diversified does is they're what's known as a PDP buyer, and PDP meaning Proved Develop Producing. They're looking to go out and buy wells that are already producing, and have a very long tail of economic production ahead of them. Generally speaking, while economic, because of the natural shape of a decline curve, these wells have declined to a small fraction of their initial production rates.

If you look at a typical shale well, or even a conventional well, a shell well in Haynesville, let's say, might produce 70 to 80% of the expected total recoveries in the first year or two of that well. So if you look at kind of vintage by vintage across oil and gas companies, you know, well's drilled by vintage, their production stack is very heavily tilted towards those most recently drilled wells. And so that's what their focus is. All of these, what Diversified likes to say is, most EMP's are set up to optimize the first 40 days of a well. We're set up to optimize the next 40 years of a well, and so that's their focus.

The business was co-founded by Rusty Hutson Jr., who founded the business in 2001. He's a West Virginia native, so Appalachia focused. Bought his first package of wells in Doddridge County, West Virginia for $250,000, really, as kind of a side hustle, while he was in banking. His family, he's fourth generation on the gas family.

Walker: That's a very casual, $250,000 side hustle oil and gas well.

Carreon: Yeah. And a foreshadowing of the capital allocation process. He remortgaged his house. He took out a second mortgage on his house to pay for about a third of that purchase price, and then the other two-thirds was seller financed. He really liked the assets. They were brought to him by his dad, actually, who knew the seller personally, I think. So he got his hands dirty early, and saw what you could do by just keep keeping these wells producing and actually kind of tending to the well, so to speak.

They've been acquiring assets ever since. Today, they've obviously branched out from what their roots were in, bread and butter acquiring conventional, vertical wellbores in Appalachia and really the paradigm shift there being, and we can get into specifics but basically, when the Shale Revolution happened in the early 2010's, a lot of operators pivoted to saying, "We got to get in on Shale. We need to go start leasing up the more attractive Shale acreage, and who can we find to offload our conventional assets to so that we can have capital to drill?"

But also somebody that's reliable enough to make sure that you keep those assets producing, because one of the things is that a lot of these conventional wellbores sit at the 4-5000 foot depth range, right above Shale, which would be more in the eight to ten thousand foot range. In order to maintain holding that least by production, you really have to trust that operator, who you're giving those conventional wells to, because if they screw up, you lose that lease. So, that was kind of their initial bread and butter is, "Hey, so many operators are trying to get rid of these conventional assets. They're going in all in in Shale. We'll take them and we will just cash flow them and be kind of the right home for these assets, and you know, happy to kind of go any direction from here.

Walker: No, that's great. So, just to summarize, what they're doing is they're going out and they're saying, look, company X, you're focus on making these big wells. They're going to make most of their cash flow in the first year or two. If you think in the first year or two, it's going to produce 100 barrels of - they do gas but I'll just say oil - 100 barrels of oil a day. By your four, it's only 20, and that's on its way to 10, and then it'll be probably be like 10, 10. 10, 9, 7, 6. See, look, we'll take these old declining wells off your hands and we'll manage them in. An older well, because it's not doing 100 it's doing 10, it needs a different cost structure, right? You need to be much leaner, much more focused. So that's everything they're doing that. That's makes some that sense. I think that's great.

I want to talk about their acquisition strategy a little more. This is the most controversial thing about them and we can talk about the arrow, which ties into it. But a lot of people, when I look at this and I think when you hear it you say, "Oh, DEC, they're going to go buy from some of the best operators in the world, right?" Their recent deals, I was saying it was Chevron but it was ConocoPhillips. They did deals with ConocoPhillips. They did deals with EQT.

They do deals with CNX. CNX, the person who wrote The Outsiders which I think is the most popular book among value investors currently. Like that's their chairman, right? So they bought from the dude who literally talks about how to do financial engineering and financial and capital allocation. They bought wells from him, and they're saying, "Hey, we're buying from all these sophisticated sellers, and we're getting great purchases on them. The PV10 would mean discounted cash flows back at 10% per year, they're saying we're buying from sellers at PV17, so 17% IRR. PV20, PV30, a recent deal was over PV40.

So I think a lot of people are going to say how are they getting these prices on it. How does this make any sense? I threw a lot at you, I'm just going to pause there.

Carreon: No. Yeah that's a really great question. There's a lot of different elements at play here. While the recent deal was from Conoco, it's a $200 million acquisition, they have bought assets from CNX. They have bought assets from EQT. Not all of their Acquisitions have taken... They bought assets from Titan or Alliance Petroleum, or Core Appalachia, at Seneca - companies you haven't heard of also. So that's not the shape of all of their acquisitions. But so over the past, since Inception, they've made about 26 acquisitions. They put about $2.7 billion to work, at an average cash flow multiple of call it three times.

One thing that I hear often is saying, "Man, they bought this asset for two-time, after three times, this is too good to be true." You know, trust the simple narrative and the simple narrative is, "Oh they're getting sold these assets because they're not actually assets or liabilities." And that is a simple narrative. But in reality, when you look at a three times cash for multiple, the reason that it's three times is because that is really what's required to pencil in a mid-teens to high-teens IRR.

One of the things that is attractive about Diversified's business model, being a PDP cashflow focused acquire is that it really works across commodity environments. So, take right now, for instance, the strip for natural gas is extraordinarily strong. You look at an asset like Conoco and say, "Holy smokes. They bought this asset for PV17 and two and a half, a little under two and a half times multiple, like, how is that possible, Conoco's super sophisticated?

Well, the flip side is, yeah, they're buying it at a 17% IRR, but if you go take those dollars and put them to work in the Permian, at this drip, put them to work in the Haynesville at this drip, the marginal economics of drilling a new well in Tier 1 Acreage, is in like the near triple digits IRRs, on some of the best locations. So that's one kind of component.

Walker: Let me just push back on that, because the Conico one, this is the one they just did, right? They did it within a month ago. So this is really fresh in people's minds. They bought 82 million of EBITDA from Conoco for $240 million, I think the net price was 210, PV17, everything talks about. And I don't disagree with you. Every company I talked to, I've talked to a lot of oil and gas companies, says, "Hey, if we go into the Permian right now like with that gas at $9, $6 next year, whatever it is, like the IRRs and these wells were getting paybacks within nine months, on any wells we drill. Obviously, there's a risk of wells who's going to not produce, which you expect or something.

You've got pretty good engineering and stuff on the Permian at this point. They're saying we're getting paid back with the 9 months, which I hear you. Take a old decline asset, sell it for PV17 and go plow it into that 9-month payback well all day, but this is Conoco, this is a hundred billion dollar company, unlimited costs of unlimited funds, cost of capital probably like their debt, 3-4%. It's basically US treasuries. They're such a good at credit. Why does Conoco need to sell assets at PV17 to go fund some drilling? They can just stuff these on their balance sheet. It's better than the debt that they take out, you know?

Carreon: Yeah. So I mean every deal has its own dynamics. For Conoco and specific, and for the majors. I mean, Conoco has been aggressive and going into the Permian as kind of like that being a very major focus for them. Frankly, I think, it's just simplification. I think if you talk to the folks at Conoco, this asset went on the non-core asset list that we're looking to the best and it is not coming off until we sell it.

There is a team of people that is on that group, and their focus is selling these assets . They have other marketed deals right now, that they are just looking to sell. I think, the majors are their own bees, they come with bureaucracy, they have a lot of things. Like Indigo Minerals is exactly what I kind of penciled out. They bought these Cotton Valley assets last year from Indigo, and that was exactly to take those funds and just plowed into the Haynesville Acreage, because it is such attractive acreage.

But this is not like a one size fits all right. They've bought from many of these types of players before. You have typical private equity 10 to 15-year life funds, and the trick is is that they might have developed developed a certain leasehold with this private equity fund capital. But oil and gas wells don't last 10 to 15 years. They last much, much longer than that. So they get to the end of this and they got to figure out what to do with it.

It's even more complicated by the fact that and as you know, I used to be on the LP side of the table at the University of Notre Dame [inaudible]. We had a number of oil and gas partners, and that number is be line to limit approaching zero, right? I mean, it won't be zero, but it is extraordinarily hard to raise additional capital as an oil, and gas, private equity fund right now. I have very close with a number of groups, obviously, still many of my friends who are at large pensions endowments foundations. The only calls that you have these days with your GPs on energy private equity is, "When are we getting our money back? And go take these to market and don't call us unless you have a sale."

Walker: Has that changed in the past? Let's say six months since Russia-Ukraine, but it's because energy prices are skyrocketing. And I think people are starting to see, especially gas, which Diversified does, but even oil, people are starting to see energy security is important. Gas is getting labeled kind of ESG, has that changed at all or is it still, 'Hey, let's just get out of these dying fossil fuels."

Carreon: I think it's, "Hey, let's get out of these dying fossil fuels." I mean, it

Walker: Bought it all into Shopify.

Carreon: Yeah. Yeah. What a better time to be taking some risk in equity markets, right now, right? I mean, like in other places. I think you could always make the argument. It's like, "Hey, are we really going to sign up for another 10-year locked vehicle in energy," We've lost our shirt[?]. Now, we're getting a chance to actually get out with some kind of semblance of decency at today's price levels. Just sell it and lets take what we can and run, but it was a combination of obviously, from an ESG perspective, things really moving the opposite direction. There's a lot to talk about there, but also just the experience of every LP and these private equity funds, has just been treacherous. I mean, they've lost a lot of capital up until recently and I think people are just, "It's not worth the headache."

Walker: I think it was Diversified who had a line - you mentioned two things there. They had a line and their last call where they're like, "Hey, the current strength of commodity markets is actually learned a lot of sellers out, right? People, when gas at 250, they're like, "Oh, let's just hold on." Gas at night and like, "All right, we got our chance. We got our dead cat bounce. Let's get out of here while the getting's good."

So one side of the asset sales equation is why is - and I hate to sit on one thing but Conoco is a big company and it was just a very nice illustration that one side is, why are sellers selling it such nice prices, and I think you addressed that. The other side is, it should be a competitive market for assets, why can Diversified buy the deal before Conoco was at a 40, PV10, or something, right? Why can they get 40 IRR? Why isn't there someone - why aren't you and I, throw in funds together and saying, "Hey, we'll bid 35. Hey, we'll be bid 30."

And I think one aspect of that is what you just addressed, there's not a lot of buyers left out there. You need to have operational experience, you need to have all that, so there's just not a lot of buyers. The second one, which I want to talk to you about and we can use this transition to AROs, is kind of the synergies, the operational skills and especially, the Asset Retirement Obligation management. So do you want to start talking about that and then we can talk about... Hey, I think you know where we're going with AROs.

Carreon: Oh, yeah, for sure, for sure. Yes. I guess, one thing I would pencil out here too, is that there are absolute synergies in this model that do allow you to purchase assets for a different price than a competitor, who doesn't have a footprint nearby. It is a route density model and we can get into that and so if you like...

Walker: Can I just... it is a route density model more so than just your average, generic oil, and gas person buying like. Obviously, every oil and gas person would like to buy the field next door. There'd be synergies there. But Diversified has particular synergies to their routes density model.

Carreon: Well, in terms of the route density model for a typical A&P[?] is how do you get the most efficiency possible out of your drilling rigs? How do you get the laterals as long as to have continuous acreage? How are you running these things, effectively, 24/7 to just squeeze every single efficiency dollar that you can out of your drilling rigs? This is totally different in that it's route density in maintaining your wells, operating those wells.

If you look at Diversified's current acreage footprint in Appalachia, in a certain 50 mile radius, where they have only DEC employees now. There were employees scattered from five or six different companies, not necessarily efficiently. One company might have had at footprint on one well way over at one side of that 50-mile radius and then another well, and just the amount of, what they call the windshield time, just driving from one well to another and making sure things are a huge part of this business model and taking that out. So now you could say, "Okay, well now you don't have to totally crossed this 50-mile radius. You take these wells that used to be owned by this company and now your focus on this group. And we're going to take these and put them to this person."

All of a sudden, you're saving a huge amount of time. So there are some unique things there, and synergies are really important to that. I think the other thing I'd call out and this is kind of maybe bringing in oak tree, a little bit. One of the challenge is that these aren't just financial assets, you have to know how to operate these assets. . You can't just come in and buy them as a financial buyer, and expect to produce a good return. Really Diversified business model is built on, we're buying these up, we're buying these assets, and we're going to operate them efficiently. Like, private equity companies come in, buy a business and try to turn it around. It is very similar here, but you're just trying to stave off something that you bought from a 9% decline, and how do you get that to a 7% decline?

The thing that people don't often think about, and this is, like the EQT assets that they bought, are just a absolute prime example of this, is that if you buy a package of assets, that's, let's say, in this instance, producing X amount of cashflow, and you model that in at a 7% annual decline. And for those first, even five years, let's say, you can stave it off to a 5% decline or a 4% decline, or this case, they held them flat for two years. That production wedge that you just created in the first five years is going to hold, for many, many years, 20 years thereafter. And, sorry, go ahead.

Walker: Oh, no, it's the difference between, if year zero is 10, and on the current decline, it was 8, so then, you're starting your 3-year decline starts from 8. If you save that off, your 3, you're starting from 10, right? So not only you're starting 25% higher, but it's 25% higher on the whole [inaudible].

Carreon: Yeah, you're rebasing the production. And what you'll find is that even if in the first couple years, you can do something to rebase the production on a 20-year asset or a 30-year asset. I mean, they're looking at 700 million of cumulative excess revenue from that single deal. That was, I mean, a monster amount of additional cash flow from doing things that, in the immediate term and in isolation seem like very small things. That's another thing, it's just being scrappy.

They're very scrappy, and they're very... And I only notice, because I spent so much time with them. But they're very scrappy, they're very returns focused, and their whole model is really built on buying things that are not in core. And so, these assets that have declined to such a small percent of production that, at this point, might be less than 1% of Conico's production volumes. They are non core to Conoco. They have forgotten about these assets. They just want them gone.

Walker: I'm just going to jump in here. I think another push back would be your EQT are like the best guys in natural gas, right? It's run by the rice brothers. They've got a huge history. They're really great. They're really good at this stuff. And I think people would say, "Why can Diversified go and get a well to stop well declines that EQT literally the best guys in the natural gas business?" And the answer, and you can tell me if I'm wrong, but the answer isn't what you just said.

Look, these are a small piece of EQTs overall assets. EQTs focused on going and drilling new wells that are going to be gushers. They want access to LNG. They're talking about doing equity investments into $9 billion LNG things that selling 50 million of non core low production assets to Diversified. The management team can't even spend time thinking about how to get those assets producing better.

Carreon: Yeah, that's exactly right. So I mean, EQT is phenomenal too, so this is a very fair question. I mean, Toby Rice is the guy. They are great, great operators. They bought those assets in 2018. So another thing of the flip side of giving somebody capital to plow in at 100% IRRs on a Tier one well, is a lot of these players were very over leveraged. In 2018, they bought a couple of assets out of bankruptcy in 2018, in 2017. On the flip side, they are scooping up assets when people are in distress, and so depending on the environment, it's different assets that come to market. It was a 500 million or so deal for EQT, which was pretty helpful to bring their debt cost down. Not their debt cost, the amount of debt that they had, down. And undoubtably I mean, they got to give somebody else the AROs which was diversified, so that is absolutely a benefit. You're giving up costs, the expected future cost to somebody else.

Walker: That transition is great. The most frequent pushback I've gotten in Diversified... I just did a long series on Diversified, the thing that stuck in my mind was the buyer seller issue, which we've already addressed fully. But the toughest thing with Diversified is they acquire these old wells, and with old wells come AROs, Asset Retirement Obligations, right? You've got an old well, it emits methane, it makes basically pollutants, and you have to handle that.
The most frequent pushback I've gotten is, hey, Diversified, they buy these things, and a lot of people think they're playing kind of a shell game with the Asset Retirement Obligations.

I'll just give a quick example. It was in 2020, they bought assets from CNX, and CNX, if you look through their [inaudible]. I clip this in one of the articles I posted. CNX reported a gain on sale, because... I can't remember the exact numbers. But basically, they said, "Hey, we had 100 million in Asset Retirement Obligations. We're getting off our books with this. We sold it. We're getting a small gain on sale, because the cash is greater than what we had in our books in Asset Retirement Obligations, and all that." And then if you went through Diversified financials, you can see they booked a bargain gain on purchase and buying these assets. And they say, "Hey, we think it's only going to cost $14 million in AROs, in Asset Retirement Obligations."

Both sides, two very sophisticated scenarios, both sides are kind of in their financial sane, we pulled one over on the other side, right? And you look at that big difference and both sides cannot be right. Well, both sides could be right if Diversified's costs of managing these liabilities are way lower, which might be the case. But a lot of people will just say, "Look, they're just playing a solid game. The AROs don't come through for 8 years. In 8 years, they're gonna have a massive liability issue with AROs, or it might be longer than 8 years."

But they're pushing the problem out, they're pushing the problem out, and eventually, it's going to come back to haunt them. I threw a lot out there. We're going to talk all things about AROs, but just highlight, how would you think about what I just said?

Carreon: Yeah, it's a great question. I guess, just to preface, I've known this business since 2017, and it took me to 2021 to get comfortable with a lot of these same exact issues.

Walker: I've been studying it for about a year since you said it to me, and [inaudible]

Carreon: They are very good questions, and I will do my best. One of the things that you mentioned, is the bargain purchase accounting, and this is something that I think, there's a handful of short reports, or pretty much any...

Walker: Can I just let you.. But to me, the gain on bargain itself, I don't care about the accounting, but I do care about CNX says, "I've got a gain on sale," and then Diversified says, "I've got a gain on bargain purchase." That's where I start getting word, I don't really care about the accounting games of a gained on bargain purchase or not.

Carreon: Okay, okay. I'm going to just to clarify that for people. There are two ways that you can classify an acquisition. One is an asset acquisition, one is a business combination. Depending on how many employees they bring on, if there's midstream, lots of other factors, they basically have to go through with their auditors to determine is this an asset acquisition, or is this a business combination?

If it's an asset acquisition, you never have a bargain gain on purchase. But if it's a business combination, you have basically two options, one is to put goodwill in, or the other is to put either a gain on purchase. And because they are effectively acquiring commodity producing oil and gas wells, putting goodwill in for these purchases really doesn't make a whole lot of sense. So they go through, they value the assets of what they think they're worth. And then, they occasionally come out with a bargain gain on purchase, largely because, again, this is an attractive environment to acquire these wells.

If you actually believe that, it is reasonable to understand the company reports, metrics that strip all of these out, and that is what they kind of beat home to investors. Like when you think about a bargain gain on purchase, typically, you're thinking about a CEO or management team that is inflating earnings. It's not backed by cash, and they're using it to pump the stock to potentially sell their own, monetize their own share, and, pull one over investors. Rusty has literally never sold a single share of Diversified, and neither has his co-founder, Robert Post. So I think, that one's pretty easily put to bed.

Walker: It would also be, as you said, it would be a company, it's reminiscent of the Enron WorldCom days, where be a company that's reporting huge earnings per share, and they're going out in to you, and, "Look at earnings per share!" And then you would go down to the cashflow line, and the Enron thing was they wouldn't even report a cash flow statement until the 10Q came out, right? They'd have zero cash flow from operation despite billions of dollars in EPs. They're printing cash flow. They're paying out a big dividend, which we're going to talk about in a second, but maybe they're playing games with accounting, maybe not. But it's not because there's no cashflow behind us. And they're never really pointing to the gain on bargain purchase. So, 100% there with you.

Carreon: So for the CNX acquisition and specific, there's not exact template of a way to account for AROs. For many of these companies that are very focused on drilling wells, the way that they will account for their AROs, is they will drill a well, and then they will set a fixed time. Say, we expect this well to last 25 years, or 30 years, and then 25 years later, or 20 years later, you might look at that well, which Diversified did and go through with third party reservoir engineers and say, "Actually, this well has, in our opinion, another 30 years of production lab."

But on CNX, since they drilled that well so long ago, and they've never changed that date, it's like, "We're going to plug this tomorrow, or we should have already plugged this." That exact type of thing. They will, very often, go to the table with sellers and look at assets that are producing at levels higher than assets that they're already profitably operating. And those sellers will be saying, "Based on when we drill this well, our set date is this," and that's what we have the ARO mark at.

That is the largest component by far, is that you have just static assumptions that a operator uses, and they're not necessarily... Again, there's a difference between being conservative and being accurate, and you want to be conservative, but you don't want to be conservative to the point where you're completely inaccurate. That's the diff[?] here of like, what is actually correct. And so that's the biggest component, the other component, which - again, I highly encourage everybody to just think about these on an undiscounted basis, because you get so much weird stuff. Like, there was a small difference between the undiscounted values, between what CNX thought and what Diversified thought, but it was pretty small.

If you just thought about these on undiscounted basis, they were effectively saying the same thing. Besides those two, the other portion was Diversified, at the time, was a much smaller business. They had a higher cost of capital, and the weird thing about these is that you use your cost of capital to discount their cost. So yeah, the ARO flip from a low single digit to like a mid high single digit discount, because Diversified has a higher risk of like. That didn't make any sense, right? But it's just how the accounting works. That doesn't make any sense to me either, and they will tell you that, but that's why I just encourage everybody to think about them in undiscounted values. And then we can talk about, maybe going until, like, well life longevity and some of these other questions, unless you want to take it in a different direction?

Walker: No, no, please continue. I'm learning a lot. I'm having fun. So please continue.

Carreon: Yeah, yeah. So, I think another pushback that you hear a lot, and I think we'll spend this whole podcast in push backs but another...

Walker: You know, the bull case is really simple, right? They're buying assets at PV20 Plus, they trade for half of their PV10. They're paying a 10% plus dividend yield , but boom, bull case. Done. Like super cheap, accretive acquisitions. We're good.

Carreon: Yeah, I know, this is what we should be spending time on. So, the way that I think about it in the way that Diversified thinks about it as well, is like just think about the union economics of Diversified. You have a well tender, Diverse got 1400 employees about, I think around 1000 of those are in the field, a bunch of them are well tenders.

There's a couple of different things that determine the load, the capacity of a single well tender. So, how difficult the geography is, how densely routed the wells are. Sometimes you have multiwell pads, where you have 10, 15 wells on a single pad. Also just the amount of moving parts, is there a pump jack? How much fluid is on the wells, lots of different stuff in determining how complicated are these, and how much time does each well tender need to spend at each well site, to properly maintain these assets.

If you look at the Appalachia footprint, which is the vast majority of their wild count, it's about two thirds of their production but the vast, vast majority of their 65-70,000 wells. The density for a well tender is somewhere between 50 and 150 wells, per well tender. And so if you think about - go read any given Diversified energy hit piece. They'll say, "Oh my gosh, these are all stripper wells," which is defined by less than 90 MCF of gas per day of production. And it's absolutely true. That is vastly, vastly lower than these wells coming on and millions of cubic feet a day, when they are initially producing and, 5 to 7 BCF of production for a single year in the beginning. And this well, maybe we'll hit 100,000 cubic. It's very, very different, right?

But think about that one, let's just take a stripper well, 90 MCF a day. That single well, we'll add a $4 strip. We'll produce about $140,000 of cash flow of revenue, of gross revenue. The biggest fix expense is these well tenders who get paid 75, $70,000 per year. So a single stripper well, of which is maybe one of 50, or one of 150, and a single well tenders portfolio, can more than pay for the whole salary of a well tender, of which the remaining 49 or 99, or 149 wells are extraordinarily high margin. Gas wells.

The beauty of these assets is that they declined. So the beginning initial phase of a well was hyperbolic declines. The Diversified focuses on buying assets. They're in the exponential declines, which just means that it's a set decline rate, so that's 7%, 5%, whatever it might be. This is based on the geology, based on a lot of different things. And so Diversified's average well is a lot lower than 90 MCF, it's more like 10 or 11 MCF a day. But even that well, you know, like you have people can equip like 10 MCF a day. That'll buy you lunch, maybe or something, I don't know.

Walker: Yeah. Maybe at last year's pricing, but today, that'll buy you a fancy lobster.

Carreon: Yeah, that'll buy you a nice lobster lunch, power lunch. But yeah. I think what people don't appreciate is that what they are trying to do is to build density into an efficient way to take care of these assets. And when you're able to take care of 50, or 100 wells, something that's producing $10-12,000 of cash flow year, that becomes very meaningful.

On the other hand, the other biggest expense that you have, besides that fixed, is transportation costs. And the beauty of Diversified is that they own a lot of the transportation, in Appalachia, in specific. So truly, you're talking about covering the cost of a well tender, and then some SGNA, but I always just kind of chuckle when people talk about how could these be unprofitable. For one, just go read their financials, it's not that challenging, especially in this environment. But the other thing is just think about it on a well by well basis. These wells are producing a lot of cashflow, and so that's kind of the attraction.

Walker: One of the interesting things to me, so one of the experts I talked to, he said something like, "Look, these are really low production wells, but some of the things Diversified does is they'll only run that wells for 2 hours a day, or they'll run it for 2, then they'll shut it off for 10, then they'll run it for 2 more." These wells are producing so little, doing that and saving the power costs on that.

You might keep the same production but with 10 hours less of power cost. I'd never heard of a well shutting down for 10 hours and then coming back for two yourself. You know, just little things like that, that add up. And obviously, everything you're talking about is more important. But that was just one of those little nuggets that jumped out to me like, "Oh, I'm guessing a company focused on fuel, on things that are producing 100,000 MCF," or they're not going to think about, "Hey, let's shut this thing off for 10 hours to save 20 bucks of power costs or something," but it's meaningful at this scale.

Carreon: Yeah. So, again, one of the things I think is like I just encourage everybody, go spend time with the company, because they're very open book, and they're great people. Bobby Clayton is the head of upstream operations for Diversified, and he is kind of like your very old school oil and gas guy, who conventional wells in and out, is his thing. And he just knows exactly what you're talking about.

You don't think about some of these things or equipment that was once used on a well, that just shouldn't be used on a well anymore, what is this doing here. The amount of cost that they're able to save by just right sizing wells, and taking compression off of wells that shouldn't be on wells, or adding compression that should be on wells. Wells that might be producing too much, but then are producing too much water, and then you're you got expensive water costs hauling. Adjacent wells that aren't producing anything, but you need them to stay open so that water can go into those well.

I mean, it's a lot more complicated than... It's not, "Oh, they're buying a bunch of holes in the ground, and they're claiming they can, you know," There's a lot to it. And so, go spend time with them, because they will do a better job than I will, explaining a lot of these things.

Walker: Well, I think you're doing a great job. But let me ask you more on the Asset Retirement Obligations. Again, this is an area of sticking point for a lot of people. One of the things they say is, "Hey, we have an advantage with Asset Retirement Obligations, because we're focused on these we're inhousing our crews. We've got some of the local economies of scale you talked about." And I think, I can't remember exactly, I'm looking at a couple different slides. But basically, they say, "Look, our peers, we think it cost them $25,000 or more to kind of plug and retire a well. It's costing us these days under $20,000." So that is a massive, massive difference. Especially when you're talking about wells that right now, we're producing, call it 70,000 in cashflow or something. If you can take the ultimate retirement obligation from 25,000 to 20,000, yhat is a huge increase in your IRR on this well. I might not have said that perfectly, but I think that makes sense. So my question is, do you believe them on the ARO? Why do they have an advantage, a cost advantage against, they just bought assets from Conoco to go back to Conoco, EQT, one of the largest gas drillers in the entire world? Why does Diversified have an advantage at plugging wells versus all of these guys?

Carreon: Yeah, so the first and most simple reason is that none of those companies, including Diversified up until very recently, plugged their own wells. They all use third party contractors, and those contractors have on average, like a 30% margin. So, yeah, Diversified saying, "Hey, we save 25% by in housing," but reality, they're just saving themselves on the margin that the third party contractors were... That's not entirely needed an explanation, but that is a big part of it.

Walker: Is that fair? Because I don't want to push back too hard on that. But if I said, "Hey, I'm Ford, I went and bought my seat manufacturer, and I'm taking their margins out of the seat." All of us say, "No, you're just adding complexity or timeline, that was kind of just cost of capital. You're just increasing your capital. You're kind of just making it back on your cost of capital," I guess, I'm throwing a bunch out at you. But is it fair to say, hey, just buy inhousing, we're taking out the third party margin?

Carreon: It is, because 80% plus of the cost is just time, it's cost on time. So cement is your other material. You have some cement costs, where you could say, in the seat example, you would be saying, "Okay, well, am I going to benefit by Ford by inhousing, making my own seat, since this seat manufacturer makes 10 times the amount of seats that I would make inhouse," you wouldn't save because they're passing on some economies of scale that they get to you and us. Is that kind of what you're saying?

Walker: Yeah, I think so. I think so.

Carreon: And so, in this case, it is just a crew with the plugging rig, and you are paying for the time that it cost that crew, and then they are marking it up, 30% on time. If you are able to have the same time or better time, and bring that inhouse and not pay the markup on time, assuming you're not getting taken to the cleaners on the 10% you're spending on cement, you're going to save money.

Walker: I'm going to think about that because another one would be, "Hey, we hire a lawn mower guy to go cut our corporate grass. Are we going to save money if we inhouse the lawn mower guy?" Yes, it's silly, because that's such a small expense. But no, you're really not going to save money. I think it would come out to the same thing because the lawnmower guy, he's just charging you for your time [inaudible]. I'm gonna think about that one. That's an interesting one.

Carreon: I guess, in that case, it depends on how you value your time. The other thing to consider here is that, if you're a third party plugin company, and for one this is a fairly small industry, which is these wells, one of the things is that they last so long, as it is. And the industry on the whole, undoubtedly, has some issues with not properly addressing these AROs in time. We can get to that if we need to. But basically, we have not plugged that many wells, as a country, and part of the reason is because many, many of the wells have lasted so long, that we're now getting to the point where we really need to start addressing this, and start ramping up and plugging.

It is still a fairly small industry, I expect it to grow a lot, especially with the federal money that's coming into space. But the other thing to consider is that if you're a third party plugging contractor, you're just focused on getting other people's business. That takes time, and that takes effort. The beauty of insourcing for Diversified is they are going after third party business, but they always have the option to just do their own well. And so the ability to keep your crews busy is a huge advantage.

Walker: And add on to that, I think that it comes back to that local economies of scale, right? If you're going out there, maybe if there's Plot A, B, C, D, E, you only land for A, C and E. So there's lots of driving time in between, but if Diversified, owns them all, they can just say, "Hey, you go to A on Monday, B on Tuesday, C and D on Wednesday." And you can save a lot of the kind of driving and hassle time and all of that.

Carreon: Exactly. And when you're bidding on a third party project, you can strategically just bid on the ones that are already close to your own wells.

Walker: Yep, yep.

Carreon: Yeah. They've had a lot of success with this. In terms of addressing, I think a lot of people have the concern about saying, "Oh, my gosh, 70,000 wells, 60,000 wells, pick your number."That they're going to have to retire, how on earth are they going to meet these obligations. So they've already plugged over 400 wells, as Diversified. less than $25,000 cost across all of those wells that they've plugged. When you include the wells of the companies that they bought that they've plugged, it's more of like 1100 plus.

They have a very big data set of what it costs them in Appalachia to plug a 4000 foot conventional well, and so they have a very good sense for that. The other thing is that, "Okay, you take the 25,000 per well ARO costs." The first opportunity is what do you save by inhousing that? Okay, maybe you save 5000 a job by insourcing that inhouse. Okay, that knocks X off your ARO.

The other thing is that, as I mentioned, they've got the capacity right now with 15 well plugging crews to plug 600 wells a year. I kind of expect that their average margin on a well plugging job would be somewhere between 15 to 20,000, for the margin. Right now, that's because there is a very high demand, particularly, because of the pool that just came from this huge federal package to plug wells and there's not enough capacity. And so if you didn't have your teams inhouse, you were fighting uphill, because your cost just went up a bunch.

Thankfully, they have they have the inhouse ability to plug in these wells. You can do the math, I'm saying, "Well, what if we plug one third party well at $20,000 margin, for every three wells or every two wells?" I think, it's likely that they could come out with a net plugging costs of $10,000 or less. If that's the case, then you're looking at an extra billion dollars of cashflow for shareholders.

All that aside, I think that if I were a non-shareholders interested party that was worried about these environmental liabilities, the thing that I would say to comfort those worries, and maybe this is not what they would want to hear is that you should absolutely be cheering them on for every acquisition that they do in Texas and Louisiana. Because on the whole, those are very different types of well packages that the ARO is much smaller.

Typically, they're taking, like the Barnett, they're taking unconventional wells. And on an unconventional well, in the tale exponential decline, it's very similar, very predictable. Maybe a bit higher, like a 7% decline instead of a 7 or 8% decline instead of a 5 or 6, but it'll produce 30 to 40 times the production, as a conventional well in those terminal years. But the ARO is only 3 times higher. So you get a huge amount of operating leverage on those wells, and they're throwing off a ton of cash. So you should really be cheering them on to do as many of those Central Region acquisitions as they can, because that's just more cashflow that they're going to be able to have to plug Appalachia assets.

Walker: I just want to give people an idea. You said, "Hey, if it ends up costing them $10,000 net per well to plug all these wells, because they're getting margin from third parties and all this sort of stuff, that's an extra billion dollars. Just to give people an idea, this is a $1.4 billion market cap company, another $1.3, 1.4 billion of debt. So we're talking about an under $3 billion enterprise value company, right? You just said, a billion dollars of excess cash flow, to ExxonMobil, that would be nothing, but to these guys, obviously, that comes over years and years. But to these guys, that is a very meaningful amount of excess cashflow.

Let me let me stick with AROs, and ask you another question. You're kind of mentioning it, or alluding to it when you said, "Hey, when they acquire wells in Texas, and Louisiana, lower AROs, that's more cashflow to cover all the other areas." But a frequent criticism, you will hear of these guys from a Baris, these guys are actually doing a very clever, but very cynical form of financial engineering. And that is this, we buy assets with big AROs, we juice them for as much cash flow as humanly possible, in the near term. We dividend it all to shareholders and interest payments to that and stuff, and then in the end, when that bill for the AROs comes due, we're going to file for bankruptcy or file that asset for bankruptcy, and hand the keys over to state regulators. This is a very, very frequent form of criticism you'll hear, and this will probably bring us into the Bloomberg piece, but what would you say to people who said, "Hey, the whole trickier is under sell AROs, pay everything out to shareholders and leave someone else with the back."

Carreon: Sure. Sure. I mean, I think the first thing I would say is that, there's zero evidence that that is happening. They have never turned over the keys, and walked away from an obligation that they have acquired. If you look at their 2 really big acquisition windows, that was 2018, and 2021, they bought a huge amount of assets in 2018, and they went through COVID. And they didn't turn over the keys to any assets. I would say, that's point number one.

Point number two is that they historically, have paid a flat 40% of cash flow as a dividend, and now it's even less than that. So, their 10% dividend today is maybe not a third, but somewhere between 40% and a third of cash flow. And so it's cheap, but what I would say is, is that, especially with where the strip is right now, I mean, this is an argument that really is just, you have to have kind of your fingers in your ears and be singing lalala. I mean, there's no way to... It's very hard to reconcile that, unless you say, and this is absolutely like we can get into theoretical examples here. But if natural gas falls to 150, tomorrow, and stays there forever, is there going to be a problem here? I would say, probably, yes.

Walker: But that's not a diversified - it's a diversified problem, but it's a Diversified problem caused by an industry problem, right? Like, that's just general industry risk, whereas what people are talking about is, nat gas is 7, but Diversified has been lying about AROs for years, and the bill eventually comes due.

Carreon: Yeah, that argument doesn't really hold water. I think the other thing here is that, the way that I think about it, and let me be very clear, again, like I said this at the outset, the reason that I like Diversified so much is because I've spent a lot of time with them. I think they're exceptionally high integrity people. Again, a guy named Rusty that owns a bunch of wells, what a better story to
write...

Walker: A bunch of old declining wells.

Carreon: A bunch of old decrepit wells. I mean, there's no better story, it's very juicy. But in reality, I really strongly believe that they are doing everything that they can to do the right thing. By the way, let me just say firsthand that, this Bloomberg piece, while I didn't agree with a lot of the things that were in it, I do think every incremental thing is a kick in the seat of the pants. And right after that Bloomberg piece, they deployed 600 field handheld sniffing devices to all of their well tenders. That's a great thing. While it was uncomfortable to have that piece out, I do think that that was probably the catalyst for that, and I think things will continue to get better because they actually care.

Walker: We've alluded to the Bloomberg piece a lot, and you just talked about them. Why don't we just quickly say - I'll include in the show notes - why don't you just quickly say what the Bloomberg piece that we keep referring to is? So we're not making this stories[?] an illusion.

Carreon: Yeah, yeah. There was a Bloomberg green piece that came out in October of last year. I think that the majority of the well visits in that piece, was like mid summer or maybe early summer, something like that, of 2021 There was a group of 2 reporters that basically went around to 44 wells, largely on state land, it was mostly state game land, because they couldn't get approvals to go on to private lands, as my understanding.

They visited 44 wells, so 1/20 of 1% of Diversified's wells, and use the handheld sniffer and a FLIR imaging camera to basically look at a lot of Diversified's wells and across 60% of the wells, they found that when you use the thermal imaging camera or the FLIR, sorry, the FLIR camera, you could see that some amount of methane was leaking from these wells. And so there was a big piece that came out that basically was... Speaking to what is surely a real problem, which is that a lot of these old wells do leak methane, and there is an environmental issue with particularly, neglected old oil and gas infrastructure. Some of which is completely abandoned.

So they put out a report that was pretty scathing, basically saying 60% of these wells, they look decrepit, they look old. This, exactly what you're saying, this company is built on a ticking time bomb of buying these old wells. They have no intention to plug them. It's run by a guy named Rusty. It smells like methane to us, it smells like money to him. The group is called methane hunters, right? I mean, the reality of being an oil and gas company of any type, is that there are people that will just want to keep it in the ground.

Again, if you look at the actual results from that, I think that there is certainly some things that should not have been occurring, that I think, that's without a doubt, a couple of those wells, a number of the wells, for one, they visited 120 of the 1% of the wells, you can't really draw any conclusions from that. For several of the wells that they had visited, they were very recently acquired by Diversified. They hadn't really had a chance to get to them, to fix them.

Some of the leaks of that 60% were pneumatic devices, which is a priority for everybody to fix. Pneumatics are actuated by compressed natural gas, methane, and usually those pneumatics are relating to like getting fluids off the wellbore. So they're necessary to the function of these wells. But when they actually took the samples with the - when they use the, the imaging camera, the only thing that you can tell is that there's some amount of methane leaking.

I know you've covered this to some extent in your piece, but like, go sit at a fuel repumping station and look through one of these things, you will be terrified. I mean, if you lived your life looking through one of these things, you would think the world is ending.

Walker: The quote expert told me was, he was like, "Do I know about the Bloomberg piece? Yes. Did I read it? No, there's been 100 hit pieces like it. If you take a FLIR camera and go turn a lawnmower on and look through the FLIR camera, as you said, you will think the entire world is ending. But no, t's just a lawnmower."

Carreon: Yeah. And so the amount that they actually measured with the high flow sampler, was very much in line with what Diversified had already disclosed in their sustainability report. I'm not saying that that's okay, and neither do they think that that's okay. They're trying to get their emissions down, and their biggest priority is methane. Their most recent sustainability report, which was the 2021 sustainability report, was a methane intensity of about a third of a percent. So of the total natural gas that they produce, roughly 1/3 of 1% escapes as fugitive emissions. When you think about fugitive emissions, the thing to keep in mind is that methane is what Diversified sells.

They are very incentivized to go, and get more molecules to the sales meter, because typically, and they said for these leaks that were identified by these 2 reporters, it was a total repair cost of $2,000. And most all of them were turn of a wrench, to tighten the pipe. These are not hard fixes, they require consistent attention and time. They are aligned with you, in terms of wanting to make sure these don't escape, as emissions.

The other thing is that the average Diversified well tender lives 30 minutes from his well. These people live in the communities that these wells are. They're not trying to pollute. These people care. A lot of you these well tenders, they love being outdoors. They're very patriotic people. You know, it's so easy to paint things with a negative brush, but in reality nobody wants to be part of the problem.

Walker: I don't know if this is too naive on my part, but one thing that kind of got me a little more comfortable with this, as well is, this Bloomberg piece has been out for, let's call it a year at this point. If there was real meat to this bone, I would have thought some politicians would have jumped on this and started like shouting. Not that you can make a career out of just like crucifying one really small oil and gas company, but you can make a pretty good local career or a sort of one, out of kind of crucifying them on don't leak in our backyard. To my knowledge, I could be missing something, I haven't seen anybody really tried to make anything of it, which suggests to me that the problem was pretty small and Diversified with sitting down with couple of people, were able to explain, "Hey, if you really try and turn this into thing, it's probably not going to go well for you. Because there's really not anything here," and people believe them. I don't know if I'm naive on that or not?

Carreon: No, I think when you talk to state regulatory bodies, when you talk to... I mean, diversified is co-managing the state of Ohio's state program. They have a very, very good reputation for doing the right thing. While that might not sit well with some people who want a more extreme outcome, or who cannot possibly conceive that an oil and gas company could be part of the solution. You know, it's hard for them to swallow. But I think the...

Walker: I don't know if this is a bull or bear case, but you will frequently hear, Diversified's doing so many wells and has so much AROs. They're too big to fail, and they'll also mentioned the Ohio state regulatory program. Some people will say that in a negative way, as in, "Hey, they're never going to pay the AROs in full because they'll keep going to the States and be like, look, if you leave us out to dry, we're just going to hand you a billion dollars worth of AROs. So give us some breaks, let us keep harming the environment, because if not, you get this bill of goods." And a very cynical bull case would be the same thing, but that says, "Hey, they can use their cashflows[?] to do that. I don't think either are necessarily true, but I think it is worth quickly addressing.

Carreon: Yeah. I think that is certainly speculate - people of course, say that all the time. The reality is, is that depending on what source you look at, I mean, there's an estimated million orphan oil and gas wells out there. They've got 70,000, 60,000, I mean, too big to fail. We already have a monster problem in the United States. My personal view on this and you know, I'm based in New Orleans, my personal view on this is that the onshore liabilities are going to be a walk in the park. We are, you know, knock on wood, without some kind of major across all oil and gas fallout of some disasterous proportion, we are going to take care of these onshore AROs, the offshore AROs really freaked me out.

When you start diving in, particularly into just the gulf, how many non producing offshore, abandoned platforms there are, it is terrifying. These are way more complicated to address. I'm not saying that we don't have a problem, we need to address this, and it's going to be a collective effort. But it is not the pipe sticking out of your backyard and middle of nowhere, Virginia, that scares me. You can address that, that's not a super complicated thing. Deep water abandoned well, that freaks me out.

Walker: Having dealt a little bit with longtime listeners who know Amplify Energy, having dealt with this a little bit with Amplify Energy and the oil spill off the coast of California, I can say that it is no joke handling environmental liabilities and offshore. It is just absolutely crazy. You've been super generous of your time. But I do want to ask 2 more questions before we go, and then I'm happy to keep going because I'm learning so much for this.

The first question, look, it wouldn't be a podcast without asking, and it's particularly relevant here. These guys pay on a massive dividend, and a lot of people will look at that and say, "Look, they're out here saying, we trade for half of PV10, 33% free cash flow yield to our stock," which by the way, it's not free cash flow yield that's juiced by super high energy prices, because one of the great things I like about these guys, is they hedge so much that they're kind of realising $3 oil and gas prices when gas at 9. It's 33% on hedged numbers, they've got great visibility.

Why are they paying this massive dividend? Why don't they keep raising the dividend? Why don't they buy back stock, like a lot of people will point to the dividend in lack of share buy backs as, "Hey, further proof that they want to leave a bag of goods to the AROs at the end, and they're just trying to get all the cash out of the state, in the meantime." One of my push backs on curate - sorry, I'm rambling here.

Carreon: No, no, no. This is great.

Walker: Q rate[?] in 2020, they paid out a big dividend, they paid out some buffers, they paid a big dividend. And a lot of shareholders looked at them and say, "Look at the free cash flow year, they're going to give you all that shareholders." And my kind of different point was, John Malone has never paid dividends before. The man hates paying taxes. He always buys back shares. If he's paying out dividends here, it suggests that he's really worried about terminal value here. And a lot of things happened in between now and then. But I think that proved out right. And here, I could see a rhyme and reason why they're trying to get all the cash flow out of the estate.

Carreon: Yeah, so on this one, I think, there are a lot of reasons. When you think about what they're trading off, like right now, their stock is very cheap, very cheap.

Walker: Very cheap.

Carreon: They are able to still buy acquisitions at a competitive, or maybe I would, say even more attractive price than what they're... They're trading at a half a PV10, so maybe that's a pretty high bar right now in specific. But you also have to think about that acquisitions have a strategic... it's not apples to apples. Take the Conoco example, Conoco is very contiguous to the Tapstone assets that they had. They bought them for PV17, let's call it 70% of PV10. Which, yeah, okay, that's more expensive than buying back your stock at half of PV10. But they are going to get some synergies on both that Tapstone footprint and the Conoco footprint by plugging in that asset. That model is built on keeping the density going, and making sure that you can drive down your cost per well.

So there is a strategic benefit to making sure you continuously plug in assets. That's kind of number one, is that they need to, in order to keep... lIf you think about a well tenders' footprint just as is, that is going to be continues to be declining at some rate. You need to ideally, keep plugging in wells to that footprint to keep, at least on par, but hopefully, give that tender even more production.

One of the things that I'm excited about here and again, I don't want to turn this into a 2-hour pod, but I would love to, but they have 8.6 million net acres of undeveloped acreage or partially developed acreage. Let's say that you have a well attended that's got 50 wells in their geographic coverage area. Well, one of the things that could be a potential worry saying, well, okay, let's take Appalachia where they've required everybody already, in this area. There's nothing else to plug in. Well, they can go into the best spot in that radius and drill a $300,000 well, to keep the production in this dense footprint high enough to make it economically viable, for that well tender to keep servicing the wells.

Walker: Is there still gas for them still? Because my understanding, not all, but a lot of the land is it's pretty tapped out at this point. It's very well-drilled, well-developed.

Carreon: No, that is not the case.

Walker: Okay.

Carreon: I shouldn't say that's not the case. That is the case at certain price decks, I would not say that's the case at this price.

Walker: That's a great point. It might have been the case when gas was 250 or 3, but when gas is 9, there's... This is one of the things that a lot of people said, we have fields that were completely on economic for 5 years, when gas was 3, gas are 9, these are like the most profitable fields in the history of the world to drill at this point.

Carreon: Yeah, yeah. So I think at $5, $4-5, they have lots of areas in Appalachia, that they can use to infill drill, to keep the route density economically attractive. And then, we can don't have to go on this tangent, but in the central region, particularly in the Cotton Valley, those are 10-11,000 foot wells deep. There are many, many horizons uphole, from where those wells are drilled. They're actively doing this right now. But like the Austin formation, which is uphole from the Cotton Valley, I mean, at $4 gas, the returns they're getting on some of these uphole perps and re completions are very attractive, very attractive.

Walker: I didn't realise it. Look, that's one of the things both CNX and Diversified, which CNX was the other one I did the industry dive on. Their stocks haven't moved as gases went off, because people keep looking, say, "Oh, they're 90% hedged in the short term, so we're not going to get that short term cash flow gusher." Like, yeah, of course, I wish they could get that short term cash flow gusher, but they're almost more levered in the long run, because they're going to start hedging out 2027, at prices 50% higher than they were 6 months ago. And by the way, they do own all that land of acreage, and when gas goes from 3 to 9, a lot of that acres that wasn't economic to develop, they can develop and they're completely unhedged on stuff that they haven't drilled, obviously. They get a lot of value that I think the market hasn't given them credit for.

Last question, and then I'll let you go. I just want to ask opportunity costs, and we don't have to talk the DC versus CNX, but I do want to compare DC versus your first podcast, BSM, right? And I think they're an interesting comparison, because BSM benefits from oil and gas rising. They have a very similar dividend yield, you know, both are yielding around double digits right now. But when you look at BSM, you don't get this great acquisition roll up steadily. But also no debt on the balance sheet, basically, no headaches with Asset Retirement Obligations and everything. It's just this very clean story with lots of leverage to higher energy prices, but it's very clean story.

I was just wondering if all portfolio management is opportunity costs, holding cash versus buying BSM versus buying DC versus just go into buying Berkshire and sitting on a beach somewhere or something. So, just the opportunity costs of these 2 versus anything else in the oil and gas industry you're looking at?

Carreon: Absolutely, yeah. I am very partial to natural gas, so both both BSM and Diversified. I think that it's a bit of an unsung hero, and I think that that will be more appreciated, and...

Walker: One of the interesting things as I've done, I haven't quantified it, but some people have done work too. If you really believe in electric vehicles coming on, all that energy to charge them has come from somewhere. They said it's a lot of power and natural gas is going to have to power a lot of that. Then you're up in LNG - sorry, I just had to throw [inaudible]...

Carreon: No, yeah. And if you look at backyard here in Louisiana between Austin Houston, I mean, the LNG that's both approved, look at the FERC website, proved under construction and approved, like between the driftwood, different things that are seems like they're getting to FIT pretty soon. I mean, you have a very bullish picture for demand, particularly for Gulf Coast demand for natural gas, which is very good for, you know, not to be long winded here. But one of the things historically, that I was worried about with Diversified is that it was all Appalachia.

One of the things that really got me interested is when they started doing more Gulf coast because I really liked Gulf Coast gas and as you know, BSM has just a crown jewel of portfolio in Gulf Coast, Haynesville Anchorage. So, as you kind of correctly point out, BSM is definitely a bigger position. It is a, in my mind, just an absolutely irreplaceable asset, extraordinarily high quality. As you think about that kind of lights cap stack of energy, mineral rights are the king. You get paid, you go through bankruptcy untouched, you have no cost.

I would say that for both Diversified and BSM, to some extent, you are benefiting from a view of potentially running out of tier one acreage. Diversified, I mean, BSM has a huge, undeveloped asset base as well as very well mapped out quality tier one acreage. But as across the country, we continue to drill out our tier one locations. Drilling costs are going up, and the productivity of the wells, my guess would be that they're going to continue to come down. As that happens, the price of commodities has to go up. I mean, that's...

Walker: Not from these levels, [crosstalk] from where people are used to. Yeah.

Carreon: But from what people are used to. And so the reason why we had such a treacherous environment was truly like, we saw productivity gains in these wells that were just unbelievable, more than anybody, would have expected from shale wells. The DNC drilling and completion costs for these operators just continued to fall and fall and fall and fall, and they were just so innovative on how to squeeze every dollar out of these drilling rigs. In 2018, 2019, on our lateral foot basis, across most of the basins I've seen is really where you saw productivity peak out. So it's already going down.

Walker: I was just going to say, one thing that's interesting for both DC and BSM, is BSM was saying on their last call, they're like, I can't remember what acreage it was. But they said look, what was it? I can't remember what acreage was. But he said, 15 years ago, we ascribe zero value to that acreage, and now it's like one of our largest producing acreages, because of developments and technology. Not even price developments, just developments in technology made it economical.

Both BSM and DC as the technology gets better, as you were pointing out earlier, a lot of DCs things that weren't economic, they've got all these old wells, you might go take another look at and say, "Oh, we're not using 1980s technology anymore, we're using 2020s technology," and we actually can go and find a lot of oil that's really economical to produce, and all the infrastructures built out there. Both of them really benefit from continued increases in technology, as well as prices going up and all that tech stuff.

Carreon: Yeah, yeah. I guess the last point I would say is that in terms of comparing and contrasting BSM and DEC, is that BSM is on the most conservative end of the spectrum as you could possibly imagine. I mean, they have no debt now. I think that that business should be run with some debt. I wouldn't necessarily call them aggressive acquires of assets, but they certainly are aggressive in terms of getting operators onto their lands and trying to spool up kind of organic development, and they have a great team for that.

DC, on the other hand, they are dealmakers. Diversified is a energy only private equity business. They had very niche thing that they do which is by producing wells. They're private equity guys. They are very financially savvy. Look at their debt structure, they have all of their debt is an asset backed long term fixed rate structures...

Walker: Which I think they were one of the pioneers of, with old declining wells, if I'm remembering correctly.

Carreon: They didn't... They are the first to do it. And so these are ABS structures that are 6 different separate vehicles that is just incredible structuring of this... All the reasons that people hate private equity, Diversified ticks the box

Walker: I've tried to pitch smaller companies on doing that to realize some value for land, for production, I don't think they're getting any credit for. And all of them said, "Look, it's a really interesting model, but it takes expertise, cost and scale that we just do not have," which is obviously a feather on their cap.

Carreon: Yeah, yeah, so very different businesses. I think that the attraction for Diversified is that people will continue to hate oil and gas and sell them assets.

Walker: One last question, and then I'll let you go. I got so many questions. I tried to do one stock, one podcast, but I have to ask, BSM, their CEO, but it wasn't huge in the grand scheme of things. He bought $750,000 worth of stock earlier this month, which would be huge for me, it's not huge for him. But this is the first insider purchase, I think, since 2019, and it's the first sizable insider purchase, probably ever. A lot of people were wondering about that. To me, I just think it's, "Hey, if you listen to the Q2 call, that was the most bullish, I think I've ever heard him, on the company. I think he was in an open window, and he said, "Let me take this pocket change under my cushion and put it there." But what do you think?

Carreon: No, absolutely. It is very hard for me to understand how we haven't had a little bit more of a move, with as bullish as they were on the last quarterly call. I know we talked about this, and you kind of rightly pointed out to me that, for whatever reason, even though we've had a really strong strip in natural gas, and with Freeport coming back online, I don't see how that doesn't get stronger. But we've had a very strong strip of natural gas, and somehow the business seems to be entirely correlated to oil.

I thought that was a really funny observation that you pointed out, but it seems very true. Even though it's 75% production of nat gas, it seems to move everyday with oil. And they basically, if you pencil out what they've said, with a Athan, who was drilling their prized asset, which is the Selby trough, and I keep tabs on those wells, and they are monster wells. In between that, and maybe some additional growth on the Austin shock acreage with a expect to have about 30 wells drilled over the next 12 months. They're pencilling in a 25% growth between last quarter and end of 2023 exit volumes for the royalty piece.

Because it doesn't look that high if you just take the gross numbers they gave you, but the working interest piece is declining. So when you back into what that means for the royalty volumes, it's like a 25 or a little higher, year over year, or maybe six quarters increase. And that's all gas basically, I mean, it's all gas. Then, I think you exit that, probably still growing in the low teens or high double digits, or high single digits. It's very cheap. I think it's really attractive.

Walker: Look, it's just one of those ones I love. One of my other favourite podcast questions is, how do you kill this company? Like with BSM, the more I've done on it, the more it's like, there's no debt on this right? The CEO owns about 25%. The way you kill this company, okay, oil and gas go to zero overnight, yes, fine industry risks like that. But if you start to talk company specific risks, the way you kill this company is horrible capital allocation. Like on the scheme of complete incompetence, and, again, the CEO owns 25%. Have they made some missteps? Yes. But one of the things I liked on the Q2 call was, they owned up to a lot of those missteps and they said, "Hey, we're aware of what we did. We're going to keep systematically hedging. We're not going to be cowboys one way or the other. We understand, we sold some at the bottom, but we wanted to make sure we got through to them and don't worry, we understand the value."

It's one of my favourites because great earnings growth, they're gonna give you the cash back and it's really hard to kill. And BSM and DC have another interesting thing in common, where there could be like an ownership catalyst. Where DC, all their assets are in the US. They're listed in London. They've been very clear they'd like to come over to the US at some point, which I think would make a lot of sense. BSM, MLP structure, half the people I talked to I say MLP and they say, "Not for me, pass," which I completely understand, but both them, maybe one day that changes.

Anyway, I've rambled Andrew, I've learned so much from you. It's so great talking to you. So great to have you on the podcast. Anything we didn't cover you think we should hit or anything?

Carreon: No, this has been great. I think we could keep going for another hour and a half of the [inaudible].

Walker: But the good news is you run concentrated but I know most of your other holdings, so I'll be ready to bring you back on for podcast number three. But Andrew, this has been awesome. Thank you so much for coming on. Again, looking forward to podcast number three.

Carreon: Yeah, I really enjoyed it. Thanks for having me.

[END]