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

Hi. Good morning, everyone. Thanks for joining us. We are extremely pleased today to have with us Ezra Yacob, the President of EOG Resources. Ezra began his career at EOG in 2005, and he's set to take over the reins on October 1. So just a short background here. EOG is the largest E&P in the U.S. The company is focused on being the lowest cost operator, providing the highest returns and being the lowest emissions producer. So EOG has had a very strong track record of good shareholder-friendly initiatives. The company has increased its dividend. It's never been cut. Recently, they declared a $600 million special dividend, which was pretty meaningful. And based on our numbers, we forecast tremendous capability to continue to do special dividends going forward. So with that, Ezra, thank you so much again for joining us, and maybe we can just jump right into the Q&A.

Yes, please, Jeanine. I'm thrilled to be here. Appreciate Barclays hosting the event. And yes, why don't we dive right in?

Okay. So maybe it makes just the most sense to start with your macro view. You've been taking a disciplined approach, and you've been very consistent over the past couple of quarters talking about how EOG will not grow production until the market clearly needs its barrels. And you've laid out 3 macro factors that you're watching. So maybe if we can just kick off, can you discuss those 3 macro factors? Where we stand on those right now? And when you think that they will support resuming oil growth?

Yes, Jeanine, that's a great place to start. And you're right, we've been pretty consistent with our message that we don't want to push our barrels into an oversupplied market or a market that doesn't need it. We didn't do that during the last downturn in '14, '15, '16, and we're certainly not interested in doing it right now. And so we're looking at, as you said, kind of 3-mile markers out there, the first being demand simply, global and U.S. demand. We're looking to see it return to pre-COVID levels. And that's happening very rapidly. We're getting very close to that. I think everyone's watching those numbers. And even with the kind of uneven openings and the variance that we're experiencing across the world, you're still seeing continual increase in demand month-over-month. And so that's a great positive for us. The second that we're looking at is the inventory levels. And we'd like to see those inventory levels at or below kind of the 5-year historical average. And those are also kind of falling right in line with our expectations. They're essentially there right now at or a little bit below the 5-year historical averages. And then the last one we're waiting for that we're looking to is the spare capacity. And that's a lot of the off-line barrels around the world. And we're all familiar with what OPEC+ is doing with their spare capacity that they have off-line and the way that they're bringing their oil back online. And we think as demand increases and then we bring those barrels back online, the market will get back into balance. Hopefully, that will be -- that should be sometime in 2022. But again, it's a little bit early still. We'll have to see how the variants play out. Like I said, you've got kind of a staggered kind of stop-and-start approach to things right here, but things are moving forward, and we're feeling very positive about it.

Okay. I don't know if you have any commentary, but 2022 consensus numbers for EOG, closer around 9% year-over-year oil growth on $4.5 billion of CapEx. And so when we're thinking about next year, can you just talk about EOG cycle times? And how much lead time you might need if you were to transition from maintenance mode to growth mode next year, how flexible your service contracts in terms of activity and just anything related to that transition to growth?

Yes. That's good, Jeanine. It's -- as we sit here today, it's -- we're into September already, but it really does feel like '22 is still a long ways off because of the variance. And right now, we're experiencing Delta and things like that. So while it's too early to talk about 2022, I can give a little bit of color especially if we kind of look historically on the way that our flexibility in our operations works at EOG. And the big foundation for it is the fact that we're in multiple basins. We have diverse operations across multiple unconventional plays in the U.S., each with a pretty robust, high-return inventory of double-premium wells. And so what that allows us to do is whether we're flexing up or flexing down, in this case, with your question going from a maintenance mode into a growth mode, if we just simply add one rig to each of our operating areas, we can essentially increase our rig count by about 30% to 50% pretty easily. And that's really the beauty of being -- having a decentralized company, having a diversified approach in multiple operating areas is it allows you to kind of flex up and down. Now the other part of that is the flexibility in our contracts, as you mentioned. And again, part of the flexibility that we're able to negotiate in those contracts is the fact that we trade on our reputation. EOG executes on what we say we're going to do. And so oftentimes, the vendors that we work with realize that we're going to be the last one's drilling and probably the first ones to begin drilling, simply because we've got a low-cost structure, as you highlighted, we're in multiple basins, and that allows us a lot more flexibility to it. And those are some of the contracts we work with that we really appreciate the vendors and the partnerships we've developed throughout the year. So as we look forward, we still have the flexibility within our [ shop ] that we can flex to whatever capital program we decided upon.

And so we talked on the macro factors, the multi-basin portfolio and then your vendor contract. Is there anything else that we haven't touched on that is something that you would consider in terms of figuring out 2022 activity?

Yes. Well, the other piece on any of our capital allocation programs throughout the year is where is each of our assets in the life cycle of the play. As an example, the Bakken is significantly longer in the tooth, if you will. It's turned into a bit more of a legacy asset. Dorado, our natural gas play in South Texas, one of our youngest ones. Powder River Basin is one of our younger ones, Permian and Eagle Ford, somewhere in between. So we're very cognizant that we never want to push any of these plays faster than our capabilities to incorporate the data and make sure that we're optimizing the capital efficiency of that program in any given year. So some of that is just technical learnings. Some of it is getting infrastructure in place. And not just midstream gathering, but also things like local sand, water reuse, things of that nature that really allow us to kind of optimize the development of the resource.

Okay. Maybe if we can move to your shareholder return strategy. EOG, as we kind of opened, has a very strong track record of paying a growing and sustainable dividend, December cut. So maybe just starting with the base dividend. How do you and the Board decide what level that should be? For example, several of your peers are saying, "Well, we determine the base dividend as a percentage of cash flow at a certain cycle price and so we want to be within a certain range." How do you determine what the level of the base dividend is?

Yes. So that's a great question, Jeanine. Let me just go through some of our free cash flow priorities. The first is, as you highlighted, and we've talked about it a lot. It's a sustainably growing base dividend every year. The second one is a free -- a very low debt and strong balance sheet, and we feel that, that's one of the triggers that we have that really supports our base dividend. We've paid a dividend for about 20 years, over 20 years now, and we've never had to cut. And one reason we haven't is because of that strong balance sheet that we have. The third cash return or the cash return options, the third cash flow priority is share repurchases or special dividends. And as you know, and you mentioned at the opening remarks there, we announced a $1 special dividend earlier this year on the Q1 call, it was payable on July 30. And then the last thing that we've talked about are some small bolt-on acquisitions. And we highlighted some of those on the earnings call, on the Q2 earnings call just last month. These are not large. These are not corporate mergers and acquisitions. These are small strategic bolt-ons. And so going back up to the top, the reason we value that base dividend so much is the base dividend is it's forward-looking. And the way we think about it is not only is that an opportunity to return cash to the shareholders. But we like the message that it sends, both internally and externally that, that's the new mark, that's the new baseline of the business. It's reflective of the increasing confidence, the increasing capital efficiency of the business going forward. So when we meet and we discuss with the Board, we stress tested through a variety of different pricing scenarios, supply and demand models associated with different price curves and have the great confidence in it. But we also just look for other things internally into the business as we're making those recommendations to the Board, such as how are the returns going? What are the reinvestment opportunities look like for our company? How sustainable is it? What's happening with the cost basis of the company? Something we highlighted on the second quarter call is we've driven down our unit operating costs to below 2019 levels this year, and that's with less production. And so those are some of the other things that we look at just to see where the strength of the business is and make sure that we're not missing anything, make sure that when we raise that base dividend, we can do it confidently and know that it really is a sign of the increasing capital efficiency of the company going forward.

Nobody likes to cut the base dividend. So that's good. Maybe on the special dividend because that seems to be one of the main talking points in the company right now with -- at least with our conversations with investors. So correct me if I'm wrong, but even though it sounds a little formulaic, it's not really formulaic. So it's not really just taking your criteria of the $2 billion of reserve cash, plus whatever you're going to reserve for the $1.25 billion of 23 notes and then the rest gets returned to investors. It's just not that simple. On the last earnings call, I feel like the messaging was as you generate the free cash flow that you're committed to returning cash to shareholders in a meaningful way, you want to do it at the right time for the right amount. And so maybe we can just unpack those comments a little bit. And we're going to tell you a little specific. I don't know how much you're going to tell us. But what qualifies as meaningful? So the $600 million, especially in [indiscernible] first, that was, obviously, very meaningful. But can you just touch on what you mean by meaningful and how you determine the appropriate amount for the next special?

Yes, I think that's great. You've already done a pretty good job on packing it all. I would say on a base dividend of $1.65 per share, $1 is meaningful. But EOG has -- we're in a position where the free cash flow generation potential for our company is very large. And again, it's on the backs of not only lowering the operating cost of the company, but it's our reinvestment hurdle rate of those double-premium wells is just continuing to improve the company. And so when we think about the additional cash flow priorities, we've talked -- I just laid out the 4 of them. And the first thing I'd say is if we unpack it, like you said, the first thing we've talked about is, how much are -- what's the reinvestment rate? And we've already said that we're very committed to not growing into a market that doesn't need our barrels. We've also said we are not interested in doing any large corporate mergers and acquisitions or any large marketed packages that are out there. Typically, we're more interested in the small bolt-on acquisitions where they can be very strategic in nature and be very high return. So when you start with that and you look at the amount of free cash flow that we have the potential to generate this year, pretty quickly, you're checking things off the list, and you're starting to zero in on what we mean when we say we want to be flexible. We're committed to returning free cash flow to their shareholders but we want to be thoughtful about it. We want to do it in the right way, and we want to do it in a way that really generates significant long-term shareholder value. And so whether that's a special dividend, additional special dividends or share repurchases, strengthening the balance sheet, increasing the base dividend again, those are all things that we think of in concert together with one another to complement each other. And what I would say is the special dividend by -- almost by definition, is more backward looking. We just talked about that base dividend being forward-looking, reflecting the capital efficiency of the company. The base dividend is something that once you realize the cash on the balance sheet, that's when you can start to think about distributing it or doing something more meaningful with it. So that's really the way that I would put the framework around it. I think you kind of summarized it really in the question quite well. The 2 takeaways, I think, you should have is EOG is very committed to returning cash to the shareholders. We've outlined a framework of our priorities for it. And if you look at our track record, we've executed on the things that we've said we're going to do. And that's really the best way to think about EOG going forward.

Yes. I think, just the -- what qualifies as the right time right amount, that's what some investors struggle with. I mean we noticed on the 2Q earnings calls in terms of conversations on what the right return on capital method is, I don't even know if there is the right one. But we noticed that several management teams kind of started talking more about buybacks versus a variable dividend given kind of disconnect with equity and oil prices. So in terms of -- I know you talk with your shareholders a lot. And so can you just quickly maybe to some high-level talking points on what the feedback has been from your investors on the special dividend versus another return on capital form?

Yes. Generally, the challenge for our industry with buybacks is the fact that it is a cyclical industry. And it's one with North American tight oil. You've seen that it can be quite volatile at times on top of kind of a normal cyclical environment. And so the buybacks are a little bit complicated in those environments and especially buybacks in times of rising oil prices. The special dividends are ways that you can give back to the shareholders. And they have a little bit more line of sight and a little more confidence in actually what they're returning from that. I think the biggest thing for our industry right now is we need a little more visibility with the spare capacity in the oil price to really become a bit more attractive to some of the generalist investors. I think we can continue to commit and return cash flow. And the industry has got a very competitive financial profile right now. But ultimately, it's going to take a little more transparency on where the macro environment is going to settle out and what the long-term oil prices are looking at to really attract a lot more investors back to the space. For us, like I said, we're in a fantastic spot right now. We're working both ends of the equation. We're driving down the cost base of the company. We're continuing to explore and add double-premium inventory. So that once we start to see signs that we can reinvest again, we can reinvest in high rates of return projects that will continue to improve the capital efficiency of the company. And what that does, obviously, is that continues to put us in a spot where we can sustainably return cash to the shareholders dominantly through that base dividend growth.

And so the generalist conversations that you have, do you have a broad sense on like what free cash flow yield or what dividend yield really starts the conversation for energy with those types of investors or is it just not that simple?

I'm not sure if it's really that simple. I think right now, the free cash flow yields, the cash return, the yields, the shareholder returns that the industry is putting forth is quite competitive across the broader market. Unfortunately, like I said, I think, it comes back to the sustainability of that, I think, with so much spare capacity off-line, the recovery, as we said, is it's hard to imagine, but it's still kind of early in the recovery with these -- the number of variants that are out there. I think that's giving a little bit of pause for the generalist. I think once that starts to clear up, and the generalist investor can really start to see that the industry has changed, there is a lot more discipline in U.S. shale, I think, you'll start to see the generalist come back to the space in more meaningful ways.

Yes. I mean I think in addition to what you just mentioned, something that with the game chamber, in our view, for equities and energy is that now investors are being paid to sell the stocks. Because now you've got better dividends, special dividends and things like that. So we think that, that just kind of adds to the attractiveness of the sector. But like you said, it's kind of a question of is it sustainable. And there's a lot of skepticism on that. So okay. So we've ticked off a couple of your financial priorities. We did the base dividend, special dividend, buybacks. Maybe if we can just switch to the balance sheet real quick. So in our numbers, EOG is fast approaching 0 net debt. And so our question for you is, does your net debt makes sense for EOG or for any E&P in general?

Yes, Jeanine. I think a low debt is a very valuable thing in this industry. That's what I would say. We covet a pristine balance sheet. It gives us confidence in our base dividend, gives us confidence in really our operations every day. It's one of those things that it allows management to really make the right decisions and have the flexibilities to make the decisions and running the company to increase the business value, whether that comes from taking advantage of countercyclic opportunities because you have that strength of the balance sheet. Prepurchasing tubulars is one example we talked about in the past, being able to grab different parts of the supply chain. Contract negotiations. We spoke earlier about the flexibility of our contracts. A lot of those things come back to the fact that we do have a strong balance sheet. It's what allows us to, again, execute on what we say we're going to do, both operationally, financially, so on and so forth. And so having a low debt company and again, a cyclical industry that, again, can be very volatile at times, I think, it's a very, very strong advantage, and it's one that we pride ourselves on.

Okay. And then one of the things that stands out to us is year-to-date, EOG has paid out more to investors than you've actually generated on the free cash flow side. So following up on that, what is your appetite to kind of use the balance sheet going forward to sustain a certain level of cash return to equity holders? We talk about investors needing to believe in the sustainability of oil prices, but what about the sustainability of cash returns and doing that through the cycle?

Yes. No, I think, we've been pretty transparent, pretty open with that. But that's one reason when we raise that base dividend, we do it in concert with a strong balance sheet. And so we wouldn't hesitate to need to do that if we needed to. Last year, we actually issued equity at the downturn because we wanted to make sure that we could shore everything up, not only on the operations side, but with the dividend as well. And so depending on how you slice and dice what you're issuing [ debt ] 4, when we raise that base dividend, we do it in concert with strengthening the balance sheet because it's one of the variables in the equation to making that sustainable and running an ongoing company forward.

Okay. And then the last financial priority, you touched a little bit on it earlier, but the low-cost acreage bolt-ons. So we feel a lot of questions on the uncertainty on EOGs acreage bolt-ons. The A&D market has certainly accelerated for the entire industry over the past year. And so how do you really address investor concerns that outsized free cash flow from EOG is going to be allocated towards acquisitions instead of getting paid out? And maybe to start off that, if you could just touch on how much EOG spent over the past couple of years on the bolt-ons.

Yes. So we talked about on that earnings call, and that's one reason we wanted to be a little more transparent on it. We've -- so some of the small bolt-ons, just to give a scale and the size of it, across 8 deals, we acquired about 27,000 acres at an average of $2,500 per acre. So like I said, these are -- and these are in the Delaware Basin. This is acreage that is geographically near, if not contiguous with our existing acreage position. So acreage that can be kind of brought into the fold very quickly, can be drilled at times can very, very quickly go into our existing infrastructure. And those are the types of things we talked about with these small bolt-on acquisitions. We're not interested in doing any large-scale transactions, any large-scale mergers and acquisitions. Not that we don't evaluate them and look at them. We do, just to make sure we're not missing anything. But the way we evaluate our business, it's always on a returns basis. And so when we look at these small bolt-on acquisitions, even those need to be not only additive to the quantity of our inventory, but it really needs to be additive to the quality. It needs to be something that our teams covet that they want to get out there and drill in short order so that you can actually generate a return on that investment. When you're talking about a large-scale transaction, if it's high-quality acreage, that could be additive to the quality of our inventory, it's usually going to be very high-dollar acreage. It's usually going to come with a lot of PDP which you're buying at typically a low return dollar amount. Those things, we have a hard time actually generating a real positive return at it. In a lot of ways, the larger the transaction is the more quickly you actually need to get out there and drill it up and bring that value forward to try and generate a return on the asset. We do much, much better with these small bolt-on acquisitions, and then we do much better with our organic exploration opportunities. Those are both low-cost opportunities. They usually have significantly more upside because what we're exploring for is, by definition, better than what we have. We think our 11,500 premium well inventory, 5,800 wells that are double-premium, that's a pretty deep inventory of drilling potential. And so really on our exploration plays, what we're looking for is something that's going to be additive to that. It's really going to increase the quality of that existing inventory as opposed to just adding additional locations that may or may not get drilled in the next 5 to 10 years. So that's really where we land on the mergers and acquisitions. We've made a successful company out of organically growing it and being a first mover, and that's the way that we'll continue.

But -- so just on -- back to the bolt-on. Is it fair to say that over the past 1, 3, 5 years, whatever, your bolt-on to then a couple of hundred million a year, or just are you able to ballpark that for us?

Yes. I think the best thing to do, we just say over the 12 months, that's directionally going to be about right. Say over the last 12 months, you've got that 27,000 acres, about $2,500 an acre.

Okay. Okay. And then touching on the exploration that you just mentioned. You're doing domestic exploration. You're doing international exploration. And why expand your exploration efforts internationally? Why go outside of the Lower 48? Why now?

Yes. So we've always had a bit of an international presence. As you know, we've been in Trinidad for about 20 years now, operating a shallow water -- shallow water gas environment. It's been a very high return, cash flow positive business for a number of years there. We've had forays internationally into Argentina. Most recently, we exited China. And so we've always been on looking for international opportunities. Now the thing about the international opportunities is we're not trying to go international just so that we can be international. These need to be prospects that actually compete on a returns basis with our domestic portfolio. And the fact of the matter is, what we've been able to find in the last couple of years is a very low-cost entry environment. It's been very countercyclic, if you will. It's been an opportunity where we don't see a lot of competition for it. And in both cases, both Oman and Australia, we found environments where the regulating bodies are welcoming to us. The above-ground contracts and surface environment is one in which we think it's very favorable and it can compete with our domestic portfolio. Both opportunities were low-cost entries, and both opportunities have very kind of quick evaluation period. So we can get in there, evaluate, see if it's what we anticipate it's going to be and make a decision point in pretty short order. And those are exactly the types of environments that EOG thrives in. When you think about domestically, our exploration opportunities, it's really been about the same approach. And like I said, it was low-cost entry, during this environment. And the other thing that we've noticed is, internationally, it's been a little bit easier to get -- to be able to evaluate some of these deals during the pandemic because so many of these companies have gone a little bit more virtual. And so instead of needing to travel long distances and sit down and really develop the relationships, as you know, the world's opened up a little bit and has embraced a little bit more virtual technology. And that's made some of the evaluation process be a little bit quicker.

And so I guess from our perspective, a lot of our conversations with the international exploration, it's kind of like, well, EOG is not spending that much money on it right now. So no big deal. But then when you hit a discovery and then maybe there might be more upfront capital cost because it's not shorter cycle. And so then you start seeing nonproductive CapEx, and then it kind of gets away from the short cycle, high-return type opportunity. So how do you address that concern for investors in terms of your international efforts?

Yes. So it's a challenge. On the offshore, I guess, I would say, we're leveraging our experience there in Trinidad, where we figured out different ways to make those be shorter cycle and cost competitive on a returns basis, rate of returns basis with our domestic portfolio. And it's very difficult. It takes some really innovative thinking. Oftentimes in the offshore -- shallow water offshore world, similar to onshore North American shale, companies get into a real cookie-cutter mode. And that's where you start to see a lot of the leakage in the cost creep. And so staying focused on that, approaching each of these projects with real kind of surgical precision is the way that you can keep the cost down, very strategic on what you're exploring for and keep the return profile competitive with what we're doing domestically. That's on the offshore side. On the onshore, in Oman, that is an unconventional prospect. So as we drill and develop that, we're going to need to be cognizant on what the cycle times look like. It is a country that has existing oil and gas services. And so that's something that was very desirable for us for the reasons that you just mentioned. And as we evaluate that, we'll keep that in mind. But ultimately, you're right, our company is not based on one that likes to have a lot of dead capital sitting around on projects. We're very returns-focused, and that's where these projects are going to have to come. So it's not just a simple matter of discovering oil. We've said before, even domestically with our exploration program, it's not a stretch that we're going to find oil on some of these prospects. It really comes down to, are these prospects going to be additive to the quality of our inventory that we already have. And that's a high bar. We're fortunate that it's a high bar, but that's how we look at these plays. And that's why getting in for a low-cost entry, evaluating quickly, are really some of the most important things when it comes to these international prospects.

Got it. I mean time flies and you're having fun as we -- I wish we had more time. We're actually a minute over on our block. So thank you so much for your time. It's been a real pleasure, and I hope you have a great rest of your day.

Great. Thank you, Jeanine. And I hope you have a good conference. We'll talk to you later.

All right. Take care. Bye.