EOG's Diversified Focus Will Yield Abundant Profits

| About: EOG Resources, (EOG)
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In early May, EOG Resources (NYSE:EOG) declared a dividend of $0.17 per share, giving a projected yield of 0.7%, payable July 31, 2012. The $0.17 matches the dividend payable April 30, 2012, which was at an increased rate from the previous dividend of $0.16. EOG has steadily raised its dividend over the past five years, never failing to raise its dividend every four quarters, and sometimes sooner. Given this, and the company's healthy balance sheet, I think it is likely that EOG will continue to raise its dividend regularly for the foreseeable future.

EOG's dividend is also more consistent than that of its top U.S.-focused competitor Range Resources (NYSE:RRC), which has a projected yield of 0.3%. Chesapeake Energy (NYSE:CHK) has a projected yield of 2%, but I do not believe that Chesapeake's dividend yield is sustainable, given the company's current financial outlook. Devon Energy (NYSE:DVN) is a stable competitor for EOG, and has a higher dividend, with a projected yield of 1.2%.

Continued Focus on Liquids for EOG

EOG aims to grow its oil and liquids production using methods identical to those that allowed it to become a player in natural gas. EOG built up its inventory since making the decision to diversify its production, and now, it faces the task of drilling on its resource base. EOG was better prepared for this switch than many other U.S. based small to mid-cap natural gas companies, and began its transition in 2007 with the North Dakota Bakken shale and the Forth Worth Barnett shale - a year before competitors Chesapeake and Kodiak Oil & Gas (NYSE:KOG), among others, foresaw the over-saturation of the natural gas market and made the switch.

EOG expects that worldwide oil demand will increase by 1 million barrels of oil per day each year, and is indicating that it intends to exploit this opportunity by becoming a primary supplier as other suppliers exhaust their assets meeting demand and while the break-even price for drilling in OPEC countries increases.

Conversely, EOG believes that it will be several years before natural gas prices in the U.S. reach normal levels and is predicting that the return to normalcy will be predicated on U.S. regulatory actions, forcing electricity producers to switch from coal-based energy generation to natural gas. This is in line with predictions from analysts and the industry at large, though in stark contrast to the prediction of Chesapeake CEO Aubrey McClendon that gas prices will stabilize by 2014.

Diversified Focus, But Still Exploiting Shale

EOG is the single largest oil producer on the South Texas Eagle Ford, a shale play, with interest in 572,000 net acres. It estimates its reserve potential as 1.6 bboe net after royalty. Pushed by its successes on Eagle Ford and the contiguous U.S., EOG is expanding internationally. One of its first international explorations, the Conway field in the East Irish Sea in the U.K., was a playbook success with a potential of 20 mboe uncovered. EOG expects to begin production on this play in early 2013.

Despite its new focus, EOG still holds millions of acres with high natural gas potential. EOG is indicating that its strategy will be to invest the minimum amount of capital necessary in exploration and active wells to hold its leases in these areas until prices return to more profitable levels. In the meantime, EOG is willing to divest some of its non-producing assets, as it did with the June 2011 sale of its Stanley, North Dakota condensate recovery unit and 76 mile dense phase natural gas pipeline. Showing that it is focused on the eventual rise of natural gas prices, EOG reserved capacity in the pipeline for its future production in the agreement.

As natural gas prices outside of the U.S. remain relatively strong, EOG could benefit by exploiting its 100,000 net acres held in the Neuquén Basin in Argentina. Although Argentinean prices are artificially low, Argentina's Gas Plus program allows companies to charge market prices for gas extracted from unconventional deposits uncovered in investments made after 2008. EOG's current exploration of the Vaca Muerta shale falls into this category. EOG's 100,000 net acres are dwarfed by competitor Repsol YPF holdings, which cover 3 million of the Vaca Muerta shale's 7.4 million acres.

Apache (NYSE:APA) and Exxon Mobil (NYSE:XOM) are also working in the Neuquén, which is estimated to have 774 tcf of recoverable gas. In addition to natural gas, recent explorations done by Repsol indicate that 77% of the shale formation is oil containing. It's worth noting that Exxon Mobil is increasing its shale interests worldwide, as it expands its position in the Woodford Ardmore shale to 230,000 net acres. It is currently operating 10 rigs on that play. Its increased shale plays bring Exxon Mobil into EOG's shale territory, even as EOG enters Exxon Mobil's territory in the off-shore Conwy field, as noted above.

Back to Argentina, at depths between 5,500 and 14,000 feet, the Vaca Muerta reaches thicknesses of 2,000 feet, which combined with the Argentinean government's relaxation of price fixing for new investments makes the shale economically feasible for players with shale extraction experience - which EOG has in abundance. In this play, experience is required since the Vaca Muerta is three times thicker than the Eagle Ford shale in the U.S. EOG is likely to find this an extraction challenge, but I am confident that EOG will be able to scale up to make this play profitable.


EOG's timely diversification into oil and liquids, as well as its international expansion, have served it well given the current economic outlook for U.S. natural gas. I think that EOG is wise to take a bullish view on this market, though its intentions to keep its existing natural gas plays active enough to retain its leases indicate that it is not yet as bullish as others in the industry.

EOG competitor, Apache, is trading around $88 per share, with a forward price to earnings of 6.3 and a price to book of 1.2. Chesapeake is trading around $17, with a forward price to earnings of 6.4 and a price to book of 0.9. Devon is trading around $65 with a forward price to earnings of 8.9 and a price to book of 1.2. EOG is trading at a premium to these peers, around $106, with a forward price to earnings of 15.6 and a price to book of 2.2. However, EOG's positive outlook does much to justify these numbers. For those who already own the stock, EOG should be a hold, and a consideration for a buy for those looking to build their portfolios in the oil and gas sector.

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