EOG Resources, Inc. (EOG) Earnings Call Transcript & Summary

Thanks, and good morning. This is Scott Hanold, Managing Director of U.S. E&P and Research. Glad to have EOG Resources. We're doing our fireside chat here, and we're pleased to have Ken Boedeker, the Executive Vice President of Exploration and Production on with us; as well as Dave Streit from the Investor Relations team. What we'll do is we'll start out, and I'll let Ken provide some high-level kind of thoughts, and then we'll get into some Q&A discussion. [Operator Instructions] So with that, Ken, I'll let you make a few opening comments.

All right. Well, thanks, Scott. I just want to thank RBC and Scott and all of you for joining us today. And I hope this finds everybody healthy and safe, and their families healthy during this time. So thanks for joining us, everybody. I just really wanted to start out. I've got a couple of minutes of kind of high-level EOG points I want to get across, and then we can jump into some questions. But really, the thing to know about EOG is we are a resilient company. I mean we're resilient for 2 big reasons. One is our culture. It's our big competitive advantage where every person here at EOG is a business person first. And we've taken on this latest challenge of low prices in the pandemic with that type of culture in mind. And then the second thing is, is our premium investment strategy where we make sure at EOG that every dollar that we spend is creating a high-return at the prevailing prices. So that's really the resiliency of EOG is the culture that allows us to do that. If we look at kind of the near- to medium-term focus that we have, right now, again, we're focused on all the money we spend, creating a 30% return at prevailing prices on a well level. That's really for a 20% all-in type of return. We've shown in the past few months and are continuing to show that our operational flexibility, where we can cut production and cost quickly as well as turn production back on as needed. Times like this really accelerate our technical innovation. If you think about it, we have a chance to really focus on getting better. And these times allow us to do that and really with that, our strategy going into the second half or the last half of 2020 is to really accelerate our production into what we see as a price recovery in the second half of the year. Obviously, having a strong balance sheet has always been one of our main stalwarts and protecting it and protecting the dividend is #1 on our mind as well as setting us up for longer-term growth, whether it's exploration, infrastructure, ESG initiatives, we really want to set the company up and come out of this stronger. I've been with the company for 26 years and been through several downturns, and one of the characteristics of EOG is we've always, always come out of these type of situations stronger. So with that, just leave you with kind of the -- what we've done in the past 3 years, we spent about 80% of our discretionary cash flow on CapEx, generated a 14% ROCE, increased our dividend 124%, generated $4.6 billion of free cash flow, paid down $4 billion in debt and increased our proved reserve base by 55%, and that's all at an 80% capital to discretionary cash flow ratio. So we've had an outstanding past 3 years and plan on emerging from this current downturn even stronger. So with that, Scott, I think I'm ready to go ahead and we'll throw it open.

All right. That's great. And it's obviously been some very challenging times over the last few months, and you've had a pretty good yearlong tenure with EOG. When you step back and look at the E&P industry and EOG specifically, what do you all think, given this latest downturn and how you look at the future, what does the industry need to do, what does EOG need to do to bring back investors and be more competitive to broad markets? And specifically, could you address what kind of production growth rates, free cash flow yields, dividends, leverage levels are appropriate for the industry and EOG?

You bet. I think what this latest downturn has done is it's driven even further capital discipline into the industry. So if you look at that as an industry and as a company, what we -- what we need to do as an industry is we need to spend within cash flow and generate significant free cash flow. We're one of the best in our peer companies, where we've only spent 80% of our discretionary cash flow on CapEx. So not only do you need to generate significant free cash flow, but you really need to invest at high returns. That's one of our stalwarts of the company is our premium drilling is what we call , it's just a way of allocating capital, where on a premium basis, our $40 flat, a 30% return minimum investment strategy has definitely paid off for times like this. And we need to -- the rest of the industry would need to invest and create high returns to be able to pull any capital or any investment back into it. As far as some of the other parameters that you talked about. Really for EOG, we're focused on creating long-term shareholder value. We believe you can do that with a strong balance sheet that allows you -- it gives you flexibility throughout the commodity price cycles as well as helps to protect the dividend. And our dividend is the primary way that we're returning that cash to shareholders, and we're really focused on a growing and sustainable dividend. So -- and generating free cash flow. So after that, if we look at it, our other investment opportunities include a lot of high-return drilling programs. So we look at all that, and that's really how we're going to look at it in the future as well.

Okay. Are there any specific targets or marks or goals EOG has when you look at free cash flow yields, dividend rates and leverage? Are there specific targets for us to think about?

We really don't have any specific targets on that. I can just tell you what we've done in done in the past, like I said, we've invested at roughly 80% of our discretionary cash flow over the last 3 years. And we've grown our dividend 124% during that time. Now it's hard to say how much the dividend will grow in the future, but it's one of our goals to have that dividend growing through time. So we don't have any exact numbers for you to shoot towards. We just know that our strategy is to continue to show the capital discipline and reinvest at higher and higher rates of return and provide a high -- 14% ROCE over the last 3 years. Our goal is to keep increasing that ROCE.

Okay. Understood. And you had a pretty strong perspective on your dividend growth rate over the next several years prior to the downturn in oil prices. And sort of 2 questions. Is that goals still achievable in the current commodity and price environment? Can you talk about the sustainability just in general of EOG's dividend at strip prices, if we were to look at it that way?

Sure. If you look at our dividend, if you first look at it, we've never cut it in the history of the company with -- throughout any downturn, and we haven't cut it this time either. So that's one of our top priorities is to maintain that dividend. We do a lot of stress testing on the dividend before we ever announced it or increased that at several different oil prices. And I believe that you can see in the disclosures that we had at the end of the last quarter that we can maintain CapEx -- or excuse me, maintain our production levels from the fourth quarter of this year and our dividend at $40 oil. So you can see that maintaining production levels and sustaining the dividend is very doable at a $40 price environment.

And what kind of price would it take to get back to a dividend growth rate that you were all contemplating earlier this year?

If we see prices higher than $40, we will look at growing it. I don't know that you'll see it grow at the rate that it has in the past. But we are committed to growing our dividend as prices allow. So that's pretty much where we're at this point.

Okay. I got a few questions coming in from investors. One of the questions is that you've recently liquidated your hedge -- some of your hedge -- oil hedge books. Can you speak to what this says about your macro view on oil prices?

You bet. From a hedge perspective, we hedge very opportunistically. So it's -- we have a, I would call it, a very sophisticated macro model, where we can look at what we see commodity prices doing in the near to medium term. And if we see those prices going up, we don't hedge. It's that -- it's pretty much that simple. If we see those prices going down, we do hedge. So you can kind of look at our hedge position and see where we think prices are going to go. At this point, we closed out our hedges. I think we did that late last week. We see very little capital flowing into the industry, and we see higher declines from all the shale players throughout the rest of the year. So supply being down and we see demand coming up, and we think that sets us up for increased prices. So that's really why we liquidated the hedge position when we did.

Understood. Thanks for that. And just when you step back and think about, you guys took a very assertive approach, relative to some of your peers, in terms of shutting production that you discussed in the first quarter conference call. And certainly, with a more bullish view on the macro, can you talk about the levels at which some of that curtailed production can -- do you plan on bringing back online?

Yes. We look at that. Let's say, first of all, we have a real advantage in our information systems. We can look at every well, every day, look at the variable and the fixed costs, and we can marry that with what we're actually selling the product for, which is important when you consider different things, like the differentials that you're seeing from, say, Houston Ship Channel or the month-to-month roll that you see. So when you marry all that together, we curtailed because our cash margin was getting substantially lower in certain wells in certain areas, and we didn't want to take the risk of it going lower. And then looking at a growing price environment in the second half, if your margins are way down, it doesn't take much of a price increase to more than double or triple your cash margin. So we did curtail wells. They were still economic. They were still making cash. But we felt, with our strong balance sheet, we didn't need to sell our oil at that low-margin, that we could -- we could curtail it and sell it at a later date at a much higher margin. So that's what we did. And as far as bringing those wells back on, you can see on our guidance that we've put out there that we plan on third and fourth quarter just continuing to not only bring on those wells that we had curtailed or shut in, but to bring on wells that we've completed and not turned on yet.

Okay. And with the latest move with removing the hedges, obviously, indicating you are more bullish on the macro, does that indicate that the effort to bring on curtailed production as well as wells that haven't been completed, could that happen sooner than originally planned?

You sell a lot of that oil a month out. So we plan on bringing those wells on in third quarter, and we're going to -- we're evaluating that. But for right now, I think everybody should use what we have in our third quarter guidance as numbers on what we plan on -- how we plan on bringing our wells back on.

Understood. I appreciate that. One of the things I want to shift back to is some of the discussion on the balance sheet, and you've maintained some fairly attractive leverage metrics, some of the lowest in the industry. Can you give us a sense of when you look at the balance sheet and balance sheet management, discuss plans for some of the upcoming debt maturities that you all have? How do you see -- what are the options you have with that? And in this market, how do you see EOG addressing those?

Sure. First of all, let me say that there's never a better time or an example of when a strong balance sheet is really beneficial then right now. I mean, it allows you to make those calls on whether you want to curtail production and maintaining your dividend. Having a strong balance sheet is just key in this cyclical industry, where you can't really predict any of these -- the commodity price over a long period. So we think a strong balance sheet is just key to running a good business in E&P. In terms of our debt, we did have $1.5 billion bond offering about a month ago. We took $500 million of that and paid off our bond that was due in April, and then we paid off another $500 million bond yesterday with that. We have 1 more bond coming due in February of next year for $750 million, and we anticipate being able to pay that off or we're planning to pay that off with the cash on hand.

Understood. Thanks for that. And does the company have a target leverage ratio that you'd like to maintain? Is there a level where if it gets above that, you start feeling uncomfortable?

Not really. What we've seen is we've seen higher and lower leverage ratios through time as we need to run the business. It's never been high enough to be a concern. But obviously, having low leverage ratio is a huge competitive advantage to us. If we look at the last downturn, we did the Yates acquisition at that point in time. And we would not have got that acquisition done, had we not had a really strong balance sheet just because the Yates family wanted a company that had a strong balance sheet to be able to show for their family, to be able to show that it was a good deal. So anyway, a strong balance sheet is a huge advantage for us.

Understood. And I'll key off one of your comments there, talking about the Yates acquisition. And how does EOG see the consolidation opportunities or the opportunities on -- new opportunities during times like these? Are there things that look more attractive today than they have in recent years? And how do you plan to evaluate those?

Yes. I would say that we're always evaluating different bolt-on acquisition opportunities. We're not interested in any expensive corporate M&A opportunities, but we're always evaluating bolt-on opportunities, like the Yates acquisition. That was a significant amount of acreage, and we were an operator that -- the low-cost operator to be able to develop that. So that's where the synergy there was. So we're always evaluating that. As far as the market goes, right now, there's a couple of things that are hurting the market in terms of being able to see a lot of consolidation. One of them is we need to see what kind of a, if you want to call it, a stabilized commodity price or what the more stable commodity price, I guess, is the way to say it, would be. So the buyers know they're getting a reasonable deal and the sellers know that they're getting a reasonable deal. And then the other thing that's hurting a lot of the consolidation in the market is there's just some higher debt levels of a lot of companies out there that should be looking to consolidate. And really, nobody wants to take those additional debt levels on. So we see that working through the system in, say, the next 6 to 12 months, but it's not going to happen immediately until we see what demand looks like after we come out of this pandemic.

Okay. And another question coming in that I think kind of plays again right off the idea of sort of consolidation and building your portfolio. But you've been very active, I think throughout your history, in being a leader, finding new plays, developing new plays. Is there -- can you talk about what kind of efforts right now is ongoing in sort of some of these exploration efforts? And is there any new updates on some of the new basins that you're working in right now?

Sure. When we saw the decline in commodity prices, we did go ahead and high-grade both our, I would call it, our development drilling program as well as our exploration drilling program. So we did high-grade that. We still have capital going towards it. We're still testing several of those plays. It's just going to take us a little bit longer to get those tested in a lower price environment than it would have been in the pre -- in the price environment from late last year. So we're continuing to test those. Seeing results, we'll let you know as we get results that we feel we should disclose. But we're right in the middle of that. Our goal with those exploration plays are to really bring them into our inventory and have them come into the front part or the upper third, maybe upper quartile of where our inventory is, so that they would be very much returns and finding cost competitive with what we have in our existing premium inventory. What we're focused on are wells or plays that are -- have a little bit better reservoir quality, a little higher perm in existing areas where we should be able to bring them to market and have a little bit flatter declines. So we're right in the middle of testing those plays and we'll definitely let people know as we get additional results.

Yes. I mean that's a pretty high bar to being upper quartile to be competitive in your portfolio, I'd say. And when you think about there's probably more holes poked in the ground in the U.S. than anywhere else in the world. How likely is it -- are you going to find something? And is there stuff out there with scale that can have scale to EOG and can compete versus your premium portfolio? Is there still stuff out there?

Yes. We definitely think so, that's what we're at. I would say that as far as scale goes, we're going to say it's above a couple of hundred million barrels in that range. So it definitely has scale. We see this as an opportunity. There's hardly anybody else in the industry right now doing any exploration, and acreage and entry costs are very, very low. So it's a prime opportunity in a lot of these plays. And one thing EOG can bring is we've been in this industry for a long, long time, and we understand what makes plays work or what we think makes plays work and what doesn't as well as we can bring the scale, which will allow us to have lower costs in these plays than maybe some of our competitors did. Some of these plays have been tested, and they were either too expensive or they've been tested and it was with a significantly previous generation of stimulation technologies. So we're just going out and trying to apply our best practices from all of our different plays to these new ones, and like I said, have sufficient scale to be able to allocate a decent amount of capital to in the future.

Understood. I've got a few other questions coming in from the audience. And one of the questions is, certainly, there's some indication that you're a little bit more constructive on the oil macro. One of the things that we heard from a lot of your peers is that a lot of the production is going to be brought back online in the mid-$30 per barrel WTI level and maybe not too far north of that to start seeing some new drilling start to occur by some of your competitors. And how do you sort of think about like a bullish context of the macro with a lot of the industry players starting to bring production back in the mid-$30s. It seems like those 2 kind of ideas are in a bit of conflict.

Yes. Understood. And I think what you're going to see -- some of the existing shut-in production will be coming back on. There's no doubt about that. So we're going to see supply side, and you're going to see prices do a similar thing with pullback until we reach some kind of a balance within the market. Your comment about starting to drill in the high $30s, I'm not sure I see that. I don't know that there's many companies out there that can generate reasonable returns in the high $30s. And I think that's what they'll need to generate as returns because there won't be any -- very much cash available in the market for those companies to tap outside of their own generated cash flow to be able to do that. So I guess, by not having any -- by them not outspending cash flow, it's going to put a cap on how much development that you can do.

Okay. So then just as a broad construct, I mean, certainly, it sounds like you think while there's some sawtooth likelihood in U.S. production, it's just not sustainable at these oil prices, and I would assume that's part of it. And then where does -- I mean, is there a specific level, and this is another question coming in, with OPEC+ production or compliance level that's embedded into your kind of a macro view at this point.

Yes. I mean, our macro view definitely takes into account where OPEC is and what they might end up doing. We're going to have to see what demand comes back at post pandemic, to help see how that market rebalances. Obviously, there's an excess production in OPEC, which is going to put some kind of a, I would think, some kind of a cap on where the prices could be. But we'll just have to see how that is. Our longer-term outlook is that where prices currently are now, they're not sustainable for any amount of time. .

Okay. I mean, could I ask you, what is your view on oil prices in 2021? Do you have a perspective of sort of the range where we could be looking at?

I don't really want to give you a range. We just think that they -- as we get into 2021, demand will be back, and we will see less capital coming into the industry because, obviously, people are going to have to have the -- this is going to force more and more capital discipline. So we see prices being constructive from here and don't see them going down at this point.

Okay. Understood. Kind of another incoming question, back to the leverage levels, just your thoughts on your credit ratings. Are you willing to defend your A- credit rating? Is that something that does matter? And if there is a move by some of the agencies, as we've seen some aggressive moves in the past, you potentially push to a potential downgrade bucket? Can you talk about what kind of strategies you do? And is it something willing to defend your credit position?

Sure. Well we're 4 notches into investment grade. So we're not really worried about defending that. That's more of an output of how we run our business. We run our business to generate free cash flow and high returns. And then what you see is when you do that and generate ROCE that -- and keep the balance sheet where it's at, that you'll see us maintaining definitely well into investment-grade ratings.

Understood. Obviously, Ken, your expertise is on the E&P side and so, certainly, I would like to delve into some questioning regarding that area. But maybe to start out with, we talked about curtailing production, and how do you think about adding rigs and frac crews back? I mean, certainly, is there a more comfortable oil price when you look at adding the curtailed production versus new activity back online?

Yes. If you look at what we're looking at for the end of the year and into next year, what we've put out is that we can maintain our Q4 exit rate at about $40 oil and $3.4 billion in investment. And that would entail adding some rigs and some frac crews for that type of a scenario there. If we see prices go up, obviously, we could add a little bit more. In terms of adding, whether it's drilling rigs or frac crews, a number of those are on standby right now. We have the flexibility in their contracts to be able to add them back. Some of them are still on our locations. Adding them back and getting -- it won't take a long time to get them back on high-performing levels of when they left. We'd be able to add back the preferred rigs first, obviously, and the preferred frac crews first. And what we see is at that level, it will be easy to add crews and everything back, and we should be up and running and continuing to get better on our operational execution side within a month or 2.

Okay. Understood. And when you look at the actions that you had to take and the industry took -- obviously, we're seeing the output, which is, obviously, the base decline rates take -- really take hold. And can you discuss EOG's decline rate? I guess, was a little bit steeper than a lot of investors had expected early on, but it does seem to flatten a little bit more. Can you talk about like on your asset base, how you see the differences between where outsiders look at decline rates and where you guys see actually things actually are?

Sure. If we look at midyear decline to midyear decline, it's 32%. What we published for the first quarter call was -- I think it was about an 18% drop and from one quarter to another. And that's what we see with our wells. We're highly efficient at getting the oil out, which means you have very high IPs and steep declines early on and then they flatten out. Now on a corporate basis, when you're not growing, like we won't be growing this year, our decline will definitely flatten out on a corporate basis second half of this year and into next year. It's just a matter of the shape of the wells and of the production that you're adding into the base.

Good. I got it. With that, I do see, we've just hit our time limit. But Ken, I've always would like to leave it open to you, is there any kind of final comments that you'd like to provide before we finish up?

I just want to thank you, Scott, and thank you, everybody, for listening in, and stay safe. And just remember with EOG, we've always come out of these commodities downturn stronger than when we went into them. So we just appreciate all of your support.

I appreciate your time, Ken. Good luck. Thank you.

Thank you.