Believing that a powerful stock market trend may be developing for independent natural gas and oil production companies in 2011-2012, we raise estimated Net Present Value (NPV) for buy-recommended EOG Resources (EOG) to $120 a share from $92. An impressive resource position in an oil prone zone of the Eagle Ford Shale of Texas helps justify a $7 billion increase in NPV split $5 billion in oil and $2 billion in natural gas. An active trend in large companies acquiring or joint-venturing with smaller producers alerts us to hidden value in unproven acreage. We saw similar signs exactly 32 years ago when we completed an analysis that placed acquisition values at 100% of future revenue, not discounted cash flow, from proven reserves. That surprising finding caught the early stages of a renewed cycle of resource appreciation. Those signs occurred in a backdrop of relatively gloomy economic and political expectations, similar to today.
It Feels like the Carter Years are Back
In the spring of 1978, the second year of the U.S. Presidential Cycle, we were upset enough apparently to write, “..the U.S. oil outlook has deteriorated as the Carter Administration persists in holding U.S. crude oil wellhead price 7% below already low lawful levels. We remain hopeful that this incredulous posture is only a political ploy to be corrected in a few months.” Instead, price controls persisted and a punitive “windfall” tax was added. Today, emboldened by an unfortunate oil blowout catastrophe, the Obama Administration is magnifying the damage to the economy and to the people of Louisiana and Texas by curtailing offshore activity. At the same time, the threat of punitive taxation persists for oil investors.
As a result of negative government policy, the restrictions in supply are in place. Less supply automatically means a higher price than would otherwise be the case.
Reduced domestic supply made the world more vulnerable when the Iranian Hostage Taking caused a curtailment of international supply in the final two years of President Carter. Ironically, the Iranian threat is here again. Extremist views expressed by President Ahmadinejad increasingly seem to be isolating the country. If Iran has no friends to protest, military intervention to destroy the country’s program to develop a nuclear weapon may be more likely.
Hedge the Negative, Invest in the Positive with EOG
While independent producers are a hedge against a Jimmy Carter type outcome, we hope for a more prosperous and peaceful global economy. In that case, we need oil for economic prosperity and natural gas for a cleaner environment. EOG has an impressive record applying horizontal multi-frac technology to develop new supplies of both. Our new NPV shifts the balance more toward oil at 42%, up from 34%. New oil in South Texas may add a third to current oil-equivalent production and reserves. Oil cash flow is growing in the quarters immediately ahead.
Compared to large cap U.S. Independent Producers, EOG’s McDep Ratio is near the median and debt is low. Cash flow multiple (EV/Ebitda) is higher at 8.5, but justified, we believe, on prospects. The near-term trend appears down for oil price where the latest settlement of six-year futures at $79 a barrel compares to the 40-week average of $86. That suggests time to accumulate shares before an upward trend resumes.
Originally posted on July 6, 2010.
