There are a few conference calls that are extremely valuable sources of information for an oil and gas investor, especially an investor interested in the unconventional resource game.
Next up is Mark Papa and the EOG Resources (EOG) call. EOG got in early and got in big into many of the most economic unconventional oil resource plays. Papa is well known in the industry for being a straight shooter. Thank you to Seeking Alpha for making the written transcript of these calls (the latest EOG transcript is here) available.
EOG, like Chesapeake, is setting aside natural gas drilling and trying to make an aggressive move to oil and liquids. Here is Papa discussing a business transition that was envisioned several years ago:
“I'll now discuss our 2011 business plan and operational results. Our business plan continues to be consistent and straightforward. We're rapidly making the organic conversion to a liquids-based company by exploiting our world-class North American horizontal oil positions, while still preserving 100% of our large North American natural gas resource play assets and maintaining a low net debt to cap ratio. As our first quarter results indicate, the plan is working just like we drew it up on the chalkboard four years ago. We've invested the majority of our capital in very high reinvestment rate of return, domestic oil development projects, which will ultimately flow through our net income and show up as superior ROEs and ROCEs. We're very comfortable regarding our 2011 goal of approximately $1 billion of asset sales, which will help maintain low debt ratios. In the first quarter, we received $260 million from property dispositions and asset sales. Since March 31, we've received an additional $387 million of proceeds and we're actively working on an incremental $400 million of sales. So this goal is well in hand."
Papa also hits on a topic that I think is not appreciated by many investors. As EOG and CHK make the transition to higher value oil and liquids production, actual production growth metrics are not important. Trading one unit of low value natural gas production for one unit of oil production is going to provide extra fuel for cash flow growth:
“At the current 23:1 crude oil to natural gas price ratio, I believe the overall production growth yardstick is somewhat meaningless. In today's world, the metrics of liquids production growth and product mix change should be the focus since cash flow, returns and earnings will follow liquids growth and that's how we define EOG strategy.“
As McClendon did in the Chesapeake call, Papa tries to point out the fact that the size and value of certain EOG properties are not factored into the EOG stock price. Particularly for EOG is the undervaluation of its massive and valuable Eagle Ford position:
I'll now discuss several of our key plays, beginning with the Eagle Ford. I'll start with an editorial comment. I believe Wall Street continues to undervalue our Eagle Ford oil position. Perhaps the undervaluation is disbelief at the sheer size of this onshore position. Not many people can believe the fact that we've captured a 900 million barrel oil equivalent net after royalty position, consisting of 77% oil and 11% NGLs, with very high reinvestment rates of return. I can't think of a single company, independent or major, who has captured this size net oil accumulation in the onshore lower 48 in the past 40 years. We're in the first inning of developing this asset and just like the Bakken, this is becoming one of the hottest plays in North America. EOG, by moving early, has captured the largest acreage position in the crude oil window. We're the biggest producer from the oil window, with net production of 23,000 barrels of oil equivalent at the end of the first quarter. Our press release contains multiple individual well results, so rather than providing a well-by-well recitation, I'll provide some context regarding the overall play. There are three key points: First, we are currently drilling with 18 rigs. Simply put, we continue to have 100% success with our drilling results. We've now drilled enough wells throughout our 520,000 net acre spread to feel very comfortable that all the acreage is good. Our most recent success is in a new fault block identified on 3D seismic at the north easternmost end of our acreage, where the Hill Unit #2 well tested at 1,233 barrel oil per day initial rate. The results from the wells were drilled across our entire acreage position are very consistent. The wells in the northeast and center portions of our acreage IP at between 800 and 1,500 barrels of oil per day, plus rich gas, while the southwest wells IP at 600 to 800 barrels of oil per day, plus rich gas. As with any resource play, the wells exhibit a steep decline the first few years and ultimately level out at 100 to 200 barrels of oil per day over the long term.
Our per well reserve estimates are unchanged from our previous estimate between 430,000 and 460,000 barrels of oil equivalent, net after royalty. Second, project economics have improved with oil prices and our ongoing focus on cost efficiencies. Last quarter, I quoted 65% to 110% direct after-tax unlevered reinvestment rates of return, using current well cost. Using the current NYMEX oil strip, the per well economics are 95% to 140% direct after tax. Additionally, we still expect to further improve these economics by decreasing well cost from the current $6 million target to our goal of $5 million by 2012 with our self-sourced fracs. When combined with the size of the prize, this bodes huge for EOG's future profitability. Over time, we'll invest between $10 billion and $15 billion developing this asset."
Papa then circles back to the Eagle Ford in the question and answer session of the call:
Joseph Magner - Macquarie Research - With the successful test of the northeastern fault block in the Eagle Ford, can you just remind us how that's captured in your 900 million barrel resource estimate?
Mark Papa - Yes, Joe. As I kind of stated in my editorial comment there, I don't believe the 900 million barrels is even remotely captured in our current stock price. And so, if we were to say, wow, we have a new fault block and it increased our barrels from 900 to x, I'll consider doing that if and when I see the 900 million barrels that we already have reflected in the stock price. So don't look for us to make any adjustments to the 900 million barrels based on one well, one fault block or anything like that. But obviously, it's an area that we hadn't given any credit to and we found it on the 3D seismic and drilled it. And right now, this Eagle Ford's turning out to be one of those things that you almost have to pinch yourself and say this is too good to be true. One-hundred percent success rate across 120 miles is just phenomenal. So that's a good non-answer to your question but that's the explanation I'll give you, Joe.
David Wheeler - AllianceBernstein - On the return to the Eagle Ford, you mentioned the returns are 95% to 140% at the strip but at a $6 million well cost. If well costs come down to $5 million, what does that do to the returns.
Mark Papa - They're almost sinful to repeat. They are consistently north of 100% is what we can say. It makes a big difference to knock it from $6 million to $5 million. So that's why I'm so excited about the play, David, is we're looking at a play that at least on a direct basis is going to yield us north of 100% rate of return for $10 billion to $15 billion of investment. And if you think across every other single E&P company in the world, I can't think of one who's got this sort of investment opportunity, particularly in a, let's say, a relatively benign climate like Texas and the United States as opposed to some foreign country. And I really think that it's just -- people just haven't realized exactly what EOG has captured here. And again, I'm sorry, I'm blowing off on the editorial comment. But you led me into it there, when you said what happens when the well cost gets knocked down $1 million a well.
... To put some context on the size of the Eagle Ford in relation to EOG, the company has a market cap of roughly $27 billion and believes it can invest $15 billion in the Eagle Ford at 100% plus rates of return. That would certainly suggest that the Eagle Ford acreage is worth at least half of EOG’s current market cap.
But the Eagle Ford is far from EOG’s only large play. A full list of its main positions (as per the last investor presentation are as follows:
Major Oil Plays:
- Biggest Oil Producer in North Dakota – 600,000 Net Acres in Bakken/Three Forks
- Biggest Oil Producer in Eagle Ford – Premier 520,000-Plus Net Acre Oil Position
- Biggest Producer in Barnett Combo – Dominant Acreage Position
- Strong Wolfcamp Shale Position – 120,000 Net Acres
- Strong Leonard Shale Position – 120,000 Net Acres
- Biggest Oil Producer in Niobrara - 220,000 Net Acres
- Reactivating Vintage Vertical Fields – Manitoba Waskada, Mid-Continent Cleveland,
- Permian Basin Bone Spring
Major Gas Plays:
- Horn River – Expect to convert big Gas field trough Kitimat LNG to oil-indexed field Haynesville/Bossier – 11 Tcf*, Net on 190,000 Net Acre Position – 78% in Sweet Spot
- Marcellus – 3.3 Tcf*, Net 210,000 Net Quality Acres
- Barnett – Currently EOG’s Biggest Producing Gas Field
- Uinta Basin 7 Tcf*, Net – No short-term drilling required to hold acreage
When I look at this assembly of large resource plays I have to wonder just as I do for Chesapeake ... when does a major oil company make a play for these assets? With the potential for upside to recoverable reserves through technology advancements locking up positions in the large resource plays has to be very important to majors.
I also like to get the thoughts from Papa on where he sees oil and gas prices going. My understanding is that EOG has developed some very robust databases from which they make commodity price decisions. Fortunately Papa is happy to share:
Now, I'll discuss our views regarding macro and hedging. Regarding crude oil, we still like both the short- and long-term supply demand fundamentals, although guessing which way short-term oil prices will move is a speculative call. We're currently 27% hedged June through December of this year at a $97 price. And for 2012, we're approximately 6% hedged at a $107 price. We continue to have a 1:3 cautionary view regarding North American natural gas prices but believe in the 2014-plus time period, natural gas markets will balance as gas power generation demand increases.
Our hedges are consistent with our macro view. We're approximately 48% hedged at a $4.90 price for June through December this year. Additionally, we sold options at a $4.73 price that if exercised, would mean we're 86% hedged through year end. For 2012, we're approximately 38% hedged at a $5.44 price, with options that if exercised, would increase to a 69% hedge level at a $5.44 price.
And Papa provides the six important things investors should take away from this conference call:
1) First, our shift from a natural gas to a liquids company is essentially complete. At current prices, we'd expect approximately 70% of our North American revenue to emanate from crude oil, condensate and natural gas liquids as opposed to 30% from natural gas. A large majority of the liquids are oil and not NGLs.
2) Second, all of our oil plays are onshore North America, with the vast majority in the U.S. All of this oil is sweet, good quality and highly desired by refineries.
3) Third, our reinvestment rates of return are very strong. I think they're the best in the industry, led by the Eagle Ford.
4) Fourth, during my visits with shareholders, I'm often asked about industry capital allocation. We recently tabulated 2010 actual and 2011 projected North American gas production for all mid- and large-cap public independent E&Ps. EOG is practically the only company who's not growing North American gas volumes in this oversupplied market. This is truly amazing to me. Investors who focus on the efficacy of capital allocation, this should be a positive discriminator in EOG's favor.
5) Fifth, for the first time, we've introduced our Powder River Basin acreage position, where we've already drilled eight consecutive successful wells.
6) And sixth, we are on track to execute our 2011 capital expenditure program, while maintaining low net debt.
I’m not an EOG shareholder and not likely going to be buying in the near future. I think it is an excellent company but I believe I’m better off looking to smaller producers that have locked up valuable acreage positions in emerging unconventional plays. I started buying several Canadian companies that fit this description and will write about them in the coming weeks. I’m hoping for further pressure on oil prices so I can buy more of these companies at even lower prices.