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

Well, good morning, everyone, and welcome to our first company session of our 2020 conference. Again, we hope everyone is doing well out there, and we can't tell you how sad we are that we're not welcoming you to Miami, but hopefully, we'll be back there next year. We have EOG kicking off our first fireside session today, and I'm delighted to welcome Ezra Yacob, who is no stranger to many of you, and of course, is Executive Vice President of Exploration and Production. And on the line also is David Streit from the Investor Relations team. So gentlemen, thank you so much for making the time for us again this year. And hopefully, you guys are all doing well out there. What I'd like to do to -- and I apologize if we have a delay on the line. Just a few housekeeping remarks for everyone. If you have any questions later on in the call, we'll have a chance for Q&A. [Operator Instructions] I'm going to ask Ezra just to make a few opening remarks on to how he sees the lay of the land in light of recent events, and then we're going to go through our prepared Q&A with myself, and we'll get to some of the line questions later on. We expect this session to go no more than about 45 minutes. So Ezra, take it away.

Sure. I appreciate that, Doug. And we appreciate Bank of America hosting the conference here and working through this virtually. I think it should be a good few days. And so I'd kick it off, we had our earnings call just last week, and I think there were 3 real highlights that we discussed on the call. And I'd like to run through those really quickly before we jump into the Q&A. The first one to start with is really our continued operational results from 2020. We feel it's a real testament to the focus and -- of our employees and what they have gone through in 2020 and the results that they have been able to generate. This last quarter, we've been able to generate $760 million of free cash flow. Our crude oil production finished up about 2% above our target with an impressive CapEx being -- coming in 23% below our target. Our cash operating costs were 13% below the target there, and we've already, to date, achieved our 2020 well cost production of 12%. And again, that's really from the ground up, our employees out there in the offices and in the fields really working and staying focused on their daily execution. So the results from this year, in light of everything that 2020 has had to offer, have just been very impressive for EOG, and we're very proud of those results to date. The second thing that we highlighted on the call was an update to our Austin Chalk exploration efforts. And that's resulted in the announcement of a dry gas play in South Texas that we're naming, we've called Dorado. The Dorado dry gas play added to our EOG premium inventory, about 1,250 net wells in both the Austin Chalk and underlying the Austin Chalk there in the Eagle Ford. It's a massive resource. We think we've been able to capture over 20 Tcf net natural gas potential for EOG. And the great thing about this prospect is the location of it. Not only do we have great rock quality there in the Austin Chalk but being in South Texas, along the Gulf Coast, we feel very advantaged to both differentials and the optionality that we have for marketing. And then the last thing, I'm sure something will touch on here in the Q&A, Doug, is we provided a little more of a framework, a little more transparency to our thinking with regards to a 3-year outlook. The outlook is really built around the 70% to 80% reinvestment rate. That's based on a $50 WTI oil price and that yields for us an 8% to 10% oil growth. The plan is really built around disciplined reinvestment to grow free cash flow, and we think that's the best way to maximize shareholder value. It's been a very consistent EOG strategy for the last few years, and it's one that we look forward to carrying on in the coming years. And really, those are the 3 highlights from the earnings call, Doug. And I think with that, we could probably open it up and dive right into the Q&As.

Well, yes, I'm grateful for that. Thank you, Ezra. And of course, the kickoff here is that framework. So let me start there because, to me, there is nobody more pleased to hear EOG as one of the biggest independents, lay out some framework as to how the market can think about that reinvestment rate. So can you walk us through how you're thinking as a company has evolved? And what I'm really referring to is, if you go back 10 years, we all know that the macro, unfortunately, is something we all have to live with. It's a necessary starting point, as I like to say, but none of us really have any insights to how it's going to play out. But when you look at the growth in U.S. shale production in the 3 years prior to the pandemic, they outgrew global demand growth and that clearly was a situation we think was unsustainable. So the responsibility of management to provide a framework has really been articulated, I think, better than anybody by EOG in this last couple of months. So talk to us about how that thinking evolved? And what would it take to define an oversupplied market? When do you define that the market is no longer oversupplied, if you like?

Yes. That's great, Doug. I think really the -- as you said, over the past 10 years, the fundamentals of the company haven't really changed. Our capital allocation strategies haven't changed. It's still built upon disciplined growth, reinvestment and disciplined growth where you're generating high returns to allow a pace where each of the assets that we're investing in can continue to get better, thereby lowering the cost basis of the company. I think as you touched on what has evolved for us, I think, is how we view the oil price with regards to the global supply and demand balances. And what I mean is not just looking straight at supply and demand numbers, but the inventories, the rate of growth, the rate of investment from various geographic regions, geopolitical interruptions. And as you mentioned, what is -- how many barrels are being held off the markets for various reasons? What is OPEC’s response? What is -- what are they doing to cure kind of an oversupplied market? And so when we look forward into that, taking all those factors into consideration, one of the things that I think our evolution of thought on supply and demand has been is -- is OPEC necessary -- are they needing to consistently pull barrels off of the market? And if they are needing to do that, then I think what you're saying is phrased very well, that doesn't seem to set up a sustainable go-forward pricing environment. And so it's a balancing act. There should be a natural tendency for more expensive barrels to be displaced by lower cost barrels as technology advances. I think we can all agree with that. But that's not really what we're talking about. If we see barrels consistently being removed from the supply side, just to help with inventories and things of that nature, then that's not an environment that we want to grow into.

I realize it's a tricky one, and you probably -- I'm sure you all rolled your eyes when I asked the question to Bill on the call. But the way I phrased it to him was, let's say -- we actually just came off a geopolitical panel with one of the members of the GMMC, which was pretty insightful. And the takeaway there was that the Saudi-Russia agreement is probably going to continue to see intervention through 2021, which I think is probably welcomed by most commentators. But the scenario I put out for Bill was, let's assume oil is back at, let's say, $50 WTI. But it's only there because OPEC is still holding back production. Is that a scenario where EOG resumes up to 10% growth that you talked about in the call?

Yes. So I think there are -- like you said, there are a couple of other factors to look into. It definitely depends on how much OPEC is pulling off. It depends on where the inventories are at. But if we're under the environment that we are today, then no, that's not -- if OPEC has 7 million barrels off-line and the inventories are overbalanced, then no, that's clearly not -- even though oil price seems like it's got a little bit of a momentum behind it this morning, that's not going to set up to be an environment that's sustainable and one that we want to grow into. We're looking for a clearly balanced supply and demand market where we can feel confident that the price will -- the price that's being reflected will be with us for a little while.

I guess I don't know if you paid much attention to this. I'm sure some of the folks that focus more on the oil price maybe did. But it was remarkable to us that in April, Saudi basically tripled the exports to the United States and the increased production at the trough of our pandemic and the majority of that oil turned up in U.S. inventories. I'm just wondering if you guys think about what that means for Saudi signaling to the pace of shale growth? Do you have any thoughts on that?

Well, I think the signal there is that, as you've said, they were in a position where they felt like they were continually taking barrels off of the market, low-cost barrels and were feeling that they were, in a way, subsidizing some of the U.S. shale investment. And I think it's clear that they are not willing to do that anymore, and I think that's the right way to think about it. Again, for global supply and demand balances to really work out, I think there should be a natural, like I said, a natural evolution where your higher cost barrels are displaced. But if at any time, you're arbitrarily removing low-cost barrels from the mix, that's not a sustainable outcome and that will eventually show up in your inventories, and it will eventually show up into a scenario where OPEC or other countries, for that regard, NOCs will be forced to make some hard decisions. And so again, I think those are the types of variables that we're looking at, and that's kind of more than just the supply and demand balances and the short-term oil price, kind of looking at all of those variable macro signals to try and figure out what is the market really telling us with regards to needing our oil or not? And I think with that framework that you see that we've laid out over the next 3 years, it's a good indication of where we think -- how long it's going to take to kind of get the supply and demand back into balance.

When you figure out maybe you could let us know.

Yes. Sure.

But my last question, I'm not going to beat this horse to death too much more, but I do have one last question on this because you did mention the 7 million-barrel number, but the Saudi-Russia started taking those low-cost barrels off the market in September 2017. And it was obviously -- it was -- that we didn't have the inventory overhang there. So I guess just to kind of close out this part of the discussion, if we did still have a situation where inventories had normalized, but Saudi-Russia was still doing what they did between September 2017 and the end of 2019, which was more of a sort of 2-plus million barrel a day off the market, how does EOG respond in that scenario?

Yes. I think then -- I think that's getting really close to a tipping point, and there are some of these other factors that we talked about. You need to look at the rate of investment across some of the other areas for that. What is the U.S. shale growth rate? What is the industry here domestically doing? Are we blowing and going? And are people outspending cash flow? Are they reinvesting in projects that are not creating returns in that scenario? What you're describing now from '17 until -- hopefully, where we're going in the future, we do think that over this last year, there has been a structural shift to U.S. shale. And that the growth model is not a model that a lot of companies can fall back on. I think there are only going to be a few companies, ourselves being one of them, that has the depth and quality of inventory to actually be able to provide low-cost barrels and high returns to deliver shareholder value. And so it's a little bit difficult trying to take the framework of '17 and put it to where we are now just because of that structural shift. So I think that's the way to really view how it's going to come in the future is, in combination with inventories, the geopolitical interruptions, what OPEC is doing with their barrels, but also the rate of investment and the quality investment that's coming on U.S. but also around the globe.

Okay. I think we've beaten up on the oil price long enough. So let me turn to more EOG-specific issues. So at the trough of the pandemic, you've high-graded your capital allocation. I think you talked about returns, competitive returns, premier locations at a $30 oil price. The possibility to get back to $50 at some point, how would that change then the way that you allocate capital? I guess what I'm asking is, obviously, you were targeting only projects that would generate that type of return at a very low oil price. Do you start diversifying the portfolio again? Or do you chew through, if you like, the highest quality assets first, even in a higher oil price environment? So how does capital allocation adjust?

Yes. So I think we're always focused on managing the portfolio and high-grading our drilling inventory. And I think finding the right balance of capital allocation across our entire portfolio is a key characteristic of what we call disciplined growth or disciplined approach to investing. I think the big takeaway from this year is just how strong, as you said, the upper end of our premium inventory can be, and that's -- really that's what helps focus our exploration effort. As we're exploring for new plays, we're not only looking for plays that can add to the back end of the inventory or add inventory depth at 30% premium rate of return, but we're really looking for things that are above the median rate of return, which is a 60% direct after tax rate of return at our premium price deck of $40 oil and $2.50 natural gas. So when we think about ramping back up and reallocating the capital, I think it does remain focused on the upper end. We definitely want to -- the advantage of being in multiple basins allows you to diversify your capital and allocate your capital in such a way that you're not going to run into any issues, you won't be hamstrung by any issues that happen to creep up or get created in a single basin. And so from that regard, there will be a little bit of diversification. And then, of course, we want to diversify so that we can continue to improve in each of those assets, not only on the well productivity side through data collection and technology advancements but also through just the simple addition of in-basin infrastructure, gas gathering and things of that nature that also help drive down the cash operating costs and eventually flow through to some of those rate of return increases. So it's really an eye of disciplined growth into each of the assets at a pace where they can all continue to get better and continue to lower the operating cost of the company.

Okay. That makes sense. And I think you've got that luxury of being able to diversify across the portfolio, to your point. And that leaves me really perhaps a good segue to the Dorado play, if that's a right pronunciation. You guys, some time ago, I guess, about 10 years ago, you pivoted away from gas. And clearly, it was the right thing to do and exploration led you towards a very significant oil portfolio. Now we're talking about gas again. What's behind that? And should we expect that to be a bigger part of the EOG story going forward given the perhaps slightly more constructive outlook for gas at this point?

Yes, that's a good question. The Dorado announcement, like I said, it's a major resource. But I'm not -- I don't know if I would go so far as to say -- as to characterize it as a pivot back to gas. The way we think about it, first and foremost, is the gas or oil projects, they need to compete on a returns basis on that premium deck, which is, again, it's $40 oil and $2.50 natural gas for the life of the well. So looking at it from a returns perspective, we end up being somewhat agnostic when thinking about the specific hydrocarbon phase, as long as the projects can meet that hurdle rate. Now that being said, at this time, as you just reiterated, we're seeing some long-term growth in demand for gas, both domestically and in export markets because we do feel that as a fuel, it will play a significant role in supplying lower emissions energy. And what Dorado has really done for us is it's given us a robust option on gas development. It's very high-quality reservoir. As I started off the conversation with, it is along the Gulf Coast. So it's in a great location, and it adds diversity and flexibility for our capital allocation. The great thing about this prospect is, in 2019, we drilled some 15 wells in the play. And in 2020, we had the flexibility to go ahead and pull back as prices softened up and we reduced the budget on it. And so it's always been, I think, consistent with our core strategy to have multiple basins, as we just talked about, working to provide operationality and flexibility, and Dorado is really just an extension of that. And so we couldn't be happier to have this gas resource that we can go to when we feel it's opportunistic for us.

So Ezra, your -- obviously, your primary responsibility is exploration, I guess. So can you just explain how the process works internally? I think the way Bill described it was this was a bottom-up idea that was developed in the field. So how would you characterize the current exploration activity, whether it be gas-focused or oil-focused or just returns-focused?

Yes, sure. I'll give a little bit of color on -- pardon me, the background of Dorado, and then I think that will set up the framework for the current exploration activity. But Dorado was an outgrowth of our Austin Chalk specific exploration efforts. And we had, I think, as everyone knows, we've drilled close to 100 wells in the Austin Chalk overlying our Eagle Ford oil position. And what that allowed us to do was really collect data, log and core data and quantify where the best targets are within that Austin Chalk section as far as landing or horizontal and the part of the reservoir that will really react very favorably to our horizontal completions technology. Using that data is what really kicked off our rather widespread Austin chalk exploration effort. So when you think about core data, log data, combining your completions data, that is very, very bottoms up. That's from our front-line employees, collecting the data and building their models and that's really how it started, and that's really what drives the exploration effort. And that's really what highlighted Dorado as being the highest quality Austin Chalk rock. And then it, of course, is in South Texas, in the gas window, and that's how that project came together. Fast forward that to our current exploration effort and the same thing has gone on. The teams and the divisions have been recognizing the performance of some of these hybrid targets that we have. It's something I talked about on the earnings call. These hybrid targets are a higher rock quality than the traditional unconventional shale targets, maybe a step towards unconventional porosity and permeability. And trying to figure out and determine the best landing zones in these hybrid technologies, similar to the Austin Chalk, that will really respond favorably to completions technology is what we're seeing as significant upside. And we're developing those, some of those in the Permian, some of them in the Powder River Basin. And we've taken that data and the teams have really spread that out across the North American continent to try and identify other bypassed hybrid systems. These are usually targets that are too tight for vertical development, and so they have been characterized as kind of a bypassed pay, but it looks like these targets have the potential to come back and be exploited horizontally. And the effort is basically ongoing right now in each of our divisions. There's a lot of cross-divisional collaboration, especially on the petrophysical side where we determine our log models to really get these targets mapped. And we're feeling very optimistic on the progress of that exploration effort. It is dominantly oil-focused, I'd say, and domestically focused, even though we have announced Trinidad and this Dorado gas play as of recent.

Maybe just a couple of follow-up questions on this, maybe out of order slightly, but to what extent -- I mean, the Eagle Ford is notorious for having overbuilt infrastructure. To what extent has that been a factor in helping the economics, the relative economics, of Dorado, if at all?

Well, there is a lot of takeaway in the area for Dorado. I don't know if I'd characterize it as being part of the Eagle Ford. It's really from historic gas fields in the area, some shallower conventional sand fields that are located down there. The area is really pretty separated from our Eagle Ford oil development acreage. It's acreage that we've really leased and picked up in the last couple of years. And so it wasn't contemplated originally as part of our Eagle Ford build-out in the infrastructure. And then as far as third-party gathering in the area or something more on the broad scope of that, like I said, a lot of that has to do with the pre-existing shallower conventional gas fields in the area, but that is helping to drive down the cost of our transportation. And then just the geographic proximity to the Gulf Coast is what helps the transportation stay low. And then, of course, our differentials are squeezed pretty low also, and that's a very advantageous thing to the Dorado play. And then lastly, the firming up of the gas price. I think calendar '21 is looking at maybe $2.90 right now, cal '22 is probably $2.75 or something like that this morning. And so when you apply that to the metrics that we're seeing at Dorado, you're talking about a 75% to maybe 100% rate of return. And those -- at the rates that the Austin Chalk have, the upfront well costs and those types of prices, those wells have the ability to really pay out in roughly 12 to 18 months. So we're -- as I said, we're very, very excited about it. And you’ve hit the nail on the head, it's a combination of rock quality and geography.

That's good to know. And I guess, just to be clear, those returns are fully loaded for infrastructure cost or any incremental infrastructure costs?

No, no. Those are actually direct after tax rate of return. So those are just going to be direct to get the well flowing, so well site facilities, drilling and completions. As you know, we've made that premium direct after tax rate of return hurdle rate at 30% because we feel, historically, when you fully burden it with land, infrastructure, seismic, G&G, whatnot, that will usually drive that down to about a 15% all-in. So when you're talking about 75% to 100%, I'm not sure if I could do the linear math on there, but still very favorable.

But you've got plenty of fat in there, for sure. Well, I can't leave exploration without touching just quickly on Oman. And I realize it's relatively early. I think you saw Tethys come out yesterday with another press release that you had farmed in there. Why did Oman make the cut? And what should we think about the role of international exploration in the portfolio?

Yes. We -- so that's great. There was another press release out yesterday. So we've -- and we've talked about it. I think the first press release was there in mid-September that we'd made a country entry in Oman. Our position is in the Rub' al Khali basin, which is a known hydrocarbon bearing basin across the Arabian shield. And the thing about Oman is they have a very stable history and have historically had oil and gas operations. It's a big part of their country. There are a number of ongoing oil and gas operations, both conventional vertical and unconventional horizontal in country right now. So that gives us pretty good confidence that we'll be able to get access to low-cost services, the technology that's needed to make these unconventional plays work. And we've spent a lot of time, over the years, looking for international opportunities. As everyone may or may not recall, I guess, we've made an entry into Argentina into the Vaca Muerta at one point. We've been in China now for a number of years, where we're developing a horizontal tight gas sand play. And then, of course, we have our Trinidad business, which is a bit more of a legacy business on the conventional side. But what we look for typically is a partnership where geopolitically, things will be stable, and we can have confidence in that and then access to services and personnel to make these plays work. And then, of course, we need terms that are favorable for both parties so that everyone can feel very comfortable about the benefits that can come. And I think NOCs and countries, in general, have been more favorable to realizing that the terms maybe historically set up for conventional prospects need to be tweaked a little bit for the ability to make these unconventional plays work. And that's what we found in Oman. It's just, so far, a great partnership. And we couldn't be more excited about the upside potential in the country.

So this is an unconventional play then? It's not conventional?

Yes, the -- our focus here is on developing an unconventional play in that Rub' al Khali basin.

Okay. Sorry to beat on this a little bit. But just to be clear, Tethys already has some production in that area. Do you -- does your farm-in agreement give you a share of that production?

No. No, it doesn't. It's a -- the Tethys' agreement contemplates a farming in operatorship of their acreage position with a focus on the unconventional assets or the unconventional potential.