3 Reasons Why Exxon Mobil Should Acquire EOG Resources
Exxon Mobil (NYSE:XOM) is the world’s largest publicly traded international Oil and Gas Company. It has both upstream as well as downstream operations and generates annual sales revenue of more than $420 billion. On the other hand, EOG Resources (NYSE:EOG) is an independent oil and gas exploration and production company that primarily operates on the upstream side of the hydrocarbon business generating annual revenue of around $15 billion. A vast majority (around 94%) of the company’s total net proved reserves are located in the U.S. Here, we outline 3 key reasons why Exxon Mobil should acquire EOG Resources.
1. Higher Production Growth
Exxon’s upstream production has been relatively flat over the past decade. It actually declined slightly from over 4,210 thousand barrels of oil equivalent per day (MBOED) in 2004 to 4,170 MBOED in 2013. This has also been a case with most of the other large integrated oil and gas players, as they have been unable to add enough new production to more than offset natural field declines. This could partly be attributed to the shear size of these firms, and also fact finding and developing large hydrocarbon reserves is getting more and more difficult and expensive. According to a recent study by Evaluate Energy, finding and development costs for the major integrated oil and gas companies have increased from below $10 to over $20 per barrel of oil equivalent over the past decade. [1]
On the other hand, EOG Resources has witnessed a significant growth in its hydrocarbon production over the past few years. The company has played a key role in the tight oil revolution in the U.S., which has taken place primarily due to the evolution of horizontal drilling and hydraulic fracturing techniques that enabled energy companies to tap the huge tight oil reserves in the U.S. at commercially sustainable rates. The company’s net oil and gas production has grown sharply from just around 353 MBOED in 2009 to over 510 MBOED last year, implying a CAGR of more than 9.5%. This year, we estimate EOG Resources’ net oil and gas production to average more than 575 MBOED followed by almost 10% CAGR growth in the next couple of years. During the first six months, the company’s net hydrocarbon production averaged 577 MBOED, up more than 17.5% over last year. [2]
Although EOG Resources’ net oil and gas production is only a small fraction (less than 15%) of Exxon’s, the exploding growth from increased development of its acreage in the Eagle Ford and Bakken shale plays could provide a significant boost to Exxon’s overall growth outlook. The chart above highlights the trend in historical and forecasted hydrocarbon production growth for both Exxon and EOG Resources.
2. Better Volume Mix
Hydrocarbon production can be broadly split into two categories – liquids, which include crude oil, natural gas liquids, bitumen and synthetic oil, and natural gas. Liquids are generally more profitable to produce than natural gas because of higher price realizations. Last year, Exxon sold liquids at an average price of around $95 per barrel, compared to just around $41 realized per barrel of oil equivalent (BOE) of natural gas. The proportion of liquids is therefore a key driving factor for cash margin earned by exploration and production companies per barrel of oil equivalent. [1]
In 2009, liquids made up more than 60% of Exxon’s total hydrocarbon production. However, their percentage contribution declined significantly after the company acquired XTO for $41 billion in 2010, which increased its natural gas production by 31% y-o-y that year. More importantly, most of the increase came from the U.S., where natural gas prices have been significantly depressed by international standards due to a sharp rise in production from unconventional sources. (See: Key Trends Impacting Natural Gas Prices In The U.S.) This weighed heavily on its operating margins. Therefore, Exxon has been trying to improve the proportion of liquids in its production mix over the last couple of years by slowing down its shale gas development program in the U.S. Last year, liquids made up 52.7% of Exxon’s total hydrocarbon production, up from 51.5% in 2012. This year, we expect the proportion of liquids to rise further. [1]
On the other hand, 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 in the coming years, as it plans to increase its focus on the development of its liquids-rich acreage in the Eagle Ford play. EOG Resources is the leading oil producer and acreage holder in the Eagle Ford shale. It 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. 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. We therefore believe that by merging with EOG Resources, Exxon can unlock a sizeable opportunity to expand its upstream cash EBITDA margin that, by our estimates, stood at 54.5% last year. The chart below highlights the trend in historical and forecasted E&P EBITDA margin for both Exxon and EOG Resources. [3]
3. Lower Crude Oil Prices
The price of front-month Brent crude oil futures contract on the ICE has declined has by more than 25% since hitting a short-term peak in June and is currently trading at around $85/barrel. Since lower crude oil prices impact operating margins of all oil and gas companies negatively, the NYSE Arca Oil & Gas Index(^XOI) has declined by more than 15% over the same period. Year-to-date, the index has fallen by around 2%, compared to a 8.5% gain for the S&P 500.
However, the independent exploration and production companies, like EOG Resources, have been hit more severely by the recent decline in oil prices since they do not have downstream refining and chemicals businesses, which provide a relatively stable stream of cash flows to the integrated oil and gas companies like Exxon Mobil. The S&P Oil and Gas Exploration and Production Select Industry Index has declined by almost 28% since the WTI crude oil prices peaked at around $100/barrel in June. Year-to-date, the index has fallen by around 11.1%. EOG Resources’ share price has melted by more than 20% since oil prices peaked out in June, compared to a decline of just 9% in Exxon’s share price. In other words, acquiring EOG Resources has become relatively more feasible for Exxon today than it was just 4 months ago.
Additionally, we also believe that the recent decline in crude oil prices on increasing supplies and slowing demand growth has enhanced the case for Exxon Mobil to acquire EOG Resources in order to provide some impetus to its top- and bottom-line growth. This is because lower crude oil prices will pressurize Exxon to increase its focus on boosting hydrocarbon production to drive upstream earnings growth. On the other hand, EOG Resources can partially insulate itself from increasing downward risks to its tight oil development program in the U.S. from lower commodity prices by joining hands with a larger player that has significant exposure in downstream refining and chemical operations than gain from lower commodity prices.
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