Initiating Coverage Of EOG Resources: $105 Trefis Price Estimate

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EOG Resources

We are initiating coverage of EOG Resources (NYSE:EOG) with a $105/share price estimate, which values it at almost 18.3x our 2014 adjusted diluted EPS estimate of $5.75 for the company. EOG Resources is an independent oil and gas exploration and production company that explores for, develops, produces and markets crude oil, natural gas liquids, and dry natural gas from major producing basins in the U.S., Trinidad, Canada, and the U.K. A vast majority (around 94%) of the company’s total net proved reserves are located in the U.S., while the remaining are spread across other international markets including Trinidad, U.K., Canada, Argentina, and China. [1]

In our analysis, we have broken down the company’s operations into 3 divisions:

  • Crude Oil
  • Natural Gas Liquids
  • Natural Gas

See Our Complete Analysis For EOG Resources

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Below, we take a look at the key value drivers for EOG Resources.

Growing Base Of Proved Hydrocarbon Reserves

The amount of proved hydrocarbon reserves is an extremely critical metric for any oil and gas exploration and production company. It directly impacts the company’s production growth outlook, as it represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. EOG Resources’ total proved hydrocarbon reserves stood at 2,119 million barrels of oil equivalent (BOE) at the end of last year. This implies that the company held enough reserves at the end of 2013 to be able to produce oil and gas for the next 11.3 years at 2013 production rates. [1]

More importantly, despite the sharp growth in annual hydrocarbon production recently (around 9.2% CAGR between 2009 and 2013), the company has been able to grow its proved reserves base quite consistently. Last year, EOG Resources’ reserve replacement ratio stood at 271.9% by our estimates, which implies that the company added more than 1.7 times additional proved hydrocarbons reserves to its reserves base than the amount of oil and gas it produced between January and December 2013. Its average reserve replacement ratio for the last 5 years has been over 225%. This speaks volumes of the successful exploration program and long-term sustainability of EOG Resources’ core business. The table below summarizes the company’s proved reserves (in millions of barrels of oil equivalent) and reserve replacement ratio for each of the last 5 years. [1]

Leading Position In The Eagle Ford Shale

The Eagle Ford shale formation in South Texas runs from the US-Mexico border north of Laredo in a narrow band extending northeast for several hundred miles to just north of Houston. It is currently the largest tight oil play in the U.S. by EIA estimates. Its proved crude oil reserves of 3.4 billion barrels are greater than those of the Bakken Formation of North Dakota. [2]

EOG Resources is the leading oil producer and acreage holder in the Eagle Ford shale. The company holds 632,000 net acres in the play, a majority of which, around 564,000 net acres fall in the crude oil window of the formation. EOG Resources derives more than 55% of its total crude oil production from the Eagle Ford shale. At the end of the first quarter of this year, the company’s average daily net crude oil production from the Eagle Ford shale stood at 207,000 barrels, compared to just over 30,000 barrels in 2011. During the most recent reported quarter, EOG Resources’ net crude oil production from the formation grew by over 45% year-on-year. [3]

Improving Production Volume-Mix

EOG Resources’ net production volume-mix has been improving over the past few years with the proportion of liquids (crude oil and natural gas liquids) in its total oil equivalent production increasing. Liquids are generally priced higher than dry natural gas due to higher energy density and ease of transportation among other factors. In addition, severely depressed natural gas prices in the U.S., primarily due to a supply glut, have further eroded the incentive for upstream oil and gas companies to drill for dry gas. Last year, EOG Resources sold liquids at an average price of over $87 per barrel, while the company realized a price of just around $21 per BOE of natural gas on average. Therefore, despite lower finding, development, and lifting costs per BOE of natural gas, the production of liquids has become a far more lucrative source of revenue for upstream oil and gas companies in the U.S. [1]

The proportion of liquids in EOG Resources’ total production volume-mix has improved significantly from just around 22% in 2009 to 56% last year. We expect the company’s sales volume-mix to improve further as it plans to increase its focus on liquids production in the coming years. During the most recent annual investor presentation, EOG Resources pointed out that it expects to grow its liquids production by double-digit percentage points in the long run, while natural gas production is expected to remain relatively flat after declining by around 6% this year. [2]

Improving Well Productivity

Over the last few years, EOG Resources’ average well productivity has increased considerably on optimized spacing and efficiency improvements in fracking techniques. The company’s average initial production (IP) rate of crude oil from a normalized 5,300-foot lateral well in the Eagle Ford play has increased from around 1,500 barrels per day in 2011 to over 2,000 barrels per day last year. Higher well productivity leads to lower per unit production costs, which results in better operating margins for an upstream oil and gas company such as EOG Resources.

Declining Well Costs

EOG Resources’ average total cost associated with the drilling and completion a single well has also been declining over the last couple of years on improving operational efficiency. The company’s average completed well cost (CWC) for a normalized 5,300-foot lateral well in the Eagle Ford shale has declined from $7.2 million in 2011 to $6.1 million in 2013. This year, the company plans to further reduce it to around $5.5 million/well, which is expected to play a key role in helping it meet its capital expenditures target of $8.1-8.3 billion for the full year. [2]

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Notes:
  1. EOG Resources 2013 10-K SEC Filing, sec.gov [] [] [] []
  2. U.S. Crude Oil and Natural Gas Proved Reserves, eia.gov [] [] []
  3. EOG Resources Investor Presentation, eogresources.com []