Late last year I came across this article
that detailed the thinking of EOG Resource’s (EOG
) CEO Mark Papa on unconventional oil and gas plays in the United States.
Papa is pretty well known as a straight shooter in the oil and gas industry so when he says something it is worth listening to.
This comment caught my attention:
The true impact of unconventional drilling in unconventional rock formations is the most underreported event in the mainstream press today
As did this one:
It's a new paradigm. Unconventional drilling has dramatically changed the U.S. natural gas and crude oil picture in the U.S. and is probably the biggest change in the last 40 years in the industry. Everybody in the world is chasing these shale plays.
And I think this unconventional revolution makes for in interesting opportunity.
This is a technological step change that has made millions of acres of land extremely valuable. The oil and gas industry obviously knows this, you can tell by the way the industry is snapping up the land and shifting capital in that direction.
The stock market however, seems a little slow on the uptake.
From what I can tell there are dozens of smaller oil and gas companies that hold large acreage positions in these emerging unconventional plays. And the stock market is valuing that land as being virtually worthless.
My portfolio holdings reflect my belief in this disconnect between what I (and the oil industry) think the land is worth and what the stock market does.
Undervalued Already, With a Value That is Increasing
I recently went back and listened to the second quarter EOG Resources conference call again. And I’d like to share some observations of mine from that call.
Papa had three key observations about the EOG position Eagle Ford play in particular:
EOG has 561,000 acres, which is the largest net position in the oil and wet gas windows. Since the entirety of that acreage is prospective EOG has maintained a high level of drilling activity so that it can vest their leases. Papa explained that EOG’s well results have been remarkably consistent across the property and that they have had a 100% success rate. The typical IP rates throughout the trend have ranged from 700 to 1,600 barrels of oil per day plus gas and NGLs. Papa believes that the rates of return on these wells are the best of any large resource play in the industry.
Papa estimates that there is approximately 21 billion barrels of oil within EOG’s 561,000 acres. EOG’s current stated recoverable amount is 900 million barrels. That represents about a 4% recovery factor, and now that EOG has derisked much of the play the company is working to increase that.
In the near term Papa indicated that ways to increase the amount oil recoverable can come from improving the amount of reserves per well, or by reducing the well spacing to increase the net present value of the play.
EOG has been working on both ways of increasing recovery and has some encouraging results. The 900 million recoverable barrels assumes 130 acre spacing. EOG has been experimenting with tighter spacing and early results indicate that tighter spacing might be the way to go. At this point Papa thinks it is too early to quantify the reserve impact of tighter spacing, but would say that it is definitely positive.
As I wrote above, while the stock market is slow to assign much value to large acreage positions like EOG has in the Eagle Ford, the oil industry believes there is significant value there. Papa brought forth a data point to help investors understand just how valuable EOG’s 561,000 acres are.
The first was Marathon Oil (MRO
), which purchased $3.5 billion of Eagle Ford acreage from Hilcorp Resources. This purchase was for $21,000 per acre. Papa thinks EOG’s acreage is of higher geologic and product quality than the land in this transaction.
Papa made sure to mention that when EOG initially started leasing in the Eagle Ford that it was paying $450 per acre.
What I really want to focus on is that the 900 million barrels of recoverable oil that EOG is quoting is based on a 4% recovery factor.
I think the stock market is undervaluing these unconventional resource players based on the currently assumed recovery factors such as EOG’s 4%. The kicker however is that I think these initial recovery estimates are going to be proven low, perhaps dramatically so. If I’m correct, then these unconventional players are even more undervalued than I currently model them as being.
Papa spoke to this in the conference call. He refused to provide any estimates on what the eventual recovery factors might be, as his nature is to underpromise. What Papa did do however was refer to EOG’s previous history in the Barnett shale natural gas play where recoveries are now reaching almost 40%, which is much, much higher than EOG initially guided.
It isn’t just Papa talking about increasing recoveries in these unconventional plays. I’m seeing it in the Canadian unconventional producers that I follow as well. For example Canadian producer Petrobakken (PBKEF.PK) has reserves booked assuming a 5% recovery in its Bakken play, but believes that eventual recoveries will be 25%. I’d say Petrobakken might be exaggerating if it weren’t for the fact that its nearest rival Crescent Point Energy (CSCTF.PK) is suggesting recoveries will be 30%.
That is why I’m attracted to these companies these days. I think that the undeveloped acreage that these companies own in various unconventional resource plays is being given to investors for free today by Mr. Market. And on top of that, the value of all of that acreage is likely to increase significantly.
Disclosure: I am long PBKEF.PK.