Zach Dailey - Marathon Oil Corp. Lee M. Tillman - Marathon Oil Corp. Thomas Mitchell Little - Marathon Oil Corp. Dane E. Whitehead - Marathon Oil Corp..

Doug Leggate - Bank of America Merrill Lynch Brian Singer - Goldman Sachs & Co. LLC Pavel S. Molchanov - Raymond James & Associates, Inc. Jamaal Dejon Dardar - Tudor, Pickering, Holt & Co. Securities, Inc. David Martin Heikkinen - Heikkinen Energy Advisors LLC Devin J. McDermott - Morgan Stanley & Co. LLC Roger D. Read - Wells Fargo Securities LLC John P.

Herrlin - SG Americas Securities LLC Paul Sankey - Mizuho Securities USA LLC.

Welcome to the Marathon Oil Second Quarter 2018 Earnings Conference Call. My name is Paulette and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded. I will now turn the call over to Zach Dailey.

You may begin..

Thanks, Paulette, and thanks to everyone for joining us today. Last night we issued a press release, slide presentation, and investor packet that address our second quarter results. Those documents can be found on our website at marathonoil.com.

Joining me on today's call are Lee Tillman, our President and CEO; Dane Whitehead, Executive VP and CFO; Mitch Little, Executive VP of Operations; and Guy Baber, our new VP of Investor Relations. It's been a pleasure working with everyone in IR over the last several years. Now, I'm very much looking forward to my next opportunity here at Marathon.

We're excited to welcome Guy to the team and he and I will work together closely over the next few weeks to ensure a seamless transition. Today's call will contain forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

I'll refer everyone to the cautionary language included in the press release and presentation materials as well to the risk factors described in our SEC filings. With that, I'll turn the call over to Lee who will provide a few opening remarks before we turn to Q&A..

balance sheet, cost structure, portfolio simplification, that collectively generate compelling corporate returns with profitable growth and outcome. Thank you. And with that I'll hand it back to the operator to begin the Q&A..

Thank you. We will now begin the question and answer session. And our first question comes from Doug Leggate from Bank of America. Please go ahead..

Thanks. Good morning, everyone. Lee, I think your consistent execution really deserves to be applauded because I think you've really done a great job turning this thing around since you came here. So, just wanted to say congratulations on a great quarter..

Thank you, Doug..

I did want to make a couple of questions regarding the cadence of your relative activity going into the balance of this year and then into next. First of all, in the Bakken – I've only got two questions by the way. First of all, on the Bakken, it looks like you've got quite a wide range of variability across those Three Forks wells.

I'm just wondering if you can touch on what's driving, I mean, tremendous wells on the one hand but obviously you've got some wells at the other end of the spectrum as well.

So, what was driving the differences in completion? What's gone into the underlying decline rate with your ESP strategy? And just give us some idea of what – how you see the cadence of the Bakken over the next, let's say, through the plan period, through 2020?.

Yeah. Well, maybe I'll take a little bit of that question and then also let Mitch chime in, Doug. First of all, just on cadence, per our plan this year, we are going to have a bit of waiting from a well to sales standpoint in the fourth quarter. So, you should expect to see that as the year plays out.

From an overall activity standpoint, we continue to try to maintain a level of activity that optimizes, if you will, the continuity in our crews both on the drilling and the completion side in the Bakken.

With the success though that we have seen particularly in the Hector area and certainly and not only the Middle Bakken and the Three Forks, we continue to be very encouraged about what Bakken activity might look like as we begin planning for 2019.

And in terms of variability and I'll let Mitch maybe chime in a little bit on that, we are going to see some natural variability across the play as the geology varies. But having said that, I think when you look at the consistent outperformance using our enhanced completion designs, that is very much a common element.

And then from an artificial lift perspective, we continue to take full advantage of the best available technology. We think managing the life of the well is equally as important as generating early IP 30s. And so our team and the asset is very focused on how best to optimize using not only ESPs but also other forms of artificial lift.

So with that maybe Mitch, if you want to chime in anything else, just on the Three Forks specifically..

Yeah. Sure, Doug. I think Lee covered it at a high level pretty well. What I would say is we've talked about before the tremendous technical database that we have here and the integrated workflow that we've applied on a sub-regional basis to optimize across the play.

Lee aptly noted we do see some geologic variation across the play and we've also talked in the past about instilling a culture where we're never satisfied with yesterday's results. So, we still continue to trial various designs which would alter pumping strategy, proppant loading, and diversion technology.

And so some of the variability is driven by those trials as we look to optimize on a return basis across the entire play.

But in aggregate with the expansion of the core into Hector and now Elk Creek when you look at performance in aggregate being up over 100% since 2016, I feel good about the capability and the commitment of the team there to continue to drive further improvements..

Forgive me guys, if I can just get kind of a clarification on here.

Is it a work over-risk with an ESP strategy or as these things – has liquid volumes increased with increase with water content and so on or is that not an issue?.

We've got a pretty extensive use of ESPs that we've migrated to over the last few years in the Bakken. We see that as a way to uplift returns through maximizing production through the early phases of the well life.

And so I don't – I'm not entirely sure I understand or if I'm answering your question on work over-risk but we've got dozens of ESPs in the ground, longest of which are probably more than three years old or have been in service for more than three years. And so it's a natural part of our business up there is probably how I would characterize it..

Yeah..

And if could just add....

Sure. Go ahead, Lee..

...clearly we're always focused on how to enhance the reliability of ESPs and we keep a very close watch on mean time between failures, which of course, these are pumps and over time they will have wear and tear on them.

And so the further that we can extend that useful life of ESPs, that will obviously cut down on the intervention required from a well work standpoint..

Thanks, Lee. My follow-up is just a real quick one. Are you comfortable with the current rig allocation after moving the rig out of the Delaware? And is the connectivity in the Delaware enough to achieve your HPP requirements? So, I'll leave it there. Thanks..

Yeah. No, absolutely. Well, first of all, just for absolute clarity on the rig drop in Permian, that was really driven by the excellent work from the Permian D&C teams there that have really captured very really early in our cycle there in Northern Delaware some significant efficiency gains.

And what that has translated into is that we could deliver our program which was designed to not only protect our leasehold but also generate learnings as we get into the early kind of appraisal kind of drilling work that we're doing there.

And we could do that all and do it with less rigs and match those rigs up with the dedicated frac crew that we're running in the basin. So, that was a great outcome and it's purely efficiency-driven and again matching up with the one dedicated frac crew.

We are without a doubt going to achieve all of the objectives there that we set out for 2018 around not only leasehold but also continuing to understand the basin. We had some multi-well pads that we even talked about this quarter. So, that work is all on track..

Terrific. Thanks for your time, guys..

Thank you, Doug..

Our next question comes from Brian Singer from Goldman Sachs. Please go ahead..

Thank you. Good morning..

Hi, Brian. Good morning..

resource capture, bolt-ons, and return of capital to shareholders. Can you talk about the buffer you would want to see in your balance sheet for the first two of those to have more confidence and to execute on the third, return of capital to shareholders, i.e.

what are you looking for to kind of pull the trigger on share repurchase within or beyond your existing authorization?.

Yeah. Yeah. Brian, I think the best way to think about it is first of all on the balance sheet side, I think with all the great work done by the team in 2017, we feel very comfortable with the way we have the balance sheet positioned. When we look at net debt to EBITDAX on a forward-looking basis, we feel very comfortable with how we position that.

So, we can kind of I believe set that one to the side. We don't have another maturity until well out in time, 2021, so I think let's just kind of park that one.

I think coming back to what are we looking for, I think we've been very consistent in the messaging there which has been around, we want to see sustainable free cash flow being generated from our model before looking at incremental direct return of capital to our shareholders.

Now, I say incremental because of course we do still have what within our peer group is still a very competitive dividend that we're paying.

I think as we continue to gain that confidence and see this trend, it really started in earnest this quarter with $250 million of organic cash flow and we used organic cash flow because we think that's more indicative of the underlying performance of the business.

But as we look at that and gain that confidence and look out in time, I think we're getting more comfortable that we can accommodate not only the needs we have in resource capture, but also looking at options to return directly to shareholders. And as you stated, we have the authorization in place.

We are certainly not going to preannounce any execution though against our existing authorization..

Great. Thank you. And then my follow-up is with regards to the Bakken.

You highlighted your ability to apply enhanced completion techniques outside of the core with the Bear Den pad and I wondered if you could add any color on how widespread those implications are to your noncore Bakken position and any further plans there versus more of a regional impressive well performance in this area..

Yeah. I think just again to put Elk Creek in a little bit of perspective, it still is a really – it's still a constrained area there. It's not as aerially extensive as what you would see in Hector. But what it does is it continues to confirm our ability to go in and not only predict performance but be successful at delivering against that prediction.

I think what we want to think about though is that we have two very key tests coming up in the remainder of the year. One of those is pushing further south in our Hector acreage, more to the south of that place, so we feel very good about the northern part of Hector and feel that we have essentially de-risked that and moved it into the core.

But we do have a test to the south and then the other test of course will be in the Ajax area. And both of those tests will be later in the second half of the year..

Great. Thank you..

Our next question comes from Pavel Molchanov from Raymond James. Please go ahead..

Thanks for taking the question, guys. You made a point in the press release and the verbal comments to highlight the lack of gas flaring on your North Dakota acreage. I don't think you've drawn attention to that issue before.

Did something change policy, regulatory, anything like that that encouraged you to kind of single that out?.

No. Not at all.

In fact, the reason we wanted to highlight that is just to assure folks that as we see more activity in the basin, as you know, North Dakota continues to their regulatory regime around gas capture that we kept everyone up to speed on our view of that, and that we are not only in full compliance but certainly don't see any impacts on our four development plan there.

So, it's really just more competence setting. And I think it's also important too. I know that the state does put out data on flaring and sometimes that can get confused relative to actual compliance. And we wanted to be absolutely clear that we were in full compliance, no impact relative to our forward development there in the Bakken..

Okay. In Q2, you had 13,000 boe a day of U.S. production outside of the big four resource plays. And your solds looks like 4,000 of that since.

Where is that – the remainder, I guess 9,000 boe a day?.

Yeah. It's kind of distributed out. There's still a bit of an element in the Gulf of Mexico. We still have a couple of small assets in the Gulf that are largely contributing to that bottom line in the North – in the remaining kind of North America production..

Okay.

And are you – is it safe to say that you would be looking to kind of continue cleaning that up?.

Yeah. I think we're kind of in the nits and nats at this point in the U.S. They're smaller, if you will, assets but we'll continue to look to monetize those to the advantage of the shareholder just like we did in the current quarter. And it's just part, as I said in my opening comments, we never view portfolio management as being done.

We're constantly looking to upgrade, simplify and concentrate the portfolio and you should expect us to continue to do so..

Okay. Appreciate it..

Thanks, Pavel..

And our next question comes from Jamaal Dardar from TPH & Company. Please go ahead..

Good morning, everyone..

Good morning..

Just had a quick question. You mentioned looking at the free cash flow in your model in order to determine maybe the pace and execution of buybacks.

I just wanted to get a sense though at current strip ballpark what you all are seeing in terms of free cash flow over that 2021 plan?.

2021? We haven't talked about – hey....

Jamaal..

Jamaal, sorry, this is Dane Whitehead. Yeah. We really don't forecast out to 2021 but we want to think about the rest of 2018.

I think the fact that we generated $250 million of organic free cash flow in Q2 and a commodity price environment that is very similar to what we're looking at for the balance of the year right now, it's kind of reasonable to think that we will generate that kind of ratably for the rest of the year..

All right. That sounds good. And just moving operationally, you saw some really good results here in the oily Woodford play that we haven't seen in a while from you all. Just kind of want to get an update on the size of the opportunity set there.

We haven't been updated on the resource in some time and I guess the data disclosure was that maybe that was a little lower working interest. So I just kind of want to get an update there..

Sure. Jamaal, this is Mitch. I might refer you to slide 12 where we kind of highlight the near-term activity in Oklahoma. And you'll note a number of multi-well infill pads down in the SCOOP area, in the general area of the Lightner.

We have been talking about for the last couple of quarters this pivot from STACK leasehold protection to a focus on infill development drilling in high confidence areas in the overpressured STACK and SCOOP. We think we've got plenty of running room in and around the Lightner. You see the near-term activity there.

I think that Lightner is a really good indicator of the type of deliverability and returns that we would expect from that area. We would expect some variability in oil cut.

As we highlighted the Lightner came in above expectations on oil cut but from a returns and deliverability perspective the activity that we've highlighted there for the remainder of 2018 in terms of infill drilling pads should expect similar kind of economic results as we saw in the Lightner..

All right. That makes sense. Great results there. So, just want to see if we could – that will be repeatable. I appreciate the time, guys..

Thank you, Jamaal..

Thank you..

Our next question comes from David Heikkinen from Heikkinen Energy. Please go ahead..

Good morning, guys, and good results in the quarter. Congratulations. I was thinking through and comparing other companies in the Delaware. Many pointed to higher OBO spending driving higher CapEx.

I was just wondering if you guys are seeing the same trend in OBO that could impact your budget for the remainder of the year?.

Yeah. Hi, Dave. This is Lee. Just – you know, I'll maybe address OBO just in general. It's an element of our business that's particularly relevant in both Oklahoma and Northern Delaware.

It's also notoriously one of the more challenging ones for us to predict and build into our modeling as well because you're somewhat reliant on the feedback that you get from the other operators. And of course their plans change, their capital allocation may change, their timing and pace may change.

But I think in general what I would say is that we've had to, like many, watch very carefully the OBO spend. And we treat OBO spend just like we would our own operated spend, we're returns-driven. And if we don't see adequate returns, then we will not support those investments.

So, with activity increases, there will be a natural bias up in not only operated activity, but also non-operated activity. So, it's just like any element of our business. We're managing it. We're managing it based on returns, and it's fully contemplated in our $2.3 billion capital budget..

I'm not trying to read between the lines. Does that say that you've got plenty of free cash flow? So, it really is just purely returns. You're not drawing a hard line on $2.3 billion. Like, commodity prices are up. So, I'd expect returns would be good..

Yeah..

So, just in Oklahoma and Delaware, that biased your budget a little higher just given activity level..

Yeah. I mean, I would say within the $2.3 billion obviously there's been puts and takes throughout the year. OBO is just one element of that but we are going to support higher return opportunities whether they'll be non-operated or operated. And but it has to come in and compete for capital allocation just like any piece of our business.

So, no, we're not going to artificially constrain and make poor business decisions..

Yeah. I didn't think so. Thanks, guys..

Thank you, David..

Our next question comes from Devin McDermott from Morgan Stanley. Please go ahead..

Good morning. Thanks for taking the question..

Good morning, Devin..

I wanted to ask on the resource play exploration strategy. You've acquired a large position in the Austin Chalk at this point. As you noted, an attractive low cost of entry. As we think about how that strategy there plays out over the next several years and the overall spending profile for resource play exploration.

Is it now going to focus more on the exploration and appraisal in the Austin Chalk? And that's where that spending will largely be bucketed or are there other opportunities that you continue to look at beyond that as we move toward getting more information on Austin Chalk over the next several years..

Yeah. Well, certainly the REx opportunity set is much broader than just Austin Chalk. There are numerous opportunities that that team has actively engaged in today. I would point out though that Austin Chalk and Louisiana, it is a unique opportunity in terms of its scale and the entry point there.

And so elements of that will be somewhat difficult to replicate in some of the other opportunities, so it is unique in that sense.

So as difficult as it is to forecast this part of our business, I would say that the pace of spend certainly that we saw in the first half of the year which was largely dominated by Louisiana Austin Chalk that was a pretty unique opportunity set..

Got it. That's helpful.

And the other question I had is actually shifting over to international, Equatorial Guinea you highlighted in the context of potentially being a regional hub for growth in that area, I was wondering if you just add a little bit of color on what the opportunities that is that you see there, if that's an asset where we could see growth over time and just how you're framing that..

Yeah. I think that our starting point is we have a – we are very uniquely positioned in EG with that integrated gas infrastructure that we have there. We also know that there is not only the opportunity that we're currently pursuing which is the Alen field and bringing it in as backfill gas.

But we know that there's regional gas in the area that ultimately we'll need to find a monetization route. Some of that within EG. Some of it maybe even outside of EG. But geographically this is a very well-positioned asset and infrastructure.

We know that the EG government is very keen to continue to progress their role in regional gas development and we're going to support that initiative..

Great. Thank you very much..

Our next question comes from Roger Read from Wells Fargo. Please go ahead..

Yeah. Thanks. Good morning..

Good morning.

I guess if we could. Hey. If we could come back a little bit the question was asked earlier about share repos. I believe on the last conference call you kind of gave an idea of the amount of cash you would want to have on hand.

I was wondering if you could kind of refresh us as to what you'd like the balance sheet to look like before you considered increase shareholder returns whether it's a share repo or a dividend increase..

Hey, Roger, this is Dane again. We feel like as Lee said earlier, we feel great about where the balance sheet is right now from a leverage perspective, net debt to EBITDA is trending sub 1 time which is I think kind of top of the peer group.

And we don't have any current maturities, next one's in 2020 and it's $600 million, so easy to handle one way or another. From a managing the business perspective, we've been pretty consistent saying it's nice to have that $750 million in cash on hand.

Interim month, we see some fairly significant swings as receivables come in, as payables go out, and we also want to have a little bit of flexibility to do bolt-ons or other REx activity from time to time with short notice. So that's sort of the minimum operating level we'd like to maintain.

We're feeling – obviously we're in a better position right now than that from a cash perspective which gives us the flexibility to do the things that Lee mentioned in his opening comments.

I mean, we can balance our approach with adding future inventory at low cost that can generate high full cycle returns and also give you consideration of return of capital to shareholders. And so we feel pretty good about that and as we continue to generate free cash for the balance of the year that will give us additional flexibility..

Okay. Thanks. I guess a follow-up on that. So obviously, the move here into the Austin Chalk, relatively attractive lease costs.

As you think about acquisitions, is there anything on the larger scale at this point that looks interesting or attractive or it's really we should think more of the smaller, I guess you described bolt-on type positions?.

Yeah. Yeah, Roger. This is Lee. Absolutely, we are focused squarely on the smaller bolt-ons. Larger-scale acquisitions simply are not on our radar screen. We feel that there have been – there are some really unique opportunities in and around our core basins that are in that kind of small bolt-on category.

You'll recall that we did one in 4Q in the Northern Delaware.

And so, that's the type of opportunity that we're going to continue to look at to – what we'd like to do of course is to continue to take advantage of the amazing execution being delivered by our teams in these core assets and it's going to be hard pressed for others to demonstrate that they can drive more value but we want those, even those smaller acquisitions to come in and compete for capital allocation from a full cycle basis.

So, that's the criteria that even those will have to meet to get in through the door..

Okay. Great.

And if I could just throw in one last one and it's into the weeds, but on the OBO issues where you're not funding, you're choosing not to go forward with that, any – SCOOP/STACK you highlighted, but is that the leading resource play where you're seeing that or is it spread across Eagle Ford, Permian, Bakken, et cetera?.

So first of all, I want to be really clear. We do not expect to be in a non-consent position on a lot of opportunities. That's not our expectation. I mean, we expect operators are going to bring forward their best opportunities just like we are. But the areas where we have the larger non-operated exposure are Oklahoma and Northern Delaware.

Both of those teams have an economic criteria that they test all opportunities against, and then we make a decision on that basis. And also bear in mind that leases may have different terms associated with them too around participation. And so, all of that will factor into our forward-looking decision..

Great. Thank you..

You bet..

Our next question comes from John Herrlin from Société Générale..

Regarding the Austin Chalk, when will we hear test results? Will that be more beginning of the next year, Lee?.

John, we're – as you know, very, very early days here. We're looking to spud the initial well in later this year. Meaningful results are going to be later in 2019. Clearly, this is an exploration play, and I want to remind everyone of that. So, it's going to take us a bit of time to get our arms around what the data is really telling us.

And it is going to be a relatively limited data set even at that point in time. In parallel, we're also participating in a multi-client seismic survey, which is also going to support whatever well results we get.

So, the integration of all of that data is ultimately what will decide whether or not this is something that we want to take into more of a development mode..

Okay. That's fair.

Assuming it does go ahead, how's the infrastructure there in terms of access in, you know, midstream, et cetera?.

Yeah. Well, clearly there in some areas of the Chalk in Louisiana there has been I would say more conventional development that kind of goes back into the kind of the 1990s. But I would say that infrastructure will be one of those areas that we have to focus on initially and ensuring that we get out in front of that.

But from a geographic location standpoint I like being close to the Gulf Coast. I like the fact that this is an area where there has been hydrocarbon development in the past.

So in that way it's very similar to places like Oklahoma and South Texas where even though we brought in the unconventionals there was a conventional business there that kind of came in before us. And of course we're going to certainly enjoy having indexing more to an LLS basis than somewhere else..

Great. Thank you..

Yeah. Thank you, John. I appreciate it..

Our next question comes from Vin Lovaglio from Mizuho Securities. Please go ahead..

Hello.

Can you hear me? Hello?.

Yeah. Go ahead, Vin. We've got you, I think..

Hi. It's Paul Sankey here..

Oh. Hi, Paul.

How are you doing?.

I jumped on to Vin's line and maybe we should get him – force him to ask the question but I don't think he's expecting to. I'm always fascinated by your position right across the U.S. unconventionals.

It seems to me it must be very challenging to plan given the scale of changes that we're seeing whether it's in differentials, whether it's geologic performance. And of course I was wondering as well how cost is changing in the different regions.

Could you talk a bit about all of those things? It feels perhaps like the Bakken is much more attractive now based on transport differentials. It feels like Oklahoma might be dropping off a bit geologically. And then your perspective on drilling and completion costs as well. Thank you..

Yeah. Certainly the multi-basin model in our opinion offers a lot of advantages but it does require a level of planning and optimization that is different than if you were in a single basin mode. There are a lot of different factors that go in. Obviously, you're getting new performance data each and every day. You're getting new cost data.

You're getting new realization data each and every day. So, our planning processes, we have completely overhauled them to reflect the realities of the unconventional plays which means capital allocation is no longer a once a year exercise. It's something that we do in real time.

And so, you should expect to see us continue to adjust and flex as we see developments in each of the individual basins. And whether that's some type of dislocation from a realization standpoint or some kind of dislocation even on a cost standpoint, we do have the ability to reflect that in our allocations going forward.

There's little doubt though that when you look at somewhere like a Bakken where you've had the combination of both productivity gains, strong realizations, and continued reduction in the cost structure that those barrels are going to be extremely competitive even within our multi-basin model and that's why you see us driving a lot of capital that direction in this year's plan.

So, that was our perspective when we started the year. I think the – probably the pleasant surprise for us has been the sheer outperformance of what had traditionally been these non-core areas like Hector and seeing them compete head to head with the Tier 1 inventory that we have across all of our basins..

Right. And then of course, I've seen that the Tier 1 has a cost disadvantage because of the larger amount of activity in those area..

Yeah. I mean, I think it varies. I think a lot of kudos to our supply chain group and the operations team's working with them that they have continued to find innovative ways to control our cost structure whether that is looking discreetly at things like local and regional sourcing of materials, including sand.

I think the month of June we sourced all of our sand locally in the Permian for instance. So we're looking for instance at continuing to assess ways to broaden our vendor population and open up our services to a broader cross-section of vendors.

And we're even considering potentially terming up some element of our activity to ensure that again we not only have the security of well-trained, strongly executing crews but also can potentially lock in some favorable commercial terms..

Interesting. Thank you, sir..

And I'm showing no further questions at this time. I will now turn the call back to Lee Tillman for closing remarks..

Thank you. I want to conclude by thanking all of our dedicated employees and contractors that deliver excellence in all they do 24/7. Welcome again to Guy and certainly thank you for your interest in Marathon Oil. That concludes our call..

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect..