Why Has EOG Resources’ Capital Efficiency Improved Despite The Commodity Downturn?

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One of the most common, yet significant, outcomes of an economic downturn is the cost and capital efficiencies that it forces the companies to strive for. The commodity downcycle, that began in mid-2014 due to the mismatch of demand and supply in the crude oil market, has left almost all the companies in the oil and gas industry looking for a way to curb their operating costs to uphold their margins in a low commodity price environment. Due to the weak cash flows, these exploration and production companies were forced to cut down their capital spending budget over the last two years. Lower capital spend, coupled with depressed price realizations, resulted in a sharp decline in the production for a majority of these oil and gas producers. However, that is not the case with EOG Resources (NYSE:EOG).

The US-based oil and gas producer recently posted a strong set of June quarter 2016 results on the back of capital efficiency gains and reduced operating costs, while most of its rivals faced a tough time in the quarter, despite an unexpected recovery in commodity prices. This is largely because of a shift in the company’s strategy concerning its exploration and drilling activities. Over the last few quarters, the company has been focused at improving its well productivity by building a strong inventory of premium locations. A premium location, according to EOG, is an area/well which has enough net resources to generate a direct after-tax rate of return (ATROR) of at least 30%, at a $40 per barrel crude oil price.

EOG Resources’ Strategy To Focus On Premium Locations

EOG-Q&A-9-2

Source: EOG Resources’ 2Q’16 Presentation

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Thus, to expand its premium drilling inventory, the oil and gas producer is either converting its existing locations into premium locations by using longer laterals, and innovative technology, or is increasing its exploring activities in its key basins such as the Eagle Ford, Bakken, and Delaware Basins. As a result of its consistent efforts, the company has managed to grow its premium reserve potential from 2 billion barrels of oil equivalent (billion boe) in February to 3.5 billion boe at the end of the second quarter, representing a 75% rise within 6 months. At present, EOG holds approximately 4,300 premium drilling locations, implying a drilling inventory of over 10 years.

EOG-Q&A-9-3

Source: EOG Resources’ 2Q’16 Presentation

Since the company plans to continue to add these high return, low cost, premium locations to its drilling inventory, we expect the company’s capital productivity to improve significantly in the coming quarters. In simple words, the company’s production and returns are likely to grow faster, even with fewer wells and lower capital spend. Below, we show how EOG’s capital efficiency has improved over the last two years.

EOG-Q&A-9-1

Have more questions about EOG Resources (NYSE:EOG)? See the links below:

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for EOG Resources

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