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FANG Diamondback Energy

Participants
Travis Stice Chief Executive Officer
Kaes Van't Hof Chief Financial Officer
Adam Lawlis Vice President, Investor Relations
Derrick Whitfield Stifel
Neal Dingmann SunTrust
Scott Hanold RBC Capital Markets
Scott Gruber Citigroup
Gail Nicholson Stephens
Brian Singer Goldman Sachs
Jeanine Wai Barclays
Jeff Grampp Northland Capital
Asit Sen Bank of America
David Deckelbaum Cowen
Michael Hall Heikkinen Energy Advisors
Charles Meade Johnson Rice
Richard Tullis Capital One Securities
Leo Mariani KeyBanc
Call transcript
Operator

Good day, ladies and gentlemen and welcome to the Diamondback Energy’s, Fourth Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. Adam Lawlis, Vice President, Investor Relations. Sir, you may begin.

Adam Lawlis

Thank you, Kevin. Good morning, and welcome to Diamondback Energy's, fourth quarter 2019 conference call.

During our call today we will reference an updated investor presentation, which can be found on Diamondback’s website. Representing Diamondback today are Travis Stice, CEO; and Kaes Van't Hof, CFO.

During this conference call the participants may make certain forward-looking statements relating to the company's financial condition, results of operations, plans, objectives, future performance and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements due to a variety of factors.

Information concerning these factors can be found in the company's filings with the SEC.

In addition, we will make reference to certain non-GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon.

I will now turn the call over to Travis Stice.

Travis Stice

Thank you, Adam, and welcome to Diamondback’s fourth quarter earnings call.

Before I start with my remarks, I want to pause and recognize an individual who passed away last week, Clayton Williams, who was truly a larger than life West Texan and a man that paved the way for so many in our industry who came after him. He was a wildcatter, a patriarch, a philanthropist, and a Texas Aggie.

Later today, we will lay him to rest and celebrate a life well lived, but I couldn't start without reflecting on what Claty has meant to so many people. Mr. Williams and family, our thoughts and prayers are with you today. Godspeed Clayton Williams! You will be missed.

Turning to the fourth quarter, Diamondback ended 2019 in a position of strength, achieving 5% oil production growth quarter-over-quarter, along with our highest oil realizations of the year. This, combined with our industry leading cost structure resulted in 18% quarter-over-quarter EBITDA growth and 31% quarter-over-quarter adjusted EPS growth.

We repurchased 2.4 million shares in the quarter for approximately $199 million, utilizing free cash flow and a $43 million gain from an interest rate swap that was unwound as part of our first investment grade bond offering in November to repurchase shares at a depressed valuation.

Further, Diamondback did not slow operations in the second half of 2019 and maintained continuous operations with eight completion crews running consistently through the end of the year, setting us up for continued growth and operational momentum in 2020.

Taking a step back to review the full year, 2019 was a busy year for Diamondback. We successfully integrated our merger with Energen, doubling the size of our company, while achieving greater cost synergies in a shorter period of time than originally promised at time of deal announcement.

We grew pro forma oil production 26% year-over-year from a $2.9 billion capital budget, increased our dividend by 50% and repurchased 6.4 million shares or about 10% of the shares issued to complete the Energen merger.

On the corporate development front, we sold non-core assets, dropped down mineral interests to Viper and took our midstream business public. In November, we executed of the final piece of our synergy scorecard and refinanced $3.0 billion of the company's long-term debt, following our upgrade to investment grade at an attractive interest rate.

Well, I'm proud of what we accomplished in 2019. We don't spend any time looking backward at our tracks in the sand, but rather looking ahead and concentrating on the future. 2020 has already brought its own industry challenges and we are focused on navigating these challenges by staying disciplined, improving our industry leading cost structure, growing production, increasing environmental transparency and returning more cash to stockholders.

Our dividend remains our primary method of returning capital to stockholders and as evidenced through our announcement today, we are strongly committed to continuing to grow this dividend, which sits at a 2% yield at today's stock price.

We will continue to be opportunistic with our share repurchase program and outright debt reduction to maintain balance sheet strength, but our dividend is considered first dollar out when it comes to capital allocation at Diamondback.

Looking to the year ahead of us, Diamondback expects to grow oil production in the first quarter of 2020 on the back of our strong fourth quarter production in route to our 10% to 15% year-over-year expected oil production growth in 2020.

We expect to execute this plan within the same capital budget framework as 2019, while completing 7% more lateral footage with the same amount of capital.

Our oil realizations are expected to improve to nearly 100% of WTI in the first quarter of 2020, which will be a nice tailwind for per share metrics. Full service start-up of the EPIC and Gray Oak pipelines in the second quarter will increase our exposure to the export and Gulf Coast markets, as well as increased cash flow through our 10% ownership of each pipeline at Rattler.

We will also continue to work to drive down cash operating costs through the year, with LOE expected to decline relative to 2019 numbers.

We believe this capital and operating plan reflects the optimal capital efficiency for achieving a peer leading combination of grow and free cash flow in 2020, should commodity prices decline further from current levels, we will be prepared to act responsibly and cut capital further, just like we've done multiple times in the past. If commodity prices rally, we plan to use excess free cash flow to accelerate our capital return program and reduce debt.

With these comments now complete, operator, please open the line for questions.

Operator

[Operator Instructions] Our first question comes from Derrick Whitfield with Stifel.

Derrick Whitfield

Hey, good morning all, and congrats on your decision to reinforce your return of capital message with a substantial dividend hike.

Travis Stice

Thank you, Derrick.

Derrick Whitfield

Perhaps for you Travis, as we critically evaluate your inventory additions in the well performance trends by intervals, it’s clear to us that the Middle Spraberry in the Delaware Second Bone Spring intervals are becoming more valuable intervals within your inventory set.

Focusing on the Bone Spring shale in Pecos, to what degree have you guys delineated the trend across your footprint and are there specific or any specific reasons this interval can't account for a larger percentage of your Delaware allocation in future years.

Travis Stice

Yeah, Derrick certainly we are very encouraged at what we're seeing in the Second Bone Springs across our Delaware position and look for continued results like we posted that we're going to continue to allocate more, more capital to the Bone Springs, but you know we are very encouraged about that inventory development and also our existing inventory as we continue to drive down costs and improve returns on all of our Delaware position.

Derrick Whitfield

Sure. And as my follow-up, I’ll stay on the Bone Spring shale. I imagine your operations team could drive meaningful cost improvements in a fulfilled development scenario. Could you speak to your current completed well costs in comparison to the Wolfcamp A and also comment on the potential savings you could see in a fulfilled development scenario.

Kaes Van’t Hof

Yeah Derrick, I think from a drilling perspective it's about $40 to $50 a foot cheaper.

You know so assuming the same completion design at the Wolfcamp A and Pecos that would be about $0.5 million cheaper on a 10,000 foot lateral. We’ll say one of the benefits is, there's been so much infrastructure dollars, some many infrastructure dollars spent in Pecos that you don’t have to load up the Bone Spring pads with the same level of infrastructure spend as we did for the Wolfcamp A over the last few years.

So, you know really excited about the results we are seen there. It’s certainly becoming a competitive zone to the Wolfcamp A and we’ll start to take more of the capital dollars in that field.

Derrick Whitfield

Thanks guys. That’s very helpful.

Travis Stice

Thank you, Derrick.

Operator

Our next question comes from Neal Dingmann with SunTrust.

Neal Dingmann

Good morning all. Travis, my first question is on investor metrics. Among the Permian players we have a fuel generated amongst the highest combination of oil drilled free cash flow yield and divided yield at about over 15% already. Could you speak to your confidence on sustainability to maintain this or potentially grow these metrics in todays – you know or even the lower oil environment.

Travis Stice

Sure, Neal. I made a comment in my prepared remarks that our board is committed to continuing to grow our dividend. The free cash flow yield and volume growth, we feel confident that those numbers are multi-year in duration and obviously we've got an inventory that can support that.

So we're really pretty excited about sustainable oil production growth, as well as increasing free cash flow, total free cash flow yield and dividend growth as well.

Neal Dingmann

Very good and I would be remiss if I didn’t ask a second question on M&A. Could you all just comment, Travis for you Ks, that your view on the need for M&A especially in such a continued volatile energy tape.

Travis Stice

Yeah, you know look Neal, our shareholders expect us to know everything that's going on out here in the Permian and with Bruce on the ground out here, we certainly do, but they also expect us and I know that from our past performance that anything that we consider needs to be accretive, which means you know on several metrics free cash flow, cash flow per share, EPS inventory quality and operational efficiency.

So, you know any deal that we're interested in, it’s got to be extremely compelling from a price perspective given our current stock price and the abundance of cheap opportunities out there in the marketplace.

As I just was talking to Derrick, you know we’re very confident with our inventory and that inventory is going to drive growth for many years in the future, but we also have responsibility to our shareholders to continue to stay in the game and looking at opportunities that are really attractive.

Neal Dingmann

Very good. Thanks for the details.

Operator

Our next question comes from Scott Hanold with RBC Capital Markets.

Scott Hanold

Thanks, and maybe it’s just a good time to follow up on the last question.

Just in general, do you look at your lateral length and you know as you go to these longer and lateral lengths, I mean look at your average lateral inventory.

You know how do you see that progressing? I mean is there a lot of opportunities you had to block up? I know you talked about a Northern Delaware transaction, but as you look at your footprint, what should we expect that lateral length to look like, say in the next year or two on average.

Travis Stice

Yeah, you know Scott our asset themes you know have their own little business development opportunities where they know that drilling longer laterals improved economics and increased our returns to shareholders through increased free cash generation, and that's part of our day-in and day-out business. We would like to always drill longer laterals.

I think somewhere in that 10,000 foot length is probably where our inventory is typified by today, but certainly we’ll look to always to push that.

Scott Hanold

Okay, fair enough. And as you step back and talked about the proposition you give for investors in that mid-teens growth, strong free cash flow yield and good dividend yield, you know how do you see that you know growth rate, that production growth rate going forward and you got that low to mid-teens number kind of set right now in this year, but as you look into say 2021, 2022 would you like to maintain that rate? Does that maximize your free cash flow or do you think over time it could fall to sort of the 10% to 12%?

Travis Stice

Well, certainly the law of big numbers catches up with you and you know if you're going to maintain flat CapEx on a year-in and year-out basis, that’s going to have an impact on your overall production growth.

So we believe that having that double digit growth rate combined with the yield that we have, provides our investors a clear differential investment thesis and we've got the inventory that we think we can support that for multiple years to come. But as we continue to try to grow production on a larger and larger production base, you're going to have to see the CapEx numbers, minus capital efficiencies continue to increase.

Scott Hanold

Yeah, and I guess the bottom line, I should have been more succinct in saying, as you look forward to that free cash flow, you know how does it get allocated between dividend, buy backs and investing in the business to continue to grow. Like how does that allocation change over time?

Travis Stice

That’s an important point Scott.

You know really, free cash flow should be defined as cash flow available above your sustaining CapEx and for us, you know right now the sustaining CapEx to keep production flat, exit-to-exit is about $1.6 billion.

Now, above that in the mid-50s oil price environment, we have you know a couple of billion dollars of cash flow to allocate, and today in 2020 we’re allocating two-thirds of that to growth and a third of that to shareholder returns.

You know so I think for us, we shouldn't capitulate on growth.

I think Diamondback is still a growth story and now it’s a growth with free cash flow story.

Scott Hanold

That's perfect. Thanks.

Operator

Our next question comes from Scott Gruber with Citigroup.

Scott Gruber

Yes, good morning.

Travis Stice

Good morning Scott.

Scott Gruber

Well, just a quick question on the Midland Basin development by zone.

You guys have been pretty forthright here with the 2020 mix. Is the mix largely optimized at this point? As we think about ‘21 and beyond, is there much additional shifting between zones and changing that percentage of total development beyond ’20?

Travis Stice

Yes, Scott.

So I think you know the big mix, the shift to co-development happened in 2019 with a little carry on into 2020. The whole point of the core development strategy is to get the economic zones that are available today all at the same time.

So I think, as you think about development strategy going forward, the Middle Spraberry and the Wolfcamp B will have a bigger piece of the total pie versus past years. I’m hopeful that it stays about consistent to 2020, but as we move across various areas where in some areas the Middle Spraberry is better and in some areas Wolfcamp B is better, but overall this development pace is going to be standard across the company and we are co-developing everywhere in the Midland Basin.

Scott Gruber

Got it! And maybe just turning back to the dividend growth to see the doubling today.

As we think about you know the go forward, you mentioned continuing to grow the dividend, how do you think about where you want to place the dividend? Obviously the stock price will dictate the yield. The near term, is there a number that you're targeting, you know over the next, call it year or two to continue to grow that dividend? And then longer term, how do you think about a proper pay-out ratio for the business just given the volatility in the commodity price?

Travis Stice

Yes Scott, so we’ve heard a lot of feedback from investors over the last 18 months, particularly around the dividend and grow in exchange for that capital return.

I think the only consistent message we've heard from our large shareholders is that they want the dividend larger sooner.

So for us, you know we took a big jump this year as we are fully shifting to growth plus free cash flow in 2020 and that was an important step for us.

Now I think in the future, the dividend is still going to be the primary return of capital and going to need to grow. We don't want to grow it to the point where our implied yield or the payments we need to make on that dividend are a restraint on our business plan, but today it's unfortunate that we got to a 2% yield near the stock price, but we were always focused on getting that dividend to a meaningful level, which is near a couple bucks a share.

Scott Gruber

Got it. I appreciate it. Thank you.

Travis Stice

Thank you, Scott.

Operator

Our next question comes from Gail Nicholson with Stephens.

Gail Nicholson

Good morning. LOE, can you talk about the progression for LOE throughout the year and then what specific projects you guys are working on that will drive improvement?

Travis Stice

Hi Gail, yes.

So we took it a nice step down in the fourth quarter. We guided to 440 to 480 for the year. I would say the first half of the year, it's probably going to be on the higher end versus the back half of the year we start to see some benefit from large projects, particularly on the electrification side of our fields.

Right now we are renting a lot of power generation infield and while that’s – with these turbans is better than small diesel generators, it's not as efficient as being hooked up to the grid.

So as we progress through the year, we should see a nice trend down in LOE based on getting electrification in Howard County, Pecos County and Northwest Martin County.

Gail Nicholson

Great, thank you. And then on the infrastructure spend in 2020, what percent of that is one time project versus normal course of business, and how should we think about that trending in ‘21 forward?

Travis Stice

Yeah, I would say that's a one-third one-time project.

With the integration of Energen, we have learned that some areas are better for gas lift in our field.

So there are some gas lift projects that are one-time in nature, and then the electrification as I mentioned there will be some one-time projects.

I think you know credit to our facilities team, we're going to complete 340 wells this year and about half of those need zero dollars from an infrastructure perspective.

So I think that's a pretty impressive feat by the infrastructure team.

Gail Nicholson

Great! Thank you.

Operator

Our next question comes from Brian Singer with Goldman Sachs.

Brian Singer

Thank you. Good morning. I wanted to follow-up on one of the earlier questions with regards to the trajectory between CapEx, free cash flow and growth. When you look at your inventory and your expectation for further efficiencies on the cost side, how long do you see your ability to source double digit growth at flat CapEx and where are you on the trajectory versus growing CapEx in future years relative to seeing your growth rate decelerate to the low end or below the 10% to 15% range.

Travis Stice

Hey Brian, it's important what service costs are going to do, right. I mean if service costs stay flat, you know our midstream and infrastructure budgets will continue to decrease, and therefore we’re able to get more in that wells within the same budget framework.

So I think we’ll address ’21 and ‘22 as we get closer and see what service costs and oil price does, but we're not going to give up on sustainable growth, but also that growth in the free cash flow on a gross basis year-over-year.

Kaes Van’t Hof

You know look, the organizational emphasis has always been to grow and as we mentioned earlier, also grow the dividend.

You know one of the ways that our guys differentiate themselves in the way that we become more and more capital efficient as we go forward in time end-to-end. Well, we know that that becomes somewhat asymptotic as you go forward in time.

You know that's still part of our core competencies, is to pick pennies and nickels up where we used to pick up you know the dimes and quarters.

And so organizationally Brian, we are going to continue to drive efficiencies well into the future.

Brian Singer

Great! Thanks and then can you add any color on how do you see the production trajectory and CapEx trajectory through the year and the set-up that that would provide going into 2021?

Travis Stice

Yeah Brain, you know I think the way we have it setup is to be – you know operate fairly consistently throughout the year as exhibited by 2019. We did not slowdown in the second half of the year and we have no intention to this year. We're running 21 big rigs today, two salt water disposal rigs and you know 8.5 factors essentially and that pace should be pretty consistent.

I think we do plan to grow off of what was a very good number in Q4 and then as you think about the rest of the year, we should have fairly consistent growth from Q2 through Q4.

So we would really like to set up here and also the set up for ‘21 as we don't plan on slowing down in the back half of the year.

Kaes Van’t Hof

Yeah, you know Brain, just like I was talking about the organizational culture of efficiently, it didn’t make sense to us to go to the operations organization in the back half of last year and say, ‘okay guys, start laying equipment down and then we're going to ask you to pick it back up in the first quarter and immediately assume the same level of operational management and capital efficiency.’ So that was the reason we decided to continue with the efficiency and that's what's led to what we feel like is a good growth in the first quarter as well.

We are not having to catch up or make up ground that we lost from laying down activity in the fourth quarter.

Brian Singer

Great, thank you.

Operator

Our next question comes from Jeanine Wai with Barclays.

Jeanine Wai

Hi, good morning everyone.

Travis Stice

Hey Jeanine, how are you?

Jeanine Wai

Good morning. Great! Thank you. My first question is on buybacks versus debt reduction, just following up on some of the prior questions.

With the 2% dividend yield now at the current share price, how do you think about buying back stock versus specifically reducing debt? We know that your debt is trading at a higher yield. This could increase strategic flexibility in the future.

You've got some nice IT tailwinds going on for you as well.

Travis Stice

You know, I’ll let Kaes answer that in detail. But I’ll just say, in general you know, the higher the oil price probably the less you buy back stock in our business and likewise the converse of that's also true; the lower the oil price, the more you're going to buy back.

Kaes Van’t Hof

Yeah, I would agree with that. Today, where we are, we still have free cash to buy back stock.

We are not concerned with our leverage ratio or overall leverage. Certainly it’s important for an oil and gas company to decrease leverage over time, but unlike other companies, we also have a significant amount of equity in two subsidiaries that is monetizable, you know not at a moment's notice, but can be monetized.

So I think for us on the balance sheet side, we're going to keep taking care of converting our old high yield notes into IG notes throughout the year and continue to drive down the overall interest expense at the company.

Jeanine Wai

Hey great, that's very helpful. And my second question is on inventory. How do you think about the cost of adding Tier 1 inventory? For example, how did the cost compare from moving current Tier 1 – current inventory into Tier 1 via exploration, appraisal, whatever else you may think of verses inorganic additions either via M&A and acreage trades tend to be pretty high ROIs as well.

Kaes Van’t Hof

Yeah, acreage trades are certainly the highest rate of return possible and we got about 40 of them done last year with the two combined businesses of Energen and Diamondback.

So that was a lot of low hanging fruit for us to improve.

Now you know I'll let Travis comment on the other piece, but all I would say is that any inventory additions today in the Permian are significantly cheaper than they have been in any time in our short history.

Travis Stice

Yeah, like I mentioned earlier, you know we have a set of metrics that we have to be accretive on and we'll continue to – we’ve always done accretive deals and we’ll always look at these accretive metrics.

You mentioned like three different ways and one of them was exploration and while that's been a very small part of Diamondbacks history, we did release results on our 25,000 acre play that we entered in about three years ago with – had a really, really low cost on this energy well and while for a $20 billion company, one well test is not particularly that significant, but it sure was a good test for the first well that we drilled, the Xanadu well.

I think it’s IP 30 or something over 100 barrels a foot and now we're turning it over to the execution guys who would be moving to the appraisal stage and drive costs down and as we drive costs down it’s going to push up the returns for that and you know probably attract a one to two rig program in our future capital allocation decisions.

So it’s really all three of those things. Acreage trades are certainly a day-in and day-out opportunity, looking you know at accretive acquisitions you know and extremely low valuations that we see today and then we sprinkled in a little bit of exploration success.

So I think we're executing on all three of those strategies.

Jeanine Wai

Thanks. Great! Very helpful. Thank you for the detailed response.

Travis Stice

Thank you Jeanine.

Operator

Our next question comes from Jeff Grampp with Northland Capital.

Jeff Grampp

Good morning guys.

Travis Stice

Hey Jeff.

Jeff Grampp

Was curious, we’ve talked a bit on kind of how you guys are thinking about growing the business going forward and I guess related to that I was wondering, if I'm looking at slide 10 I think, you guys referenced both the PDP oil decline and BOE decline rates. How should we think about those changing given that you guys will still be growing the base? Do those really moderate at all given that you are still growing or just kind of wondering high level, like if we had rolled out forward 12 months, how do you guys think that maybe changes if at all?

Kaes Van’t Hof

Yes Jeff, it won’t moderate much.

You know we will have a big tailwind from 2019 to 2020 on the decline.

You know 2019’s decline was north of 40% on the oil side. This year you know high 30’s on the oil side, you know given that we're no longer maximizing growth within cash flow and accelerating or adding you know five or six rigs this year, so you know that should help. I can't guarantee that it'll keep going down from here, but certainly don't expect it to ramp up significantly given the steady state development we’re heading towards.

Jeff Grampp

Got it. Thanks guys.

For my follow up, Travis may be for you, you know you guys in the prepared remarks obviously had a substantial checklist of accomplishments that you guys did in 2019. I was wondering, you know what's on the 2020 checklist in terms of kind of more strategic objectives or goals for the business in 2020 that you know maybe in 12 months you’d come back on the 4Q ‘20 call and tell us about.

Travis Stice

Well, certainly as we sit here today, the level of major corporate development objectives that we had in 2019 won’t be repeated in 2020. That was an incredibly you know busy year for us. What we're really focused on this year is you know growing the business, increasing shareholder returns and really refining you know our differential story of growth and yield and we think we've got the framework exactly suited to be able to do that.

Jeff Grampp

Got it! Alright, that’s it for me. Thanks guys.

Travis Stice

Thank you, Jeff.

Operator

Our next question comes from Asit Sen with Bank of America.

Asit Sen

Thanks, good morning. I have one for Kaes and a follow up for Travis. Kaes, I appreciate the update on sustaining CapEx, but historically you have talked about generating a $675 million of free cash flow at $55 oil. Could you talk about the sensitivity to this free cash flow to changes in oil price and how would you think about adapting the activity program to lower oil prices, say in a $45 scenario.

Travis Stice

Yeah Asit, you know I'll take the second part first you know. If we saw $45 oil for a couple of months, you know we would do the right decision, make the right decision and cut back on capital spending.

You know I will say you know this this addition of free cash flow to the story now allows us to not whipsaw around our activity levels based on you know a weekly or daily or a monthly move in commodity price.

So this gives us an operations organization, you know an ability to continue to operate steadily and you know drive efficiencies through the year.

You know on the free cash flow side certainly you know above 55 we start to get a lot of the benefit of you know, our three way colors or unhedged production.

So I think at the mid-point of our guidance on oil, you know $1 in oil price above 55 gives you, you know $65 million or $70 million of free cash.

Kaes Van’t Hof

And I’ll just add to that from a general perspective or might be a higher level perspective.

You know Diamondback has always demonstrated that you know when returns you know to our investors go up, you know we lean into that.

Now we’ve moderated that comment a little bit now, because we're still focused on free cash flow generation, but what goes along with that is when returns go down to our shareholders, we slow activity down and I think you go back in early 2015 and again in 2016 and even again in late 2018. We've got a track record of doing just that when the commodity tells us we’re not getting paid for it, you know we moderate all activity accordingly.

Asit Sen

Thanks. Travis, a follow-up for you.

You guys have been a leader in making changes to compensation structure and appreciate ESG component as part of management scorecard. Could you provide some early examples of some of the metrics that you're going to track? What's motivating this move and perhaps speak to the issue of flaring and how PRRC has positioned Texas and your conversations with them.

Travis Stice

Sure.

You know the one thing just I want to point out is that, the transparency that we try to communicate with our investors we believe is best-in-class and we spend a lot of time talking to our large shareholders and some of the things that we instituted in this release were as a result of direct communication with those shareholders. Things like holding ourselves accountable for ES&G measures.

You know we've got – you know it might be up to 10% to 15% now.

Every individual’s compensation is going to be tied to ES&G metrics. Things like water recycle, spill control, total recordable incidence rate, flaring, those are not subject to discretion. Those are quantitative measures that we will incentivize you know a better performance on. That's one thing that we've proven at Diamondback is, what gets rewarded gets done and we intend to do that in our scorecard.

You know we've also adjusted, and again we've laid it out in a very transparent way, but – and will be some more when we release our proxy here in a month or so.

You know we've adjusted now our total shareholder return you know to where we have modifiers for anything below 0% or negative TSR. We've now got a modifier that takes down our long term incentives.

Now the converse of that's also true. Anything above a 15% total shareholder return gets some adder, but again, that's in response to conversations that we've had with our shareholders.

So we really have two objectives.

We have the first which I think is the most important, is that we want to be best-in-class on all of our ES&G measures. And secondly, we want to be best-in-class on the disclosure associated with those things and we believe that what we released last night is a very important first step in achieving both of those objectives.

Asit Sen

And on flaring Travis?

Travis Stice

Yes, so flaring in the Permian basin is an issue that we as an industry have to address. There's flaring that's voluntary flaring that should be eliminated as quickly as we can. I mean companies have to put their balance sheets to work and you know make sure the gathering system is in place prior to bringing on wells. Certainly at Diamondback we follow that to the strictest letter.

There's also you know a collaboration that we have to make with our gatherers.

You know even if we're tied into systems, our gatherers have to make sure that they've got you know contracts in place that allow that gas to be you know custody transferred at the well head and that gas moved to market.

And so it's really – it's not all in the upstream guys. It's really a holistic issue that needs to be addressed by everyone to try to eliminate you know a certainly routine flaring now here in the Permian as quickly as we can.

Asit Sen

I appreciate the color Travis. Thank you.

Travis Stice

And I'll just add to that. I’ll see if that’s you know – the scorecard that we've added you know in the ES&G has flaring in there and I can tell you from, you know from a – we talk about it on our executive meeting.

We have you know pretty rigorous reports that we review every week and we talk about creative ways that Diamondback or Rattler could bring the balance sheet to their – to cause you know a flaring to be eliminated quicker than if we just relied on somebody else.

So we're trying to be creative and willing to put our balance sheet to work if need be to eliminate the flaring.

Asit Sen

Thank you.

Operator

Our next question comes from David Deckelbaum with Cowen.

David Deckelbaum

Good morning, guys. Thanks for the time. I just wanted to ask a couple of follow ups on just the Pecos activity.

I think the first half of the year you guys are running about six rigs there right now. Is the plan, does that slow in the back half of the year and then going into 2021 or should we think about that as kind of a steady state program?

Travis Stice

Yeah David, I mean it’s more about completion cadence right.

So in the first half of the year you know we do have more completions in Pecos than the back half.

You know I think overall you know 2019 we completed almost 100 wells in that field and you know I think the goal here as an organization is to get that down to 60 or 70 on a go forward basis.

So when we are allocating capital in the second half of the year to better return areas, one rig going to ReWard and one rig going to the northern Midland basin, particularly as the held-by-production issues that we had in Pecos has subsided and you know we can have a more steady state plan there with you know five rigs or so running full time.

Kaes Van’t Hof

And David, I’ll tell you, the execution teams, particularly in Pecos county have done a remarkable job of you know maintaining results or improving results, some of which we talked about in the Second Bone Springs, but they'd really driven a lot of costs out of the equation and so now the returns continue to improve with the same or better EUR’s per foot, but much lower cost per foot.

So you know it’s again a good example of what Diamondback excels at as you work on the numerator and the denominator at the same time and we're driving the rate of return positively for our shareholders.

David Deckelbaum

For sure. It’s encouraging to hear that. It also sounds that as you get into the back half of ‘20 and going into ’21, absent everything else, some of those HBP obligations obviously subside going into ’21?

Kaes Van’t Hof

Correct.

David Deckelbaum

And then I just wanted just to ask one more, just framing this conversation around M&A.

You’ve highlighted a lot of priorities around sustainable free cash dividends growth. When you screen now for M&A, you start with a priority of free cash accretion, because you did talk about obviously things have to be accretive.

You also talked about acreage you know being at heavily discounted valuations right now. Do you still see room for you know what would otherwise be NAV-accretive M&A or does everything now have to become free cash accretive.

Travis Stice

Well, certainly that has vaulted to the top of the category list of the things we look at, but we really focus on several key metrics.

If you're asking probably what we screened on the first certainly free cash flow per share, it is way up there. Also cash flow per share, earnings per share and then you know the more traditional measures of inventory quality and what Diamondback can do with that property you know in the form of operational efficiency and then of course NAV is what we still fundamentally believe, that NAV is an important valuation metric for our business. But you know those are what we believe are the right ways to focus on anything you're looking at.

Kaes Van’t Hof

And right now the stock word is we’re focused on buying back the stock, because it’s trading at the deeper discount to NAV than anything we're seeing in the market.

Travis Stice

Yeah, I agree with that.

David Deckelbaum

Understood! And thanks for confirming we don't have to delete our NAV model just yet, but thanks guys.

Travis Stice

Yeah, hold on to that.

Operator

Our next question comes from Michael Hall with Heikkinen Energy Advisors.

Michael Hall

Thanks. Good morning.

Just answered my question as it relates to how the stock price looks relative to M&A opportunities, so thanks for that.

I guess the second one I had just to follow-up a little bit on the evolution of co-development.

You addressed it in the Midland basin, but most securities in the Delaware is just kind of looked on the slides, the proportion of the Wolfcamp A that’s driving the 2020 program on slide 14 I guess, how does that evolve over time? Should we expect that to kind of grind lower as a percentage of the total in ‘21 and beyond or any color on that?

Travis Stice

Yeah Michael, I think that's fair, right. I mean there’s a secondary zone in each of our three fields that we think you know competes for capital today and Pecos, it’s the Second Bone Spring, so that's going to get more attention. In ReWard it’s the Third Bone Spring.

You know we're doing a lot more co-development between the A and the Third Bone Spring in that acreage position in 2020 and beyond.

And then up in the Vermejo area, the Third Bone Spring is good, but also the Wolfcamp B you know deserves some attention from a rate of returns perspective.

So each of those fields has a different development strategy, but you know unlike the Midland basin, where in the Midland basin the zones that are being co-developed from a rate of return perspective are in a narrow band.

You know the Wolfcamp A versus the others on the Delaware basin had always said, drill to Wolfcamp A and go to the other zones later, but with the Second Bone particularly in Pecos getting better, that's getting more attention.

Michael Hall

Great! That's helpful color. I appreciate it. Thanks guys.

Travis Stice

Thanks Michael.

Operator

Our next question comes from Charles Meade from Johnson Rice.

Charles Meade

Good morning, Travis, to you and your whole team there. I want to go back to the – there’s a little bit of tension in some your – or at least I see some tension in your prepared comments.

You talked about how you know we've had a lot of volatility in late ‘19 and even in early ‘20 with the commodity price; that’s on one hand, but on the other hand I get your message that the dividend, your commitment to the dividend is, you're committed to it and those are the first dollars out the door.

But I'm wondering if in broad terms you can give us any insight your thinking or the boards thinking? Is there a limit, maybe a soft limit on the percentage of your cash flow from ops that you wouldn’t want to exceed in terms of the dividend payout if commodity prices fell lower and conversely – go ahead, I'm sorry.

Travis Stice

No, finish, I’m sorry.

Charles Meade

No, I would say conversely is there some minimum level that you're targeting if oil prices hit higher.

Travis Stice

Yeah you can go by and look at some of our previous prepared remarks where we talked about the board you know wanting to seek a dividend yield that approaches the S&P 500 and you know to get prescriptive, much beyond that, we don't think is the right way to communicate that message.

Kaes outlines right now that how we look at – what to do with free cash flow above our maintenance CapEx, but I think at the end of the day Charles, just simply said, when we look at capital allocation, we look at ways to drive not only current shareholder value, but also long term shareholder value and some of the dividend, and the growth of that dividend is very important in that conversation.

What we have seen is, some companies that get dividend, let the dividend get so high, it actually can become an impediment to doing what oil and gas companies are supposed to do, which is convert resource into cash flow.

So we are ever mindful of that, but it's a discussion that we have at the board level on an annual basis and I can just tell you that we're laser focused on current shareholder value creation and long term shareholder value creation.

Charles Meade

Yeah, that's helpful color, thank you for that Travis. And then going back to your limelight, your limelight well and I appreciate your earlier comments that you guys are a much bigger company now, certainly than when you guided this play three years ago, but that it's still encouraging to get that kind of first well result. What would you need to see – in the combination between well cost from here and productivity from this first well, what would you need to see from the play to make it really compete in the top tier of your overall portfolio for capital?

Travis Stice

So we are pretty pleased with the oil profile that came out of it, that we are seeing so far in that first well and the decline profile looks actually pretty good.

Of course we are ever mindful of this single well intersection, but you know I think its two things. One, you've always got to push you know greater recoveries and we have to push a lower development cost, which is something that’s right in the wheelhouse of a Diamondback operations teams, both driving EUR and reducing well costs.

So I think there is more to come on this story. We’ll probably drill one or two more appraisal wells this year and then, you know we’ll talk about it more in 2021 if we are successful in accomplishing those objectives and it starts attracting more capital in the allocation process.

Charles Meade

Thank you for that, Travis.

Operator

Our next question comes from Richard Tullis with Capital One Securities.

Richard Tullis

Hey thanks, good morning. Travis, real quick on limelight, just to continue with that theme.

You drove the Merrimack with the Xanadu well. The upcoming appraisals, do you anticipate going after any other targets there in limelight area?

Travis Stice

Yeah, I’m going to let Dave answer the question. Dave.

Dave Cannon

Yeah, for the next two wells that we have upcoming for the appraisal project, as we move to the south within the limelight trend, we are actually going to be targeting the upper portion of the Woodford. I mean then we are going to be drilling the well close by to the Xanadu, further driving development efficiencies into the Merrimack itself.

Richard Tullis

Okay, thank you. And lastly for me, looking at the Northern Delaware basin acreage swap referenced in the release, how did that transaction or group of transactions come together and how much net acreage remains in New Mexico?

Kaes Van't Hof

Yeah Richard, we’ve worked on probably almost 40 trades throughout the year. This was certainly the largest for us. Entering New Mexico as an operator to operate six or seven sections just didn’t make sense you know given that we get bolt on to other blocks of acreage that we operate in Texas.

So that certainly – that trade is one of many that worked out really well. Today we have about 2,500 acres left in New Mexico, primarily non-op with you know one operated well.

Richard Tullis

Alright Kaes, thanks so much. I appreciate it.

Kaes Van't Hof

Thank you.

Operator

Our next question comes from Leo Mariani with KeyBanc.

Leo Mariani

Good afternoon guys. I just wanted to follow-up on one of your earlier comments here just as a point of clarity. If I heard it correctly, did you guys kind of say that you know production growth on a quarterly basis in 20 would be maybe a little slower in the first quarter and then picked-up in second quarter of ‘20 and then kind of be steady for the rest of the year. I just wanted to make sure I understood that cadence.

Travis Stice

Yes, that’s fair Leo.

You know we plan to grow off of what was a very, very good number in Q4. It exceeded our internal expectations, but we do expect to grow off that number in Q1 and then have steady growth throughout the year.

Leo Mariani

Okay, that's helpful. And then I guess just with respect to well costs, I wanted to see if you could kind of give us anything, a little bit sort of leading edge here in terms of maybe what you've seen.

You know in the last couple of months here just to kind of kick off the year in 2020 maybe versus you know fourth quarter averages. Were you guys able to continue to drive, efficiencies or maybe benefit from some lower service costs deals that you might have negotiated in 4Q to kind of start the year in ’20. Any comments around that?

Travis Stice

Yeah, so service cost reductions are not things that we count on as we forecast our capital budget. Those are not permanent. We know when commodity price turns back around, those go away. What we really are focused on is what type of cost improvements can we make that are more permanent in nature and that’s again what I – the Diamondback operations organization just absolutely excels.

You know we were talking just this week about a 15,000 foot lateral that we got drilling in 11 or 12 days and so we can continue to see faster and faster well results from our operations organization and we expect that to continue to happen throughout this year.

Leo Mariani

Okay, thank you.

Travis Stice

Thanks Leo.

Operator

And I’m not showing any further questions at this time. I would like to turn the call back over to Travis Stice for closing remarks.

Travis Stice

Thanks again to everyone for participating in today’s call.

If you got any questions please contact us using the contract information provided.

Operator

Ladies and gentlemen, this concludes today's presentation.

You may now disconnect and have a wonderful day!