EOG's New Oklahoma Oil Play

Summary

• EOG Resources has set its sights on Oklahoma's Woodford oil play.
• How EOG built up a 50,000 net acre strong position on the cheap.
• Overview of EOG Resources' Mid-Continent asset base and future development strategy.

Oklahoma has long been a hotbed for oil & gas activity. For upstream operators the Mid-Continent region has plenty going for it including; ample takeaway capacity, extensive midstream infrastructure, ability to obtain West Texas Intermediate pricing for oil sales due to the region’s proximity to the Cushing oil hub, easy access to favorable gas pricing (including East Texas’ Katy Hub and Louisiana’s Henry Hub pricing benchmarks), relatively easy access to favorable natural gas liquids benchmarks (such as the propane pricing benchmark based in Mont Belvieu, Texas), and extensive oil & gas development opportunities. Let’s dig into how EOG Resources, Inc. (NYSE:EOG) is investing in and capitalizing on Oklahoma’s geographical and geological upside.

Overview

At the end of 2017, EOG Resources had an interest in 130,000 net acres in the Mid-Continent region (namely Oklahoma). Management expects EOG will complete 35 net wells this year in the Mid-Continent region, versus just five net completions in 2017. Expect that to drive double-digit production growth through 2020, albeit a task made easy as EOG's existing output is very small. Last year, the firm pumped 2,000 barrels of oil, 1,000 barrels of NGLs, and 12 MMcf/d of dry gas on average out of the region.

EOG Resources entered into a joint-venture with The Carlyle Group L.P. (CG) back in mid-2017 to develop oil & gas opportunities in Ellis County, Oklahoma. Carlyle agreed to fund up to $400 million in development activity targeting the Marmaton Sand play in the Western Anadarko Basin over a four-year period.

Last year, EOG drilled 18 gross wells and completed 10 gross wells in the Mid-Continent. In light of the firm bringing 2 net wells online on its new Woodford acreage that year, it appears EOG has a rough 33% interest in those Marmaton Sand wells.

New position

Where EOG’s Mid-Continent upside will really be generated is in the Woodford oil play, a Tier 2 opportunity as things stand today. Over the past four years, EOG Resources slowly built up a 50,000 net acre position prospective for the Woodford at an average price of $750 per acre. This position is centered in Oklahoma’s McClain County, but also covers acreage in the adjacent Grady and Cleveland counties.

Source: EOG Resources

Management noted this during EOG Resources’s Q4 2017 conference call;

“Located primarily in McClain County, Oklahoma, adjacent to the gas condensate plays properly known as the SCOOP and the STACK, the Woodford oil window is a black oil play with a concentrated sweet spot of high quality rock. Our discovery of the Eastern Anadarko-Woodford oil play is a great example how EOG's decentralized structure is a perfect fit for exploration-driven organic growth. Our team in Oklahoma City identified the potential of this area based on historical log and production data and began leasing in 2013.”

This position is located to the Southeast of the well-known STACK region in Oklahoma’s Blaine, Kingfisher, and Canadian counties. Investors should note that the reason why acreage is significantly cheaper in McClain County versus the STACK region is because it isn’t prospective for the Tier 1 Meramec oil play. The Meramec, at the right price, is one of the most economical unconventional oil plays in the world but as such, that acreage isn’t cheap.

It wasn’t until November 2017 that management decided it was time to push EOG’s Woodford position into the limelight, effectively ending the phase of leasehold additions and launching the start of the appraisal and optimization phase of development. EOG completed only two net Woodford wells last year after one net well was completed the prior year, which is hardly enough to get a fair gauge of future well productivity. This is why EOG plans to step it up a notch as it plans to run two drilling rigs and one completion crew in the area this year.

Management expects EOG will complete 25 net Woodford wells in 2018, with the average well sporting a 9,500-foot lateral at a development cost of $7.8 million (includes drilling, completion, and well connection costs). Each Woodford well is expected to produce around 800,000 barrels of oil equivalent over its lifetime after royalties (1 million BOE in total), with a 70% oil cut, 20% NGLs cut, and 10% dry gas cut.

Assuming that is true, that’s good for a very competitive DD&A cost of $9.75 per BOE in a play with relatively low operating/transportation costs due to existing regional infrastructure (assuming the water cut is low). Adjusting for the expected difference in oil realizations versus NGL (2:1 difference) and dry gas (20:1 difference), EOG’s production mix guidance generates an adjusted DD&A per barrel of oil equivalent sold of $12.11.

Guidance versus realism

So far, EOG sees 260 net “premium” (Tier 1 relative to the rest of its well location portfolio, which is tops in the space) well locations in the Woodford play assuming 660-feet spacing between each well. 260 net well locations with an EUR (estimated ultimate recovery) rate of 800,000 BOE net indicates 208 million net BOE will be extracted from this acreage.

During EOG Resources’s Q3 2017 conference call, management noted;

“Our current inventory of 260 net locations assumes an average of 660 feet between wells. We expect to test spacing down to 330 feet. The addition of the Woodford play demonstrates EOG's ability to consistently add premium quality rock and inventory. Plays like the Woodford enhance the diversity of our portfolio and provide the flexibility to consistently grow production, while maintaining capital efficiency for years to come.”

Now this guidance is nice if true, but investors should note this means little until we see a larger slate of well productivity and development cost data. One key concern is well spacing, and how viable a 660-foot spacing strategy really is. Well spacing is a big determinant of the size of an upstream firm's potential well inventory, if not the largest factor once the formation being targeted has been fully delineated. Another concern comes down to productivity assumptions, as a 800,000 BOE EUR rate with a 70% oil cut is very impressive if true and too high to take for granted.

EOG Resources’ most recent well was the 10,500-foot lateral Curry 21X #1VH well, which yielded a 30-day IP of 1,730 BOE/d (84.4% oil mix) and a 150-day IP rate of 1,385 BOE/d (80.1% oil mix). A strong well for sure, however, one well doesn’t make a play. This is why investors should see the Woodford as an exploration/appraisal/optimization play for EOG, not a guaranteed development opportunity.

Final thoughts

Well inventories don't last forever, especially not Tier 1 opportunities in hot plays like the Permian Basin and the Eagle Ford. EOG Resources was able to buy into an existing Tier 2 play on the cheap. The firm didn't need to take on hundreds of millions or billions of dollars in debt to create its nascent Woodford position, and this is crucial as many upstream firms "neglect" to include interest payments in their estimated well return guidance. Not that EOG Resources doesn't play the same game, but I bring this up to note that buying into a Tier 2 play on the cheap can be a better strategy than buying a Tier 1 position through an extremely expensive debt-funded deal.

If you want to read more about EOG Resources, check out the advantages its Eagle Ford position has over the Permian Basin here. Thanks for reading.

Analyst’s 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.