How Big Could The Eagle Ford Turn Out To Be For EOG?

 |  About: EOG Resources, Inc. (EOG), Includes: LSTMF
by: Devon Shire

"Someone's sitting in the shade today because someone planted a tree a long time ago"

I have that quote as being attributable to Warren Buffett, but really anyone could have said it. Anyone could have said it because it is simply an obvious statement of fact.

And that obvious statement of fact is also a certain recipe for long term investment success. A recipe that the vast majority of investors are no longer interested in following in this age of frenetic trading with the financial networks covering every tick of the market.

I've decided to take a long term approach to my investing and my favorite way to do this is to keep buying shares of unconventional (tight) oil producers. I believe the acreage that these companies have locked down will grow significantly in value over the coming twenty years.

My Role Model

I have a childhood friend who is sitting under a big tree that his father planted in the 1970s. His father didn't get much of a chance to sit under that tree because for most of his life that tree was still small and growing.

But now almost 40 years later that tree has turned into a Redwood.

What my friend's father did was plant a tree that took the form of a large parcel of real estate that at the time was well outside the boundaries of city limits. When my friend's father bought that land it was priced for its primary use at the time which was farming.

Today with the passage of time and because the land's primary use is now commercial and residential instead of agricultural the value of that land has risen exponentially.

My friend, his brother, his sister and all of their kids would never have to work a day for the rest of their lives if they chose not to.

Yes, I'm green with envy.

But I've been planting little trees of my own in a specific type of company over the past three years. My expectation is that twenty years from now these little trees will have turned into a forest, and the cash that I have invested will have multiplied many times.

The little trees that I have been planting involves buying shares in companies that have locked up large land positions in unconventional oil (tight oil and not gas) resource plays.

I think Mr. Market is greatly underestimating just how much cash flow that real estate is going to generate over time.

EOG Resources And The Eagle Ford

The general public has now caught onto the revolution in oil production that is going on in the United States because of the application of horizontal drilling and multi-stage fracturing to tight oil resources.

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What I think is greatly misunderstood is that this first wave of production and recovery through primary drilling is actually going to be the least economic oil recovered from these unconventional resources.

The second wave of production from these unconventional plays through the application of Enhanced Oil Recovery (EOR) is where the really big money is going to be made for these companies.

Let's consider EOG Resources (NYSE:EOG) and its Eagle Ford assets.

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EOG has the largest position in the core of the Eagle Ford. Initially, with well results and technologies available in 2010 EOG thought it would be able to recover 900 million barrels from its Eagle Ford acreage.

That was the initial assessment.

At the end of 2011 EOG gave us an update on what they thought the Eagle Ford was capable of. With results of well downspacing testing EOG believe that the spacing between wells could be decreased from 130 acre spacing to 65 to 90 acre spacing.

Because of that EOG increased its recoverable reserve estimate from 900 million barrels to 1.6 billion barrels. That is an increase of 700 million barrels.

There is of course an incremental cost to this increase in recoveries of course. EOG will be paying for the cost of drilling a lot more wells to do the downspacing.

But that additional 700 million barrels will be recoverable at BETTER economics than the first 900 million barrels. The incremental 700 million barrels will have better economics because:

- There is no incremental land cost, that acreage is already tied up

- Roads that were already being built to reach the initial 900 million barrels are a cost that won't need to be duplicated for the incremental 700 million barrels

- Much of the pipeline and processing infrastructure spending that was already required for the first 900 million barrels won't need to be duplicated for the incremental 700 million barrels

I can't exactly quantify the difference, but the concept is that if the first 900 million barrels have a present value of something like $25 per barrel, the incremental 700 million barrels would have a higher present value, say $35 per barrel. The cost of producing the incremental barrels is less, the sales price is the same, therefore those barrels are more profitable.

In 2012 EOG provided a further update and it appears the value of its Eagle Ford acreage has increased again. Instead of 65 to 90 acre spacing, EOG thinks optimal well spacing will be 40 to 65 acres. The expected increase in recoverable barrels this time is 600 million bringing the total on EOG's acreage to 2.2 billion barrels.

Again, these incremental barrels will be more profitable than the first 700 million barrels because they won't require a repeat of a lot of the initial infrastructure spending.

Secondary Recovery The Really Big Prize

These increases in recoveries and value as a result of downspacing are not the end of the good news.

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There is going to be another big jump in recoveries and value through the application of Enhanced Oil Recovery techniques.

For EOG and the Eagle Ford that EOR is apparently going to be in the form of natural gas injection. CEO Mark Papa commented on this in the most recent conference call:

In the case of the Eagle Ford, it would be through the gas injection and we have commenced our pilot gas injection project down there in the Eagle Ford, and the reason I mentioned it on the script is that it may be as long as two years before we really have a read on the outcome of a pilot project. I just only want to give a timeline on it, but its worse our investors knowing that the pilot project is underway but it's not anything that we are going to be able to provide quarter-by-quarter feedback as to how is the pilot coming or anything like that. But it is fair to say that we are cautiously optimistic that we will come up with a method of significantly enhancing the recovery above the 8% number.

Not only will the natural gas injection result in increased production and reserves, but the economics of that production and reserve additions will be significantly better than the 2.2 billion barrels of primary production I referred to earlier.

Think about it. Here are the items that are required for natural gas injection that are already paid for through primary recovery:

- Pipelines

- Roads

- Processing infrastructure

- Natural gas (the product being injected is a by-product EOG is already producing)

- The producing wells

Every barrel of incremental oil recovered through EOR is going be much more profitable than every barrel recovered through primary production.

EOG will spend less and produce the same amount. It will be a wonderful thing for the cash flow statement.

If oil prices continue to rise it will be even more wonderful.

Petrobakken Using Natural Gas Injection in the Canadian Bakken

Petrobakken (PBKEF.PK), a company that I closely follow is ahead of EOG in using natural gas injection on an unconventional oil reservoir and the early results look very exciting.

The chart below shows the increase in production coming from the natural gas injection. Production from the offsetting wells has more than doubled and is showing no signs of decline.

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The impact on Petrobakken's recoveries over time from EOR is going to be enormously valuable for shareholders.

Under primary recovery Petrobakken believes that 15% to 17% of the oil in the ground in the Bakken can be recovered. With EOR that recovery figure is expected to increase to 30%.

The second 15% being recovered is probably going to require less than half the capital invested to recover the first 15%.

These Are Long Term Investments

I hope you can see why I'm taking a lesson from my friend's father who planted a little tree 40 years ago that is now providing financial shade for all his children (and their children).

I'm buying unconventional producers like Petrobakken and EOG that today are valued based on very low recovery factor expectations. Ten years from now when the market realizes that the actual reserves recoverable from these properties is four or five times what is currently expected these companies are going to have much higher share prices.

These aren't investments that are going to provide me with a double overnight. But over ten or twenty years I expect that these investments will have doubled a couple of times.

And if the price of oil continues to creep upward as I expect it will, then this plan will work out even better.

Disclosure: I am long PBKEF.PK. 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.