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EOG Resources: Getting Oil Revenue with a Natural Gas Kicker (NYSE: EOG)

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As most of you know, the global oil market has been turned upside down by Putin’s decision to invade Ukraine and the resulting economic sanctions imposed on Russia by the United States and its Democratic allies. . While the price of WTI Crude fell sharply last week (see chart below) following the Biden administration’s decision to release 1 million bpd for 180 days from the US strategic oil reserve, WTI is still close to $100/bbl and this is ~2.5x the break-even point generally considered for most domestic shale production (~$40/bbl). It means low cost producer EOG Resources (New York Stock Exchange: EOG) is going to have plenty of free cash flow this year to reward its shareholders both through its base and, increasingly, through its variable quarterly dividend. Meanwhile, the relatively recent discovery of Dorado has excellent long-term potential.

WTI Crude Weekly Price Chart

WTI Crude Weekly Price Chart (CNBC)

Investment thesis

As mentioned earlier, EOG has a two-tier dividend policy: a regular, or “base”, quarterly regular dividend (currently $0.75/share) and a special, or “variable” dividend, which was $1 /share in the first quarter.

Given the current macro-environment, the benefit for EOG’s shareholders clearly lies in the exceptional dividend. Note that the $1/share distribution in the first quarter was primarily based on oil prices and free cash flow generated during the second half of 2021. During the fourth quarter of last year, WTI was in average of about $77.44/bbl. However, in the first quarter of this year, WTI averaged $93.33/bbl, more than $25/bbl higher than in the fourth quarter. Considering that EOG has reported that it is FCF positive when WTI >$32/barrel (see page 6 of this presentation), to say that EOG is generating tons of FCF at current prices is an understatement. This, of course, bodes well for large special dividends throughout 2022 and perhaps another significant increase in the base dividend as well.

To put that into perspective, EOG generated $5.5 billion in FCF in fiscal 2021 as WTI averaged $68/bbl. The result – given the shareholder-friendly nature of EOG’s management team – was that the company doubled the base dividend and returned $2.7 billion to shareholders (~50% of total FCF ) through basic and special dividends.

If WTI averages near the current price ($100/bbl) for the rest of 2022, EOG could easily return around $7-8/share (or more) in total shareholder dividends this year. At Friday’s close of $120.33, the midpoint of this estimate ($7.50) equates to a return of 6%+.

Discovering the Dorado

EOG Dorado Discovery

EOG’s Dorado Discovery (EOG Q1 Supplemental Presentation)

In the meantime, EOG has not stood still and announced at the end of 2020 the discovery of a large field of dry gas in southern Texas which it calls Dorado. Most of you know that one of the reasons EOG has been so successful over the years is that it was primarily an oil and NGL focused business (i.e. i.e. liquids) and that it was relatively insulated from the fall in the price of natural gas. However, as the chart above shows, EOG not only thinks Dorado is a potentially massive 21 TCF resource, but its breakeven price would only be $1.22/Mcfe – significantly less than Haynesville games. or Marcellus. This led EOG CEO Ezra Yacob to say the following during the Q1 conference call:

And that’s one of the reasons we’re very excited about our prospect Dorado. We believe it’s competition in North America is essentially the lowest cost of supply, not least because of its geographic location, close to so many marketing hubs, including the Gulf Coast. So we’re very excited and very lucky to have him.

EOG has already established a dominant lease in the Dorado area (160,000 net acres) and claims to hold 1,250 prime drilling locations. In 2022, EOG plans to approximately double its activity on an annual basis – running two rigs and a target of 30 net well completions. It’s not hard to see a future in which EOG is a major supplier of natural gas to Gulf Coast LNG export terminals (much of which could go to Europe).

Risks

Typical risks apply to an oil producer like EOG: massive geopolitical uncertainties regarding Putin’s war of choice in Ukraine and the resulting sanctions against Russia by the United States and its Democratic allies. Rising oil prices can exert downward pressure on the global economy and could, at some point, cause oil demand to be destroyed and oil prices to fall. However, for EOG stocks and the price of oil, as we have already seen, these risks obviously also have upside potential.

EOG could potentially break through its “premium” shale drilling inventory in 10 to 15 years. That being the case, EOG will either have to make new discoveries or enter the M&A market…something it hasn’t been much involved in over the years (preferring mainly to add resources by buying new itself). area leases).

Meanwhile, EOG’s balance sheet is clean – ending fiscal 2021 with almost as much cash ($5.2 billion) as long-term debt ($5.6 billion). The company is currently trading with a forward P/E of just 9x.

A Word on the Shale Oil False Narrative

In the meantime, my supporters know that another risk is the risk of what I have called the “new era of energy abundance”. A word on that, if you don’t mind.

After watching every shale oil company CEO over the past decade market shale as a “short cycle” resource that can be scaled up (or scaled down) quite easily and economically due to market conditions, it makes me laughs to see them (and many politicians and media “pundits”) now claim that it is no longer “in short cycle” and that it would take “at least a year” to significantly increase production . It is simply wrong. A shale well can be drilled, completed and brought onto existing pipelines in a matter of weeks, two months at most. It’s just a fact. Are there supply chain issues following the Covid-19 crash? Sure. But one thing every energy investor knows is that any problem in the oil sector can be solved with money. And God knows there’s a ton of money in the oil business today.

I’m also amazed that those energy company CEOs at the recent CERA conference were also complaining about a “lack of capital.” This is also very interesting to me given that almost all major shale operators already have A-rated balance sheets, generated tens of billions of FCF last year (at much lower prices…), and generate obviously tons of FCF right now. prices. There is certainly no “capital shortage” in the domestic shale patch right now. For example, an EOG peer Conoco Phillips (COP) generated $10.4 billion in FCF last year. Chevron (CVX), another major Permian producer, generated $21.1 billion in FCF for fiscal 2021. You’re going to tell me these companies can’t afford to bring another rig into service in the Permian Basin?

It’s also kind of funny (other than the destruction of billions of shareholder capital…) that some of these same companies weren’t complaining about a “lack of capital” during the silly “drill baby drill” mantra of the recent past that saw their production growing as fast as possible in an already oversupplied market at O&G prices less than half of what they are today.

Meanwhile, the other false narrative is that somehow Biden, “greens” or “regulations” are stopping shale oil companies from increasing drilling and putting new rigs in. forms at work tomorrow morning in the Permian Basin. Nothing could be further from the truth. First, ~80% of shale production comes from private land. Second, regulation of Biden’s leases on federal lands has been delayed by the courts. Meanwhile, major shale oil players have literally thousands of unused federal drilling permits.

Bottom line: Be under no illusions, the only reason US oil production isn’t increasing is because these energy companies have chosen not to. That being the case, investors should be careful not to buy into the false narratives that are being thrown around. Shale oil wells are always “short-cycle”these companies have tens of billions of barrels of proven shale reserves (even at 40$/bbl, even less 100$/bbl!), they have tons of capital, and there are pipelines to get that oil to market immediately. So, we still live in an “era of energy abundance”, and it pains me to see the American oil industry not reacting to a war situation and putting the screw on Putin for what he did in Ukraine (not to mention middle class Americans being hammered at the pumps and by inflation in general) and the existential threat that the world’s worst autocrats pose to free democracies. That said, the artificial constraints on US shale oil production growth mean higher oil prices, which is extremely bullish for EOG (and others), at least in the short term.

Summary and conclusion

EOG is arguably one of the best shale play operators in the United States. It is also very shareholder friendly and could very easily pay out $7.50/share in total dividends to shareholders this year (6%+ yield). Also, if US shale oil production doesn’t react faster (and it doesn’t seem like the CEOs want to…), despite the release of 1 million bpd from the SPR for 180 days, that’s only ~1/3 of the estimated reduction in Russian oil exports (3 million bpd). As a result, before all is said and done with Putin in Ukraine, we could easily see WTI reach $150/bbl this year. And that not only means EOG shareholders will benefit from excellent dividends, but they could also see a significant increase in the share price, leading to total returns that could blow up the S&P 500.

I’ll end with a 10-year chart of EOG’s stock and note the cyclical nature of the up-and-down cycles and that it’s still below the price it reached in 2018:

EOG stock price chart
Data by YCharts