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

All right. Terrific. Well, I hope everybody is having a great day 2 of the conference. We're excited to have EOG present at the conference this year and specifically new CEO Director, Ezra Yacob. Ezra, thanks for being here.

Yes. Thanks, Neil. I appreciate it. Congratulations on switching so seamlessly to a virtual format. Really appreciate the time.

Umang and I have a number of questions for you today, but maybe just give us a lay of the land, what's top of mind for you. It's been 2 quarters now that you've stepped into the CEO role and how has the transition been. And what have you been spending your time thinking about strategically in this new role?

Yes. It's a dynamic time to step into the role, obviously. It's been fantastic. Having Bill move into the Chairman seat on our Board and still being able to utilize our entire Board as a resource for us. And really here at EOG, it's always about the team. It's really the senior management team that's got a wealth of experience and knowledge to help guide us through what is a slow but sure recovery that we've been seeing. As we said on the Q3 call, we've had an outstanding year in 2021. We continue to strengthen our balance sheet, issued a number of special dividends and increased the regular dividend kind of commensurate with what we've been seeing as the financial performance of our company on the backs of drilling premium wells for the past 6 years, 5.5 years, and this year, really shifting into high gear with double premium. And we're excited to head into 2022 as we continue to see, as we said on the Q3 call, demand recovering, that spare capacity coming back online and all signs pointing to a continued positive environment for the industry.

That's a great segue. Ezra, maybe you can talk a little bit about the oil macro. What do you think is -- what is your near-term and longer-term view on the macro?

Yes. Umang, near term, like we said on the Q3 call, what we've been looking for, what we're really watching is 3 things. It's for the demand to recover to pre-COVID levels, which it is. It's getting back there. Still a little bit light on things like jet fuel and kerosene. But overall, trending in the right direction, very positive. The second thing we're obviously watching -- the second and third things really go together. We're watching the inventory levels to make sure that they get to or remain below the 5-year average, which they are also at right now. And then the last thing, of course, is the spare capacity that's off-line around the world. And earlier just this week, OPEC Plus continued to reiterate that they're following their announced schedule and bringing another 400,000 barrels per day online. And that's kind of the interesting thing as we highlighted on Q3 is just to see where that spare capacity really gets to. Obviously, there have been some problems on start-up, starting to see potentially signs of underinvestment over the past couple of years and to getting some of that spare capacity online. And so as we talked about on the Q3 conference call, we kind of forecast that those 3 things will really line up here in 2022 and really bring the market back into more of a balanced nature. So that's near term. Longer term, we're still very bullish on the global demand for both oil and natural gas. We think any energy -- long-term energy solution is still going to include a need for low cost, lower emissions, certainly, oil and natural gas. And I think the U.S. E&P sector and EOG is a leader in that sector is poised to be able to deliver that to the world.

Great. It sounds, Ezra, that nothing is changing with respect to your plans to grow production by 5%, back to your pre-COVID levels.

Yes. That's a good way to phrase it. What we said on the Q3 call, and we don't have any updates to that announcement was that if those 3 things are achieved in 2022, as we anticipate they should be, which they should be there, maybe as early as the end of Q1, spring time, maybe summer, again, depending on how that spare capacity really manifests itself. And yes, EOG would be in a position to return to kind of pre-COVID levels of production, which would be about 465,000 barrels a day, no more than 5% growth. But again, as we said on that call and as we're seeing, it's still kind of a volatile recovery here that we're in the midst of. And so we'll come out with our final plan here towards the back half of February. And that will really be the official time that we issue our '22 guidance.

Ezra, just building on that, I know it's too early to even look past '22. It's hard to even get visibility into the year that we're in. But there are other producers at this conference who've talked about running their business in a shale plateau manner to maximize free cash flow. It sounds like EOG continues to have a slightly different view on it, which is if there is a call on U.S. shale, you believe that you are a natural supplier into that post '22.

Neil, there are a handful of North American E&P companies. And again, EOG is one of them. EOG is a leader in them that I think we can supply the world. We can compete globally with the cost of supply, really do. Now that doesn't mean spare capacity. That's in an environment where you're talking about adding oil to the market in a heads-up manner. We can supply low cost and lower emissions barrels than many places across the world. And we do think that demand is going to continue to grow in the near term. And you're starting to see potentially the effects of underinvestment now for a number of years across the globe that could show up on a bit of a supply -- a little bit of a supply weakening in the near term. For us, we're going to take it year by year. We've talked about what we're planning on for '22 as we come out of this recovery. But going forward, yes, we do have a multi-basin asset. We have captured a very high return inventory across multiple basins. And we think we could deliver additional barrels to the market. For us, though, the thing to keep in mind is, every single year, growth output is not really the goal. The goal is definitely to get better in every single asset. And that to us is really what discipline is. It's not necessarily disciplined growth. It's really about disciplined reinvestment. And that doesn't mean investing when oil prices are high, 90% of your reinvestment rate or anything. What it means is investing at a pace where each of your assets is getting better year after year. We've got a great company today, but I -- our goal is on being even better tomorrow. And you do that by continuing to bring in higher return projects that lower the cost base of the company. And what we've seen in 2021 is we were able to do that even at a maintenance level of production. However, if the world has a call on oil and there's room to grow our low cost, lower emissions barrels into the market, we can certainly deliver on that. But our goal is to be the lowest cost, highest return producer, delivering low emissions barrels to the world. And we think that's the best way to deliver long-term shareholder value.

Umang, I think you had a question on gas.

So Ezra, you have a diversified portfolio of assets. You also have gas assets. So how do you think about the gas macro here more in the near term. We talked about being bullish longer term. But how do you think the gas macro set up near term? And how does that impact your decision to pursue more gas-related developments and exploration opportunities?

Yes, it's a good question. We are -- when it comes to gas versus oil, our premium price deck really kind of makes us agnostic to it. We consider it as a returns question first. So that premium price deck that we run our oil investments on is a flat $40 oil price for the life of the well. And our investments need to clear a 60% direct after-tax rate of return. And that's the definition of a double premium well. On the gas side, the price is $2.50, for the life of the well, again. And so that's really what governs -- kind of throttles our opinion on there. Now when we look at our most recent announcement, the Dorado natural gas play and how quickly could we ramp that up or provide a lot of investment into that, it falls back on to the disciplined investment model that we're talking about. We are cautiously, I would say, constructive on natural gas prices and demand in both the short, near and long term. So with Dorado, it really comes out to how quickly can we get in there but accurately develop that thing in a way that we're able to integrate the data, the earning -- the learnings that we have from well to well, how can we continue to build out the infrastructure, commensurate with our growth so that we're really optimizing the value creation there and the returns at the same time. That will really be the throttle for us. As we said on the Q3 call, we're wrapping up our second full year of development there in Dorado. We drilled in 2019, obviously pulled back in 2020 with the rest of our business. And we're wrapping up our second year there here. And the wells are outperforming the type curves, which is fantastic, and the well costs are trending right down the way you think they would at the end of year 2 in one of these resource plays. So we're very excited to have the option on that gas asset. We think it's basically the best geographically positioned gas asset in the country. It's in a drilling friendly area. It's just down dip from our oil window so we've got exceptional operational synergies along the lines. And then it's also well positioned with access to a diverse set of multiple markets where we can deliver that gas to. So I think you'll see it continuing to be a bigger piece of our business going forward. But we have a lot of optionality with it is the real takeaway.

When do you think, Ezra, that, that will move from point more of an exploration play to one that contributes a sizable amount of cash flow of the business?

Yes. It's -- I'm not going to put any hard guidance out there on the Dorado gas play. What I would say is a double premium returns at $2.50 natural gas price, the returns are phenomenal at spot prices like today. So it really comes back to growing that asset, again, in any of these unconventional plays. And this is just some of the experience we have being involved in nearly every unconventional North American play in the last 1.5 decades or 2 decades is you don't want to bite off more than you can chew. You don't want to get out too aggressively in the early learnings of any of these plays. And you also don't want to overbuild infrastructure at any given moment. You want to be able to grow your infrastructure at the right pace. You want to be able to integrate your learnings at the right pace. And that's really the way that you make these things durable and high return for the long term.

Ezra, let's talk about exploration in greater depth, which is where do you stand in terms of your additional prospects? And talk about inventory broadly because one of the pushbacks that investors sometimes provide EOG is, does the company have the organic depth of inventory if we're not announcing large new exploration plays? So how do you respond to that?

Yes. There's -- we don't have any concern on our inventory. We have 11,500 locations that make that premium hurdle and 5,800 that make the double premium hurdle. And so that's not really a concern for us. And really, our exploration play is -- it's not focused on expanding the already robust inventory that we have, it's really focused on increasing the quality of that inventory, similar to making the shift from drilling nonpremium wells to premium wells in 2016, the real emphasis this past year focusing on double premium as we've expanded that inventory and increase the quality. The next phase of our exploration is really focused on capturing the sweet spots across multiple basins, dominantly oil-focused opportunities of rock types and reservoirs that we think will provide the next step change operationally for EOG. Internally, as we focused on drilling double premium wells this year, we're seeing internally the immediate effects of that. We're seeing it on our direct wellhead rate of returns. We're seeing it on our finding costs. And we're confident that in the next couple of years, that's going to translate through to our financial performance, similar to how when we shifted to premium drilling, it took a couple of years to really show up on the financial performance. So our next step is really to capture some of these exploration opportunities. We've drilled 15 exploration wells in 2021. That was what we announced, and we've talked about. And it's across multiple plays. It's -- some of those plays -- some of those wells are initial wells in those plays, initial wildcats. In some of those other plays, we're more along kind of the appraisal, testing repeatability of that nature. What I would say, Neil, is in any of these plays, from where we're looking and what we're really exploring for, the risk is not necessarily if we're going to be able to produce oil and gas out of these wells. The risk on it is whether or not it's actually going to compete, command capital from some of our other projects that we've already captured. The read-through on that is, is it going to be significantly north of the double premium metric and additive to the quality of the inventory? Because again, that's really what we're after.

That makes a lot of sense. Well, let's talk a little bit about capital returns. And I know Umang has a number of questions around the asset base. So you've seen other companies, and we talked about this in November, that provided a very clear frameworks around capital return and one of the things both Bill and you have talked about was the importance of flexibility and that the company has earned the right to provide -- have more flexibility about whether it's optimal to buy back stock, do special dividends, and so there's value in having that option value. So just talk about your capital returns framework. How investors should think about it? And I have a couple of follow-ups afterwards.

Yes, Neil, they should -- hopefully, our message is out there that our framework is -- should be thought of as a consistent message that we've been executing on for close to 5 years now. When we originally came out with the free cash flow priorities in 2018, it was pretty clear that our #1 priority is commitment to a regularly growing and sustainable dividend. That's it. And we've proven that. We've grown the dividend from $0.67 per share to an announced $3 per share since the shift to premium drilling back in 2016. In concert with raising that regular dividend, one way we can be so confident that we won't cut it because we don't want to be in a position like that, and in over 20 years of paying a dividend, we've never cut it. And it's because of our balance sheet. We keep, as you guys know, one of the strongest, cleanest balance sheets across the industry. And we do that because at times, we've had to rely on that balance sheet. But again, we do it in concert with raising that dividend. That's one thing that gives us great confidence when we do raise it. That and the cash cost of the business continuing to decrease through our reinvestment hurdle rate. The next priority that we have and we've talked about are to expand the business through bolt-on acquisitions. These are small, surgical, strategic bolt-on acquisitions. These are not corporate mergers and acquisitions, nothing large scale. And we've highlighted those throughout the last year. We talked about doing -- acquiring 27,000 acres across 8 deals in the Delaware Basin. So that's the type of size and scope that we're talking about. And then the last one, of course, is with excess free cash flow, we're committed to delivering that, returning it to the shareholders in either the form of special dividends or in a share repurchase opportunity. And I think we've demonstrated our commitment to that this past year. We've issued 2 special dividends, about $3 per share in total. We paid one in July, paid one here in December. And in November, on the quarterly call, we announced that we had refreshed our authorization for a share repurchase. It's a $5 billion authorization. It's more of a shelf authorization. We plan to use it if we see an opportunistic time rather than more programmatically. And I think the big thing, Neil, to take away is it's our consistency of message that we trade on. We like the fact that we can -- we have a track record of telling our story, laying out our plan and executing on it. Again, it's a way that I think our investors value our message and they value our commitment to creating long-term shareholder value and being consistent with the message. Formula definitely works for some companies, works for a lot of companies, not just our peers, but even in the broader market. For us, we just -- we feel that if you run a formula, macro environment might change, you might need to tweak that formula. And while there's nothing wrong with that, that's just not the message that we send. It's not what we've done historically. And we prefer to set out a long-term plan and really kind of stick to it. That does require a bit more flexibility, though. The biggest thing I would say is in 2021, the feedback we've gotten is people are seeing our commitment to returning excess free cash flow as we accrue it on the balance sheet, and they're satisfied with that commitment -- that level of commitment and are happy, obviously, very pleased with what we were able to do in 2021.

Yes. And that might be the framework, right, Ezra, which is you want to run what is a minimum $2 billion of cash on the balance sheet or maximum, I should say. And so every -- maybe it's twice a year, I don't want to put words into your mouth, but there over a period of time as the cash builds, you can release that excess cash and depending on where the stock is, it's either in the form of dividend or a buyback. So I think the pieces are there to come up with the conclusion about how you're going to allocate the capital with the real key indicator, the amount of cash that you're accumulating on the balance sheet.

Yes, that's right. And you can appreciate when you're running a company our size, and we meet with the Board, obviously, regularly. It's a topic of conversation is what do we want our cash position to be? What are we seeing in the macro environment? What are we seeing in the near term, long term, things of that nature. You're right. Historically, we've said the $2 billion kind of allows us to run the business. It's like a cash reserve that allows us to stay out of commercial paper. We do carry some more cash on hand, like currently we are because we have an upcoming bond that will be due. So we've got strategic opportunities to allow that cash number to flex a little bit more. Obviously, we have a higher dividend now and that reauthorization in place. But in general, that's exactly the message. The framework is in place. We've demonstrated our consistency to it, and we're proud to be able to do it. We're very proud to be in a position where we've got a leading balance sheet, a leading regular dividend and still in a position with the strength of our asset base to continue to improve the free cash flow generation potential of the company going forward.

Ezra, I'll turn it over to Umang in a second, but to just round out this point around capital allocation. Given the confidence you're talking about, let's call it, around your exploration program, the depth of inventory, it doesn't sound like M&A is a priority for you.

Yes. No, it's not, Neil. We evaluate a lot of M&A deals. You can imagine that with the strength of our balance sheet, we get phone calls about different deals, various things of that nature. And we look to make sure that we're not missing anything. The challenge for us is it really starts with the strength of our pre-existing asset base. Again, the inventory depth is so strong and so deep that really to find quality acreage that could really command capital away from what we're already drilling, it needs to be very, very high-quality acreage. Oftentimes, these M&A deals also come with production. And when you're paying for production, as I sit here today and I talk about the reinvestment opportunities we have at these high returns, well, those aren't the same high returns you generate when you're just purchasing production. So it just makes it very, very difficult when we try to look at those opportunities as being additive to our own inventory. Conversely, with the organic exploration, we're not exploring for the same stuff that we're already in, the same reservoirs, the same rock. We're not exploring for areas within those. We're really trying to crack open new reservoirs, things that we think really are additive. And as I said, the trick with our exploration potential, our exploration program is really that it needs to be additive to the quality. If it's just going to add numbers, just inventory, I don't think that's the way that we really consider building shareholder value over the long term. What we really want to do is continue to strengthen the asset base of the company and bring those lower-cost reserves into the mix as quickly as we can.

Umang?

Before I talk about the asset base, Ezra, maybe quickly on the cost inflation side of the equation. Last quarter, you talked about targeting flat well cost year-over-year. And you mentioned that you secured around 50% of the cost. What are your latest views on cost inflation for 2022?

Yes. No real update since that Q3 call. It's still going to be pressure points on labor, fuel and steel are the main ones that we're seeing out there. For us, as you said, we've secured about 50% of our well costs. The thing about EOG is we've got -- our culture is set up in a way, the company is set up in a way with multi-basin portfolio, decentralized approach, utilizing technology to increase operational efficiency and being opportunistic about grabbing different pieces of the value chain and bringing those in-house, whether it's chemicals or drilling mud, drilling motors, some of those things that we've talked about in the past that we have a way of kind of insulating ourselves against some of those spot price increases. Now there aren't -- there's no way to get around some of the broader -- the more broad inflationary pressure points that I just mentioned. But we're offsetting those through some of those operational efficiency gains. We have good -- strong relationships with our vendors. And we're implementing some things throughout 2021 and into 2022 that should allow us to keep our well costs flat in 2022. And that's after a year in 2021 where we met and exceeded our 5% total well cost reduction goal and actually extended that out to a 7% well cost reduction goal. So it requires a lot of heavy lifting. But really, the value is always created at the front lines in EOG. It's created in our asset level teams and the division offices, and those engineers and geologists are working every day just to drive down the cost and increase the well productivity, and they're very good at it.

Great. That makes sense. Ezra, I'll pivot to asset level questions, and maybe I'll start with the Eagle Ford. And this has been an area of concern for a lot of investors, the play itself that it is very mature. And productivity on an adjusted for lateral basis has been declining over the years, even as your well costs have reduced. So how do you see the return profile of Eagle Ford going forward? Do you feel like we are at a point where you won't see -- we won't see any productivity declines in the basin going forward, specifically for EOG?

Yes. No. The Eagle Ford is definitely mature. We've been drilling there for over 10 years now. And I still feel that it is a fantastic resource. I mean your point is a valid one. The productivity gains have obviously gone down as we've moved into the parts of that play that are less pressured. But with that, obviously, becomes -- there's some less faulting in there. We've talked about that, and that's one way it allows us to drill longer laterals. The important thing is, is that productivity as you move into areas that might have less productivity, as you develop these plays and they become a mature asset, have you taken the steps early on to be able to create high returns when you have to move into those areas. And what I mean is, have you built out the correct infrastructure to keep your operating cost down? Have you put in place the correct technical advancements? Have you been collecting rock quality, log quality to make sure that you're able to drive down those well costs and increase the well productivity as much as possible? And in the Eagle Ford, in fact, we have. The amazing thing is that 2021 was the highest return program that we've ever had in the Eagle Ford. And you're exactly right. We've actually moved into areas that have a lower well productivity. But the fact of the matter is, over the last decade we've been drilling there, we've collected enough data and built out the infrastructure in a way that's allowed us to optimize that return profile. So is it still a main growth driver of EOG in year 11, 12 of drilling? No. No, it's not. Is it a major return driver for EOG? Yes, it certainly is. And we kind of -- we're very excited about the potential of the basin for really years to come.

Let's pivot to the accrued driver for the company, which is the Delaware basin. So how do you see the productivity evolving for that basin? And is there room for further innovation to bring costs down and improve the positioning of the asset on the cost curve?

Yes, I believe there is. I think for the companies, and again, this is -- harkens back to what I was talking about a few minutes ago. For the companies that have the size and scale to really continue to collect data and test. The companies that are sophisticated enough not to get -- fall into a manufacturing mode trap, I think those companies, including EOG, have a little more room to run on the productivity side. It's a phenomenal basin, with multiple targets. And especially some of those shallower targets, EOG has been developing mainly focused on our Wolfcamp target here. And as we drill through these shallower targets, we're constantly collecting data as we drill down through it. And so think about the way I just described year 11 and 12 in the Eagle Ford, and the way that we proactively collected data and built out infrastructure and allowed ourselves to have our highest return program this late in the life of that play. That's the same way you should be thinking longer term about the Delaware Basin for a company like EOG. We're still developing the Eagle Ford, collecting -- or developing the Wolfcamp and collecting a lot of data on the shallower zones. And we feel that we're still unlocking little pieces of data that allow us to improve that well productivity. And with the efficiencies as we build -- continue to build out our infrastructure, it opens up different parts of the basin that allow us to drive down the costs.

Great. And my last question on the assets is on Powder River Basin. You talked about innovation driving productivity improvement in the basin. Walk us through how PRB is competing for capital versus other basins. And do you see room for PRB to attract more capital down the road?

Yes, I really do. The Powder River Basin got our pace of development there and our pace of integrating learnings really -- it was probably more affected there during the pullback in 2020 than anywhere just because the -- where we were in the life cycle of that play. I think we've got a slide in our Q3 earnings deck that I'd encourage everyone to look at on the Powder River Basin that shows the cost advancements that we made in our Niobrara play up there. The total well cost reductions have been really fantastic. The team's done a great job in 2021. And we continue to -- where the pace of that play is make great strides in delineating the different parts of the basin, high-grading the specific landing zones, and we see a lot of upside. The fantastic thing about that basin, it's very similar to the Permian, and you've got 2 widespread, well-known, very robust source rocks in the Mowry and the Niobrara. And in and amongst those 2 source rocks, you have a number of hybrid opportunities, silt zones, sand zones, a whole section of reservoir that really provides itself to horizontal drilling and completions as far as when you think about the geo mechanics or how that rock is really going to break. We're very excited to see the progress that we've got in the Powder River Basin. And I think you'll continue to see it improve and become a bigger piece of our story.

Ezra, I'll round it out on some housekeeping modeling type of questions. But there are 2 things that we get asked about a lot which is cash tax position and your hedging strategy. Any thoughts on both? One of the good things about being profitable is that you're profitable, but well, the bad thing is you have to pay taxes. And being unhedged has been or more unhedged has been the right call for the company. But with the curve having lifted, do you feel the need to layer [ internal ]?

Yes. We'll -- so yes, we'll be in a cash tax -- we're in a cash tax paying position. That's how it goes. And we're a profitable company, as you said. It's something that we're proud of. That's a sign of it. It unfortunately hasn't happened very often in our industry, but we find ourselves in that position, and it's something that we're proud of, and we own it. And going forward, that's what we expect to remain. And we think that, again, as I say, there are a few companies in the North American E&P space that are competitive in the cost curve and have the size and scale moving forward. I think you'll see for a handful of companies, that starts to become a bit more of the norm. With regards to our hedging strategy, nothing's really changed there. We like to head into a year if we see the opportunity of being hedged about 20% to 30%, somewhere in there, it really helps with our budgeting strategy. It helps with our line of sight. Think of it as a way, again, we don't manage the business, the company on a short-term, quarter-by-quarter basis. We really manage it for the long term. And so having a pristine balance sheet, having a little bit of certainty on the hedging side allows us just to run the business a little more fluidly and a little more long term with regards to things like marketing contracts, takeaway, rig contracts, things of that nature. This particular year, we saw the opportunity to layer in 22 hedges at $65 oil on an average, which is fantastic. When we're basing our return investments -- when we're basing our investments on a return profile of 60% at least direct at a $40 flat price deck, 65% is fantastic. And we're able to -- this year, we're entering '22 with about 70% locked in at that 65% number. So really, we're allowing our investors exposure to a 70% upside in that oil price which, as we are entering '22, things are stacking up pretty well. Now obviously, it's a very volatile time still in the recovery. It's early in the recovery of this pandemic or endemic. And so we'll see how it goes. We feel very happy, very pleased with where we ended the year on the hedge book. And really, that's a -- it's been a consistent strategy that we've seen really allows us to run the business and has really worked for us very well for the past few years.

Well, Ezra, thank you on behalf of Umang, myself, Goldman Sachs and our clients, congratulations on assuming this CEO role. Thank you for being here at your first Goldman Sachs Energy Conference as a CEO, and referral for you guys to have a good 2022. It's going to be an important year.

That's fantastic. Thank you, guys. Thank you for all the support, and thank you for perseverance switching this thing to a virtual. I think it's been a great conference, and I'm very excited to see all the energy and the positivity out there. So you guys have done a fantastic job and look forward, hopefully, to seeing you guys. So stay safe.

Same to you.

Thank you, Ezra. Take care.