Why Is EOG Resources Acquiring Yates Petroleum Corp.?

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The global commodity downturn that has uprooted many oil and gas companies over the last two years, has entered its third year of devastation. With the macro factors changing every minute, the outlook of commodity markets continues to remain uncertain. As a result, the smaller oil and gas companies are dashing from pillar to post to sustain their operations, while the oil and gas majors are eyeing the best oil and gas assets at attractive prices to complement their growth over the long term.

Such is the case with EOG Resources (NYSE:EOG), which has announced its plans to acquire Yates Petroleum Corporation (along with some of its subsidiaries) to further its target of expanding its presence in the Permian Basin, one of the most cost-effective oil fields in the US. The oil and gas producer aims to buy Yates, a privately held independent crude oil and natural gas company with a sizeable presence in the Permian Basin, for approximately $2.5 billion in a stock and cash deal. The news was received positively by the market, causing EOG’s stock to rally more than 6.5% post the announcement of the acquisition. In fact, a majority of the industry experts believe that the deal is inexpensive for EOG and will be immediately to accretive for the company’s profits as well as returns.

EOG-Q&A-10

Source: Google Finance

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Terms Of The Deal

Under the terms of the definitive agreement entered by the two companies, EOG will issue 26.06 million shares worth $2.3 billion and pay $37 million in cash to the shareholders of Yates, subject to certain closing adjustments and lock-up provisions. Further, the US-based oil and gas producer will assume and repay Yates’ outstanding debt of $245 million, which will be partially offset by Yates’ anticipated cash of roughly $131 million. EOG expects to close the deal by early October, and plans to commence drilling on the Yates acreage in late 2016 with additional rigs added in 2017. Post the closure of the transaction, EOG intends to maintain Yates’ office in Artesia, to support the combined operations.

Deal Rationale

Yates, the New Mexico-based company, holds 1.6 million net acres mainly in the Permian Basin and the Powder River Basin in Northeast Wyoming, which are some of the sweetest oil drilling prospects in the US. Since much of Yates’ acreage is adjacent to EOG’s existing leases in these basins, it makes economical sense for EOG to invest in these assets even during the weak oil price environment. This is because in order to enhance the productivity of a well or region, oil and gas companies need to drill vertically as well as horizontally for more than a mile, which requires a large area of land to be clubbed together. Having a large acreage in the same region, along with the use of the latest and innovative technology, EOG will be able to drill longer horizontal wells, resulting in higher well productivity, and in turn, higher returns.

Permian map

Source: EOG Resources’ Website

In addition to this, EOG Resources has been focused on improving its well productivity by building a strong inventory of premium locations over the last few quarters. A premium drilling location, as defined by EOG, is a well/location that generates a direct after-tax rate of return of at least 30 percent, assuming crude oil prices to be at $40 per barrel. With its consistent efforts, the company 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 rise of 75% in just 6 months. 

EOG-Q&A-10-1

However, the deal is likely to increase EOG’s position in the Permian and adjacent plays by more than 200,000 acres, to 574,000 acres, and double its position in the Delaware Basin in southern New Mexico and West Texas. The acquisition will immediately add an estimated 1,740 net premium drilling locations in the Delaware Basin and Powder River Basin to EOG’s existing 4,300 premium drilling locations. This 40% growth in the company’s premium drilling locations will increase its drilling inventory, much higher than the current inventory of 10 years.

EOG’s Premium Drilling Locations 

EOG-Q&A-10-3

Source: EOG Resources-Yates Deal Presentation

Thus, we believe that the Yates deal will augment EOG’s strategy to expand its presence in Texas and New Mexico, while enhancing its premium drilling location inventory, which will improve  returns even in the low oil price environment.

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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