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

All right. We're really excited here, Umang and myself to welcome Ezra from EOG to this conversation about balancing growth versus free cash flow generation. Ezra, thank you so much for being here today.

Yes. Thank you. It's been a good conference. I had some great meetings. I appreciate being back in person.

Yes. It's nice to see everyone and a lot to celebrate over the last year in the energy sector and hopefully more to come. As we think about EOG, what do you think is underappreciated in the conversation -- in the stock and in the value of the business right now?

Yes, that's a good question. That hits right at the meat of the matter. I mean, I think what you have with EOG is we have a very different [Audio Gap] a lot of the rest of the E&P space here. It starts with our multi-basin portfolio. We are -- we see a lot of advantages, a lot of leverage to being able to build and work across multi-basin asset base. That base has been created dominantly organically as well. It's taking information and technology that we have from one basin, applying it to the next. And then as we develop new technologies in the new basin, we extrapolate those back to the previous basin. Much of that inventory has been discovered and found and based. And the investment decisions were all based on our premium pricing deck. That deck is a $40 WTI oil price and a $2.50 natural gas price for the life of the asset. And so as we add new plays, new exploration areas, new basins, you think about that is that we're only adding things that are additive to the preexisting inventory. And for us, it's not inventory unless it makes at least a 30% and dominantly right now a 60% direct wellhead after-tax rate of return based on that price deck, $40, $2.50 natural gas for the life of the well. I think that's the first thing that's underappreciated. The second thing that's underappreciated is the fact that we support that by being a low-cost operator. And we really do that in 2 ways. We focus on it by utilizing technology to increase operational efficiencies, so sustainable well cost reductions. That's just less time on location is essentially what it comes down to drilling, keeping the bit on bottom, not having to make trips. The second thing we do is we strategically look for opportunities to bring different pieces of the value chain in-house. Historically, we've done that with sand, chemicals, water. Recent years, we've been doing drilling mud and more recently, things like drilling motors. The third piece of differentiation for us is our financial policies, our cash-return strategy. We're still focused dominantly on the regular dividend. We look to increase in a sustainable manner, the regular dividend because we really think looking forward, that's the hallmark of a great company, not just in the E&P space, but across the broad market. That should be telling the investment community what we think the increasing and ongoing capital efficiency of the company is. And we're proud that we were able to raise that 10% this year again. On top of that, we've made a commitment to return a minimum of 60% of our free cash flow every year. This year, we're on track to exceed that. We were able to return just over $5 billion to the shareholders, inclusive of the regular dividend. All of that is also supported by what I think is the industry's strongest balance sheet. We have a strong cash position, very low debt, and that provides us a lot of counter-cyclic opportunities to make investments that otherwise we may have to think twice about. We're a safety and environmental leader. We're utilizing technology to drive down our emissions intensity. We're using technology to use things like carbon capture and storage pilot project that we'll be starting up this year. We've instituted some new technology called closed-loop gas capture to eliminate flaring. And we also just announced and are rolling out iSense, which is some continuous methane monitoring across all of our assets. And the thing that really is our competitive advantage that really makes us special is our culture. This is ongoing for 30 years now to create a decentralized entrepreneurial, really business-minded interdisciplinary group of employees that work and live close into the field where we have our assets. Those are the things that I think are really underappreciated and those are the things that really create a very interesting and unique value proposition for the investors.

Thanks, Ezra. Let's start on the macro. And I know EOG over the last couple of years has really started to build out some organizational capability around forecasting commodity prices scenarios. Talk about how you're looking at the oil balances in 2023.

Yes, there's a lot going on, but at the same time, you can boil it down to kind of a few things. We entered this year looking at the operational capabilities in the U.S. to kind of build a model on U.S. growth. We looked at the supply-chain constraints that are out there. We looked at the rig utilization, frac utilization, things of that nature. And we forecasted that growth would be significantly [ muted ] from where it's historically been, and that's what we see coming up. And we're kind of looking at that same type of direction going forward into 2022. On the global scale, on the real macro though, the things that are moving forward that we're looking at, and there's a lot of the stuff that we talked about on the last call, not a whole lot has changed quite yet. But obviously, the Russian sanctions, how are those really going to play out? So we've got crude sanctions in place now. In the first part of February, we should have some product sanctions, so we think we'll have a bit of a bigger role. And then obviously, another one on the supply side, we've got lower U.S. growth. But ultimately, the SPR has been a very, very big driver. When you look at what the SPR has done, we're basically at the same level of inventory where we were roughly a year ago. But the SPR has arbitrarily added about 650,000 barrels per day on an annualized average. Now all that really came in the last 6 months of the year. So basically 1 million barrels a day. And that is finished. There was a small release here. There are a couple more small releases. But dominantly, the majority of that is going to be done. And so on the supply side, we definitely see some tightening. Now on the demand side, it's a little more difficult to see. We'll see what happens with the recession that a year ago, I think all -- many people thought were going to be here by now. We'll see how the recession plays out on demand. What we've seen over the last, I would say, 4, 6 quarters is that dominantly energy demand and use has been pretty inelastic with recession fears. But then the second one, the big one is China demand and China recovery with 0 COVID being taken off the table now. I can't tell you when China recovery is going to come back. I assume it's going to kind of ebb and flow. But I think it's safe for all of us to assume that China demand is going to come back. And so what you see is, going out throughout this year, well with front months are showing some lower pricing due to what we think is the inventory level is heavily influenced by that SPR. You're going to get to a spot this year where we're forecasting pretty tight supply and demand balances.

Talking about the gas macro, Ezra. How are you thinking about the setup near term, especially after the weather has really spoiled the gas party recently? And then how do you balance that versus your organic growth plans for 2023?

Yes. We're very well positioned on the natural gas side with Toronto. And I'll get back to that in a minute. But on the macro gas side, yes, gas is always difficult, right? Because you have to work up your oil macro first, so you understand what's happening with associated gas. And then ultimately, you need to come down to what does the weather look like, which is a difficult thing. So as we sit here today, obviously, price has pulled back pretty dramatically in the last month. And a lot of it has to do with 2 drivers. The first, obviously, it's been a warm start to winter. That's the first thing. The second thing is not unlike the SPR, but you've arbitrarily had 2 Bcf a day kind of taken offline for the last 6 months with the outages down along the Gulf Coast with Freeport. That should come back online. So you're going to have right off the bat 2 Bcf a day that comes back online and helps demand. And then the other thing that I think we all need to keep in mind, and we're watching this, we're modeling this is really what presented itself this past year and especially in the summer, has been gas to coal switching and what the relationship is there. Not only has the U.S. retired, ultimately, a lot of coal-fired generation -- power generation, but you've got increasing power generation demanding natural gas in light of that also. And this is power generation that renewables can't keep up with. While you got that going on domestically, abroad, you've got increased use of coal-fired power generation. And that's really disrupted, or altered is maybe a better word for it, the actual trade routes and trade flows for coal. So now we've got a higher coal price. It's come off a little bit from the summer, but still [indiscernible] we're exporting a lot of coal, plus you've got the ultimate [indiscernible] we sit today with gas safely at about the 5-year average gas price somewhere at the 370, 375 range. I'd say we're constructive on '23. And then I would say we're bullish on '25 and beyond. And that's because of the increased demand coming along the Gulf Coast for the increased LNG that everybody has been well aware of. For us, how it affects our capital allocation, Dorado is a natural gas play. We discovered it's Austin Chalk, Upper Eagle Ford and Lower Eagle Ford there in South Texas. We've been drilling it for a few years now. We're about 50 wells in, in that play, and we have what we think is identified over 1,000 locations. We think it's got the potential to be 20 Tcf ultimately recoverable. If you think about that 20 Tcf number, one way to do the simple math on that is that would be 1 Bcf a day produced for 50 years. So it is a world-class resource. The finding cost competes with some of the lowest-cost gas in the U.S. And obviously, with it located in South Texas, the transportation fees are going to be very, very low. It's going to be better positioned to take advantage of the major demand center in the U.S., which is along the Gulf Coast, not just LNG, but also petrochemical. For us, that's not a -- it's a play that eventually we'll be able to flex on really quickly. Right now, it's so early. We're honestly still making progress on completions designs. We're still building out some of the infrastructure, sand, water lines, things of that nature. So for the next couple of years, it will be really investing in that play with 2 kind of bookends on it. The first is when would you end up over capitalizing that? Well, for us, that's simple. It's the same as any other portfolio or any other asset in our portfolio. You overcapitalize the minute your returns start to decrease, or your finding cost starts to go up. That's a simple way to look at it. All you need to do at that point is just pull back a little bit, allow that team I talked about, the culture of our company, allow them to understand what they're doing, allow them to catch up, give them the tools that they need to either increase that well productivity or drive down the well costs. Now that's on the over-investment side. Now on the underinvestment side, that's a risk too. Because think about what I just talked about the culture of our company is its continuous learning, its continuous improvement. And so you need to fund each of these assets to a degree, so that they're continuing to build out infrastructure, learn about the [indiscernible], learn about different landing zones, how to complete the wells and ultimately continue to not only technically learn but also move further down the cost curve due to capturing the economies of scale, which is always an important thing in these unconventional plays.

So given where gas prices are right now, and I agree with you that Dorado is very much low on the cost curve. But the long-term outlook for gas prices are much more robust. What do you think about pulling back activity? And what gas price would we say like, you know what, these [ ads ] are much more valuable if I break them on any 2025 versus in 2023.

Yes. So the premium strategy of the company, that's an amazing thing to think about. It makes us somewhat agnostic to the actual gas price because we're making our investment decisions based on the $2.50 natural gas price that we run internally. Those Dorado wells, we have line of sight that they'll be generating double premium returns, which I know everybody thinks double premium is really funny. That's just how we talk about it internally. It's a 60% direct after-tax rate of return on -- in Dorado's case, that $2.50 natural gas price. So the ultimate thing when we think about capitalizing these projects, Umang, gets back to the fact that what is the right amount of capitalization for it? What -- first, obviously, you need to look at the macro. But like you said, we're assuming longer-term outstanding growth and the market needs the molecules. So then it really does come down to the fact that we want to make sure every single year that asset is continuing to improve. Now just $0.01 per Mcf is improvement on that finding cost. But the minute you start to go the other way, while you could still be generating upfront really high cash returns, those higher costs are going to stay with you. They're going to go into the cost basis of the company. They're going to end up raising your breakevens. And we all know that times are good in cyclical businesses, but they don't always last. Things go the other way. At EOG, we're focused on shareholder value creation through the cycles. We've done a lot on focusing on this premium price deck, basically taking pricing control into our own. A lot of people say that our industry are price takers. What we did is we basically turned that on its head, and we said, "No, we're going to go ahead and make our own price. We're going to be a price maker and we're going to make our investment decisions based on this price because we think this price is not sustainable through the cycle." What that means is we've done as much as we possibly can to decouple ourselves from the inevitable commodity price cycles, even though we're an oil and gas company. That's what we do.

So in the next 20 minutes, Ezra, let's spend some time talking about the assets and then spend some time talking about capital returns and capital allocation. Just start on the assets, one of the things we've done with some of the producers is ask the CEO to talk about the walk from '22 to '23, recognize many of you are going to provide official and fine-tuned guidance in the next couple of weeks. But what kind of [ read ] comps can you leave us with as we think about '23 off the '22 basis?

Yes. I think part of it goes back to our story being a little bit different, the fact that we do have multiple assets across multiple basins. And so when you think about that, part of the way to think about our structure is where are each of those assets in their life cycle. So we start with the Utica. The Utica is very early on. So we're still doing a lot of delineation there. We'll be doing some spacing tests, things of that nature. So we talked about on the last earnings call, we'll be drilling roughly 20 wells there is what we anticipate doing for next year. In Dorado, in the South Powder River Basin, making fantastic progress there. We don't have all the infrastructure, not necessarily gas takeaway and things like that, but again, sand, water, things of that nature. We understand spacing. We're making -- we understand landing zones where we're tweaking those in combination with the completion's designs. Both of those, you can anticipate, should be seeing a little bit more activity from what we saw this year. But again, those are at that critical point where you want to make sure that you're not moving too fast. There -- what we internally refer to as emerging plays, not an exploration opportunity, but they're emerging, they're headed towards one of our core assets. Obviously, right now, the Permian is core. The Permian is in the sweet spot. We've got our infrastructure. We've got over 5,000 vertical feet of productive opportunities across 6 different play types. We probably have something like 20 different landing zones in there depending on where we're at geologically. We've got a large asset team out there that lives and works in Midland. They tear apart the data every day. They're planning each of the wells, not through manufacturing mode, but actually looking at the geology, looking at each drilling unit individually and figuring out what the best spacing and targeting is to kind of find that balance between returns and ultimately, NPV. And so that one -- the thing about the Permian right now, though, when you transition from '22 to '23 is things out there are very tight, they're expensive and they're tight. And so again, we like the level that we're working at. We'll probably -- we've talked about carrying a pretty consistent activity level across the year. And part of that again goes back to, well pricing is up right now. And so even though well costs are up with the inflationary pressures, you still got expanding margins. Why don't you lean in a little bit harder? Well, that is taking the last 6 years' worth of premium drilling and discipline and throwing it out the window. We want to remain disciplined and move at a pace where even though we've offset a lot of the inflationary pressures out there, we haven't been able to offset it all. And we have been able, luckily, to increase the productivity gains in some of our wells, which helps to offset the well costs and continue to lower that finding cost. And that's what we really want to stay focused on. So pretty flat activity level is probably a safe forecast there. And then lastly would be some of our longer to -- longer -- the assets that are a little bit longer in the two, like the Eagle Ford. The Eagle Ford is not really a growth asset anymore. We've slowed down there. We put the sales roughly 100 to 125 wells per year. But the amazing thing about the Eagle Ford is, and this is a great example of what happens when these assets kind of go through this life cycle that I'm talking about is, it's not unlike the Boston Consulting Group chart where you end up being a cash cow. In the Eagle Ford, even though we're drilling less productive rock than we were 6, 7, 8, 9, 10 years ago, in the last 2 years, we've actually turned in the highest scorecard, the highest rate of return results than we've ever had in nearly 15 years of drilling in that asset. And even though the wells are less productive, the well costs have come down significantly. We've learned more about the asset. We've been able to put in infrastructure, things like water reuse, localized sand, things of that nature do a lot to save not only on operating cost but upfront costs.

So last year, if you think about the cost side of the equation, last year, if you think about the opportunity set, you talked about Super Zipper. You talked about moving to longer laterals. There were some secular drivers, which could improve the cost structure down. When you think about 2023, what are the things which you're evaluating in a toolkit, which can help cost come down as well?