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

Good morning, and welcome to JPMorgan's Fifth Annual Energy Conference, but maiden voyage in a virtual format. My name is Arun Jayaram, Head of U.S. E&P Research at JPMorgan. We're delighted to have EOG Resources to kick off this year's conference. EOG has been one of the leaders in value creation in U.S. shale, harnessing its premium drilling strategy. Presenting for EOG is the company's Chief Operating Officer, Billy Helms, who's going to elaborate on the company's key strategic steps to emerge from the downturn in a stronger position. With that, I'll turn it over to Billy to kick off the E&P presentations at our conference. Billy?

All right. Thank you, Arun, and glad to be at your first inaugural virtual meeting. Thanks to you and your team for everything you do. And also, thanks to everybody for listening in. I hope everybody is safe and doing well in wherever you are, if you're at home or at work. First of all, on the first slide, hopefully, you can see the slides as they are up. The title of this presentation is Sustainable Success. Certainly, I think EOG has demonstrated a history of being returns focused, disciplined on our investments, being able to continually get better, decentralized organization that's able to react quickly, and certainly we have done so in this pandemic. If you move to the next slide -- actually, you could skip to Slide 3. We don't need to go through all the legal clarifications. So on Slide 3, I certainly don't need to talk about the environment that we're currently in. The enormous demand destruction brought on by the pandemic and the lockdown of about 4 billion people has certainly resulted in probably the most rapid and significant demand destruction we've seen in the industry's history. And there's certainly been a response on the supply side as well. OPEC is cut, as we all know, 9.7 million barrels a day in response to the demand destruction and other non-OPEC producers, including U.S. producers, have also responded by also taking supply off the market, but also reducing CapEx. So that has kept inventories from reaching the tank tops that I think everybody was forecasting to have. And I think we're seeing the -- hopefully, we're seeing the peak inventories as we sit here today. And so we're going to be starting a rebalancing mode. And I think everybody can look forward to a more constructive time on a go-forward basis. So if you move to the next slide, Slide #4, really talked about how EOG is going to respond to this. We laid out really 7 points in our last earnings call that I wanted to walk through and remind everybody of the steps we've taken to respond to this. First of all, we do make sure that we generate returns for every dollar we spend. That's our #1 focus in the company and always has been and always will be. So any new well that we drill, any investment dollar we spend must generate at least a 30% rate of return after tax or it doesn't get spent. So that's true to our nature, and that's still going to be the case today. Number two, certainly, we're able to react quickly to the commodity price environment, and we've certainly demonstrated that. We cut our CapEx by about 45% from what we laid out at the start of the year. And we've also been working on reducing our ongoing lease operating expenses, and we feel like we've cut those about 20%. So the operational flexibility we built into our system at the start of the year, we talked about that at the start of the year, and we're certainly demonstrating that flexibility, and that really comes out, the culture of the company. The third bullet point is talking about how we've continued to innovate and get better. And that hasn't slowed down as a result. Actually, it's probably increased. It's the heightened awareness, I think, and the lack of activity lets everybody focus more and more on getting better each and every day. And that is going to be really noticed when its -- as we come out of this down cycle because we feel like a lot of these improvements we're making are going to be sustainable. So the main focus there is we're continuing to get better even in the downturn. And as everybody knows, the fourth bullet point is deferring production. We made the election to cut back on production during the lowest price point of the year, which we believe is the second quarter. We also -- so our production profile will mimic the oil price curve. And that was an intentional step. As we went into the downturn, we -- and all the uncertainty on where oil prices were going to go, we elected not to put production to sales at a time when the product price was uncertain. And so we pulled back on sales during the second quarter, and we should have momentum going into the end of the year. Then the fifth point here is, we've always had a strong balance sheet. That's our #1 goal, and we certainly want to do the things to protect the balance sheet. So our cash flow is really mimicked to be able to provide strong cash flow through the rest of the year and basically be able to cover the CapEx and the dividend, even into the low 30s. So that was part of our whole strategy of being able to pull back to make sure that we protect our balance sheet and sustain the dividend. The sixth bullet point here, we are continuing -- as we've talked about in the past, we are an organic exploration company, and we have a strong effort going on now in the exploration part of our business. And we are -- even though we pulled back on CapEx, we are continuing to invest in those projects that we feel like will have a long-term impact on the company. So that's part of our focus as well. And the seventh and probably the most important bullet point is protecting the culture of the company. We've done so by not having to change basically the way we operate the company. We're maintaining all of our active offices, all of our active employees, and we're really proud of the fact that we can get through this downturn without really changing the fundamental aspect of the company, and that's the culture. And we think that's going to make us stronger as we move forward. Let's move to the next slide, Slide #5. The Updated Game Plan. So we did the best job we could in trying to estimate the impact of the lower prices, what that was going to mean for production. And we tried to lay that out for each quarter of the rest of the year. That was maybe a value and attempt, and hopefully, we're going to be able to make all those numbers as we go through the rest of the year. But main point there is, yes, we did shut in production, but we also deferred any new wells from coming on production until we see a more sustainable outlook for commodity prices. So that's what's basically you're seeing in the production curve. And we did lay out what we think our maintenance capital would look like on a go-forward basis, assuming we end the year at kind of where we have guided. So it's really -- you can see that the production is going to mimic what we hopefully feel like is an improving commodity environment as we go into the rest of the year. Now moving into the next slide, Slide #6, talks about our premium drilling strategy. This -- all this -- the financial results and the ability to be flexible is made possible by our focus on generating solid returns. We came out a few years ago, and I'll spend a little bit of time on this, came out a few years ago talking about how we wanted to make sure we could generate at least a 30% after-tax return at $40. And we've adjusted that, as you know, to be able to do that same return even at lower commodity prices. But we feel like out of that stringent investment hurdle, and I think that's probably one of the most stringent investment hurdle rates in the industry, that allows us to really demonstrate strong financial returns. It helps us to make sure that we can keep a low net debt and pay off our debt and to keep the liquidity, and we build up cash on the balance sheet. And then it also drives a structure where we focus on cost. We've always been known for having low-cost operations, and we're accelerating that as we move through this downturn to really heighten our awareness of the cost production. And then moving to the next slide, it shows what that shift to premium has done over the last 3 years. This is a pretty good story, and I want to make sure everybody really takes note of it. It has really demonstrated strong performance since we made the shift. If you look at the period from 2017 through 2019, we generated an industry-leading 14% return on capital employed. We feel like that's among the top in the industry. We also increased our dividend 124%, generated free cash flow of $4.6 billion and reduced our net debt, so that's a combination of paying off debt and building up the cash on the balance sheet, of $4 billion and increased our proved reserves by 55%. So tremendous record for the last 3 years, and that's all since making the shift. If you move to the next slide, it really highlights the advantage of the premium drilling. It makes a comparison between a period of time before the previous downturn. So if you look at the period from 2012 through 2014, you can see a dramatic difference on the performance on the left side of the curve versus the right, where in 2012 to '14, with an average oil price of $95, we essentially outspent capital. We generated an ROCE of 10%. And as I've already mentioned, 2017 to '19, certainly, you only spent about 80% of the CapEx relative to discretionary cash flow and generated an ROCE of 14%, generated $4.6 billion of free cash flow and paid a dividend and debt reduction of $3.3 billion combined. So tremendous performance in the last 3 years really brought on by this heightened focus on rate of return, and we think that's paid off big dividends in the company. Now moving on to Slide #9. It just shows a list of our premium inventory, and you can see our premium inventory at 10,500 locations, that generates a 30% return at $40. And then we've highlighted a large number, 4,500 premium wells that earn a 30% rate of return at $30. And certainly, we have a large inventory. So the last thing we're worried about is running out of inventory. We're generating this inventory faster than we can actually drill it. In the last several years, we've generated twice the number of inventory locations that we've been able to drill. So the inventory is growing over time. And we're very confident we'll be able to continue to do that through our exploration programs that we have ongoing. So strong inventory, able to generate strong returns and certainly helps demonstrate our sustainable business. Now moving on to Slide #10. Certainly, there's been a lot of criticism in our business about company's outspending cash flow, destroying the balance sheet, increasing debt and not generating returns. Certainly, I think we've demonstrated exactly the opposite of that. As you can see on this slide, EOG is among the few companies that actually spends at the low end of the cycle. We spend about 80% of our CapEx to discretionary cash flow. And we -- and I've just demonstrated the returns we're generating and the resiliency of our business. And so I feel like, certainly, we've earned a little bit of reputation for being disciplined and focused on returns, and hopefully that comes through. Now I think as industry goes, the downturn is certainly going to heighten that awareness of being disciplined. And I think that's brought on by a focus really from the investors. So I think the industry will come out stronger at the end of this than they were before. Moving on to Slide 11, just talks about the history of our paying down our debt, increasing our dividend. And you see there a little bit more clarity on what actually has occurred. You can see we paid off about $1.9 billion of debt so far. We've got $1 billion of debt we will pay off this year. We did reissue some debt of about $1.5 billion this year to help finance both the debt repayments for this year as well as next year. So we feel like protecting the balance sheet has certainly paid off big dividends, certainly in this environment, and we're proud of the decision we made to do that. At the same time, we've certainly grown our dividend through our last -- you see a 22% CAGR on increasing the dividend since our -- beginning of our history. And really in the last 3 years, the steepness of that curve in the last 3 years, we've increased the dividend 124% as I mentioned earlier, so our commitment as to be a sustainable business is to protect our balance sheet, have a growing and sustainable dividend, and we're definitely committed to that on a go-forward basis. So the next slide really is coming up on my last slide, Arun. But certainly, I think we've demonstrated that the best way to be a sustainable business is to create value long term. And we feel like that we've demonstrated that commitment to these returns and really be disciplined on how we invest to make sure we first focus on returns. The growth is really a byproduct of the returns that we generate. We're also committed to having a strong dividend and we certainly have tested that through this downturn. So the last slide here that is -- really is the end of the slides, just thanking everybody for their attention, for their interest in EOG. And certainly, we've been through some challenging times. EOG is certainly ready for that challenge. And we're committed to getting better. And I think we have a history of demonstrating that our disciplined investment focus and focus on returns is proving us to be resilient. And we think a more stable oil price going forward should help industry be a little bit more disciplined, and it's good for everybody. EOG has always been well positioned in this, and we feel like we're going to come out much stronger as a result of our focus on returns and being disciplined. So we're excited about the future. So with that, Arun, I'll see if you have any questions.

I do, Billy. I've broken down some questions into several kind of key topics from investors. Let me start with a recent decision that EOG made. Obviously, you're well protected in terms of the downturn, in terms of having some hedges, which have provided some shock absorbers for your cash flows. But you did make a recent decision to cash in some of those hedges. I was wondering if you could go through the thought process and maybe some of the financial implications of that decision.

Sure. Yes. We're very thankful that we had hedges going into the beginning of the year. And we always look at each year and try to layer on some hedges to protect our balance sheet and our capital program. And we're also watching the market all the time. So as we saw the -- what we felt like was going to be the trough of the commodity price environment, we looked and saw that we should see a more constructive view going forward and looked at that as really an opportune time to cash in or take advantage of those hedges and maximize the income from those hedges. So that's basically what we did. And we are more constructive. We do have a more constructive outlook on the commodity environment as we go through the rest of the year. So we felt like that was really an opportune time to take the most advantage of those hedges that we had in place.

Great. The next topic I wanted to ask you about is just the reduction in activity. I think you're downshifting to about 6 rigs. And I think you're going to do around 485 net wells this year, obviously, a lot in the first quarter relative to the rest of the year total versus -- I think you came into the year forecasting around 800 net wells. So can you talk about the flexibility that EOG has had in reducing your capital and your activity? And where you're at in terms of activity today?

Sure. Yes, I think the thing that it really demonstrated through that is a tremendous amount of flexibility that we had going into the beginning of the year. I think we talked about it in our very first call in January or February, whenever it was. We talked about the flexibility we had. We didn't know that we were going to have to demonstrate that flexibility so drastically, but it was the most rapid drop in activity that we've ever experienced in the history of the company. And it demonstrates the resiliency of our staff to be able to adjust to a rapidly changing environment. So yes, we completed about 100 -- we brought online about 185 wells in the first quarter, and we spent about $1.7 billion in the first quarter. And really before the downturn began, we started delaying production from new wells, really in March or so, and elected not to bring on any new wells. And the uncertainty that we saw in the commodity price environment at that time, being focused on returns, it seemed like an easy decision to make, that you'd rather wait, leave the production in the ground for a couple of months until you start to see a more firm base on where commodity prices were going to go. And that's a pretty cheap storage, just keep it in the ground. So it was a pretty easy decision for us. And certainly, we just made the decision at the same time to start shutting in production, really just -- not necessarily because of uneconomic wells. But really just the uncertainty of where oil prices are going to go and our unwillingness to sell oil into an ever-falling commodity environment. So we pulled back on that activity. Certainly, we dropped from quite a number of rigs that we had start of the year down to, I guess, about 6 or 8. I think we're running about 7 rigs right now and 5 frac fleets. And so we expect to maintain about that level of activity through the rest of the year and start bringing on new wells. We expect to be able to bring online about 485 wells this year. So we have about 300 left that we'll bring on evenly, I would say, through the third and fourth quarter. There's really no -- as we start to see the improvements in the commodity environment, we'll continue to make that decision really on a daily basis. So that's why we gave the guidance that we did.

Got it. Got it. I did want to ask you a little bit about how you think about the economics of DUCs. That's been a frequent question about the industry is obviously going to be building up some DUCs as many producers, including yourself, have made the decision just from a pure economics standpoint, a return standpoint. It hasn't been economic to be active, completing a lot of wells. And so can you talk us about how EOG is thinking about the right kind of macro conditions to start prosecuting those DUCs? I think you guys have highlighted maybe 150 net wells that you're deferring, but just wanted to go through maybe the process as you think about completing some of those DUCs?

Sure. It is, for us, it all is a returns-based decision. And we've demonstrated that many of these wells, we have such a large number of wells that will generate a 30% return even down as low as $30. So it is returns based. And now that we're starting to see commodity prices moving closer to $40, we're certainly glad we've made that decision, first of all. And it is proving out to be, I think, a good thing for the company to be able to return to refocus on cost reduction. I'm very proud of the efforts the guys have been able to make on that. I think you will see where we get to at the end of the year, but we're making good progress on performing and getting our cost reductions down. So I think for us, it was really a returns-based decision. I think there's really nothing else to that really, it's just strictly a returns decision.

Great. Billy, the next topic, and you've kind of talked a little bit about this in your presentation, is just the shut-ins and the approach to the shut-ins. I know that you guys articulated on Slide 5 kind of the planned oil shut-ins on a quarterly basis. Prices have maybe bounced a little bit faster and higher, I guess, maybe relative to what the market was thinking when you gave your 1Q update, but has there been any changes or differences regarding the planned amount of shut-ins or maybe bringing back some of those shut-ins?

No. As I mentioned earlier, we are evaluating that almost on a daily basis. I think the way the market works, I think you have to remember -- you have to nominate the volumes a month in advance that we [indiscernible] them. So we're always trying to look forward and see where the market is going to go and try to make reasonable deals with the purchasers to be able to move those at a favorable price. I think right now, the guidance we've given you is playing out pretty well. I can't obviously give you any more updates to that, any more color to that. But I think we do monitor this very actively. And we've demonstrated a great amount of flexibility and to be able to adjust accordingly to what we see the market is telling us. But right now, I think the guidance is pretty much intact. I think we're not going to go out and start increasing CapEx or anything to kind of respond to the increased -- improving commodity price. We're pretty much committed to staying within our guidance as best we can.

Okay. Billy, another question we got regarding the shut-in of hundreds, maybe thousands of wells is just kind of the potential execution risk for industry to not only shut in the wells, but in terms of bringing them back and could there be any potential impact to production volumes as you theoretically shut in thousands of wells and then have to bring those back, do those provide any operational challenges for EOG in your mind?

That's a really great question. I appreciate that. The flexibility we have and the tools that we have really help us to be able to manage our business. Just a reminder, we've been spending the last several years building up these tools. These informational technology tools are able to gather, and so we warehoused a ton of data we gathered real-time to be able to -- and we send that down to the field level to be able to really react to that data at the small -- at the lowest levels of the organization to be able to manage our business. And we do push the decision-making down to those levels, too, so they can actually use the data to make real live decisions. That's enabled us to be able to react quickly. So we were able to shut in thousands of wells with really minimal time and effort. And we can bring those back on with really minimal time and effort, too. And we're not going to see any degradation due to productivity from the shut-ins either. So we actually have a slide in our deck, and I don't remember the number, that shows shut-in production in a couple of different areas, in different time scales that show the -- really the, from the types of reservoirs we're dealing with, these are really tight reservoirs, we actually get a little bit of flush production when we bring the wells back on. So we're not going to expect to see any damage or lack of productivity when we bring wells back on. It's quite the contrary to that.

Great. Just a couple of more questions. We do get a lot of questions on the dividend for EOG and your peers. We have seen quite a few of your peers having to cut or eliminate their dividends. You did talk quite a bit about the dividend in your presentation, but I did want to see if you could remind investors about your anticipated cash flow breakevens covering the dividend for the rest -- the balance of this year and next year and just overall thoughts on the sanctity of the dividend at EOG.

Apparently, you said it right. The sanctity of the dividend is really key for the company. We definitely want us -- we've never cut the dividend in the history of the company, first of all. We've grown it 124% in the last 3 years. And it's -- at the same time, we strengthened our balance sheet to be able to protect us from this commodity cycles that we see in our business. And that's part of the underlying strategy for the company. We believe that is the best way to grow long-term value for the business. We invest in our business at high returns. We have a strong balance sheet. We have a sustainable and growing dividend over time. And we think that's the way you generate long-term value creation in any business. But to be able to do that in a volatile commodity environment is certainly a hallmark of the company, and that's something we hope to steward to in the future. So as for our breakevens, we feel like we can maintain our dividend and CapEx at the levels we are with the cash flows even into the 30s for the rest of the year. And so we're very comfortable with where we stand today and being able to maintain the dividend. And hopefully, we'll see what the dividend looks like as we go forward into next year.

Great. Billy, my final question is, you guys, in your Slide 5, articulated, call it -- ending the fourth quarter call it at a -- using midpoint of the range at 420,000 barrels a day of oil. Could you talk about your sustaining CapEx requirements to keep that production flat? And does that contemplate any DUC drawdowns or just your kind of definition of sustaining CapEx for '21?

Basically, we're trying to keep the volumes flat at that level, 420,000 barrels a day for the next 4 quarters. And that came out to be about $3.4 million, and we feel like that, that balances with the dividend and CapEx at around $40 or so. So we feel like that's a very sustainable number. And we're very confident in our ability to be able to execute that plan. And that really -- the other thing to note about that CapEx level is that doesn't bake in the anticipated cost savings that we expect to see this year. So I think we're very comfortable being able to use that as sustainable capital level going forward say we exit at 420,000 barrels a day.

Billy. We're out of time. On behalf of the JPMorgan team, we want to thank you for participating in our first virtual meeting. And we also want to thank the management team at EOG for being a strong supporter of JPMorgan in many of our events. And again, thank you from my team and the rest of the JPMorgan Energy team for participating today. Thanks again.

Thank you, Arun, and thanks to all investors for your efforts to try to -- in your interest in EOG. Everybody stay safe.

Yes.