Bakken Update: EOG Has Several Catalysts For 2013

Nov.29.12 | About: EOG Resources, (EOG)

EOG Resources (NYSE: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.

EOG Resources' Williston Basin Well Results In Bo/d
File No. 90-Day IP Lateral Choke Stages

Water

Proppant

21378 793 6475 24/64

32

3433765 6867099
21239 1101 8309 30/64 42 4596164 9023010
21194 783 9562 36/64 37 874491 1705785
20691 348 10543 24/64 42 2457665 4246618
20038 663 12185 30/64 42 2325913 4864841
20255 780 12236 32/64 41 2433929 4182144
20890 768 9665 12/64 22 2769759 4052313
20886 587 9648 8/64 31 3235492 4383583
20332 N/A 6144 34/64 25 1912984 2862341
20067 N/A 9417 38/64 38 2198891 3710788
Click to enlarge

The table below covers the same area as the table above. Operators are Hunt, Slawson, Samson, Murex, and Arsenal (OTCQX:AEYIF).

Williston Basin Well Results By Other Operators In Bo/d
File No. 90-Day IP Lateral Choke Stages Water Proppant
22335 232 9471 20/64 24 1980924 3335719
21676 209 9492 14/64 31 746824 1306261
21304 296 9228 26/64 30 1381547 2382494
21020 361 10194 18/64 21 1736469 2983610
21176 545 9117 32/64 28 2626999 3360000
21581 295 8073 22/64 23 1524780 2760000
20593 596 5543 16/64 18 792189 1369624
22639 N/A 9555 64/64 37 2195967 2792800
21793 N/A 4458 48/64 14 946043 1304180
Click to enlarge

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.

EOG Eagle Ford Well Results
API No. IP Oil IP NGL IP Gas Choke Lateral Proppant

32473 - 32477

4598-3346 537-457 3.2MM-2.7MM 32/64 5499 8-10MM
32636

4012

495 3MM 36/64 4510 8.55MM
32569 2540 268 1.6MM 40/64 5126 11.16MM
32617 2242 181 1.1MM 34/64 4111 10.01MM
32536 3579 483 2.9MM 32/64 3775 5.82MM
35079 1905 112 673M 34/64 6293 9.53MM
34951 2075 115 688M 34/64 6373 10.09MM
33141 1522 220 1.3MM 36/64 6489 10.04MM
33143 1876 208 1.2MM 36/64 6599 10.12MM
Click to enlarge

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.

Magnum Hunter Eagle Ford Results In Boe/d
API No. IP Rate 30-Day IP Lateral County
33614 1333 839 5648 Lavaca
33612 2289 1203 5576 Lavaca
33600 2044 902 5461 Lavaca
33609 1590 1019 4891 Lavaca
32127 1321 1031 3815 Gonzales
Click to enlarge

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.

Penn Virginia's Eagle Ford Well Results In Boe/d
API No. IP Rate Choke Lateral Water Proppant
32134 1247 16/64 4729
32208 1847 18/64 4453 4.60MM 3.16MM
32209 1188 15/64 3913
32218 1190 18/64 3931 4.44MM 3.33MM
32217 1495 17/64 4453 4.55MM 3.48MM
32210 1399 20/64 2805 3.25MM 2.53MM
32222 1921 16/64 4200 5.51MM 4.62MM
32366 1808 14/64 3415 3.13MM 2.86MM
32376 1257 18/64 3444 3.35MM 2.81MM
32439 1202 14/64 3398 3.12MM 2.76MM
32472 1115 14/64 3703 2.28MM 2.77MM
32535 1002 14/64 3153
32480 969 16/64 3203 3.14MM 3.28MM
33625 922 12/64 4950 2.88MM 4.24MM
33632 1277 14/64 5453 4.39MM
32579 827 12/64 4453 2.30MM 2.77MM
33643 1036 13/64 4453
33662 832 13/64 4201 4.71MM
Click to enlarge

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.

Click to enlarge

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.

Non-EOG Permian Well Results In Crockett County
API No. Operator IP Rate (Bo/d) IP Rate (Mcf/d) Lateral

Water

Proppant

41558 EP Energy 756 261 7304 7.42MM
41361 EP Energy 180 315 7491
39776 Conoco (NYSE:COP) 168 1
41440 Devon (NYSE:DVN) 548 374 7623 7.56MM 6.84MM
41442 Devon 341 199 7613 6.81MM 7.92MM
41411 BHP Billiton (NYSE:BHP) 192 198 7681 9.09MM 7.95MM
41477 BHP 44 0 5700
41294 EP Energy 143 20 6500 7.18MM
Click to enlarge

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.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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.