EOG's Opportunity Extends Beyond Kitimat

| About: EOG Resources, (EOG)

Barclays Capital recently restated its overweight rating, equivalent to a buy, on EOG Resources (EOG). Analysts at Goldman Sachs are also bullish on EOG, maintaining it along with Pioneer Natural Resources (PXD) and Noble Energy (NBL) on its conviction list of stock picks. EOG is one of few stars in the U.S. independent E&P sector right now, since it has dominant positions in both oil and gas shales as well as a foothold on the Canadian liquid natural gas (LNG) export market. What makes EOG even more appealing is that it is trading low since the start of this year, despite a clear track record of success.

EOG's liquids growth is nothing short of phenomenal, especially in crude oil and condensate. From an average of 45,500 barrels of oil per day in 2008, EOG is now producing an average of 140,800 barrels of oil per day, a threefold increase that few producers can claim. To drive this growth, EOG EOG s reserves to 2,054 mmboe of proved reserves, 1,730 mmboe of which is located in the United States. A further 192 mmboe of EOG s reserves are in Canada, where it is participating in a joint venture with Apache (APA) and Encana (ECA) on the Kitimat LNG project, in which EOG has a 30% working interest.

Canadian LNG Could Be the Next Big Play - If It Gets Off the Ground

For EOG, completion of the Kitimat project will be a growth driver. As planned, the feed natural gas for the plant would come from Apache and EOG's fields in British Columbia and Alberta, which encompass 19 tcf of technically recoverable natural gas, of which approximately half belongs to EOG. The location of the Kitimat project is ideal, since it is on a deepwater, ice free harbor offering easy access to major pipelines and, naturally, the Asia Pacific liquid natural gas markets, which are booming and fueled by steadily increasing demand. A final investment decision by the partners is expected as early as this winter, after which main construction can begin.

Unfortunately, the Kitimat project is seeing delays, the most recent of which came in June when Apache is estimated that trouble securing long term contracts with LNG purchasers in the Asia Pacific region will delay the predicted first export from 2016 to 2017. This is still ahead of its nearest LNG plant competitor, the British Columbia LNG project led by Royal Dutch Shell (RDS.A) with partners PetroChina, Mitsubishi Corp, and Korea Gas Corp. Shell's project is estimated to start exports in 2019, but it needs to obtain regulatory approval, a hurdle that the Kitimat partners already cleared.

While one might think that Apache's recent massive stated in British Columbia would be a prompt for Apache to push its Kitimat contracts, the fact is that Apache is not counting on this find for near term growth and seems content to let it sit while it pursues other opportunities. In fact, in announcing the find Apache's Vice President, Worldwide Exploration John Bedingfield stated that the company was not in a rush to develop, though the field is "a huge resource for the future." This was probably disappointing for EOG, and almost certainly for Encana, since Encana badly needs new growth drivers to overcome its near total reliance on dry natural gas.

Another hurdle for all parties interested in LNG in British Columbia will be electricity. The government of British Columbia eager to avoid that there is enough security of supply to operate these massive plants in what remains a relatively remote area. This is one reason that the projected costs of the Kitimat LNG project are so high, since the plant would need to generate at least part of its own power through hydroelectric construction. This is an area of concern since British Columbian officials are eager to avoid any increase in greenhouse gas emissions through burning fossil fuels; the general attitude among officials and residents is that producing and exporting LNG is fine, but burning it for power within British Columbian air space should be avoided.


EOG is trading around $90, which gives it a price to book of 1.9 and a forward price to earnings of 14.3. Earlier this year, the stock was trading as high as $118, but it appears that EOG is being punished with the industry at large over low gas prices, as well as being discounted against weak oil prices. The decline is also moving with news about the Kitimat LNG project, since investors were hopeful that the plant would be online by 2016 despite its challenges previous to Apache's recent announcement.

Encana is currently trading around $20, which gives it a reasonable price to book of 1.7 but a whopping 67.3 forward price to earnings, based on the depressed price of natural gas. To right its ship, Encana needs to access the Asia Pacific markets where liquid natural gas prices are stable around $17 per mmbtu, especially since domestic liquid natural gas prices are beginning to follow dry natural gas prices into a crater.

Still, EOG is not as dependent on the success of Kitimat as Encana is, and though the project would still be a major revenue source for the firm, EOG has other opportunities and the cash to develop them should the Kitimat project be terminated. However, I think that if a final investment decision on Kitimat is positive, investors will be eager to buy EOG, meaning that for those who think Kitimat will move forward, the buying opportunity is now.

EOG will release its second quarter earnings on August 3.

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