EOG Resources CEO Telegraphing OPEC That U.S. Shale Producers Will Behave If Prices Go Up

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Includes: BNO, DWTI, EOG, OIL, SCO, UCO, USO, UWTI
by: Options Trader

Summary

EOG Resources does not intend to increase production if/when oil prices move higher towards $60 per barrel.

The statement by Bill Thomas, the CEO of EOG Resources, may be an attempt to relay shale operators' position on production increases to OPEC leadership.

An implicit guarantee by North American producers to refrain from production ramp-up as prices move higher could be a reason for OPEC to actually abandon this all-destructive price war.

Bill Thomas, the CEO of EOG Resources (NYSE:EOG) made a statement at an oil conference in Houston that his company will not ramp up production as the price of oil approaches $60 per barrel. EOG is the largest and best positioned pure US shale operator. It has large acreage in most prolific oil basins and is a technology leader among US E&P companies. At the same time, EOG has one of the best balance sheets in the business and is not constrained by large capex commitments and dividend payouts.

Bill Thomas mentioned that in retrospect it was a mistake to ramp up production last spring when oil (NYSEARCA:USO) prices briefly moved above $60 per barrel, he sees the industry taking a wait-and-see approach this time around. Since EOG can be considered the Saudi Arabia of US shale producers, its words and actions carry significant weight and those words are not aimed at potential investors or fellow producers. He was dropping the idea of holding back on production gains for OPEC to hear.

OPEC wants to throttle down growth of unconventional production as there has been an undisciplined and unsustainable increase in oil production over the past two-three years driven mainly by North American producers. The unsustainable portion refers to debt-financed boom, which is now coming home to roost in the form of numerous bankruptcies and dozens of prominent operators on the verge of liquidity crisis. By cutting back OPEC will inadvertently raise the price and encourage further production from higher cost areas, which is the main reason why a coordinated cut hasn't happened so far.

Enter Bill Thomas, who more or less is trying to provide some assurance that US shale operators will act responsibly should prices rise on the back of an OPEC cut. Obviously, such action among many independent producers cannot be mutually agreed upon as it would be deemed illegal collusion, however, everyone in the oil patch understands potential ramifications of another unsustainable production bonanza. OPEC can simply open spigots again and drive the remaining producers out of business in a quick manner.

Bill Thomas also stated that oil prices need to be north of $70 and up to $80 per barrel for long-term sustainability of shale producers. He is naming specific price levels and notice how those numbers markedly differ from EOG's own statements in the past, that the company has a vast number of properties breaking even at $40 per barrel. The real company-wide sustainable and profitable level is $70+ for EOG, which means for the rest of the more marginal producers it is above $80 per barrel.

Whether OPEC actually hears what Bill Thomas had to say is a different matter. It can continue with current policies and crush half the world's supply, but in a sense that would also be detrimental to oil demand in the long-run. Supply destruction would result in higher and unaffordable prices in a couple of years and speed up the world's move away from oil. Oil producers need to find a balance, which currently implies $60-70 per barrel. That is the level, at which most production can be slightly profitable and sufficient investments are made to keep production steady. At the same time, such a price level would put downward pressure on the speed of development of alternative energy sources.

In its fight with high-cost producers OPEC has seriously wounded itself and needs an excuse to justify production cuts after such great sufferings. An implicit guarantee by North American producers not to ramp up production prices below $60 per barrel could be an olive branch needed to stop this all-destructive price war.

Related ETFs: (NYSEARCA:OIL), (NYSEARCA:UCO), (NYSEARCA:SCO), (NYSEARCA:BNO), (NYSEARCA:DWTI), (NYSEARCA:UWTI)

Disclosure: I am/we are short DWTI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.