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

Good morning, and welcome to the second day of Bernstein's Operational Decisions Conference. I am Bob Brackett, a North American oil and gas E&P analyst, and I will be joined and in fact joined right now by Billy Helms, the Chief Operating Officer of EOG Resources. The structure of this fireside chat will be as follows. I'll get out of the way in about 30 seconds. Billy will present some slides and talk for perhaps 5 to 10 minutes, and then we're going to adjourn for a fireside chat format. This is ultimately your conversation. And so I encourage you to use the PigeonHole app you see on your left to ask questions. Those questions will cascade up to me, and then I'll address them right to Billy. So again, this is your conversation, encourage you to do that. As we wait for questions to come in, I will start the conversation following a pyramid principle. Start at the high level, talk about some of the macro issues going on in the market today, talk about the industry and the outlook for this industry and then dive down into EOG specifically and then even at the greatest detail some of their strategies and some of their assets. With that, I will turn control over to Billy. Thank him for being here, and we should see some slides in one second.

Okay. Thanks, Bob. Thank you for all the -- for inviting EOG to participate in the conference. And also thank you for all the great work you do for the industry and for helping us to get our message out. So thank you for that. So yes, I would like to share some slides with you for a second. Hopefully, everybody can see those. So title of our discussion this morning is a sustainable success. And certainly, I think we've come through one of the most volatile years in our industry. And certainly, we've seen the benefits of having a sustainable company, and we certainly place ourselves among those. So moving on. We'll quickly go through the number of factors. So let's just go to the next slide, here it's on this way. There we go. Okay. So real quickly, we want to talk about several things. What we consider to be sustainable we look at value creation through industry cycles is really a way to maximize the total long-term shareholder value. We do that through a number of different factors. First, we are focused on rate of return and invest for every dollar we invest, that's to generate a return. We focus on disciplined growth, and I'll talk more about how we made disciplined growth in just a second. Certainly, we want to generate a significant amount of free cash flow and be a sustainability leader as well. So those are the 4 foundational things we think about as far as running the company. In the end -- okay, here. Next, I just want to spend a few minutes, and I'll address the topics in these 3 ways or the discussion in these 3 ways. I'm going to quickly go through our third quarter results, we generated about $760 million of free cash flow. And certainly had great volume above our target. More importantly, we lowered a lot of our costs, both our loan cost and our cash cost. Then we -- I want to spend a little bit of time talking about Dorado, our new dry gas play, this an effort coming out of our exploration focus, part of the culture of the company. And then I'll finish that by talking a little bit about our outlook for the next 3 years, how EOG is currently thinking about the market. So just to talk about the last quarter, I'm going to start by talking about the EOG culture and what drives our success. We look at -- we embrace change. We're looking to drive change to continue to get better at what we do through every part of our business. We started with a very decentralized organization. It's bottom-up driven, where the ideas are generated from the lowest level and come up through the company. And then we share those learnings throughout the company through open communication and all of the technology we bring to the table. And then certainly, focus on having cost reductions through the cycles to help our business be sustainable. In that sense, about 75% of the reduction in costs that we've seen so far this year we believe is sustainable on a go-forward basis. The chart on the right, simply is an example of that. In Eagle Ford, we've been active in that play for a decade now. And you can see over time, the well cost continues to come down. We took those learnings applied them to Delaware Basin. And you can see those costs came down much more rapidly than they did in Eagle Ford and we took advantage of those cost savings and ideas to the more recent Powder River Basin, they're shown Blue. And you can see how rapidly we've been able to accelerate the cost reductions there. So that's in keeping with how we transfer cost savings across the company. It also plays out through our cash operating costs, as you can see on this slide, since we've shifted this premium strategy, you see our cost reductions have continued to come down over time. And then I mentioned the Eagle Ford is an example of how we've been able to lower costs for over 10 years in this play, and we continue to do so. So even though the play has been active for a long time, we're still finding ways to continue to reduce our cost and I might note that this is through both up cycles and down cycles in the industry. So it's not conditional on service cost reductions. It's a sustainable effort to continue to drive cost down. So as we continue to lower our well cost at each play and focus on improving the quality of the inventory, really to drive down our mining cost every year. And as we lower the mining cost, as shown here on the left, it impacts the right side of the curve, which has translated into a lower and lower DD&A rate over time. And that helps drive cash flow growth and earnings growth over time. So that's a large part of why we focus so much on cost. So I want to shift now to talk a little bit about Dorado. It's our result of our new exploration effort we have ongoing in the company. This happens to be a play. We've been active in it some time. It started out with our focus on the Austin Chalk play in the Eagle Ford. As you remember, we build a large number of really significant producers in the Eagle Ford play. And then we chased the expansion of the Austin Chalk play across the Gulf Coast, both south and north throughout the play. And we in that process of focusing on the Austin Chalk play, we landed in this sub-basin here, we call it the Dorado sub-basin, where we captured about 21 Tcf of net gas resource potential to the company. The important thing about that is it also happens to be located in an area where the market is expanding through all the petrochemical industries that are expanding in the Gulf Coast as well as LNG export opportunities. And so it's geographically located in a growing area of market growth, and it is a low-cost, low emissions play that's readily accessible to that market growth. So that's -- that ends up rolling into the inventory. So now we've expanded our premium inventory to 11,500 locations. Just to remind people the premium inventory to be able to make it into this list has to be able to generate at least a 30% direct after tax rate of return at $40 flat oil price or $2.50 flat gas price. So it doesn't include any inflation in oil price or anything like that, it's just a flat oil price. And then you can see on the graph, this green box, that's a subset of that inventory that generates at least a 30% after tax rate of return at a $30 oil price staying $2.50 gas. So the quality of the inventory is really, really strong. We always try to improve through our exploration effort, we're trying to improve the upper end of this inventory. We obviously don't need more inventory. We need higher quality inventory. So that's the effort of the exploration focus, and that's where Dorado fits in this plot. So now just to move on a little bit about the outlook for '21 and '22 and '23. In 2021, we're expected to just maintain production that are what we think will be our fourth quarter exit rate of around 440,000 barrels a day. Obviously, in 2020, you can see our volumes dropped. We made the decision in the volatile oil market that we saw emerging in the second quarter, just shutting quite a bit of production and not bring on new wells that have been completed until we saw the prices improve. So if you're familiar with the company, our second quarter volumes were at their low point and we brought back on essentially all the shut-in volumes, and now we're starting to bring on some existing wells that are newly completed wells, and we expect to exit the fourth quarter of about 440,000 barrels a day. So going into '21, our view of the macro situation is we'll still largely be in an oversupplied market next year. So we don't anticipate growing volumes next year until we see the market conditions improve. So moving into '22 and '23, assuming we're now into an area where inventories have been pulled down and the market is no longer oversupplied, we see an opportunity to maybe grow again. And we'll stick with our reinvestment ratio of about 70% to 80%. And with that investment at $50 oil price, we should be able to grow oil production at about 8% to 10%. Now BOE growth would be about 10% to 12%. So that is really a balance between looking at our current free cash flow and thinking about what the future free cash flow could be. It's really magnified -- magnifies the efforts of our cost reduction. So you can reduce your costs and lower your breakeven costs and at the same time, grow production, it magnifies the effect of both those things to generate significant amount of free cash flow and earnings potential on a go-forward basis. So that's what our overall strategy is. So all that's really driven by the culture of the company. As I mentioned earlier, we're a decentralized organization, where every employee is working to try to improve the company on every day and focus on rate of return and working in multidisciplinary teams. And those ideas that are generated from that effort is what helps EOG emerge better through our downturn. So with that, Bob, I thought I just go straight into Q&A.

Fantastic. Thank you for that. And an easy place to start would be just on that macro. And again, I remind investors, your conversation use the Pigeonhole app. On the macro, you said you don't expect fundamentals to improve into 2021. Maybe just a quick thought on that. We don't need to dwell a ton of time on the macro.

Yes. So I've seen a largely resolve the effects of this lack of demand caused by the drivers and then compounded by the decision by OPEC and Russia and others to flood the market with oil. And the result was certainly the -- what we saw in the second quarter with extremely low oil prices, and we're still continuing to suffer from the buildup of inventory through that. So as we think about a balanced market, I think we'd like to think about it is when OPEC is no longer threatened by non-OPEC growth, and we see the market come into balance, and we expect that to be probably sometime, maybe later next year, second half of next year. So we see most of the first part and going into the second half of next year, probably be an oversupplied market. And once we see that signal, that OPEC is no longer threatened non-OPEC growth, there should be room for some growth from the low cost producers. And certainly, we would feel like that mean that we can start accelerating some of our new plays.

And some folks have asked me about the fact that gas is going to grow faster than oil in the EOG portfolio and that you got the Powder River Basin and Dorado in a sense a little more visible. If you go back sort of pre 2009, you could argue, EOG was in love with natural gas. It traded at a huge premium. You had a bunch of it. It was easy to access. You fell out of love with natural gas around them, fell in love with oil. Are you ambivalent? Are you emotionally neutral at this point? Or should we read anything into that shift?

No it's -- you're exactly right. What we're in love with is generating returns. And so we can do that through investing in oil properties or gas properties, that's what we'll do. So the gas property in Dorado just gives us a lot more optionality to think about how to do that. We also manage our portfolio. We divested of our assets in the Marcellus. And shifted our focus towards Dorado, which is close to the market growth that we see in the U.S. and that was really a strategic decision to do that. And so it just gives us optionality to focus on gas, we're going to see the opportunity to generate the returns that we do.

And if we think about capital allocation, we are a depletions business every day, we're producing oil that we have to replace. And if you go back to the late 90s, the industry had sort of more cash than opportunities, and we saw consolidation and we saw M&A and whatnot. And then shale came around, and suddenly, we had more opportunities than we had cash, but also had a lot of cash and access to cash. The -- in a sense, the premium concept, if you go back to the old way you can allocate capital across an annual plan, you'd say, let me rack and stack all my opportunities, and I'm just going to keep drilling them out until I get to my corporate hurdle rate, then I'm going to stop and growth is an outcome. And effectively, with the premium philosophy, you've said, well, that's probably too much. I'm going to pull that back until that individual well or asset earns a superior cost of capital. So by the time I cascade it to the corporate level, it's beating my hurdle rate. So that was a filter you all put on that created a sense of discipline. Now talk about that in the context of the '22 and '23 plans, what is the governor on that 70% to 80%. Is that written in stone the way premium is? Just kind of talk to that.

Okay. Sure. So yes, I think what I would add to that, so the premium defines the quality of the inventory that we're going to choose to invest in. So it has to generate those returns at low prices where it won't get funded. And obviously, we have a lot of that. So we don't need more. We need better. So stuff that will compete with the top end of our inventories is what we're after. In regard to the 70% to 80%, that's what we've kind of been doing the last 3 years because we recognized that there's a very -- there's a need for a strong balance sheet. And certainly, we've tested that this year and certainly benefited from the fact that we've shifted to that strategy 3 years ago. And so as we look forward, I'd say, it's finding the right balance. We want to make sure that we invest in that 70% to 80% to protect the balance sheet with a forward look at, okay, when is our debt repayment schedule, what's it looks like. What's the dividend look like? And what might opportunities might we have to increase the dividend on a go-forward basis and give some of that cash back to shareholders. And then we also take a look at what the future free cash flow could look like if we continue to lower our cost, our unit cost and then we grow on top of that and really magnify the benefit of the free cash flow generation potential of higher volumes and lower cost and what does that look like? So we're trying to balance the current free cash flow potential of the company with the future free cash flow potential of the company for the longer term. So that's kind of our framework, the 78%, fast with an 8% to 10% of oil growth number. We think that's a happy balance that fits our portfolio, the quality of our portfolio and our capital efficiency we're able to achieve.

And then that's sort of '22 and '23. 2021, $3.4 billion in maintenance CapEx, which is basically flattish with where we're exiting now gets you to flattish production. Can you talk about how that breaks down across the budget? And maybe what basins are going to grow and what basins are going to shrink in this environment?

Sure. First of all, the $3.4 billion maintenance capital. It is a bare balance maintenance capital plan. So there's no investing with -- in exploration in that plan. There's no investing in ESG improvement projects in that plan. So it truly is maintenance capital level. So we would be mainly focused on our more active plays. Obviously, the Delaware Basin in the Eagle Ford and some in the Rockies, mainly in the Powder River Basin. in those areas. And so as we see oil prices develop here towards the end of the year and what level we're at, we may choose to spend a little bit more money to fund projects that ultimately would improve the go-forward look of the company. So if it's bolting on some exploration, acreage in some of these new plays, we're looking at the opportunities to continue into that effort or maybe help lower emissions in some of the new ESG-related projects, we have initiatives we have in the company. So we'll be looking at those kind of opportunities, but it all depends on what our outlook is for commodity prices going into next year.

When I think about the 2020 plan, 95% of it was conventional, right? It's drilling facilities, gathering and whatnot. So maybe there's another 5% or 10% that could come in or out on the ESG exploration opportunistic side?

Right. No, that's probably right. And just a reminder, too, on the 2020, for example, is an illustration that we're not focused on volumes as a company. We're not focused on growth. We did elected to actually pull back volumes and preserve our balance sheet. So that's ultimately the driver of the company is a strong, healthy balance sheet in generating returns. Every dollar we're investing in still today is generating healthy returns.

And we're going to get -- so I've been answered a couple of those questions. And I'm -- we'll kind of transition to Dorado just because it's interesting, and I want to use it almost to investigate sort of how you all allocate capital and how that culture is driven. Somebody at EOG decided it would be a good idea to go chase dry gas down dip in the southern extension of the Eagle Ford. Where did that idea come from? And how did it move from that idea to AFE for the first well? And how are you involved versus how was that district office involved?

Okay. That's a good question. So, yes. So all these ideas are generated from the bottom up. So that particular division that works on that area, generated the idea. But it was driven really out of a combination of things. So we have a very multi-disciplinary environment, and we're focused on a decentralized organization, but there's a lot of collaboration between disciplines. There's a lot of collaboration between different operating divisions. So it's -- the same is true on operational side. The same is true on the exploration side. So as we continue -- so it's really not driven out of Eagle Ford driven into the gas window. Certainly, we understand that play. But it's really driven out of our exploration focus on the Austin Chalk. Several years ago in the Eagle Ford play, we drilled this, if you might remember, several just outstanding Austin Chalk oil wells in the Eagle Ford acreage, already under lease. So we wanted to explore, okay, where else can we chase the Austin Chalk play, east, west, north, south across the states, across the whole basin. And that effort pointed us back to this Dorado sub-basin. And in that sense, we saw through the efforts of drilling the for the Austin Chalk and the Eagle Ford play. We understand how to identify the rock that needs to be targeted to make the Austin Chalk successful. We found that same characteristic in this Dorado play, and it happens to be gas. And just so happens, yes, it has the Eagle Ford underneath it. But what's primarily driving the initial development will be Austin Chalk. And so that was really born out of our exploration focus. Our collaboration between the different disciplines, but also across the off -- the different offices we have in the company. The only thing we do here at headquarters is help allocate how we spend that money between the different assets we have. And also, we encourage the exploration environment across the company, to protect the culture. So we encourage that innovation throughout the company in every level, including exploration level. So -- but the ideas are generated from the division offices.

So you've now chased the Austin Chalk. Well, certainly, in the Karnes Trough, it's phenomenal, and it works in some of the best wells. You've chased it all the way basically to the border with Mexico at this point. I suspect you're not going to cross the border to continue to chase it.

No, we're not going to cross the border.

And you've chased it as far into Louisiana and East. Why did the Austin Chalk not work over there? And what was the process by which you tried something and basically moved on to something else?

Yes. It's a constant ranking of projects across the company, and we obviously try lots of things. As an exploration at heart, we like to try lots of different ideas. And we'll evaluate a lot of different things. Basically, it comes down to your understanding of the rock mechanist, the depositional settings in the cost environment as well as where it sits in relation to the market center. So it's a combination of all those factors that lead us into these opportunities. Having said that, that's exactly what we're chasing in all of our other exploration efforts throughout the company. I think our exploration focus in the company has probably never been more robust than it is today. And that we have every 1 of our 8 different divisions focused on some exploration throughout the company.

How do you -- so I remember decades ago, I was on a breakthrough technology team. We failed, and we celebrated the failure with end of project party. And management was very deliberate about that, which is to say failure is part of the game if you're doing tech, if you're doing exploration. How do you guys incentivize failure?

That's a really good question. So first of all, we strive to always improve. The innovation, the continuous improvement culture is what permeates through EOG, and in doing so, you have to encourage experimentation, almost as an expectation. We never want to sit still. It's always, okay, what can we do to improve what we just did yesterday? Can we -- if we're drilling a well, can we find another bid design or some new tool to drill a well faster or if it's a completion design, can we find a better way to improve the productivity of a well or, again, lower the cost from making better efficient and completion designs. And the same is true in exploration. We're going to try some things and they may not work. And in doing so we're trying all those different things. We expect people to learn from it, to create new ideas about maybe to the next experiment we might try. So it's never discouraged. The experimentation is almost expected in the company and encouraged. We like new ideas and innovations and challenge the way that things are always done. We don't want to do things just because that's the way they've always been done. That's one thing we hate in this company is somebody saying that that's just the way it's always done. So it's almost an expectation. So -- and people are rewarded for new ideas. We celebrate successes. But we celebrate new ideas, too because they always lead to new things that we haven't thought about. So that's a -- it's just a constant innovation. It's almost spontaneous ideas that come from people working collaboratively together in multidisciplinary teams.

We have a follow up to our allocation question. is there a scenario where cash flow reinvestment goes above 80% beyond 2022 to 2023 or will that be a hard cutoff going forward?

There are guidelines. I wouldn't say if there is any absolutes in anything. But it -- I don't see a scenario right now that would go above that. But I'll never say never. I think we take a longer-term view of not an annual year-to-year, but what's a long-term outlook of what's our balance sheet look like, as I mentioned earlier. What's our debt repayment schedule looks like, what opportunities do we have available to the company? So it's a longer-term view. It's not an absolute, but it's a general framework of what it could look like. Having said that, right now, I don't see exceeding that number because I think we've seen the last 3 years' performance and how beneficial it's been to the company. And so it's something we're pretty firm on.

Well, there's sort of 2 scenarios in which you could spend more than 80% of cash flow, one would be a scenario where prices have collapsed and cash flows collapsed, and there's some maintenance level of activity that would be painful not to kind of drill through. And the other alternative is that oil price is so high that you're generating so much cash flow and the reinvestment rates of return on that are massive and mouthwatering and you're salivating and saying, wow, look at these returns. Can you talk about those 2 scenarios? Is there sort of different thought processes?

Certainly. So I think we just lived through the first scenario, where oil prices dropped to a level that nobody expected. And I think we still are keeping with the general framework, we pull back on activity. We didn't actually maintain production. It was the conscious decision to not sell the oil into an uncertain oil market. And then pull that off when process improved. And that's exactly what we've done. I think that's still the best decision in that environment looking back. So certainly, we understand that scenario, but I think we've demonstrated our flexibility to be able to react to market conditions. On the other side, if oil prices, say, were all of a sudden $100 a barrel, and we had all this opportunity to grow and as you mentioned, just grow euphorically into that market, the govern on that for us as a company is we'll only grow in our ability to continue to get better. We've seen the effects of growing at a pace that's faster than your learning curve, and you can actually see your costs get out of control, your productivity, the number of days it takes to grow wells. Every -- whatever metric you're looking at to gauge the performance of the company can get worse. And we don't want to go through that because we recognize that the cycles can be quick and you can turn around pretty quick the other way. So we're not going to grow. That's how we think about disciplined growth. We want to grow at a pace where we know we can continue to get better at what we do. So that would be the governor on the upside.

And that's sort of governed by learning curves. If a skeptic says, we're in the 8th, 9th inning of learning curves anyway for shale compared to, say, 2010 or 2014, now how would you respond to someone saying that this is now not only mature basins but mature technology?

Yes. I don't think we're there yet. I think a lot of companies get trapped into thinking about shale as a manufacturing business, and we're going to get into manufacturing mode and just figure out the most optimal way to do what we do best as we've figured out the formula. As we talked before, we're never through experimenting and on ways to continue to improve every aspect of what we do today. And our competition is really not how we look across the fence and the way other people are doing. It's about what we did yesterday. And how do we make everything better, whether it's drilling the well or completing the well or finding a new play or producing at lower cost. It's a focus throughout the company. So that's the difference, I would say, between our outlook on maturity in the play as we think there's still ways to innovate and come up with better ways of doing things.

You mentioned your competition. A lot of your competition has chosen this time in the cycle to consolidate arguably, that's a net force for good. What role do you see for EOG in that consolidation?