Enron’s successor, EOG, is a buy

EOG Resources (EOG) is the premier onshore U.S. crude oil producer, capable of sustaining many years of very high production growth supported by its exceptional acreage position and industry-leading technical advances. The stock is currently trading at $103 per share (as of May 5) and has an upside target of $209 per share, which is more than double its current price, over the next 12 months assuming a $62 per barrel WTI crude oil price.

It is the successor of Enron and is the second largest U.S. onshore (lower 48) oil producer with 2017 crude oil production of 335 thousand barrels daily (MBD), just behind Chevron (CVX) and ahead of  Exxon (XOM) and Occidental Petroleum (OXY). 

It was an early mover in the unconventional shale revolution in identifying the best geologic plays and capturing the best leases. In 2005, EOG was the first to apply horizontal drilling to the Barnett Shale deposit in Johnson County Texas. 

In 2007, it was an early mover in horizontal drilling in the North Dakota Bakken Shale region. In 2010, it concluded horizontal drilling for unconventional oil trapped in shales in the lower 48, which proved to be an industry game changer and captured the first mover advantage in a number of plays. 

Historically, EOG has been almost entirely focused on organic growth, while maintaining low costs and low debt levels. During the years, it has consistently generated the highest return on capital employed in its peer group. 

To develop the best competitive position in the industry, EOG’s strategy over the years was to identify and acquire acreage in the “sweet spots” in U.S. resource plays, which are relatively small. The rest of the acreage in each play is not as productive and needs much higher oil prices to be economic. There is a scarcity of premium resources in any play. EOG now holds sweet spots across all six major resource plays, which minimizes single-basin geologic risk.

In 2016, it adopted a new standard of capital discipline called “premium drilling” with a premium well defined as one generating a minimum 30% direct after-tax rate of return at $40 per barrel. At a $60 per barrel oil price, its premium wells generate an after-tax rate of return of more than 100%. First-year production from its 2016 premium wells was twice as large as its non-premium wells, while finding costs were half as large. EOG’s premium resources produce more oil from fewer wells.

As a result, its U.S. operations break even at $30 per barrel, competitive with producers in the Middle East. U.S. industry resource plays generally require $40 to $65 per barrel and deepwater production, and 13% of world oil supply, which requires $50 to $65 per barrel. Conventional onshore lower 48 and oil sands production require $65 to $75 per barrel.

EOG’s 2017 production increased 9% year-over-year to 690,000 barrels of oil equivalent per day with an 11% increase in the United States to 551,000 barrels of oil equivalent per day. U.S. production was 61% oil, 16% gas liquids and 23% natural gas. 

Company guidance provided indicates a 17% increase in overall production in 2018 to 710,000 barrels of oil equivalent per day. Rapid growth at similar rates will continue thereafter with current oil prices. The Permian’s Delaware subbasin is the primary driver of growth.

That growth holds the potential for the price of EOG to double in the next year.