EOG Resources Looks Set To Benefit From Rising Crude Prices

| About: EOG Resources, (EOG)

Summary

Strategy of improving cost structure along with the focus on efficient assets is paying off.

Developed but uncompleted wells will allow EOG to lift production on a short notice if the crude prices start to move towards $60 per barrel.

Realized average price for the second quarter will be considerably better than the last quarter which should give it a boost in the short term.

Cash position and operating cash flows will be strengthened with higher average realized price for oil.

Crude oil looks to have stabilized around $50 mark and it looks like the U.S. shale producers with strong balance sheets and efficient assets are set to benefit from this sustained recovery. A number of factors are working in favor of shale producers which will help them grow production and cash flows as the crude prices continue the upward trend.

EOG Resources (NYSE:EOG) is one of the best positioned companies to benefit from this recovery for mainly two reasons. Improvement in technology has been a key reason for the rise of shale oil and EOG resources has been developing this technology further in order to achieve better and cost effective results. Enhanced Oil Recovery (EOR) is an internally developed technique by the company that allows it to retrieve more oil at a lower cost. This is what the management had to say about the technology in the first quarter earnings call:

"EOG anticipates many benefits from the application of this new technology, including high incremental net present value and rates of return on investment, low finding and operating costs, reduced severance tax rates, lower production decline rates and increased reservoir recoveries."

When the prices for the final product are falling, it is always a good idea to find ways to decrease the costs of production. In shale oil, these advancements in technology are even more important as the process of getting oil through this method is expensive. However, the cost cutting does not stop there for EOG; the company has been able to bring down its operational costs substantially. During the first quarter, lease and well expenses decreased by 29% and the transportation expenses came down by 12%.

The second part of the strategy is to focus on assets with high expected yields, where the company can get more oil for lower capital expenditure. Both these strategies are fairly basic for an energy company in these sorts of market conditions; however, it is important to show measureable progress on the implantation of the strategy. EOG has done that by reducing costs and achieving impressive yields.

The thing that worried investors in the last few months was that the overall losses for the company increased despite these measures, but it should be kept in mind that the realized price for oil during the first three months of the year was probably the lowest since the crude oil slump started in 2014. The image below shows the realized crude prices.

Source: 10-Q

Since the crude prices went below $30 for a short period of time, there has been a strong rally in prices and the prices have been on the upward trend during the last two and a half months. This means that the realized average price for crude oil will be considerably higher for the second quarter which will give a boost to the revenues as well as cash flows. The price has gone up by more than 50%, so the rise in revenues should be substantial. For the same period, the production costs per barrel were $30.53, so the company was able to get its production costs from even the lowest realized price for crude oil.

Since the prices are showing some sort of support around $50 per barrel, it is also important to consider that EOG can benefit from this sustained recovery instantly as the company has a good inventory of drilled but uncompleted wells. This means that EOG can bring a number of new wells online within two weeks and add to its production substantially. At the moment, there are more than 250 drilled but uncompleted wells that the company can benefit from if the prices remain on the higher end of the price curve. We will probably see these wells coming online if the crude price starts to move towards the $60 mark. For the second quarter, we might see a surprise from EOG as the reduced cost and higher realized average price might result in a profit for the company.

The overall industry dynamics are also looking good for strong shale producers as the weaker companies are getting out of business and the production has started to fall. In addition to a number of bankruptcies in the United States, the production has also deteriorated substantially in China. It is now looking more likely that we will see a balance in demand and supply soon and crude prices might show a sustained recovery. According to the Bloomberg article linked above, Suadi Arabia and Russia will likely fill the gap left by the production losses in China, which allows these countries to get their target of increased market share. This was one of my biggest concerns that aggressive measures by Saudi Arabia and Iran will keep the glut going, but it looks like there are gaps opening up for these two producers to dump their excess supply without causing oversupply. This is good news for American shale producers as the prices will stabilize.

Finally, the financial health of EOG is good. The company has come out of the worst phase for shale producers in a healthy condition and despite having a tough quarter in terms of realized price, the cash balances of the company have not deteriorated. There was more than $668 million in cash for EOG at the end of the last quarter and more than $250 million in operating cash flows despite a having a poor quarter. Overall, I think EOG Resources is in a very good position to benefit from the recovering crude prices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.