EOG Resources (EOG) continues to outperform analyst estimates. There are multiple catalysts going forward that are my reasoning for a 12 month price target of $148.
EOG's current valuation is high, but company growth estimates are attainable. In 2006, company production was 21% liquids and 79% natural gas. 2012 company estimates are an average production of 86% liquids and 14% gas. EOG will continue to decrease gas production. There is further growth to be attained by increasing oil production at the expense of natural gas liquids. EOG is shifting dollars from combo to black oil plays.
Cost containment has been successful, and there is more room for cuts in the short term. Increased self-sourced sand, decreased drilling days, and less cap ex devoted to gas all will better bottom line numbers. Drilling and completion costs continue to pull back in plays like the Bakken, Eagle Ford and Permian. EOG continues to increase the realized price of oil. A larger percentage of oil produced, coupled with an expansion of shipments to St. James will provide higher realized prices. Overall production will continue to outpace analyst estimates. As costs lower, more sand and water will be used. This will improve initial production and estimated ultimate recoveries or EURs.
Much of EOG's acreage is held by production. Pad drilling development will begin decreasing drilling/completion times and costs. The combination of decreased costs and drilling times will result in a larger number of wells completed in 2013, without increasing cap ex.
In 2013, WTI prices will average $90 to $94/barrel, and the differential to Brent to remain at current levels to slightly higher. Bakken and Canadian crude differentials will improve, but remain volatile. LLS will continue to sell at a premium, with an average of $14 above NYMEX. EOG rails almost all of its Bakken crude, and should be affected little by this differential. The LLS premium is important, but there is little reason for pricing to change over the next 12 months. Realized oil pricing for 2013 should range from $6 to $7 above NYMEX. This is more than double company estimates.
Over the past year, EOG has beat earnings estimates all four quarters. Three of the quarters beat by more than 27%. Its third quarter beat resulted in a Baird upgrade. The same day, EOG received two downgrades from buy to hold. Wunderlich and Societe Generale both believe the stock price has outpaced forward growth metrics. On November 6th, Citigroup increased its outlook for liquids growth, issuing a buy rating and $135 price target. In the short term, EOG's stock price is high on valuation. I expect the fourth quarter to be a little light providing a buying opportunity.
EOG is placing significant capital into its combo plays. The Wolfcamp and Leonard shale, plus the Barnett Combo are some of EOG's prime leaseholds. These are shallow plays and have lower well costs. Combo plays produce 70% to 80% liquids, with 40% to 50% coming from oil. EOG has decided to move capital from these areas to black oil plays, due to the falling price of NGLs. With NGL production growing in the United States, prices will stay at current levels or head lower. Year over year the price of oil/condensate is up over $10 per barrel, but the price of natural gas liquids is down $20. Oil and condensate pricing for EOG's third quarter was $97.64, while NGLs sold for $30.95. For every barrel of NGLs EOG replaces with oil, revenues increase by more than 300%. Bakken wells produce up to 92% oil, and 78% in the Eagle Ford. For every dollar taken from the Wolfcamp and spent on the Bakken, oil production increases by 50%.
EOG saves a half million dollars per well by self-sourcing sand. Its current well cost in the Eagle Ford is $5.5 million. This is $2 million less than the industry average. The Bakken and Eagle Ford are fully sourced. EOG would like to do the same in the Permian and other of its plays. Look for EOG to increase sand production going forward. This will allow for increased sand use per well in the Bakken and Eagle Ford. As a secondary option, EOG would have interest in increasing sand usage in the Wolfcamp and Barnett Combo.
EOG sells most of its oil at LLS pricing. 100% of its Eagle Ford oil is priced of the LLS index. It currently rails the majority of its Bakken crude to the St. James terminal in Louisiana. Only some Permian oil is railed to Louisiana. The St. James terminal paid for itself in a matter of months. Only a small portion of its Bakken crude is sent by pipe to Clearbrook. As EOG increases development in the Bakken, more oil can be railed to St. James.
EOG is decreasing drilling and completion costs. In the second quarter, it had an average well drilling time of 14 days. The third quarter average was 13 days, but its fastest wells were done in 8 days. This has led to a decrease in drilling rigs from 70 in the first half of 2012 to 52 in the second. It also has decreased spending to drill natural gas wells. In 2012, it spent $700 million. Only $100 million of cap ex will go here in 2013. It continues to drill and complete wells faster, but more importantly improved well design has set the pace in the Eagle Ford and other of its prospects. Initial production rates have been improving, but the question is how much better will it perform over the next twelve months?
EOG's bullish views on the Bakken over the past few quarters, echoes my sentiment. Even with higher well costs, the area produces large percentages of oil. In 2012, EOG has moved from short to long laterals. These wells average 9000 to 10000 feet in length. EOG has worked Williams, Burke, Mountrail, McKenzie, and Dunn counties this year. The table below shows current well design in deeper areas of the Bakken/Three Forks.
|File No.||90-Day IP||Lateral||Choke||Stages|
The table below covers the same area as the table above. Operators are Hunt, Slawson, Samson, Murex, and Arsenal (OTCPK:AEYIF).
|File No.||90-Day IP||Lateral||Choke||Stages||Water||Proppant|
EOG has started to use mostly long laterals, between 9000 and 10000 feet. Its initial Parshall Field development was done with short laterals. The move to long laterals decreases well costs as it requires half the vertical drilling. This decreases the number of wells drilled by one half. EOG's average well costs for a short lateral was $5.5 to $6 million in the Bakken. It will be interesting to see what well costs are in a long lateral development program.
EOG is currently using over 4 million pounds of proppant per long lateral. Its best producer used over 9 million pounds, plus 4.5 million gallons of water. Table one shows EOG's well design, but more importantly it shows how lateral length, stages, water and proppant affect initial production numbers. The pounds of proppant in the second table shows what many of the Bakken operators are doing. Most are using 2 to 3 million pounds of proppant and 1.5 to 2.5 million gallons of water. EOG is also using a higher number of stages. It currently is using 37 to 42, while the average is a 30 stage frac. Lateral lengths are also important. Longer laterals mean more source rock is in contact with the well. EOG has been experimenting with lateral lengths of 12000+ feet, while most operators average between 8000 and 9000 feet. It is important to note that EOG will have fourth quarter numbers on its Bakken Waterflood program. If this goes well, the Bakken could see a significant bump in reserves. It is also a low cost way to increase production from lower production wells.
EOG is the number one operator in the Eagle Ford. It has obtained the best geology. This geology is enhanced by a superior well design. The table below shows some of its most recent results.
|API No.||IP Oil||IP NGL||IP Gas||Choke||Lateral||Proppant|
32473 - 32477
EOG was prepared for the large amounts of proppant needed in the Eagle Ford. If it did not self-source its own sand, well costs would be significantly higher. The ratio of sand per lateral foot is much higher here than in the Bakken. Baird Heirs 4H used 2436 pounds of sand per foot. EOG's well identified by the North Dakota File number 21239 used a significant amount of sand. When compared to the average well, it used three to four times more. EOG used 1086 pounds of sand per foot. This leaves significant upside in the Bakken to current results.
Magnum Hunter is another operator working the Eagle Ford. Its most recent results can be used as a comparison to show how good EOG's numbers are.
|API No.||IP Rate||30-Day IP||Lateral||County|
Magnum's results are good, but not near as well as EOG's. Almost all of the EOG wells produce more barrels of oil than total resource of Magnum's wells. Penn Virginia (PVA) is another operator working this area. It has completed a significant number of wells in Gonzales and Lavaca counties. Magnum did not provide water and proppant data.
|API No.||IP Rate||Choke||Lateral||Water||Proppant|
Penn Virginia uses significantly less water and proppant, and has had poor results in comparison. Other variables can affect results like drilling competency, hydraulic horsepower, and completion style. It is possible a combination of these create EOG's outperformance. This is not limited to Gonzales County.
The picture above shows EOG's acreage (yellow) in the Eagle Ford. Geological shows its reasoning for this specific acquisition. The Eagle Ford has its most shallow areas in the northwestern aspect. The source rock can be as shallow as 6000 feet in Maverick and Zavala counties. These areas have lower drilling costs. The shale in these areas is also thick when compared to the rest of the play measuring 500 feet in areas. The earliest acquisitions focused on this area, but EOG purchased acreage in the oil window (green) nearest to the condensate window (pink). EOG knew purchasing acreage at depths of 9000 to 11000 feet would provide higher well pressures. This pressure is magnified by wells with higher natural gas content, or near the Condensate Window. These two variables in concert produce higher initial production rates. Southeast Gonzales County has been a focal point, as the Eagle Ford shale reaches thicknesses of 300 feet.
EOG's focus on black oil plays has slowed the development of the Permian and Barnett Combo. Both have low well costs ($3.4 to $5.5 million), but produce a high percentage of NGLs (30% to 39%). EOG is outperforming the competition in the Permian. Its last eight wells in Lea, Irion and Crockett counties have had IP rates of 840 to 1290 barrels of oil, 60 to 188 barrels of natural gas liquids, and 330 to 1036 Mcfd. The table below shows the most recent well results by other operators in Crockett County, Texas.
|API No.||Operator||IP Rate (Bo/d)||IP Rate (Mcf/d)||Lateral|
|41411||BHP Billiton (BHP)||192||198||7681||9.09MM||7.95MM|
The wells above lag EOG's most recent results, mirroring the Bakken and Eagle Ford. These results can be linked to water and proppant usage. EOG's most recent University 38 wells had an average water usage of 8697696 gallons per well. Its average use of proppant was 12012073.
EOG has several ways to continue beating analyst estimates on the top and bottom lines. I believe revenue growth can continue through several of EOG's business plans. The most important path is through oil. Moving dollars from combo plays to the Eagle Ford and Bakken is the first step. Improved well design has recently produced its highest IP rates. This has not been factored into 2013 estimates, especially the Bakken results. Oil price realizations will continue to be above NYMEX, as EOG rails more oil to St. James. It plans to spend much less on natural gas acreage. I believe further natural gas asset sales will provide additional capital for oil play development. Decreased costs should help bottom line numbers in 2013. EOG will increase production of self-sourced sand. Look for this to continue until EOG produces all of its US sand. Pad drilling requires fewer rigs to do the same number of wells. Wells can be drilled completed simultaneously. Average drill times could reduce by 30%. Oil services are also getting less expensive. Many plays have reported a bottoming of prices, but I think we could see further decreases over the next few quarters. EOG has not realized many of these decreases, as it signs mostly long term deals. When some of these contracts are up, we could see additional savings. Given the number of catalysts, EOG is a good investment going forward.
Additional disclosure: Proppant measured in pounds.Water measured in gallons.Laterals measured in feet.Bo/d: Barrels of oil per dayBoe/d: Barrels of oil equivalent per dayWells listed are labeled by the file number from the North Dakota Oil and Gas Division website. Texas wells are labeled using five digits of the API number from the Railroad Commission of Texas website.This is not a buy recommendation.