Texas Pacific Land Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to Texas Pacific Land Corporation First Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded It is now my pleasure to introduce your host, Mr. Shawn Amini, Vice President, Finance and Investor Relations. Thank you, Mr. Amini, you may begin.

Shawn Amini: Thank you for joining us today for Texas Pacific Land Corporation’s first quarter 2024 earnings conference call. Yesterday afternoon, the company released its results and filed its Form 10-Q with the Securities and Exchange Commission, which is available on the Investors section of the company’s website at www.texaspacific.com. In addition, the company has posted an investor presentation that we will be referencing today. That presentation related to produced water desalination and beneficial release can be found in the Investors section of our website under Presentations. It is also posted under the Events section on our website, which can be accessed through the News & Media tab and then IR calendar. As a reminder, remarks made on today’s conference call may include forward-looking statements.

Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company’s results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will be discussing certain non-GAAP financial measures. More information and reconciliations about these non-GAAP financial measures are contained in our earnings release and SEC filings. Please also note we may at times refer to our company by its stock ticker, TPL. This morning’s conference call is hosted by TPL’s Chief Executive Officer, Ty Glover; Executive Vice President of Texas Pacific Water Resources, Robert Crain; and TPL’s Chief Financial Officer, Chris Steddum.

Management will make some prepared comments, after which we will open the call for questions. Now I will turn the call over to Ty.

Tyler Glover: Good morning, everyone and thank you for joining us today. Driven by the continued strength of our surface derived cash flows, our first quarter 2024 results are an excellent start to the year. Water sales, produced water royalties and easements and other surface related income in aggregate had revenue growth of 19% sequential quarter-over-quarter, which totaled approximately $81 million and accounted for nearly 50% of total consolidated revenues. This was another especially great quarter for water sales as it generated $37 million of revenues, which was nearly a company record. Our source water asset footprint combined with our excellent staff, were able to push volumes throughout the Permian Basin, with 72% of volumes occurring outside of TPL’s surface acreage.

Oil and gas royalty production of approximately 24,800 barrels of oil equivalent per day also represents strong performance. Our near-term inventory of permits and drilled, but uncompleted wells remained at robust levels, which combined with high activity levels on our water and surface assets, indicates royalty production will continue to perform well. On capital allocation, the company and our Board continue to evaluate all of our options as the business continues to generate considerable free cash flow and maintains a net cash position of $837 million. This affords us tremendous ability to drive value throughout the energy cycle. I do want to spend the majority of my time this morning talking about some exciting news for TPL. As Shawn mentioned, we posted a presentation relating to produced water desalination and beneficial reuse and I will be referencing those slides.

Our remarks today will serve two purposes. First, to give an update on our technology efforts related to produced water and second, to give an understanding of the state of the produced water market in the Permian today, the latter of which has been getting an increasing amount of attention throughout the industry. Starting with Slide 2, there are two components to what we announced yesterday. First, we have developed a promising new energy efficient method of produced water desalination. Although water desalination can be done today utilizing multiple methods and technologies, the challenge has always been doing so cost effectively. Desalinating produced water also presents some unique challenges compared to normal ocean or brine water. Over the last few years, our team has been studying a wide array of technologies, helping to find something that could work economically at scale in the oilfield.

It may seem both simple yet counterintuitive, but we wondered if we could leverage a process that happens every day in people’s home, water turning into ice. We began to look more closely at this process, which is also referred to as fractional freezing. At first glance, it seemed nonsensical to make ice and a desert in West Texas. However, after running in-house experiments and further research, we pursued the idea in earnest. We reached out to a leading industrial technology and manufacturing firm located here in the United States. Over the course of a couple of years, we collaborated on various ideas and techniques. After eventually finding success with a prototype, we quickly constructed a small-scale test unit in TPL’s R&D facility in Midland.

That test trial was a success, and we are moving forward with a larger test facility capable of processing 10,000 produced water barrels per day with expansion potential to 20,000 barrels per day. The second aspect of our announcement relates to beneficial reuse. If we’re able to desalinate produced water economically at scale, then it opens up a world of possibilities in terms of what to do with that water. We’ve been conducting detailed studies in our lab to understand whether desalinated produced water could be used to grow various crops and native grasses. Our lab has a greenhouse, which is pictured on this slide. Here we use various local soils and native plants to understand the impact of utilizing fully desalinated and treated water.

In addition to extensive in-house testing and analytic capabilities, we have also partnered with leading research institutions specializing in water quality, soil and plant testing. We have another parallel beneficial reuse program underway as we are exploring a discharge of desalinated and fully treated water into tributaries that feed into the Pecos River and potentially direct discharge to the surface for Aqua for recharge. Across both of these beneficial reuse paths, we are working closely with regulators and have made significant progress with both permitting and stakeholder engagement. Robert Crane, who leads our water team, will discuss these desalination and beneficial reuse initiatives in greater detail later on this call. Ultimately, if everything goes well, our intent is to bring large-scale produced water desalination solutions to the Permian Basin.

TPL has created a subsidiary called transmissive Water Services, LLC to house our desalination in beneficial reuse efforts. Transmissip is a wholly owned subsidiary of Texas Pacific Water Resources, LLC, or TPWR, for short, which itself is a wholly owned subsidiary of TPL. We are currently in commercial negotiations with blue chip upstream operators as we move towards the next phase of constructing a larger desalination test facility. Interest has been incredibly high, as oil and gas operators understand how critical this type of technology is to keep the Permian oil and gas machine going. This first 10,000 barrel per day facility, which we refer to as Phase 2, will cost approximately $20 million on a 100% basis. Though our aim is to offset a substantial amount of TPL capital costs with any commercial arrangement, longer term, our intent and desire is to structure commercial arrangements that align with TPL’s ongoing business principles of high-margin capital-light cash flows.

We’ve had tremendous success with that model in the past as our team was able to turn TPL’s raw surface acreage ownership into a business that last year collectively generated over $250 million of high-margin revenue. So we have the proven track record. Sure our desalination technology and beneficial reuse advances get to a point where we can help launch a large-scale build-out throughout the Permian Basin. I’m confident in our ability to execute agreements and strategic partnerships in a manner that generates significant shareholder value. Turning to Slide 3 titled produced water overview. These next couple of slides are for the benefit of current and prospective investors that may not be completely – at the state of the Permian produced water market.

But I’d like to provide additional context around what TPL is trying to solve. The term produced water refers to the water that is a co-product from a producing oil and gas well. This water has very high salinity levels and contains oil and suspended solids and heavy metals. Because untreated produced water is not safe for crop irrigation or municipal use, there are two methods in which the entry deals with it. The most common method is to reinject produced water back subsurface. For many years, the water was injected into subsurface formations, either above or below oil-bearing shale formations. Due to the high levels of development activity and high water cuts experienced in the Permian Basin, the industry has begun to experience constraints concerning traditional disposal into both of these zones.

The high volumes of deep formation injection, is expected to cause seismicity in local areas as injected water can find its way into natural faults. The Texas Railroad Commission, which regulates the oil and gas industry in Texas, has responded by instituting numerous seismic response areas or SRAs, in certain regions. These SRAs have put restrictions on how much water can be injected. The industry has since pivoted to injections strictly targeting the shallower formations hoping to avoid some of the faulting issues. Although injection into shallow formations does work, it presents additional complexity for upstream operators who plan to develop overlapping oil and gas acreage, which they would now potentially be drilling through a more highly pressured zone.

The other common solution for produced water today is to reuse or recycle that water for oil and gas completion activities, otherwise known as fracking, upstream operators can use raw produced or lightly treated produced water to complete new wells. However, given the sheer amount of produced water volumes that come from the Permian, even if operators were to use only produced water in their completion activities, the Permian could still have north of 10 million barrels of produced water that would need to find a home. Turning to Slide 4. The Permian is recognized as an oil and gas powerhouse. Oil production today is over 6 million barrels per day, which is more than other well-known oil-producing nations such as Iraq, Iran and Kuwait. However, 1 unique aspect of the Permian is its relatively high water-to-oil ratio.

The Delaware side of the Permian has an especially high water to oil ratio of nearly 4x. Despite the high water cuts, robust drilling economics in the Delaware has driven a strong ramp in activity, which has generated a commensurate increase in produced water. Today, the industry is finding it increasingly difficult to handle all of this water. Given TPL’s longstanding actively managed vertically integrated water business, this is a dynamic that we’ve seen coming for quite some time now. Over the last few years, we actively sought to increase our capabilities across every aspect of produced water solutions. This is why we began investing so much effort into desalination R&D years ago. We’ve also significantly increased our treatment capacity for traditional produced water reuse.

And finally, we’ve made a concerted effort to increase our pore space ownership. Through various bolt-ons, we managed to purchase surface and subsurface pore space easements totaling over 100,000 acres. The pore space we’ve acquired, combined with our legacy surface position is critical in providing long-term solutions for produced water. In evaluating surface acreage to acquire, we often perform extensive pore space due diligence across attributes such as capacity, formation pressures and fault and seismic mapping. Although we are well positioned to facilitate traditional produced water injection for years to come, we knew the industry needed additional solutions. There’s still a lot of work and testing to be done with our emerging technology so we are encouraged and excited with what we’ve seen so far.

As we presented our technology to potential partners, customers and regulators, the feedback has been overwhelmingly positive. We’ve received immense interest from operators to deploy the test facility near their development areas, not just in the Permian, but also in other major oil and gas basins in the U.S. I’m extremely proud of the team here for their innovation, dedication and talent and their efforts will be critical in sustaining the positive momentum of Permian development over the long-term. With that, I will turn the call over to Robert.

Robert Crain: Thanks, Ty. For those of you that don’t know me, I run TPWR. I joined TPL in 2017 and Ty recruited me to help build out TPL’s nascent water business. Prior to TPL, I led water resource development efforts for EOG resources across multiple basins, including the Permian and Eagle Ford. Excited to be here today and talk about water. Turning to Slide 5, I’ll provide an overview of our technology, our targets for desalinization and results to date. As Tod described, we teamed up with a top-tier technology and manufacturing partner that specializes in industrial refrigeration and freezing where they serve clients across services, industrial temperature control and nuclear power plants. TPL collaborated with this technology partner to develop a thermal system specifically designed for produced water desalination.

While our partner retains the patents on the equipment, TPL has the exclusive rights for the equipment used towards produced water applications. In addition, TPL has filed for a process patent utilizing fractional free desalination to treat produced water for beneficial reuse. There are a couple of other competing desalinization technologies on the market today with many of them focused on heat distillation. Heat distillation can require a temperature change of 120 to 140 degrees Fahrenheit and additional energy to condense the vapor back into liquid form. However, our freeze technology uses less energy as it recovers heat from the incoming produced water and requires temperature change at a fraction of what is required for heat distillation.

With our current R&D test unit, we’ve been running extensive optimization testing as we closely monitor time spend pull down in freezing the progression of ice formation, salinity reduction and in cation reduction and energy efficiency among other factors. We had power meters installed at basically every step, so we knew how much power is being used by each piece of equipment. We have a better understanding of the various trade-offs such as higher pressure and higher analyte production or reduced power consumption. We have gained a lot of valuable insights that we can now apply as we look to scale up and enhance our next unit. We have a target matrix that we call 75 cube. This represents our high-level goals for desalination. First, it is a 75% volume reclamation, which means if we take 100 barrels of produced water, we can churn out 75 barrels of fully desalinated and treated water.

But we believe we’re well on target to achieve this goal. The second goal is a 75% reduction in analytes. Here, our goal is to remove analytes of concern. Our desalination technology is not just about freezing, rather it’s a series of processes as we seek to create a very pure water. Again, we have already far exceeded this goal. And truly, our goal is to treat water not just to meet every regulatory parameter, but to exceed it. The final element of 75 Cube is a $0.75 per barrel treatment cost. This is where we have the most work left. The biggest operating expense item of any desalinization and energy consumption. As mentioned earlier, we are metering every aspect of our equipment and process. We’re working hard to find efficiencies.

In addition, we continue to work with the utilities and developers as we seek options and novel solutions for electricity prices. Given the abundant durable power of natural gas prices that are negative at times in West Texas, we think we can find creative answers to bring our power cost down. We hope with this upcoming Phase 2, 10,000 barrel per day facility that we can make further process optimization and cost improvements. At $0.75 per barrel cost in desalinated high-spec water, we believe our technology becomes economically cost competitive and environmentally superior versus traditional subsurface injection. Our desalinization process produces excellent water quality along the most important parameters. Almost all semi volatile organic compounds, SPOCs, and volatile organic compounds, VOCs are reduced well below the maximum containment levels.

We have reduced PFAS, radionuclides and metals to trivial levels. In addition, we are working with premier research institutions to examine water analytes that are not traditionally tested. Our goal isn’t just to meet the regulatory requirements. We want to exceed across every possible parameter that can be measured and tested. We are striving for the absolute best quality fresh water we can achieve. Turning to Slide 6, where I’ll talk about our progress with beneficial reuse. There are multiple aspects of our beneficial reuse endeavors. First is our greenhouse pilot. This pilot was used to test discharge and irrigation potential for various native plants. In our Midland Yard, we built a greenhouse where we gathered local soils from Culberson County, and then we planted various native plants in El Salto.

We’re working in New Mexico State University, which has ibe of the premier labs and research facilities for plant and soil testing. The results from this pilot have been very positive. Data from this pilot was used for a road commission land application permit and TPL was granted the first permit in the state in February of this year. With that permit, TPL is expanding the facility to include an outdoor field of El Salto to study the effects in the natural environment. That outdoor plot is currently under construction. TPL will share water, soil and plant data from the Greenhouse pilot with regulatory agencies, operators and universities to help the industry further develop standards and beneficial reuse technologies. Lastly, we have applied for a Texas Pollutant Discharge Elimination system permit with the Texas Commission on Environmental Quality, otherwise referred to as the TCEQ.

This permit relates to discharging treated desalinated produced water and to tributaries in the upper region of the Pecos River. Given our multistep desalinization process produces high-spec freshwater, we will add that salt and alkalinity to match the Pecos River water quality. We will utilize a batch relief system to thoroughly analyze all water prior to environmental release. TPL’s priority is to go above and beyond the standard environmental assessment to assure safety and longevity of the project. Now turning to Slide 7 for an environmental and regulatory overview, I’ve already discussed the latest on our regulatory efforts for the last couple of slides, but I’ll just reiterate that TPL is committed to the highest standards of environmental stewardship.

Our goal is to not just meet the regulatory standards, but to exceed it. As many of you know, TPL owns nearly 1 million surface acres and to surface owners, we have every incentive to maintain and enhance the environmental quality of our acreage. We consider our surface to be extremely valuable and we’ve always managed our surface assets to preserve a sustainability attributes for future generation. Now turning to Slide 8 for our key milestones accomplished to date and further time line. We’ve talked a lot about the progress we’ve made already. We successfully tested a pilot multistep desalinization system. We’ve made significant headway on the beneficiaries and regulatory efforts. In terms of our near-term priorities, we are working to move forward with a larger 10,000 barrel per day test facility and to execute one or more commercial agreements.

We have begun equipment procurement. The facility is expected to cost approximately $20 million on a 100% basis. So our aim is to offset costs with any commercial arrangement. Longer-term, should the next test facility prove successful, then we would move toward Phase 3, which is the development of a large-scale 100,000 barrel per day facility. With demand for produced water desalination of potentially millions of barrels per day, widespread desalination adoption would require significant investment from the industry. If we get to that point, it will very likely require additional commercial arrangements as we do not intend for TPL to be primarily responsible for self-funding and developing this infrastructure. Although the exact commercial arrangements remain to be seen, we have a successful track record of executing contracts that ultimately provide TPL with a very valuable high-margin capital-wide cash flow stream.

That said, we have a lot of work to do before we get there. We still need to build this initial Phase 2 facility. We have a lot of engineering and technical work ahead of us. We need to keep driving costs down. We have to execute on our various beneficial reuse endeavors. We’re excited with our progress so far. The team here is working incredibly hard. The Permian needs to find a solution for produced water, and I believe TPL is going to play a key role in that future. With that, I will hand the call over to Chris.

Chris Steddum: Thanks, Robert. Consolidated revenues during the first quarter of 2024 were approximately $174 million, representing 4% sequential quarter-over-quarter growth. Adjusted EBITDA was $152 million and free cash flow was $115 million for the first quarter. Free cash flow for the quarter grew 30% on a year-over-year basis, driven by higher royalty production, source water sales, produced water royalties and easements and other surface related income and partially offset by lower natural gas and NGL prices. Weak Waha natural gas prices have negatively impacted natural gas realizations in March and April of this year. We do expect low Waha prices in second quarter 2024 to continue putting downward pressure on gas realizations, though we expect this to be somewhat mitigated by the stronger realizations that super major and large independent operators generally receive.

Our realizations on oil continue to be very strong, generally at 100% of WTI Cushing. Our near-term well inventory remains elevated relative to historical levels. At the end of the quarter, we had 5.1 net permitted wells, 10.3 net drilled, but uncompleted wells and 2.2 net completed, not yet producing wells. This near-term inventory gives us confidence that our royalty production remains on a growth trend. To conclude, TPL is in an enviable position today. Our balance sheet is the strongest it’s ever been. We still maintain top-tier cash flow and profitability margins. Today’s disclosure of our efforts with produced water desalination is a great testament to the team and to the multiple elements of upside the business has with its unique surface ownership.

TPL continues to generate substantial free cash flow and we are in an excellent position to drive value. And with that, operator, we will now take questions.

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