by Mark Goldstein
Moody's recently upgraded EOG Resources' (EOG) investment rating from negative to stable, as a direct result of EOG's efforts to balance low US dry gas prices with increased liquids production. EOG's credit rating is currently a firm investment grade, at A3. Although an upgrade is likely to be years in the making, EOG's 551% increase on earnings per share in 2011 bode well for the company's ability to further improve.
Energy companies, including EOG, are trapped in a catch-22. Despite pundits and analysts agreeing that natural gas production in the US is the key to US energy independence, energy companies' renewed focus on US production is driving US dry gas prices to ten-year lows. Fortunately, EOG began developing its oil and liquids resource base in 2007, and so is in a better position to weather this storm. In 2011, EOG reported total oil and condensate production of 113.4 mbbld, a 60% increase in just three years. Its year-end numbers indicated that a total of 39% of its proved reserved are liquids, and 61% are dry natural gas. Now a diversified energy company, EOG is looking to grow by further equalizing these numbers.
Territory and Activity Expansion
EOG recently announced that it would be expanding its operations to Namibia through five joint operating agreements with the National Petroleum Corporation of Namibia (NAMCOR), which gives EOG access to five license blocks onshore and offshore of the African country. EOG has a 70% interest in the offshore agreements and a 90% interest in the onshore agreements, and will shoulder the cost of training NAMCOR's personnel in the operations. This marks EOG's first venture on the African continent, and should be watched closely. If EOG is successful in Namibia it has the leverage to purchase further interests and form operating agreements with other African nations, which would diversify its current US-heavy asset base and bode well for revenue increases based on crude oil growth.
EOG, like competitors Cabot Oil & Gas (COG) and Chesapeake Energy (CHK), is converting vehicles in its fleet to run on compressed natural gas, or CNG. EOG is performing the conversion as a pilot test. CNG reduces emissions and is less expensive than traditional fuels for heavy vehicles, but as very few consumer vehicles can run on CNG blends, there are not adequate fueling stations to meet the needs of an all-CNG fleet. Chesapeake in particular is trying to change that, indicating that it intends to change consumer perception and influence fueling stations around its US holdings to supply CNG to all comers. Other energy companies interested in CNG seem content to allow Chesapeake to try the heavy lifting before moving towards supplying CNG in vehicle fuel blends on a production scale.
Currently, 80% of EOG's total proved reserves of 2,054 mmboe are located in the United States; 93% of EOG's total proved reserves are on the North American continent. In order to remain competitive EOG will need to diversify its resource base with an eye towards international expansion, as it is currently more vulnerable to production halts due to increased regulation or local disaster than many of its competitors because of its North American focus.
EOG is one of the top five operators on the Barnett shale in Texas, competing primarily with Devon Energy (DVN), Chesapeake, Exxon Mobil (XOM), and Quicksilver Resources (KWK), though there are 232 other operators currently on this field with a total of nearly 16,000 wells. Estimates are that in addition to reserves already claimed, there may be a further 26.2 tcfg unproven reserves in the shale. EOG can exploit Barnett as it was one of the early Barnett operators. As of the close of 2011 EOG owned interests in 200,000 net acres on Barnett with 37.7 mbbld liquids and 403 mmcfd natural gas produced per day.
EOG is currently trading around $110 per share, with a forward price to earnings of 16.2 and a price to book of 2.3. Devon is trading around $70 with a more reasonable forward price to earnings of 9.6 and a price to book of 1.3. Cabot is trading around $35 with a forward price to earnings of 30.4 and a price to book of 3.5, indicating it is overvalued. Exxon Mobil is trading around $86 with a forward price to earnings of 9.6 and a price to book of 2.6. Finally, beleaguered Chesapeake is trading around $18 a share, off 25% from one month ago, with a forward price to earnings of 6.5. Chesapeake's price to book of 0.9, which ordinarily would be a value proposition, is offset by deep-seated doubts over the company's ability to continue functioning.
Historically a major competitor for EOG, Chesapeake is in trouble. When reports first surfaced of Chesapeake CEO Aubrey McClendon's undisclosed $1.1 personal borrowings against his stakes in company wells, the board and the company supported McClendon, indicating that the borrowing was sanctioned under the company ownership program and that no wrongdoing was suspected. As shareholders, board members, and US regulators look more closely into the deal, the story is changing. The board is considering an end to the investment program, and shareholders are questioning Chesapeake's investments and strategies.
Chesapeake is enmeshed in more partnerships and joint ventures than any of its competitors and engaging in what some call over-active hedging activities despite negative cash flow for each year of the last decade. McClendon's questionable borrowing is bringing scrutiny from all corners, and with Chesapeake disastrously over-leveraged, analysts are questioning whether the company can survive. I agree with all of these points, and I think it is very likely Chesapeake will be forced to sell many of its assets piecemeal. With its convoluted structure complicated by so many partnerships, it is unlikely that other energy companies are viewing Chesapeake as an attractive takeover target. I am certainly avoiding Chesapeake in favor of EOG until these outstanding problems are resolved. In fact, EOG may be in a position to acquire some of Chesapeake's best assets in a fire sale.
EOG will report first quarter earnings on May 9.