EOG Resources Inc. (EOG) recently reported its fourth-quarter earnings. The earnings were a surprise because the company took an $849 million write-off on the value of its Canadian natural gas assets. Like most other energy exploration and development companies, low natural gas prices have put a damper on EOG's earnings. The good news is that revenues were higher by 32.5%. In addition, the company forecasts that in 2013 its crude-oil production will grow by 28%, with 23% higher total liquids production growth. In North America, it projects natural-gas production to decline 15% from the year earlier. While this seems to be good news for EOG, I believe that its stock does not have any near-term upside potential. Below, I will explain why.
Evaluating the U.S. Oil & Gas Industry
A review of the U.S. oil and gas industry shows that the stock of refiners performed much better than the stock of exploration and development companies. Over the last year, the stock of refining companies, like Valero Energy (VLO), Tesoro (TSO) and Marathon Petroleum (MPC), have all realized high double-digit gains. This is opposed to the energy exploration companies whose stock prices have remained flat and, in some cases, lost ground.
The reason that the stock of exploration companies floundered was because these companies were slow to react when natural gas prices tanked. They were drilling and producing natural gas when the real money was in the production of oil and natural gas liquids. In 2012, after the price of natural gas approached record lows, the earnings of exploration companies such as Chesapeake Energy (CHK), Devon Energy (DVN), and Anadarko Petroleum (APC) declined. Unfortunately, they did not respond to declining natural gas prices as quickly as EOG did. As the first responder, EOG was able to buy acreage in some of the best oil-rich shale plays in the U.S. for relatively cheap prices. EOG's portfolio now includes acreage in the Bakken shale field in North Dakota and the Eagle Ford and Permian Basin in Texas. Having large portfolio holdings in the Eagle Ford and Bakken reserves puts EOG ahead of its competitors. The Eagle Ford and the Bakken reserves accounted for more than 80% of U.S. crude oil extracted from shale and other rock formations from 2005 to 2012, while other basins - like the Woodford and the Mississippian - have produced little crude. Thanks to EOG's oil-rich portfolio, it has done a better job of increasing oil production than its peers. In 2012 nearly, 90% of EOG revenues were the result of oil sales.
EOG is still pushing forward and in the last three years the company has invested more than $16 billion to acquire additional prime acreage in the Eagle Ford, Permian Basin, and Bakken shale fields. EOG, unlike its competitors, was able to acquire these properties while still maintaining a strong balance sheet.
What is in EOG's future?
EOG's early move from gas production to oil production was strategically brilliant; however its competitors are also successfully changing their focus from drilling for gas to drilling for oil. For example, in the fourth quarter Chesapeake Energy increased its U.S. oil production by 15% and Anadarko increased its U.S. oil production by 8.5%. Both of these companies were able to increase their production because of their land holdings in south Texas. In the future, competition to produce and sell oil from U.S. shale fields will be fierce. The oil that is extracted from U.S. shale fields is referred to as West Texas Intermediate (WTI) crude. Currently WTI crude oil sells for around $93 a barrel as opposed to offshore Brent crude oil, which sells for around $109 per barrel. The reason that WTI oil sells for a discount is because there is a glut due to oversupply by U.S. exploration companies. In a forecast of things to come, the International Energy Agency (IEA) recently forecast that "U.S. oil output, aided by surging volumes from shale and other onshore rock formations, could top production from Saudi Arabia and Russia by 2017." The trend by exploration companies, which are now scurrying to produce oil, is eerily similar to the trend to produce natural gas that eventually led to oversupply, thus crushing the price of natural gas.
With the recent technological advances in oil extraction, (such as fracking and horizontal drilling) along with so many companies shifting their resources towards oil production, it is not unreasonable to believe that U.S. oil production will increase to the point where WTI prices will fall or even crash. That development would play into the hands of the refiners, but would be bad news for the energy exploration and development companies. The result would be lower earnings and possibly even consolidation within the industry. I do not predict that this will happen in the near future, but the competition among the large energy companies to produce and sell WTI crude, will certainly have a negative effect on their profits.
EOG's aggressive move to increase oil production has helped the company's bottom line and benefited its shareholders. While EOG's stock price has increased by 13% over the last 52 weeks, the stock prices of its competitors have slumped. For instance, over the last 52 weeks Devon Energy's stock price has dropped by 22%, Chesapeake Energy's stock price is down by 11%, and Anadarko Petroleum's stock price went up by just 1.4%. While I think that EOG is "best-of-breed" amongst the large exploration and development companies, because of its revenue growth, expanding profit margins, and relatively low debt level, I would not recommend buying the stock. I do not foresee any significant gains for stocks in the gas and oil exploration industry as a whole. The combination of low gas and oil prices, fierce competition, and a flat U.S. economy will prevent any of these companies from achieving significant earnings increases.