After beating expectations in the second quarter, EOG Resources, Inc. (EOG) is staying strong and holding onto the larger portion of the gains it made after its earnings release. Its second quarter 10-Q indicates that barring major setbacks, EOG is prepared to repeat its success in the third quarter, meaning now is still a buy opportunity, despite the higher price. I also think that EOG has even stronger gains in its future, based on the Kitimat LNG Project and its retention of natural gas producing properties.
Success Almost Guaranteed with Kitimat LNG
The Kitimat LNG Project, in which EOG is participating with Apache Corporation (APA) and Encana Corporation (ECA), is still attempting to acquire delivery commitments ahead of a final financial decision, which is expected sometime this winter. I think that failure to line up the delivery commitments the partners need to feel confident in further Kitimat investments is the most likely potential reason for not green lighting the project, since most other potential obstacles are already resolved. Once the partners do reach delivery commitments, I expect a positive bounce in the partners' stock prices, since the firms are likely to release details on arrangements as soon as they are made.
At least one pipeline supplier is bullish on the future of Canadian LNG, Spectra Energy Corp (SE). While Spectra is indicating that it does not believe all of the proposed or planned export terminals will be completed, it expects one to three to become operational, and is looking at enhancing its pipelines to Prince Rupert, north of Kitimat, to prepare for the rush. Spectra also has pipelines to Kitimat, though the Kitimat LNG Project will be running its own Pacific Trails Pipeline between Spectra's gas processing facilities and the export terminal.
The Kitimat LNG Project's leading competitor, Royal Dutch Shell (RDS.A) recently reiterated its belief that China's demand for energy will far outstrip its domestic supply, leaving Shell room to participate in the Chinese domestic market to the tune of $1 billion in investments per year, while still benefiting from projects like its LNG Canada project. If completed, LNG Canada would have twice the capacity as the Kitimat LNG Project, at a total cost of $12 billion. Still, the Kitimat LNG Project has an enormous head start over the proposed LNG Canada trains, since Kitimat LNG already has the necessary export licenses and is already preparing its site.
Natural Gas Is a Strength for EOG, Not a Liability
Although many correctly cite EOG's early shift to oil as the leading reason for its current strong position, what is frequently overlooked is the fact that EOG maintained much of its natural gas leasehold. This will enable it to pivot back towards natural gas production without huge capital outlays once the price environment improves. Compare this to the strategy of Chesapeake Energy Corporation (CHK), which saw revenues decline so quickly and took so little action to staunch the bleeding that it will now be required to sell some of its best-producing assets, including oil heavy leases in the Permian Basin and Niobrara. EOG will face costs to re-start its shuttered natural gas operations to be sure, but if prices normalize the outlay will be negligible compared to revenues from its oil and natural gas production combined.
At the same time, EOG is not afraid to lose some of that non-producing leasehold. It recently indicated that it would not be meeting the 40 well quota on the Marcellus Shale required by its joint venture with National Fuel Gas Co. (NFG) this year. National Fuel now has the option to reclaim control over most of the 165,000 acres shared in the joint venture, even as 20 wells await completion.
In a statement, National Fuel Chairman and CEO David R. Smith indicated that "having full control of our largely royalty-free, contiguous acreage position unencumbered by a joint venture further enhances the long-term value of our Appalachian assets," a major hint that National Fuels will attempt to wrest out of its joint venture with EOG. I don't expect this to hurt EOG given the size of the loss, but I do think it is a hint at the way EOG's leadership team is thinking about natural gas in the current environment.
EOG is currently trading around $108, with a price to book of 2.1 and a forward price to earnings of 16.4, very similar to National Fuel's value ratios. National Fuel is currently trading around $50, with a price to book of 2.1 and a forward price to earnings of 16.6. Apache is trading around $85 with a price to book of 1.1 and a forward price to earnings of 7.2, a great opportunity for this well diversified stock.
Meanwhile, Chesapeake is trading around $19, with a price to book of 0.9 and a forward price to earnings of 10.2. This is one of the cheapest value buys in the E&P space right now, but it is also one of the riskiest; without significant asset sales in the coming months Chesapeake is in imminent danger of bankruptcy. Heading into a similar position without significant and fast-tracked oil exploration, Encana is trading around $22 with a price to book of 2.3 and a forward price to earnings of 73.4, reflecting its poor revenue expectations due to a nearly 100% weight towards natural gas.
Although the positive second quarter raised the premium to own a piece of EOG Resources, I believe that the company's strong performance is an indicator of better times to come. With its leadership team strong and its growth track firmly outlined, EOG Resources is a solid buy.