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

Good afternoon. This is Bob Brackett at Bernstein. Welcome to another session of the 37th Annual Strategic Decisions Conference. I have with me for this session, Bill Thomas, the Chairman and CEO of EOG Resources. A reminder of the format I will get out of the way in just a minute. Bill will present a dozen or so slides for perhaps 15 minutes or so. We'll then switch to Q&A. This is your conversation. [Operator Instructions] In general, I'll try to start at the high level and work our way down to the details as we move through the conversation. So if one of your questions hasn't been asked, probably in that sort of logical flow. In any case, with that, I introduce Bill, and Bill, thank you so much for joining us, and please go ahead.

Well, thank you, Bob. We want to start out by thanking you and Bernstein for the conference and having us here. And we want to thank everybody that's joined, and thank you for your interest in energy and EOG and our story. So we have a few opening slides that I'd like to go through. And we want to just tell and remind everybody, especially if you're not familiar with the company, the story of premium that's really affected the company dramatically over the last cycle, and now it's going to even double that over this current cycle. So we're a leader in returns and free cash flow in the last cycle, and we're going to get better this one. So we'll go to the next slide. Our focus has always been very consistent. We have been able to -- every cycle, we've been able to consistently maximize long-term shareholder value and add to that value and increase the potential -- financial potential and free cash flow potential of the company. And so the 4 fundamentals that EOG is based on, and if you don't know the company, and you really need to know, we are a return-focused company, probably the most return-focused company of any out there. Every thought we have, everything we do is based on returns and increasing returns. We've been a very disciplined growth company. Even more disciplined in this cycle and going forward than we've ever been before, and we're focused on doing the right thing at the right time and very market-driven growth principles, and we'll talk about that. We've certainly moved in a very significant free cash flow position, and that's going to even get bigger as we go forward. And we -- I think we've earned to be called a sustainability leader, and we've got great results in reducing our emissions over time. And we've set some very aggressive goals going forward. And so we want to continue to be a leader in that area, too. So we're focused on being one of the lowest cost producers, one of the highest return and lowest emission producers in the world and being able to play a very significant role in the long-term future of energy. So just as a reminder, back in 2016, after the previous 2014, '15 downturn, we really reset the company strategically to generate very, very high returns. We said in 2016, we began what we call premium drilling. And premium drilling is just defined by -- we're only going to drill wells that will generate a minimum, a minimum, that's the worst well in the group. A 30% after tax rate of return at $40 flat oil and $2.50 natural gas prices. And that really set us on a very firm path to have strong returns and cash flow through the cycles based on $40. Direct finding and development costs. Now they drop below $10 per BOE and it certainly increased our capital efficiency of the company. So it really created a very -- has created a low-cost structure and a very strong financial profile of the company. So after we set that goal, we began to see very dramatic things happen inside the company. So our F&D costs for premium were $14.50. After premium in 2019, it dropped only to $7.95 million. Our DD&A rate went from $18.43, down to $12.56. That's a 32% drop. And our total operating cost also is a big focus in the company. That's dropped 24% over that time period. So those improvements really had great results. And this slide shows that before premium we had, as everybody knows, we had $95 oil back in 2012 and 2014. And our earnings per share were about $3.46. After premium with $58 oil, and that's a $37 drop in the oil price, our earnings per share went up. Amazing. That was -- that's an amazing thing, if you just think about that. And then our return on capital employed at $95 was 10% after premium and the oil price dropping $37 a barrel, our ROC actually went up by 4%. And then you can see the dramatic difference it had on -- we were in a deficit before on spending and after premium, we began generating very significant free cash flow every year. So we -- average $1.5 billion over that time period per year on free cash flow. So in dramatic improvements by resetting, reinvestment hurdle rate in the company. At that time, and it is probably still true today, that reinvestment hurdle rate, we think, is the most stringent reinvestment hurdle of any company of any kind. And it really sets discipline. It helps EOG be the most efficient, be the highest return operator in the business. So now as we emerge from this most recent downturn, we've doubled it. We've taken another big step, and we're now going to double premium. And double premium means we went from 30% to 60% after tax rate of return hurdle rate at the same price, $40 oil and $2.50 natural gas prices. So we're really in the process of making another very significant step change in the future performance of the company. It's going to give us higher returns, lower breakeven cost or 10% return on capital employed obviously, higher cash flow generation. The new wells are a lot better than the old wells, so they pay out much quicker. We get the cash back and so free cash flow potential is going to go up, and we're going to continue to see our cost base as our F&D costs go down. So another big step change underway. And this is my favorite chart of all the slides in our IR deck, it really shows it's plotted after tax rate of return versus well count. And this is our premium well count, all the wells in the company that we have in inventory that will generate at least 30% rate of return. And you can see, we now have 11,500. When we started in 2016, we only had 3,200. So we've grown it from 3,200 to 11,500. Now on top of that, that green square represents the 5,700 wells that we've identified that are double premium wells, 30% -- 60% after tax rate of return oil. So you can see the lowest are the premium area, that's the kind of results we had 2016 to 2020 on reinvestment. The median in our inventory now is 60 plus. And we're really drilling well within that green outline and on top of that, we've got the most robust exploration effort that we've ever had in the company, ongoing in the U.S. and some international exploration. So our returns on our exploration plays are going to be in the upper end of the double premium. So we've got really in place and set a great way to continue to significantly increase the company performance going forward. This is a couple of charts that show a double premium well versus a premium [area] well. And it's not just because of cost reduction we're going to double premium. It's actually, the wells are actually a lot better. So they produce -- the double premium wells produce 39% more oil in the first 2 years. And on top of that, they have a lot lower decline rate. So we are projecting our base decline of our company because we're shifting a double premium is going to continue to go down. And that's really a lot different profile than we've ever had before. So that helps us be more efficient. It certainly helps us to generate more free cash flow and earnings potential. And this shows the price of oil required for a 10% return on capital employed. It used to be in the $80s. We switched to premium and dropped it in the $60s, in the $50s, mid-50s. Now we're at $50 and as we shift to double premium, you can expect that to drop much below $50. We're targeting $40 down the road. So that's also because the wells are so much better, that we're improving our capital efficiency every year. So this takes less money to maintain our production or grow our production. We're just getting a lot better in every different area across the company because we've had the most stringent reinvestment hurdle rate. Now we have doubled that hurdle rate. And so we're going to be way ahead of anybody else on reinvesting and reinvesting at high returns. So our double premium, as we've been talking about it translates into higher cash returns. We are already committed this year with our regular dividend and our special dividend that we're going to be giving back $1.5 billion to cash to shareholders this year. And our cash flow priorities are we have a very strong framework is that we want to work on the regular dividends. So that's the #1 priority to sustainably increase the regular dividend, we've already increased it 10% this year. So we're committed to $960 million of regular dividend payments. We want to continue to strengthen the balance sheet. We've already paid off $750 million bond in the first quarter. And we don't have another bond due until the until 2023 and it is $1.25 billion. And so we'll talk about that more a bit in a minute. And then other cash return options as we've already exercised, we want to work on special dividend when we have a -- up cycle times. And then if we have another down cycle, we're in the commodity business. And if that happens again, that's the time that we would want to think about opportunistic share repurchases. So in the last quarter, we did announce $1 per share of a special dividend, and that's about $600 million. And then the last priority is low-cost property bolt-on. So we're not interested in large corporate M&As. We just don't see that as a viable way of improving the company. But we do see opportunities in smaller acquisitions that bolt on to our best properties that would be able to execute and generate high returns off and improve the quality inventory that we currently have. So that's a slide, that's a new slide that we're just adding for this conference that we put on our website, and it really compares the free cash flow potential of EOG versus leading manufacturers in other industries and other parts of the sector. So -- and it breaks it down into 3 different colors. One of them is the cash costs. So you can see in the other sectors, most manufacturing costs, their basic cash costs are higher than ours. So we have low operating costs compared to them. So we have an advantage there. We do have to take more CapEx to maintain or grow our production. So we have more there. But when you add it all up and you slice it all up, we are competitive or more competitive with the best-performing companies in other sectors in manufacturing. So EOG has really set itself apart. We're really a very financially successful company. And the main thing is you need to be thinking about, we have just doubled that reinvestment hurdle rate, and so we're going to get a lot better, a lot faster than everybody else. The last slide is just reiterating what drives EOG? Why are we different than everybody else? And I can tell you, being with a company 42 years, it's our culture. It is very, very unique. The value of EOG is from the bottom up, not the top down. That's the reason we don't have to do an M&A to fix the company. It's all these improvements are coming from the bottom up. The well cost improvements, the well performance improvements. Every part of the company is -- everybody in the company is highly engaged and in the process. And on top of that, we've got one of the most sophisticated information technology systems that is gathering real-time data. We've got analogs, I mean algorithms and programs and apps built for each area of our operations, and we're analyzing data quickly and coming to conclusions and making changes in the company rapidly to continue to improve the company. And we had a fantastic last year working remotely, using all this data and sharing together and making the company better. It was one of the best years ever in the history of the company on improving. So we're coming out of the downturn, fired up and ready to go. And in better shape than we've ever been with more upside and more potential than we've ever had. So we're emerging as a much, much stronger company going forward. So Bob, anyhow, thank you for allowing us to present. And that was our last slide. So I'll turn it back to you for Q&A.

My pleasure. And again, we're getting a number of questions in. I encourage you to keep throwing them at us and we'll start. Brent's north of $70. You talked about coming out of the down cycle, we're kind of there. What's your view on the sustainability of oil prices right now? What does your crystal ball say for the rest of this year and maybe looking out a couple of years?

Yes. Certainly, I think we can all agree. We're definitely entering to a very strong economic recovery. As the vaccine rolls out across the world, we're seeing that it's certainly taking care of that issue and countries all over the world are beginning to return to more normal activity. And actually, I think there's a lot of pent-up activity that's going to be happening, and we're seeing that happen. So we're seeing the pre-COVID oil demand levels that we're kind of looking for we think that we'll certainly get to that level, 100 -- 99 million to 100 million barrels a day of demand by the end of the year. We're seeing inventories in the U.S. and the world, inventory is now getting back to the 5-year average. And certainly, as time goes on, we think that's going to drop below the 5-year average, certainly by the end of the year. And the other thing we're looking for is to get the spare capacity down. We want to get that down to a low level like we have historically, had in some of the times in the past. And so that's just simply getting all the oil that's been shut in back on the market, and that's happening. OPEC had their meeting this week, and it was a very short 20-minute meeting. They're all on the same page. They're all in agreement. They're all cooperating. So they're bringing that back in a measured pace. And so it's all -- everything is firming up and I feel -- I've said this several times before. I think over the -- when I think about the last 2 cycles we've been through and now looking at this one, I feel like in this one that prices of oil, and I believe gas, too, will be a bit better and a bit more stable than they have in the last 2 cycles.

And I'll segue because one of the things you've mentioned on previous calls is no growth from EOG until the market clearly needs the barrels. And I can almost hear the checks, the things you're looking for. Talk to that and when do you see that growth needed by the market?

Yes. Like I say, it's all playing out as we hoped. Certainly, the first 2, the inventory's down below the 5-year level, checkmark, we think that will happen by the end of the year. The pre-COVID demand levels check, we think that's going to happen by the end of the year. The one that we're watching closely is how fast does the shut-in oil come back on. And so far, they're pretty much on schedule and if they stay on schedule, sometime in the first half of next year we should have all that oil back on the market and then you can check that box. So we're committed to being very disciplined, as we've shown in the past, and it's not the price of oil that's going to trigger whether we're growing or not growing, it's really market fundamentals. And so we're very aware of the market and the fundamentals, and we're watching that. And we will adjust our no growth or growth rate based on those fundamentals going forward.

And talk about what that growth rate could be in a market that is tight and demands those barrels? How do we think about the desire for some investors to see a cap to growth?

Yes. So we'll take a look at where we are next February when we announce our plan. And according to how we feel about the market, we will adjust our rate of growth, if we decide to grow accordingly. So we could do a 2% or 4%. If it's wide open, and it's obviously the world is desperate for oil. We would like to grow at a rate that would optimize all the financial aspects and optimize our long-term free cash flow potential. And we've outlined what that would be in that case going forward. So we're not ever going back into the double-digit growth rates. We're really looking at single-digit growth rates going forward. But certainly, we have the ability to maximize the value of the company over time and maximize free cash flow at the proper rate.

And talk about the downturn, effectively, a year ago, it was a very different story. What did you do last year that you're sort of proud over want to talk around where you responded to the pandemic. What are some of the major things you did last year that were planned already? So what was the plan from last year?

Yes. It was an exceptional downturn. I would rate it as probably the most unique downturn ever that we've experienced, but it was also the best, I think, response that we've ever had to a downturn. As we say, we've improved the company dramatically. And I think one of the things that we have built in to help us perform so well during a downturn is a lot of flexibility. So we learned from the 2014, '15 downturn, we need to have an ability to turn on a dime if oil prices change and react more quickly. And so we built in flexibility in our service contracts that where we could shut down drilling rigs or frac spreads and not have very severe financial penalties because of that. And then keep them on standby in case we wanted to get them back pretty quickly. And that's worked out beautifully. We were able to ramp down activity, save a lot of capital, and it helps us actually generate $1.6 billion of free cash flow in the middle of a downturn. So that's a big deal. And then some of the things that I think were accelerated by the last downturn was obviously, we were able to switch to double premium hurdle rate much faster than we would have if we didn't have a downturn. So we made enormous improvements on our costs. Our well costs were down 16% last year. And our well productivity went up because of it, too. So it just gave us more time to fine-tune the cost reduction and the well improvements and get that all into our inventory system and give us the opportunity to just go ahead and make a permanent shift to double premium all the way going forward. And that will be the biggest driver of our performance in the future. And then the thing that's been a very big opportunity for us is not only that we improve inside the company, and we saw a tremendous -- we're seeing tremendous discipline in the U.S. side of production growth and return of cash to shareholders we're also seeing a huge shift in all of non-OPEC supply. So I think the energy transition has really shifted to future supply potential. There's been an enormous amount of dollars that are not reinvested anymore and is the things that are especially not being reinvested or new exploration projects. So in the U.S. and in international, so as an exploration company, that's been an opportunity for us to pick up some very, very high-quality acreage positions and very strong technically prospects that we think that will continue to improve the company going forward and make -- if they're successful, make a very big impact on the company. So we've been able to do some countercyclic opportunity things that hadn't been available before. So that's a great thing for the future of the company.

There's a question in the queue. What is double premium, a technology or geology. I mean, clearly, it's a hurdle rate, but setting a hurdle rate doesn't necessarily create a good drilling location?

Yes. It's a combination of that dramatic continuous, sustainable cost reduction we have going on inside the company. It's operating cost and well cost. That's obviously, that increased the returns. And then on the other side of it, like I showed on the chart, the wells are better. They're 39% more oil in the first 2 years. So just a lot better wells, the double premium wells don't cost any more than the premium wells. They all cost the same. The cost reduction is going down on all of them at the same time. So the well productivity is a big driver in the double premium hurdle rate designation, and that's just a function of the rock quality and the completion techniques. That's what drives that. So it's a combination of that. As you all know, many people know, we have developed a very sophisticated ability to select the very, very best rock in each one of the plays, in each one of the targets. And we've narrowed it down to 10 or 15 feet in most of them, and we're able to keep the bit in that target, 95% to 100% of the lateral. And while drilling at superfast speeds at the same time and getting the cost down. So -- and then the completion technology continues to evolve, we were able to connect more of that good rock to the wellbore, more rock, more good rock makes better wells, lower decline rates. So that's a function, I think, of the geologic expertise, the exploration outlook that we have in the company. And then when you think about our new plays, that's what you need to think about, they are really, really focused on better rock. They're not focused on the kind of rock we have now, they're focused on rock that will continue to improve the performance of the company going forward.

Question. Between premium and double premium, there are locations that fell off what would be double premium. What's the future of those locations? Do they exit the portfolio? Or do they stay and get sort of fine-tuned and ground upon until they have the potential to move up?

Yes. Certainly, we have a good set of locations that will -- I would say they would generate 45%, 50%, 55% rate of return at $40 flat. So they're getting close. So that drives each one of our operating areas, each one of our operating divisions to make those double premium or they're not going to drill them. They don't get to drill them unless they are double premium. So it sets a standard and it sets a goal for them. So they're busy working the cost down. That's one way, working the operational costs, working the drilling completion costs, that's one way to get them there. The best way to get them there is to reduce the cost and improve their productivity. And so they're working on more specifically of drilling better targets, selecting that fine-tuning that target interval they put in drilling a better rock and then tweaking our completion technology, where we're connecting more of that rock up. So it's a continuous process of integrating a lot of G&G data and engineering data and completion and operational data. And it's all a combined process to get those wells to double premium.

How do you think -- in a sense, the unit of investments, the pad, which a multiwell pad, it sort of implies that if I'm drilling 6 wells off of a pad, all 6 wells have to be double premium, or does that pad have to generate double premium returns and some of the wells might be better and worse?

Yes. Generally, as we think of it, it's a pad. It's a pattern of wells that would be double premium or above. And you don't want to leave 1 little well out there because it was 55% rate of return. So you average them all together. And you're right, sometimes some wells will be 70% or 80% and some wells maybe 58% or something like that. But certainly, the whole pad, the whole area would be more -- double premium or more. And everybody remember the double premium 60% rate of return, that's based on $40 flat. At $60, those returns are really, really high. So the $40 flat is a big, big, big deal in making sure that, that's the real price that we want to set that standard on.

One of your peers publishes a cost of supply for their portfolio with asset level granularity. Would you consider doing so as a way to demonstrate depth of inventory?

Yes. I think we do have some metrics in our IR book in the back. Kind of in the appendix part of it that does a play-by-play breakdown on that. So people can look at that and get a pretty good idea of the inventory level and quality in each one of those plays.

What amount of capital is required to hold your production flat? And how much could that change 2 years from now based on your current plans?

Yes. Our maintenance capital, including our Dorado gas play is about $3.4 billion. And as we look at that going over time, I can't give you any specifics. But certainly, as we continue to improve the company and reduce costs and improve productivity, that will go down over time. So it's getting to a very, very low number.

Yes, effectively, without growth, base decline moderates. So as the portfolio average is up, it's lower decline. And with double premium in theory, those are lower decline as well. So all of that's pushing toward -- where do you see that decline rate going in the next 2 to 5 years?

Yes. We've got the -- that was on one of the charts. I think by 2023, we project that to be about 25%, our base decline. And as we look at that going forward, if we continue to do double premium and continue to improve on that, that decline will go even lower than that.

We have a question. In your prior slide decks for 2022 to 2023, you estimated 8% to 10% oil production growth at $50 a barrel. What is your estimated production growth now at $65 to $70 a barrel?

Well, again, we want to make it clear that it's -- our growth rate is not based on the price of oil. It's really based on the fundamentals of the market. And so we need to see each one of those -- each one of the metrics that we outlined, we need to see those fulfilled until we really move back into a growth mode. So we're really in tune to the fundamentals of the market.

There's a question with much lower cost of capital in bond markets, why keep the A- credit rating, why not drop to BBB+ credit rating to fund M&A or higher shareholder rewards?

I'm not sure I understand that question.