Who would have thought that EOG Resources (EOG) would be a $35 billion stock just 14 years ago? No one. Fourteen years ago, EOG was just getting started after its parent company, Enron dissolved into thin air and only profitable subsidiaries remained. EOG being one of those subsidiaries had a share price in 1999 of $7/share. That equates to a market cap based on today's shares outstanding of $1.8 billion. That equates to a 1,900% return on investment in 14 years. Now that is impressive. What's even more impressive is how quietly it has done it. While other oil companies have tried to appear glamorous and boast about their reserves and their production growth EOG has quietly taken the "slow and steady wins the race" mentality. And if you listen to Mark Papa's conference calls, you will hear him constantly say that he is focused on returns while keeping debt levels subdued. It is NOT concerned about being the largest oil producer in the world. (It will soon be the largest oil producer in the contiguous 48.) Rather, EOG only goes after a barrel of oil if it is profitable for the company and shareholders. Doesn't that sound like a noble idea. It's that mentality that has rewarded CEO Papa and his shareholders handsomely.
Before I get too carried away commending the job that Papa and his minions have done, we should recognize that the past 15 years have been an exciting time to be in the oil business and even more exciting to be invested in it. New technology such as horizontal drilling and hydraulic fracturing has unlocked massive amounts of shale oil and gas. So much so that the United States is now being mentioned in the same sentence as Saudi Arabia with regards to its oil. In fact, one might say that the oil and gas industry has been this nation's saving grace since 2008 by creating and keeping jobs in the United States that would otherwise be in the Middle East somewhere, and by keeping natural gas prices low. (But let's not get into politics) Furthermore, oil prices have risen from $16 in 1999 to north of $90 today. Let's just say it has been a perfect storm for the oil industry and if you show me a company that hasn't delivered impressive returns in the past 14 years, I will show you a company that was poorly managed.
However, even with a perfect storm EOG has still outperformed every single one of its peer companies. Let's compare some companies over the past 10 years to gain a perspective of just how well EOG has done. Over the past 10 years EOG has had a total return of 560%. Below are companies from the main peer group and their comparable returns.
- Pioneer Natural Resources (PXD) 420%
- Anadarko Petroleum Corp (APC) 293%
- Marathon Oil (MRO) 215%
- Chesapeake Energy (CHK) 202%
- Devon Energy (DVN) 144%
- Apache (APA) 150%
You can see from this list, EOG is clearly the best of breed but you may be asking yourself, why am I talking about past performance when as of today, only future performance matters. Well, there is a saying in weather forecasting that says the best way to predict future weather is to ask what the weather was like yesterday. EOG still has Mark Papa as CEO, oil prices are likely going higher thanks to the Fed, and there is going to be an oil and gas boom in the United States for years to come. So let's take a look at the fundamentals closer and try to forecast just how sunny the weather is going to be.
Let's start by looking at EOG's lesser known operations and why this may be something that sets it apart from other companies.
Besides the best assets in North America, and the strong organic crude oil production growth, this slide brings up an interesting point that is often overlooked. Not only is EOG becoming more efficient in all areas as a later slide will show you but it is also finding ways to increase margins by doing things "in-house." Sure, other companies are doing things themselves too, but I don't know any other company mining and manufacturing its own sand. Why would EOG do this? Out of all the things involved in drilling and completing a well, why would EOG single out sand production as the item it wants to do itself? There are probably multiple reasons. First, demand for sand has sky-rocketed since the "shale boom" started and rather than pay a premium for sand from companies like US Silica (SLCA), EOG would rather produce its own sand with sand mine operations in North Texas, and Wisconsin.
To understand just how much sand EOG is using, let's make some simple assumptions. Let's assume each well that EOG drills uses on average about 5 million pounds of sand or 2,500 tons. Your jaw may drop at that number but that is being conservative. EOG plans on drilling 644 wells in 2013. Now let's multiply 644 wells by 5 million pounds and we see that EOG will use approximately 3.2 billion pounds of sand in 2013 alone! So let's assume that EOG is completing its wells with 100% of its own sand. Now let's assume that EOG saved $.05 on every pound of sand that it delivers to the well head. Using simple math, that means that EOG will save $96 million in 2013 just by using its own sand! To put that in perspective, EOG's net income in 2012 was $570 million meaning that the savings from sand was nearly 15% of net income. This isn't taking into account the capital expenditures required to self-source your own sand but I assume EOG did the NPV analysis required to insure that this was a good investment.
Furthermore, if EOG is using this much sand, so are all of its competitors. Is it possible that EOG had the foresight to see the supply pressures that would be put on the sand industry and get ahead of the game? And is it possible that sand has potential to be the bottleneck in the entire drilling and completing process? Shale oil and gas drilling has become more like a mass production manufacturing process rather than custom manufacturing like it used to be. So with any mass production process, the supply chain becomes absolutely crucial! I think EOG had the vision to predict the sand price differential from producing its own sand as well as the importance of supply chain management.
Next we see that EOG is using a crude-by-rail system going to St. James, Louisiana, from all three of its major crude oil plays. By looking at the following slide, we see that it is gaining an excellent price differential with the crude-by-rail-system. Why is LLS higher than WTI you might ask? First of all, LLS is more correlated to the world oil markets. In addition, Argus media has an excellent white paper on this that says,
"a crude oversupply in the Midwest has combined with a pipeline bottleneck to weigh on the value of WTI at the pricing center of Cushing, Oklahoma, starting in 2007. This has pushed the US benchmark to unusual discounts to other global benchmarks."
So using simple math again, we see that EOG is gaining a $22 dollar price differential by shipping its crude oil to Louisiana. It is hard to estimate how much of the crude oil it is shipping to Louisiana but by seeing that it has the capability to ship from its top three oil producing shales, I would say it is shipping a large portion. Let's assume it is shipping 10 percent of its liquids production to St. James. In 2012, it produced 158,000 barrels of liquids per day. Taking that times the 10 percent, times $22 per barrel, times 365 days in a year we can see that EOG could have saved almost $125 million with the crude by rail system. This of course isn't taking into account the transportation cost of rail versus a pipeline, but once again, EOG would not be doing it if it wasn't a good return on investment. So we have highlighted two ways that EOG is going above and beyond what any other oil company is doing in order to give itself the competitive edge.
Getting back to EOG's core business, let's look at the Bakken and Eagleford plays as they are going to be EOG's two main growth drivers in the years to come. EOG's Bakken acreage has been an incredible performer for EOG. EOG was one of the first movers in this play and it has paid off greatly. Not only was it one of the first movers, but it found its acreage being in the sweet spot of the play. Today, EOG is the third-largest leaseholder in the Bakken with 600,000 acres. The largest is Hess Corp. (HES) with 900,000 acres followed closely by Continental Resources (CLR) with 855,936 acres. According to EOG's latest presentation it is producing 62 MBoed from the Bakken. More importantly, it is finding new and better ways to get the oil out of the ground. It is experimenting with down-spacing of the wells from 320 acre to 160 acre spacing. If this becomes effective, then the future only looks brighter. With hydraulic fracturing and shale oil being less than a decade old, it is foreseeable that efficiency and productivity gains are only going to continue to increase in the coming years. This will only result in netting more oil to companies like EOG.
Looking at the EOG's Eagleford operation, it holds 590,000 acres of liquids-rich acreage in the play. Other major players in the play include Chesapeake , Apache , and EV Energy Partners LP (EVEP). It announced at the year-end quarter, it is increasing its estimated potential reserves by 38% in the acreage. What does that mean? It simply means that EOG now believes that there is more oil under the ground than previously thought. Ultimately, as it states in the presentation, that means that EOG can now estimate that it will recover 2.2 billion barrels of oil compared to the last estimate of 1.6 billion barrels. This is the second time that it has increased the reserves in this play and that's an increase of almost 40%. Let's speculate that this happens two more times in the next decade due to technological advances. That means that in 10 years, the Eagleford's recoverable reserves will almost double for EOG again! EOG's crown jewel that is the Eagleford just keeps getting better. As EOG likes to remind us in the quarterly calls, "EOG has captured the biggest U.S. crude oil discovery net to one company in the past 40 years." Putting that into context, that means this is bigger than any 1 oil discovery that Exxon Mobil (XOM), Chevron (CVX), or BP (BP) has had in the U.S. for the past 40 years, dating back to the Prudhoe Bay discovery in Alaska in 1968.
Furthermore, well economics are outstanding in the Eagleford with an average after-tax rate of return of 100%. How many companies out there can say they are going to invest over a billion dollars and they will get an ATROR of 100%. Furthermore, it continues to get more efficient at drilling and more productive at completions. The latest record well, which will likely only be outdone again next quarter, was the Burrow Unit #2H, which IP'd around 6,300 Bopd. That is a well that would have been more common 20 years ago, but not in 2013! Additionally, here is a slide that demonstrates how EOG is getting more oil out of the ground and giving itself a larger NPV per acre.
Here is another slide demonstrating EOG's efficiency gains in drilling.
So you see, EOG continues to improve in all areas. Operations, drilling, completions, exploration, you name it and EOG is striving for improvement.
We have looked at EOG's two main plays, which will be the growth drivers for years to come. It should also be mentioned that EOG has outstanding acreage in other plays throughout the contiguous 48 states. EOG has acreage in the Haynesville shale, the Barnett shale, the Niobrara, the Marcellus shale, and most importantly, the Permian Basin. Without going into too much detail, the Permian Basin is one of EOG's legacy assets from years past and new technology has unlocked incredible potential for this sleeping giant. Recently EOG has been adding acreage to the Wolfcamp and Leonard Shales in West Texas, and New Mexico, respectively. It has 35 net wells planned for 2013 in these plays but expects to begin seeing significant increases here by 2015.
With the plethora of acreage that EOG has you can expect to see production gains for years to come. What's more, you can expect those production gains to be in the favorably priced crude variety rather than natural gas, which has been EOG's modus operandi all along. EOG has increased its liquid production by a CAGR of 35% for the past six years and is expected to do it again in 2013. It has gone from 43,000 barrels of liquids per day to a forecasted 263,000 barrels of liquids per day in 2013. Seeing those numbers and understanding that in 2007 EOG was known as a natural gas producing company, makes one truly appreciate the job that Mark Papa and his team have done to keep EOG on top even as the ground shifted beneath them.
In conclusion, I hate to agree with Jim Cramer but given all of the favorable circumstances mentioned above, EOG should be strongly considered as a long-term holding in your portfolio. Oil prices will continue to rise, Mark Papa and his team will continue to outperform, and EOG will continue to break down the technological barriers so that its first-class oil rich acreage will yield greater return for shareholders. Look for EOG to continue to be the top-performing energy stock in its class for the foreseeable future, or at least until people stop needing oil.
Next time, I will take a more in depth look at EOG by the numbers and try to show you what this view from 10,000 feet really means for the future.