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

There we are. Good morning. My name is Bob Brackett. I cover Americas Oil and Global Metals and Mining for Bernstein Research. Welcome to the 40th Annual Strategic Decisions Conference here in New York City. We are not expecting a fire drill. So if you hear a fire alarm, please take it seriously. The primary exit is straight to your back. It's a stairwell marked N. That will take you 2 floors down, and it will take you out to Fifth Avenue. If for whatever reason that path is blocked, go out to your right, back to the escalators, and take those down and exit on to 54th. Ultimately, this is your conversation. We call it a fireside chat, but you should drive the content. To do that, Ian or someone in the room can pass you the QR code on the sheet of paper. Use your smartphone, you can log and ask those questions and send them up. While those questions are coming in, I'll try to drive the conversation like a pyramid. We'll start up high level, then we'll work our way down the pyramid into deeper and deeper questions. So that's where we're headed. It is my pleasure to introduce Ezra Yacob, the CEO of EOG Resources. And what we will do, there's no formal presentation. We will simply -- I will adjourn now -- sit down and we'll start to talk. And I'll start. I heard I'm the only Bernstein analyst that tells you where to go in case of an emergency. That -- and that's something that was trained into me early on in the oil patch. It's something that you'll see at every oil and gas conference and mining conference. And so for a financial conference, it's a little out of place, but it kind of goes to the roots of what the oil and gas industry is.

So why don't I just kind of turn it over to Ezra. Who are you? Who is EOG Resources before we kind of jump into macro questions?

Yes. No, I appreciate the introduction, Bob. Glad to be here on the 40th event. It's always a great event. I was just talking about how we really appreciate the people who show up in the longer meetings that you actually have here. It makes it nice to really get into the story. For EOG, we're a $70 billion market cap company. We're one of the original unconventional players, but even before that, we're a company that really has its roots back in the mid-'80s. And throughout the '90s, we really developed a culture and a company that focused on organic exploration. And that's really what we've maintained throughout today. We consider organic exploration and organic growth through the drill bits to be something that keeps our cost base is low. And it's really the basis for our value proposition. Our value proposition really is to deliver long-term shareholder value through the cycles. So we try not to lean in on the commodity price swings. We really try to build the company to a point where we can weather the commodity price swings. We can deliver value through downturns, but it offers significant upside when times are good. And really, it's got 4 kind of principles that we focus on. The first starts with is capital discipline. The second is operational execution, operational excellence inside the company. The third is to be committed and a leader in sustainability. That's environmental performance and safety. So I appreciate you starting with the muster point. And then the fourth is focusing on the culture because that's really what drives the first 3. We're a truly decentralized organization, meaning that we have satellite offices where the asset teams live and work, and we are focused, 24/7 on trying to push decision-making responsibility and accountability out to the field, to the asset teams. And that's really what drives the business. That's really what keeps the organic exploration, the innovation going across the company.

Well, I heard organic and I heard capital discipline. I have to acknowledge the fact that the top of Bloomberg today is not EOG Resources; instead it's 2 peers, ConocoPhillips and Marathon, that have announced an acquisition of one by the other. You have been fairly -- in EOG, prior to you, have been fairly steadfast about the organic path. What does it take for you to do something inorganic? And why the hesitancy which has obviously worked for you?

Yes, I don't know if I'd call it hesitancy. It's just it's a data-driven decision. And so we look at mergers and acquisitions, whether large scale or even small bolt-ons, even trade, trading acreage around. We look at it through a returns-focused approach, kind of returns lens. So when we have done a large merger and acquisition, the Yates merger and acquisition back in 2016 and '17, it was something that brought acreage that was very contiguous with our existing acreage. We could immediately start drilling wells and realize some synergies there and put some of the producing wells in the oil infrastructure. At the same time, it did not come with a lot of production, which is when you're drilling high rate of return oil and gas wells, buying production and oftentimes, it's just a lower return endeavor. We look at things like acreage trades or small bolt-on acquisition opportunities, which we do. Last year, we acquired an acreage position for about $300 million in the Utica. It really just has to cross a couple of hurdles for us. And the first and simple one is, is it additive to the existing inventory that we have? Are we excited about getting the acreage? And the thing I would say is you should be willing to take a rig off of something that you're drilling and put it on what you've acquired. That would tell me that, all right, well, that's definitely additive. That's exciting. Buying something where you're actually not going to drill it up for a little while. Even when we trade acreage, when we ask our asset teams, they propose, hey, we want to get this acreage in a trade. We want to pay cash for this acreage, we want to lease this acreage. One of our first questions is, okay, well, why? What's the value proposition on that acreage trade? When are you actually going to drill it? If they say, well, we've got a rig moving out there right now or we've got plans to be out here next year, and this will lengthen the laterals, that's fantastic. It's great. If they say, well, it fills in a hole, but we don't really have any plans to develop this for the next 6, 7, 8 years, I mean, that's not something to really get very excited about. You're stacking up inventory in the long term. For us, we've got about 10 billion barrels of equivalents resource that we've captured across the U.S. and in Trinidad. And that's resource that covers our premium metric, our premium hurdle rate, which we measure that on the wellhead rates of return. I know it's a little bit difficult for everyone to model, but it's basically a 30% after-tax rate of return at $40 oil price and $2.50 natural gas price for the life of the asset. And that's how we kind of judge our investment criteria on the wells. And so when we roll up kind of the acquisition opportunities, mergers and acquisitions, when we look at them, dominantly, they come with a lot of production, so it's a low rate of return. And dominantly, they're in known place, which is going to come with a high dollar cost as opposed to the organic exploration effort. And as long as we can continue to explore and discover opportunities that are additive to the corporate portfolio, for us, that makes more sense on a full cycle returns approach.

I'll come back -- I have to come back to exploration, but I'll stay at a higher level first. And we'll talk about oil price. I want to bring it back to that $40 oil, $2.50 gas. But what's your view or general list of them, how should they think about oil price through the cycle? What's the next bottom of the cycle? Like top of the cycle?

Yes. Well, I don't know if I'll put hard numbers out there when the bottom or tops are going to come, but I'll put some framework around there on how we think about it. The first data point on the low end is COVID, is 2020, right? It's a difficult time for everyone. The positive on it, is it gave us a really good marker, okay? We had $38 oil over that 12-month period. And the oil price whipsawed back pretty quickly. So I think it's pretty safe to say that that's -- over the long term, that's an unsustainable oil price right there. At the same time, I think you see just in the last couple of years with some of the geopolitical activity driving up oil price, you kind of see the higher end. I think you find ourselves in a world -- and this is the same as everybody else is going to say, you find yourself in a world of a $60, $65 to $80 type of mid-cycle price range. That's where we think it's going to end. Quite frankly, in the past 5 years, if you look back, WTI, and that's WTI I'm talking about, not Brent, WTI has averaged about $65 oil. If you look at the previous 5 years, WTI has also averaged about $65 oil with all the ups and downs on it. So we feel like that's a decent starting point for the mid-cycle price. Where are we at right now? Well, there's a little bit of manipulation out there, right, with spare capacity that's kept off-line. There are some geopolitical barrels that are kept off-line. But quite honestly, that's almost always going on in the background. What we see going forward is post-COVID now, oil demand has generally lined back out with GDP at slightly different slope than what it was pre-COVID, but it looks like demand is still growing and continues to grow not only in the U.S. but in emerging economies globally as well, which is exciting for us. And then on the supply side, I think everybody can see that U.S. supply is mitigated. We don't forecast necessarily that U.S. supply will flatline or start to shrink or anything, but it is going to be more and more difficult for the U.S. to grow for various numbers of reasons. The first being all the growth for the U.S. over the past decade, a dominant amount of growth, has come from tight resources, which brings with it steep declines. The second piece of it is what we talked about just a minute ago, is that there are not a lot of companies out there that are exploring. There aren't really any companies out there exploring for new resources, EOG being one of the few. Dominantly, what you're seeing is growth of companies through consolidation, which isn't necessarily going to drive U.S. growth.

And on $65 oil over the last 5 years, what I could say is during that last 5 years, there were times where EOG was growing oil 20% a year. Now EOG is growing low single digits, and there were times when the entire sector was overspending and flooding the market. And now the whole sector is kind of growing the low single-digit growth. So that $55 world was a poorly behaved world that feels like we've moved past. Clearly, EOG has discipline. What's your view? Consolidations of are [ forming this ]. The bigger you get, generally the slower you tend to move. Is the last 5 years of bad behavior fully over? Or do you have to count on that returning?

Yes. I think for every company, it's different. For EOG, I'd say we've generated positive free cash flow every year since 2015. And so even throughout the time period, we're growing very aggressively. I think more important for us, the way we view it is it's 2 things that really we take into consideration every year when we think through our capital discipline or our capital allocation. The first is internally, what can we manage? What can we manage to optimize returns? I know people like to say that growth is an output, but it really is for us. We have a multi-basin portfolio. And so we look at each of those assets and try to capitally allocate so that each asset is improving year-over-year. And there are different ways to look at that. Rate of return is one on a fixed price. The easiest way to look at it is on planning and development costs or cost reserves. It's only going down $0.01 every year. Then you're basically getting better. And what you're going to do with that is lower your cost basis, maybe slightly, but nevertheless, you're lowering your cost basis over time. And what we look for is margin expansion, not just from top line revenue growth, but from really working the cost basis down. That's the first part of capital allocation decisions. The second part of it is obviously a recognition on the macro environment. And I would say that is maybe a portion of where industry has changed. Certainly EOG has. But the demand cycle has changed as well. Demand was growing more like 2 million barrels a day year-over-year during the 20-teens. Now it's growing plus or minus maybe 1% or so. And so you've got a bigger recognition on just the idea of does the market actually need the barrels that we're producing, balance versus what are the optimal levels of reinvestment to really optimize near-term free cash flow generation, long-term free cash flow generation and ultimately, the returns on the investment.

And a final point, then I'll move. What -- $40, what has been your double premium planning price, pre-COVID, $40 pre-COVID's stimulus ain't what $40 is today. So you could consider bumping it up just on inflation. But let's compare that $40 oil against $2.50 natural gas. What I was going to say, and I've tweaked it this morning, so I would argue that I look back and last 10 years, we spent less than 10% of the weeks below that $40 target. We've spent probably 1/3 of that time below that $2.50 target. And I thought, well, therefore, you need to adjust those 2. Then I thought about it and said, well, actually, if oil collapsed, you guys are much more exposed than -- you are much more sensitive to oil than gas, and so maybe it's fair to have a more stringent barrier at all. So having said all that, is $2.50 Henry Hub the right price for planning for double premium?

Yes, it's a good question. So the $2.50, like the $40, so we think about it for the life of the asset. So those gas wells, call it, 20, 25 years of production. What's it going to look like? I'll take you back to what we were just talking about a few minutes ago. In the last 5 years, and it's not cyclical. It's not a pure cycle. It's not a nice wave for them, but gas has averaged about $3.50. The 5 years prior to that, it's averaged about $3.60 on Hub. Differentials are what they are. And so yes, I think the $2.50 is in line. Now your point is a valid one, is that gas is not a nice cycle. Gas is off for a long time, and then it's on and when it's on, it's massive and then it comes back down. That's more -- that more speaks to our marketing diversification and strategy on that side. You cannot chase arbitrages. They happen really fast, and they go away really fast. And gas is a perfect example of it. So that's one the reasons on our marketing strategy. We talk about control, we talk about duration, flexibility and diversity of markets for our gas. In general at the company, we talk about diversity of products as well, both gas, oil and NGLs. It's one reason with our gas project here in South Texas, Dorado, we're very excited about being geographically located close to LNG and having the LNG offtake that we've captured so far is that even though we're selling at dockside and we're not getting exposed to any of the risk onshore or abroad, we're getting those molecules exposed to international pricing and international markets. What that means is you're exposing yourselves to the various arbitrages that happen soon on the global scale, not just the domestic scale. That's how we approach it. Gas is a difficult business. You have to be absolutely committed to being a low-cost operator. So when we go back to capital allocation, the rate at which you can grow, you really have to make sure you're keeping your cost down. You cannot -- if you go back to 2022, in August, gas was $8, I think, and by the time -- whoever picked up rigs and started drilling gas wells because they thought they saw a good arbitrage there, by the time, January hit, gas was back down to $2. It's the exact opposite of what commonsense would think when you're hitting in the middle of winter. You have to be diligent to be providing low-cost gas and keeping your costs down through the cycle on that. Gas is such a skinny margin, you can make up for it because it's easy to produce and it's very abundant. You make up for it on the margins. And you've got to have your gas in the right locality to capture those arbitrages when they present themselves.

Gas swings literally from a waste product, you have to pay to dispose of, not you all, but in the industry, in market. Life support machine, right? So gas markets, you mentioned the LNG market. There is an LNG wave coming, starts maybe 4Q [indiscernible] past LNG and there's a nice steady ramp. There's another market emerging for gas in the data center -- and I'm reluctant as the oil and gas guy to start talking about AI data centers. But how do you think about that opportunity given your footprint in the Utica?

Yes. We're excited, not just with the footprint in the Utica, but still with Dorado and all the gas that we've captured in the company. Let's say, natural gas demand in the U.S. right now is 103 Bcf/D or 104 Bcf/D, depending on what the rest of this year holds and the power demand over the summer. You're right, from 14 Bcf a day of nameplate capacity for LNG, you basically got another 10 or 12 under construction that's coming. In addition to that, what we forecast in the back half of this decade is just about another 10 or 12 Bcf a day natural gas demand growth from not just data centers, but almost more important than that, it's just coal power -- coal-fired power plants retiring, which is basically line of sight as well. It's Mexican imports, it's increase in industrial. And then alongside data centers, it's also just EV penetration and demand. So there is an emerging demand on the natural gas side of quite frankly, growth -- a market growth is quite a bit larger than what we see on the oil side. Now it depends on -- a lot of it's going to depend on -- there's a lot of talk about where those data centers are going to reside. Are they going to be in the Northeast and be well positioned for the Utica? They might be. We need to get some power plants approved there. Are they going to be -- I know there's talk about having them in other places in the north, across the northern part of the U.S. to keep cooling costs down. You're trading off cooling costs for energy loss through transmission. Or are those data centers actually just going to be closer to the source of supply and things like that? Either way, we feel very confident that we're well positioned and well supplied with our multi-basin approach that we should be able to capitalize on the increasing demand.

If data centers move to supply, in your multi-basin, you've got it. If you have to move to the data centers, California, any thoughts about not accessing that sort of market, is there any way EOG's gas footprint could touch the West Coast?

Yes. So California is a pretty constrained market, the specific ones that you picked. It's a pretty constrained market. We do have a little bit of gas that goes over there, a little bit of legacy capacity on pipes. But I think, in all honesty, if you're talking about data centers going out there, the state must be supporting at least the extension of nuclear out there in California. That's the opportunity.

David -- talk about ESG. We do have a question, and again, you have QR codes, I encourage you to send in questions. What role do you see EOG playing in decarbonization and net zero carbon goals for the energy industry?

Yes. So it starts with staying within our lanes, our core competencies. So investing in renewables or anything like that is not -- it's not ancillary to our business. That's not in line with what we do. Our strategy for our net zero ambition and our near-term CHD and methane emissions intensity reduction goals, which were set for 2025, and we've actually achieved, it's an approach that's in line with our core competencies. The first is reduction, just operational reduction of our Scope 1. Those are things that we know. It's designing better facilities, things of that nature. It's eliminating flaring. Step 2 or not necessarily the second tier, I'd say, of our strategy is capture. We are investigating some carbon capture and storage. We actually have a pilot project up and running approximately the last year or so. And that is, I would say, potentially one of our core competencies. We understand the subsurface exceptionally well. And for a small point source, kind of fit-for-purpose design in carbon capture and storage, I think that's something we can develop. We've got strong in-house facilities engineers. And then the third approach is -- the third part of our strategy is offsets which that's a piece of the strategy that we're monitoring right now. We're not participating in it right now. We're supportive of that market, but we need to see how that market develops here domestically. It's still going. So going back on some of these things, the carbon capture and storage project we have, it's a bit more fit for purpose. I wouldn't say that we're along the same lines of maybe the majors or IOCs where we're thinking about capturing carbon from whole cities and storing it offshore beneath some salt dome or anything like that. We're really attacking it more with in line with our core competencies, which is fit for purpose, smaller by design, identifying smaller potential reservoirs for storage and sequestration. We're using basically off-the-shelf technologies right now for our carbon capture and storage. It's a pure stream of CO2 that we're capturing. But we're using it as basically a living laboratory. That's why I say it's a pilot project. We're utilizing some exploratory efforts on exhaust gas capture and things like that area to see how we can kind of drive that forward. That's really the role that I think you see us playing is, we're a leader in the industry, obviously. We're a large producer here domestically. And the fact that we've already met our near-term emission targets; the fact that we have a net zero ambition; the fact that we're committed; we've already achieved zero routine flaring years ahead of when the World Bank initiative has organized that people do it; we're a partner within OGMP which is really based on accurate measurement of methane, I think those are the things that position us to be a leader long term. And it's something that our employees want. It's something our leadership wants. It's really something that all of our stakeholders want.

If you go back 5 years ago, EOG hosted ESG investors out in the Permian on a site visit. And one of my takeaways at the time was things like omitting routine flaring, you're capturing a product that you can sell. So it's a double victory. You've avoided emission of hydrocarbon and you've captured a revenue stream that you can put to use, turn to electricity. At the same time, even moving away from methane at -- for controlling valves, et cetera, bleed valves and moving it to something that's inert, nitrogen was easy because you can still capture that methane and turn into electricity and put it to utility. And that served you well. How do you think about CO2 where it is harder to put that utility? At what price do you need? Have you gotten far enough down to determine, to understand what the range of prices that would make sense?

Yes, we have as far as generating a return. I'll be honest with you, any of these opportunities, methane's one thing because if you're talking about flaring the methane or just emitting methane, well, by capturing it, your rate of return on that is infinite, right? Because you're selling something that you wouldn't otherwise be selling. And we've designed some proprietary technology, things like closed loop gas capture which allows us to avoid flaring by -- picture a downstream interruption, instead of the gas going to a flare, we simply reroute it basically through a facility, i.e., closed loop or we [ elected ] down a nearby well, wait for the downstream interruption to clear and then we turn them round and stuff like that. So that's very [indiscernible]. Some of these other opportunities, for these things actually to be sustainable for the world, they need to generate some sort of a return. Now it's not going to compete with some oil and gas wells, the latest -- not oil and gas wells we drill. It's just not going to compete with that. But if it can cover things like cost of capital plus some, then you're getting to the point where you want to be because longer term, I think, to be a player in the long-term energy solution, our goal is to be the lowest cost, highest return with the lowest environmental footprint producer of oil and gas. I mean that's what it's going to take. This is just part of what it needs to be done. On the CO2 side, I'd say working through the final economics on it is basically -- that's a part of what this pilot project is about. We did start with a pure strain CO2 [ story ]. For a number of different reasons, the permitting is easier. The [indiscernible] is easier as capturing and sequestering the CO2 is much more straightforward. It's really going to be a difference on the size of the prize or the size of a plume versus the amount of facilities and infrastructure or gathering that you're going to have to do. For established fields, things like the Permian, I'll be honest, it's going to be a challenge. You've been drilling in this basin for 70 years. You've got facilities scattered all over the place. And so capturing these smaller sources of CO2, extracting them from exhausts and then compiling them and aggregating them to a point source where you can put a downhole is going to be a challenge. For some of the newer fields that have been developed more recently, where you've got -- since you've had this, let's call it, an emissions kind of awakening in the last 10 years, those things are going to be lined out a little bit -- designed a little bit differently, and I think those have a lot more running room to make a bigger impact in the future.

Yes. Well, even if it's scope 2, distributed point source is out in the Permian or even scope 3, distributed point sources like the taxis out in front of a building, those are very difficult to drill. But you have the opportunity if the technology works to go find someone else's concentrate and that's probably [indiscernible]. That's logically where you might [ start ]. We have a question on [ healthy ] strategy. And I'll put that in the context of you aim and often are the low-cost producer. Your balance sheet carries cash. So you're negative net debt, positive net cash. You weathered COVID with modifying operations and shutting in some well, but you got through COVID and rebounded. [ Off ] to your hedging strategy would question, then talk to the greater issue of, are you taking enough risk as the guys sitting outside the arena?

Yes, sure. No, you lined out the answer perfectly for me. I mean I think our hedging strategy has changed in years. I think on the oil side, we're not looking at it. We're in a position where our low operating cost below breakeven is the first thing. The second thing is the strength of our balance sheet, which is a pristine balance sheet and it's a strategic advantage in this industry. And then the third thing is what we saw during COVID, which was different from 2014, the downturn there, is during COVID, the way that we structure our contracts, the way we run our business, we're able to scale down very, very quickly and reduce our CapEx to a point again where we generated some free cash flow during that year. So on the oil side, we don't really see necessarily any reason to hedge and take that opportunity for upside away from the investment community. We feel that, obviously, if investors are investing in our company a, they like our strategy; they like our assets; they like our low-cost basis; but, b, they also have a favorable outlook on the energy prices. And so we should leave our operators exposed to that or our investors exposed to that and basically do a hedge on the backside on our operations. On the gas side, we do actually have some hedges in right now. We knew that we had this LNG agreement that if we'd entered into -- right now, currently, we've got about 140 million -- 140,000 MMBtu a day that's going offshore, it's exposed to LNG prices. That goes up to 720 -- 720,000 or 720 MMBtu a day with the startup of Stage 3 at Cheniere. To bridge that, since we knew we'd be putting some investment together, we did go ahead and step into some strategic hedges on the gas side, which, just like we got done talking about on gas, at one point, it looked like a really bad decision. At another point, it looks like a decent decision. But ultimately, that's a little bit of a different approach. There was an operational and strategic reason to step into that. Longer term, I think as we build this gas business, and that's the way to think about it, is we're right now investing to build a premium gas company alongside an established premium oil company under the umbrella of EOG. As we develop that out, I think we'll arrive at a point where the idea of hedging for gas would really remain on just the most opportunistic of [indiscernible]. And other than that, we can basically manage our business on tax by controlling costs, controlling activity levels, maintaining a strong balance sheet.

One of the benefits of that cash flow comes to the question that's been asked to, which is the capital return philosophy. Historically, it's been returned more via dividend than buyback. And I would argue more versus a fixed dividend than variable dividend in contrast to peers. Any specific reason why?