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

This is Arun Jayaram from JPMorgan's E&P team. Really thrilled to have EOG Resources to kick off our E&P presentations this morning. Joining us is EOG's President, Ezra Yacob. Ezra was also recently elected President -- or pardon me, CEO of the company, and he'll take on that honor and that responsibility in a couple of months. Ezra, you're only replacing 2 legends in this space in the -- Mark Papa and Bill Thomas. But we -- I was joking with David that this reminds me of the Pittsburgh Steelers where you have -- they had, what, 3 coaches over the last 30 or 40 years that you come to a great place with the company kind of firing on all cylinders. I know you've been a big part of the success of the company. And I know there's been a lot of -- internally, there's been a lot of excitement, as you look to take over later this summer. With that, Ezra, thank you and the team for participating. I'm going to throw it over to you for a few introductory comments and then I'll begin a fireside chat, a Q&A session with you. Ezra?

Yes, Arun, thank you, and I appreciate you and JPMorgan hosting the conference here. It's a great time in our industry, a very dynamic time. And I appreciate those kind words. I couldn't be more excited, more thrilled about the opportunity to continue on with EOG and leading such a great company. And as you said, we've started this year out of the gates in a very strong position. In the first quarter, we recorded a record cash flow and net income. We're well positioned to achieve our 5% total well cost reduction. And we highlighted not only being able to continue to strengthen our balance sheet by retiring a $750 million bond, but we also announced a special dividend of $1 per share. And in addition to that, we've continued to highlight our shift to double-premium drilling, which is really increasing the rate of return hurdle for our reinvestment opportunities here from what we have been drilling over the last few years at a 30% direct after-tax rate of return at what we call our premium price deck, and that's a $40 oil price and $2.50 natural gas price for the life of the wells. We've upgraded that. So only drilling wells that can clear a 60% direct after-tax rate of return. And we really think going forward, that's going to provide the next big step change for EOG's financial performance in the next few years, in addition to also shallowing out our base decline, and I'm sure we can talk about that a little bit more. So I just am glad to be here, Arun, and we can go ahead and get started.

Okay. Great. So as I've broken down today's fireside chat into a few topics just to kind of lead the discussion. So I want to first start talking a little bit about the management change and just how you think about capital allocation of the company. So give us some perspective on the near-term transition with Bill later this summer. And maybe you can elaborate on the potential implication from the CEO change from a strategy perspective and perhaps provide your vision for taking the ball from Bill and kind of running with it.

Yes, really, Arun, the fundamentals of the company are not going to change. For over 20 years now, we've been focused on high-return reinvestment opportunities. We've always focused on returns. As we became leaders in the unconventional shale gas space, transitioned into unconventional oil, that's been the driving focus. The culture of EOG is that everyone contributes. It's a very bottoms up culture where everyone is expected to think -- to critically think like a businessman first. And we like to say that whenever there's a fork in the road and you have to make a decision, lean towards returns. That's the one that's -- you're going to make the right decision if you're always focusing on returns, and that's the best way that you can build shareholder value. And so the transition between Bill and I with such strong fundamentals like that in the company, you don't see -- you wouldn't forecast a lot of big changes on that. We're still very, very committed to being the highest-return, lowest-cost operator in North American shale with lowest emissions footprint that we can deliver.

Great. Ezra, I was wondering if you could just kind of comment on the portfolio. Over the last couple of years, we've seen your peers -- I know you've had an organic growth story for the last 20 years. But we have seen a lot of A&D within the space, including a few public or private deals. On the 2Q print, we did hear the company mentioned the word bolt-on a few times. So I just wanted to get your perspective on A&D. I know you guys did the Yates deal a few years ago, which ended up being kind of a home run for the company. But just wanted to see your thoughts on A&D in today's environment.

Yes. The way that we evaluate A&D opportunities, M&A opportunities is, are they going to be additive to our company? Are they going to be additive to the front end of the inventory so on and so forth? So when you think about this year, we're investing in these double premium wells. They generate a 60% rate of return at flat $40 oil. So obviously, today's strip price, those wells are looking to generate in excess of 100% rate of return, pay out themselves well in under a year. And so when you look at M&A opportunities in general, usually, they will come with a certain amount of PDP. And obviously, that PDP -- the investment on that PDP is not going to compete with the investment in drilling of wells. The second thing we look at is the upside opportunity on the acreage. And a lot of times, the acreage has either been partially drilled or the acreage, quite frankly, is in a position where the quality of the acreage in the basin really doesn't compete with the quality of our own acreage. So when we look at M&A opportunities, that's really the way that we judge them. We look at them back to our base business, back to our inventory. Our current inventory is 5,800 well locations that can clear that 60% or double premium hurdle, and it needs to be really additive to that. We have great confidence in our organic exploration opportunity. When you think about these organic exploration opportunities or even some of the bolt-on acquisitions you're talking about, those usually have significantly greater upside. There's a lot more upside. They're very, very low costs of entry, and we see that those are opportunities where we can really get into basins that have Tier 1 acreage positions. We can get into them very inexpensive with low to no PDP acquisition costs, and they can really be additive to the front end of our inventory. As you mentioned, we have talked about before doing bolt-on acquisitions. And these are things that are smaller in nature than a large M&A. They're usually contiguous with some of our acreage footprint. Oftentimes, we'll have data or seismic data, infrastructure, so that they can be incorporated pretty easily. And as you know, there's usually tremendous upside when you can combine those types of synergies.

Okay. Great. I wanted to ask you kind of one macro question. I think Bill mentioned on the call that EOG has been doing some pretty detailed macro work on both the oil and gas side of the equation. And I was wondering if maybe you could shed some light on your thoughts on how the recovery could look like as mobility gets a little bit better post the recovery from pandemic.

Yes. There's still a lot of moving parts out there with regards to the virus. I think obviously, here, when you look back even just 2 weeks ago, things are opening up very dramatically here in the states. Abroad, there are kind of varying degrees of how quickly things are recovering. In general, what we're seeing is potential to return to a more balanced kind of supply/demand as far as -- well, let's put it this way. As far as demand returning to kind of pre-COVID levels, maybe '19 levels, maybe as soon as the end of this year, but more than likely into next year. What we're seeing right now on the inventory side, our inventories are down to right around the 5-year average, the historical 5-year average, but obviously, with a little bit softer demand out there, the days of supply is still running a little bit high. And then, of course, everybody knows that OPEC++ has their spare capacity. It's right around 7 million barrels, I think, right now, and that's scheduled to open up and get back online by April. And that one, you can see we read a lot of the same things that everybody else does in anticipating this meeting on July 1 that they may adjust that. But we'll just have to wait and see. I think at this point, a big piece of it will come back to the variants that we're seeing across the nation. But EOG is in a good position. Like we have talked about, we're committed. We won't be pushing our barrels into a market that doesn't need it. We really want to see demand get back to the pre-COVID levels. And when it does, we'll be well positioned to move forward.

Yes. Ezra, in terms next year, right? This year, you're running, call it, a maintenance or sustaining CapEx kind of capital program this year. You guys have been very clear that next year's call on what you will grow will be dependent on kind of the macro situation. That being said, we have seen oil prices eclipse $70. There's been quite a bit of talk even from Schlumberger. I just did a fireside chat what is their expectation called of a super cycle. So one of the questions from equity investors is, how does EOG kind of think about kind of next year. I'm not asking you to make a call today, but how are you thinking about a couple of the scenarios?

Yes. Arun, that's a good question. And it's -- the first thing I would preface is we just got done talking about what the macro looks like, and it's a pretty dynamic time right now. The great thing about where we're at with this shift to double premium is that we're always getting better as a company. We're consistently lowering the cost base of the company even running the maintenance capital. These double-premium wells have the effect of dramatically lowering. They have a dramatically lower finding and development cost, and that feeds right through to our DD&A. We're working diligently by applying technology and innovation on the operating expense side so that we lower that every year. And then the other thing these double premium wells have is that they have a bit of a shallower decline just by nature of them being a higher rock quality. And so even running a maintenance program, you're still increasing your relative margins there by lowering the cost base of the company. And that supports really ultimately our cash flow priorities here. That will support a sustainably growing dividend into the future. It just strengthens the -- that will continue to support our strengthening of the balance sheet. And it really puts us with a lot of flexibility and well positioned to go into 2022, no matter what the macro environment looks like.

That's fair. So -- Ezra, the second topic I want to ask you about is just kind of free cash flow and your cash return kind of mechanisms. As you mentioned on the last quarterly print, the Board declared a $1 special dividend, which is well received by the marketplace. Can you talk about the thought behind what led to the special dividend? And maybe the rationale from here, and how do you -- how should the market anticipate distributions beyond the recurring dividend?

Yes. That's a -- the thing I would start with, Arun, is our main cash flow priorities. Our first one is we're very committed to a sustainably growing base dividend. That's what we really want to focus on. And we've done since the shift to premium drilling, which has supported that growing sustainable base dividend, we've been able to grow that approximately 146%. And we've done that really in supporting that. We've done it by strengthening the balance sheet. As a company that's basically paid a dividend for over 20 years, we've never cut the dividend. We've never had to go there because of focusing on a strong balance sheet. And that's something that that we're very proud of and we think is very important as a sign of a good company. So when we talk about the special dividend, we entered this year, as you said, with our roughly maintenance capital program to the exit of Q4 last year. We had secured enough capital, cash on our balance sheet to go ahead and we wanted to pay off our bond that was due and make sure that we did not refinance that. And then looking forward to where we're at in the environment with how things were opening up, how the vaccines were rolling out, we feel very confident that we'd be in a position to offer that special dividend as a reward really to our shareholders for sticking with us through what was an unprecedented event during 2020. Moving forward, our cash flow priorities really haven't changed. And we've very -- been very consistent with our commitment to them that it's -- number one is growing that base dividend, as I talked about. Number two is strengthening the balance sheet. And then number three, is either continued special dividends or a buyback option. And then, of course, number four, as we finished up talking about is the ability to take advantage of bolt-on acquisitions in a countercyclical environment, which we're here now. Those low-cost bolt-on acquisitions as we talked about, add a significant value of upside to us. So we're committed to returning cash to shareholders. We're returning to really building long-term shareholder value, is really what we're focused on. And that's really what the shift to double-premium wells is all about.

Great. Ezra on the last call, you guys outlined, I think it was Tim kind of some of the minimum cash balance you'd like to -- you generate a tremendous amount of free cash flow today. But maybe for the investors on the line, you could run through as they think about excess free cash flow, but how much minimum cash you'd like to keep on the balance sheet?

Yes, that's right. What Tim had mentioned was we like to see about $2 billion on the cash balance. That's what allows us to cycle through the accounts payable cycle, obviously, and allows us to stay out of commercial paper. And then some of the additional priorities that we have is we do have another bond due that we intend to service that bond and not refinance that. That bond is coming up in 2023, and it's for about $1.2 billion.

Okay. Great. Great. Our final question. You mentioned the long track record of growing the dividend. What kind of dividend growth do you and the Board think about over the next -- on a sustainable basis?

That's -- those are discussions we have with the Board every quarter. We evaluate where the company is at. And when we make that adjustment, the increases to the base dividend, it sends 2 signals -- hopefully, that's what we're hoping for is it sends the signal both internally and also externally that this is the new baseline of the business. Again, going back to the fact that we keep a strong balance sheet, so we've never had to cut that dividend, we want our shareholders to know that when we raise that base dividend to another level, that's the new kind of plateau for the company. That's where we feel very confident about it. And so there's a lot that goes into that decision. What I would say is we are able to raise it early in our premium drilling by about 30% per year. And then this last year, we put a 10% raise on that dividend growth. And the most important thing to think about, again, as I mentioned earlier, is that as we bring better and better wells with lower finding costs into our reserve base, lower cost reserves, that lowers the cost base of the company. And that's what allows you to have good insight and line of sight into growing that base dividend in a sustainable manner.

Great. I want to shift gears to next topic. Just talk about the portfolio. Can you, Ezra, just give us an update on the 2021 plan, capital activity levels and maybe give a sense of where your activity is kind of concentrated today?

Yes. This year, we're running basically a maintenance capital program. We've got some extra capital dedicated to exploration this year and some ESG infrastructure projects. So the guidance is there at a midpoint of about $3.9 million for this year. The majority of the activity is in the -- our big plays. It's in the Permian. And then in the Eagle Ford, dominantly, we're doing a little bit of increased drilling in the Powder River Basin. And then as I said, our exploration plays are commanding a little bit more capital as well. We're doing great. As I mentioned at the top of the call, our well cost reductions are coming right in line with our targeted 5% reductions year after year. That will be 2 to 3 years in a row where we've been able to lower well costs even in what is potentially turning into a bit of an inflationary environment. And we do that basically through applying technology and innovation to really increasing the operational efficiency in the field on the drilling side and the completion side. And then, of course, over time, we determine which pieces of the value chain that we might like to capture, not only do we think that we can improve some of those processes in different parts of the value chain, but there is also the opportunity there to take some of that inside of EOG and keep the costs a little bit lower to our bottom line.

Okay. So today, you mentioned it's -- the activity is dominated in the Delaware and the Eagle Ford with a little bit of activity in the Powder River Basin. Could you talk a little bit about -- a couple of calls ago, you unveiled some new premium drilling opportunities on the natural gas side of the equation and -- give us a little bit of an update on how your testing of that is going and -- we do have a pretty solid natural gas price environment. And investors have been asking, how will this kind of compete for capital on a go-forward basis?

Yes, that's great. So Arun, you're referencing our Dorado natural gas play there in South Texas. It's very, very well positioned geographically close to the Gulf Coast there. It's dominantly -- it's Eagle Ford and Austin Chalk. And I would say it's an extension of what we learned in the Austin Chalk drilling in the oil window. And things are progressing there very well. We've got about, I would say, 3/4 of a rig dedicated to that area. We will -- we've been drilling those wells. We'll start -- we actually have a completion spread that we're moving down there in the back half of this year to bring those wells on. And we're very excited with the progress that we're seeing there. In the first couple of years, just like most of our plays, we'll have a pace of development there that will incorporate not only our infrastructure build-out, but also our ability to collect data and learn. As you know, moving too fast in these unconventional plays will put you in a position where you're kind of losing value. You want to make sure you can't -- you don't outrun your headlights per se in learning about these different reservoirs and bringing them forward. And so that's really the pace that we're looking at with Dorado. It competes with our oil plays on that double-premium price deck. So on the natural gas side, that contemplates $2.50 over the life of the well for the natural gas side. So as you mentioned, natural gas in general is pretty far above that right now. So again, the nice thing about that premium price deck is it allows you to compare your portfolio not only across different phases, but across different geographical regions, rock types, so on and so forth. And so it really puts the power of capital allocation down at the front line employees level, where they know the hurdle that they need to hit to be able to be additive to the bottom line of the company. And by drilling those double-premium wells, whether it's gas or oil, that's the best thing we can do to really continue to increase our returns on a return of capital employed.

Great. As we have a write-in question on our digital conference book, can you talk about how you balance dividend growth with production growth, i.e. -- and this is from a long-only investor, how long can you maintain production growth while growing the dividend in terms of years?

Yes. So the first thing I would highlight is our double-premium inventory currently is 5,800 wells. So this year's drilling pace, that's approximately 10 years. If at some point in the future, we start adding wells to that. So let's call it 8 to 10 years of production growth. These wells, as we mentioned, the double-premium metric, these wells are paying out in significantly under a year. So you're getting your cash flow out of those wells very, very fast. What that does when you're adding those low-cost reserves again is it's lowering the cost base of the business and increasing your margins, and that's ultimately what's generating your cash flow. So when you think about optimizing your investment, you take a look at 2 different things we do, is we think about not only the near-term cash flow generation potential, but the potential to generate cash flow long term as a way to support not only the balance sheet but the increasing base dividend, as we talked about. And you don't need to just invest in growth to be able to grow those margins or grow the cash flow, right? As we said this year, with just a maintenance capital program by adding lower cost reserves to the books, you're lowering the cost base of the company. And so we don't think of it as an either/or. We think that those 2 things really go together. And that's kind of how we measure it.

Great. One question would be if you did decide to move to -- away from a sustaining CapEx but to a little bit of growth, how would your capital allocation trend between the different plays?

Yes. So whether it's almost again, irregardless of a growth mode or a capital or a maintenance program. Really everything comes down to focusing on returns. Again, that's been the hallmark of the company for the past 20 years. And so the dominant thing is looking at the returns profile of each of the individual plays for capital allocation. The second piece of it is, where are those individual plays at in their life cycle. And again, what I mean by that is the Eagle Ford is much farther along than say, the Powder River or the Dorado natural gas play. And so you couldn't ramp up the Dorado natural gas play significantly fast just because you'd worry that you're moving too fast and leaving some things behind, opportunities to put in infrastructure and drive down operating expense or just the ability to incorporate data on, say, specific targeting or completions metrics. In the Eagle Ford oil window, you're much farther along there. And so the ability to increase well productivity while it's still happening, it's smaller than it used to be early in the play. And that play is dominantly driven the increased product -- the increased economics and returns on that play is really driven by driving down the well cost every year.

Got it. Got it. Ezra, I was wondering if you could provide an update on some of your exploration activities, both in the U.S. and then a follow-up will be internationally.

Yes, sure. So domestically, going back to what we talked about at the start, we're forecasting drilling about 15 wells this year on the exploration side is what we've put out there. And the exploration prospects, of which we have a handful of them in various basins across North America, they've actually started to kind of separate themselves on the -- again, let's say, the pace of where they're at on evaluation. Some of them -- we're still leasing in most of them. But on some of them, we're drilling our exploration wells. In others, we're drilling what I would say are more appraisal wells, really starting to identify and go after just how repeatable of a play this could be and ultimately seeing what the returns profile is going to be to again make sure that these things are additive to the front end of the portfolio that we have. And these plays, again, are a bit more -- there are reservoirs and rock types that industry generally hasn't chased before. We've dominantly been focused on shales and tighter sands and things of that nature to exploit horizontally. These rock types have a step-up in porosity and permeability, getting a little bit closer maybe to conventional rock types. And those are the types of rocks that we're really trying to exploit and apply our horizontal drilling and completions technology to. And we're making progress on that. And hopefully, we'll have some results on those. We can't promise anything, but hopefully, we'll have some results on those we can talk about. And then on the international side, we've had 2 press releases this year, the first being in Oman, where we have an onshore unconventional prospect that we'll be drilling later this year. We're very excited about that. It's in the oil -- it's an oily prospect in the -- on the rim of the Rub' al Khali Basin. And in Oman, we found a country -- good partners with a country that has an established oilfield services. They've made -- they've understood that the contract terms needed to spur unconventional development are slightly different than conventional. And so we're very excited to be in that country. And then the other one is in the Northwest Shelf of Australia, where it's a shallow water opportunity, geologically in a lot of ways similar to what we've been developing in Trinidad for over 20 years. And we're very excited about that opportunity also. The great thing about these international opportunities is we're able to get access to the data throughout COVID in the virtual world, which has been a big help. And then really, since it has been a countercyclical opportunity, the upfront costs in both of these opportunities are very, very low. Very low entry costs and very low-cost opportunities to get these drilled and tested and evaluated.

Great. Ezra, my final question this morning would be just to get an update on where you're at on some of the ESG methane and GHG emission reduction target for the company.

Yes. That's -- I appreciate you bringing that up, Arun. So as you know, we established some methane intensity and GHG intensity targets a couple of years ago. Those targets are set by -- to be achieved by 2025. And we're right on target, making great progress with those. As you know, we're very proud of our gas capture percentage, which is at approximately 99.8% as a company. And we also, just recently this year, released 2 additional missions statements. The first is a net-zero ambition by the year 2040. And as part of that, obviously, this mile marker of the 2025 targets with emissions intensity for both methane and GHG are a big part of. And then the second thing that we did is, we've committed to zero routine flaring by 2025. We joined the World Bank initiative in that. We're very proud to take part of that. And I think we'll be well positioned to achieve that really before 2025.

Great. Ezra, we're out of time. On behalf of the JPMorgan team, we want to thank you and EOG Resources for presenting this morning. And we wish you the best as you take the lead of the company in just a couple of months.

Thank you, Arun. I appreciate the time this morning to share EOG's story, and I hope the conference continues to go well for you guys. And hopefully, we can do this next year in person.

Great.