What’s Driving Our Capex Forecast For EOG Resources?
Oil and gas companies capitalize finding and development costs (that include the costs associated with unproved property acquisition, exploration, and development of proved reserves) in order to distribute these costs over the lifetime of a drilled well or a raised platform. These costs, termed as capital expenditures, form the biggest single cash expense item for almost all independent oil and gas companies. EOG Resources’ (NYSE:EOG) annual capital expenditures (net of proceeds from asset sales) have increased sharply from around $3.3 billion in 2009 to $6.3 billion in 2013 and we expect the company to have spent around $7.8 billion in developing its U.S. onshore assets and building gathering and processing facilities for crude oil, natural gas liquids, and dry natural gas last year. [1] However, we expect the company to reciprocate to the changed crude oil price environment by slashing its capital expenditures in the short to medium term and wait for some stability in oil prices before accelerating the ramp up of its tight oil development plan in the long run. [2]
EOG Resources is an independent oil and gas exploration and production company that explores, 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.
We currently have a $94/share price estimate for EOG Resources, which is more than 10% above its current market price.
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We use net capital expenditures as a percentage of operating revenue to forecast EOG Resources’ cash outflow for finding and developing hydrocarbon reserves. As can be seen from the chart below, despite the sharp increase in net annual capital expenditures in absolute terms, EOG Resources’ capex as a percentage of operating revenue has declined significantly from 97% in 2009 to 59% in 2013. This could be attributed to relatively higher growth in operating revenue due to oil prices and improvements in drilling efficiency, leading to lower cash costs per well. 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. Last year, it is estimated to have declined further to around $5.5 million/well. Therefore, going forward, we expect EOG Resources’ net capital expenditures as a percentage of operating revenue to decline to around 33% by the end of our forecast period, primarily due to the anticipated cut in gross capital expenditures in the short to medium term, owing to lower crude oil prices, and drilling efficiency improvements coupled with higher revenue growth in the long run. [3]
Since the independent oil and gas companies do not have downstream operations, they are relatively more exposed to the volatility in global crude oil prices, compared to the integrated players like Exxon Mobil (NYSE:XOM). This also reflects in the fact that the S&P Oil and Gas Exploration and Production Select Industry Index (SPSIOP) has declined by more than 46% since the WTI crude oil prices peaked at around $100 per barrel in June 2014, while the NYSE Arca Oil & Gas Index (XOI), which includes both integrated and independent players, has declined by just over 23% over the same period. This is because, unlike the integrated players, these companies do not have a relatively stable stream of cash flows from refining and chemical production operations. This means that in a commodity down cycle, such as this one, these companies see a sharp decline in their operating cash flows, which lowers their capacity to invest in future production growth. Therefore, capital expenditure plans of independent exploration and production companies are far more dependent on the short to medium term outlook for global crude oil prices.
As a result, a lot of large independent exploration and production companies in the U.S. have announced sharp cuts in their 2015 capital spending budgets. For example, ConocoPhillips (NYSE:COP) recently announced that it plans to cut its capital spending by as much as 20% this year (compared to last year) due to the recent decline in oil prices. [4] Similarly, Houston-based Marathon Oil (NYSE:MRO) also announced a 20% cut in its 2015 capital spending last month. [5] Another large player in the shale oil industry, Continental Resources (NYSE:CLR), also plans to trim its capital expenditures to just $2.7 billion this year, compared to $4 billion last year. [6] EOG Resources has not announced its 2015 capital budget so far, but the company officials did announce during the third quarter earnings conference call that they plan to cut back on the development of not-so-profitable combo plays in the Barnett and the Permian shale plays because of the recent decline in oil prices. [3] We expect the company’s 2015 gross capital spending budget to be at least 20% lower than the $8.2 billion it spent last year, which comes out to be around $6.6 billion or 49% of the estimated operating revenue. Based on our current long-term outlook for crude oil prices, we expect EOG Resources’ gross capital expenditures to decline further in 2016 and increase at a growing rate to around $7.7 billion by the end of our forecast period. (See: Where Are Oil Prices Headed In The Long Run)
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Notes:- Our net capex estimate for 2014 includes the offsetting impact of the recently completed divestiture of a majority of its assets in Canada for around $410 million, net of transaction costs. [↩]
- EOG Resources 2013 10-K SEC Filing, sec.gov [↩]
- EOG Resources 2014 Q3 Earnings Call Presentation, eogresources.com [↩] [↩]
- ConocoPhillips Sets 2015 Capital Budget of $13.5 Billion, conocophillips.com [↩]
- Marathon Oil Cuts 2015 Capex 20% As Crude Tumbles, reuters.com [↩]
- Continental Resources Cuts 2015 Capex, seekingalpha.com [↩]