EOG Resources (EOG) William R. Thomas on Q1 2016 Results

Shifting to “premium”

“The third item I would like to review is EOG’s shift to premium drilling this year. The shift is a game-changer with significant long-term implications. I will cover those implications in a moment. But first, let’s review what we mean by premium. Premium inventory is defined as drilling locations that generate at least 30% direct after-tax rate of return at $40 oil. Here are a few more clarifying points regarding this inventory. First, 30% return is not an average; it’s a minimum. Second, 30% was established as the minimum direct return to ensure that when indirect costs are included, the drilling program earns healthy full-cycle returns. Third, we fully expect to more than replace our drilling inventory with new premium locations every year. Therefore, and this is the most important point. Our shift to premium is permanent and not simply a temporary high-grading process in a low commodity price environment.”

Believe that it will take $65 oil for the industry to return to growth

“First, a brief word on our macro views and how they relate to EOG’s plans. The substantial reduction in capital investment by the industry in 2015 and 2016 is causing oil supply to decline in many producing regions around the world. Led by steady declines in the U.S. and supported by strong gasoline demand, the market continues to rebalance. We agree with consensus that this process will accelerate in the second half of this year and into 2017. We believe that in the U.S., it will take a sustained $60 to $65 oil price and 12 months of lead time for the industry to deliver a modest level of growth.”

We have a robust exploration effort ongoing

“Yes, we have a very robust exploration effort on new plays, and so we have various plays actually we’ll be testing this year. We’ll update you that when we have some meaningful results. And then we’re also picking up acreage. It’s been a great time to pick up low-cost acreage in places that we couldn’t get acreage in, in previous years. So we have an active program going on. Of course, we’re very selective. We only want premium plays to fit into our capital program. So we’re identifying rock that would meet that category and deliver those kinds of returns. So we’re not shortchanging that effort at all.”

EOG Resources Presents at Wells Fargo Energy Symposium Conference

Billy Helms

Drilled a lot of uncompleted wells this year. Efficiency improved so much that will be more productive when completed next year

“we improved the productivity and we learned so much about how to better complete those wells. So, we’re actually going to get a better result at a lower cost by completing those wells next year than how we completed those this year. But, you’re right as far as going to the next year our capital efficiency should be greatly improved.”

Drilling cost is 1/3, completion 2/3 of well cost

“Typically from a well cost perspective, drilling cost is about a third of the total well cost, the completions are about two-thirds. So you can think about it in that sense that ratio as far as their capital efficiency improvement.”

We’re not sure how many rigs we’ll keep running next year

“we’re still going to have some rigs running. We’re not sure exactly what that level is going to be yet. We’re waiting to determine really what we see the oil price outlook is going to be before we set that number.”

Focus on rate of return

“ultimately, if you’re not generating a good rate of return you’re destroying capital. And we don’t want to do that as a company. So we’re always focused on rate of return”

Going into next year unhedged

“typically, we like to have about 50% of our production hedged. Obviously we don’t have that now. We don’t have hardly any production hedged next year. And so, we’re going to be looking for the opportunity to do that, we don’t currently see the current market is an opportunity to place any hedges. We’ll be looking to see what the forward curve looks like and try to take advantage of that opportunity, when it presents itself.”

Marginal cost of supply now probably in $75-$80 range

“the break-even perhaps used to be $90 to $100 probably. The marginal cost of supply was $90 to $100, now it’s probably $75 to $80. For EOG we would be tickled to death for $60, $65 price. I think we’d be able to generate really strong rate of returns and grow the company at very healthy level at $60 or $65 price environment.”

We entered the year thinking we may do an acquisition, but we never found anything that made sense

“You’re right we started off the year thinking okay in this down cycle we might seen an opportunity for a corporate acquisition. And we’re not really used to the company to doing that, but we’re hoping at the opportunities. And we looked at the lot of different things, so that we never really saw anything that would compete with our portfolio here that we’ve shown. And we do evaluate everything on a rate-of-return basis. So if they didn’t stack up, we’re just not going to do that.”

We still get >10% returns on $40 oil

“we probably need to update it with the $40 oil price, we haven’t updated this slide with that. I would say that a year ago we had this slide and we said that $40 oil, all those budgeted and rated at least 10% rate-of-return. And that was a year ago and we made steady improvements in lowering cost and productivity gains.”

Not going to accelerate production at bottom of the cycle

“We have also stated that we have no interest in accelerating oil production at the bottom of the commodity price cycle. Instead, we are drilling but deferring completions on a significant number of wells known as DUCs until oil prices improve.”

Double digit growth at $65 WTI

“If oil prices recover and stabilize around $65 WTI, EOG can resume strong double-digit growth for the balance CapEx to discretionary cash flow program.”

Slowdown giving more time to focus on efficiency

“the slowdown in activity is giving us more time to focus on efficiency improvements. While much has been made of service cost reductions, we expect, we will gain the most long-term benefits from efficiency gains.”

Going to take advantage of down cycle to add acreage

“Objective number four, take advantage of opportunities during the down cycle to add acreage. We are using our exploration skills to define high quality acreage and are having good success capturing leasehold interest in emerging plays. Competition is down, acreage is available, and leasing costs are low compared to previous years, and we are optimistic more opportunities will materialize as the year progresses. We are also evaluating tactical acquisition candidates.”

If forward oil curve continues to improve then will increase completions in 3Q

“As we described on our February call, our production profile will be U-shaped this year. If the current forward oil curve continues to improve, our plan is to increase well completions in the third quarter. Therefore, we expect our oil productions to return to growth in the fourth quarter, building momentum as we head into 2016. We are right on track with this plan.”

U Shaped production

“And so the ramp up will be, as we talked about, the production shape is going to be U-shaped this year and the second and third quarters will be the low point, but the fourth quarter, with the current plan, is to ramp up production growth and the heading into 2016 on a very strong note.”

A big spread between bid and ask on acquisition front

“There’s still a pretty good spread between the bid and ask on the acquisition front. I think we’ll be very selective. We continue to be very selective in our approach, and what we’re looking for, and I think we’ll see some opportunities as we go forward, but there will be smaller, more tactical acquisitions, as well as just continuing to be able to accrete leasehold in some of our key plays and emerging place.”

This has been the plan since February

“We made the call to defer drilling, because we thought this would be or could be a short-term cycle, and we’re hopeful and certainly we’re encouraged by the current firming of the products. So we’re hopeful that’s what will turn out.

But we still, as I said earlier, we’re more optimistic in the forward curve than what it is right now. So we believe being patient and waiting on that products to continue to come up, while also continuing to take advantages of the cost reductions in the wells and the well productivity improvement. Those will all make a very significant difference in the returns we get on the wells when we begin to complete them.”

Not tried any refracts

“we’ve not tried any refracts. Our outlook on that is that it really — technically, we believe that just drilling a new well and kind of starting fresh and making sure your lateral is in the very best target and making sure that you can redistribute the frac very evenly along the wellbore with the new well is probably the preferred way to go. We just think that the upside on the completion will be much greater than if you try to refract the well.’

We’ll be able to ramp pretty quickly since servicers have kept people in place

“If we were ramping up here in the next month or two, I think you can ramp up pretty rapidly. And that’s why many of those operators are trying to keep as many services in place even if reduced work levels just to maintain that support that service companies.”

Each week I read dozens of transcripts from earnings calls and presentations as part of my investment process. Below are some of the most important quotes about the economy and industry trends from the transcripts that I read this week. Full notes can be found here.

It’s clear that oil prices are too low right now

“our overarching goal this year is to prepare for oil price recovery. It is clear that current prices are too low to meet the world’s supply needs and the market will rebalance. We would be ready to respond swiftly when oil prices improve and resume our leadership and high return oil growth.’

We don’t believe that growing oil in a low price environment is the right thing to do

“we do not believe that growing oil in what could turn out to be a short cycle low price environment is the right thing to do. And let me repeat, we do not believe that growing oil in what could turn out to be a short cycle low price environment is the right thing to do.”

Our top lays still return 35%

” returns are what matter. Therefore we will focus capital on the Eagle Ford, Bakken and Delaware Basin plays. At $55 oil, these premier assets deliver a direct after-tax rate of return greater than 35% without factoring in the potential for additional service cost reductions.’

Going to drill wells without completing them

“First, we will reduce average rigs 50% down to 27% for 2015 and intentionally delay any of our completions, building a significant inventory of approximately 350 uncompleted wells. This allows EOG to use rigs under existing commitments and when prices improve we will be poised to ramp up completions.”

Lower costs mean higher returns at lower oil prices

“as a result of cost and oil productivity improvements in the Eagle Ford Western acreage, we can now generate better returns with $65 oil than we did with $95 oil just two or three years ago.”

Low oil prices mean unique opportunities to add high quality acreage

“low oil prices mean unique opportunities to add low-cost, high-quality acreage. We will continue to grow our acreage portfolio through leasehold, farm-in or tactical acquisitions.”

Take advantage of low service costs

“Delaying completions will also provide an opportunity to take advantage of lower service costs that will likely materialize in the coming months. ‘

40% decrease in capex from 2014

“Our 2015 CapEx estimate is $4.9 billion to $5.1 billion excluding acquisitions. The expiration and development portion excluding facilities will account for approximately 80% of the total CapEx budget.

2015 CapEx represents a 40% decrease from 2014. As Bill mentioned earlier, we’re not interested in growing oil production in a low price environment.”

The supply imbalance is not that large

The current supply demand imbalance is not very large and current prices are far short of what is necessary to sustain the supply need to meet world demand growth. When prices recover, EOG will be prepared to resume strong double-digit oil growth. For now, EOG is intentionally choosing returns over growth. In fact that’s the way it’s always been here at EOG.”

It makes economic sense to slow production until supply response is realized

“As we compare today’s oil prices to our expectations for a more balanced market, it makes economic sense to slow production until an industry wide supply response is realized and prices respond accordingly. This strategy maximizes the value of our assets and it’s the right strategy to create long term shareholder value.’

Keep our powder dry

“we want to keep our balance sheet clean and low and we want to keep our powder dry so that we will be able to take some advantage of what could be some unique opportunities in this downturn. 2016, yes if we – if things go as we think they might could and we would have say a $65 oil environment in 2016 and we believe that we could return to our very strong double-digit oil growth that we have been marching towards a last few years and that we will be able to generate very high rates of return on our capital and we would be able to stay free cash flow neutral.”

We agree with consensus that production will durn flat to negative by the end of this year

“I don’t think that I’ve talked about our shape of the recovery. But, our view now is that we really believe with the consensus opinion that as we go forward due to the response of the industry that we could have flat to maybe even negative U.S. production growth on a month-over-month basis by the end of this year, and that certainly going to slowdown U.S. production growth this year.

So, as that slows down there should be a price response and I’m not going to predict whether it’s going to be V or U or W o really what the price is, certainly the forward curve is very indicative that prices will increase in the future and we’re just going to wait and see how that goes and we’ll respond accordingly.’

Completion costs 60-65% of the well

‘our drilling cost is roughly 25% to 30% of the cost of the well. So that gives you the completion, of course, I guess we could put facilities in there so the facilities would be somewhere around 10%. So, the balance being completion’

This post is part of a series of posts called “Company Notes.” These posts contain quotes and exhibits from earnings calls, conference presentations, analyst days and SEC filings. Full transcripts can be found at Seeking Alpha

Liquids production up 33%

“Total company crude oil and condensate production was up 27% for the third quarter and 33% compared to the first nine months of 2013. Total liquids production, including NGLs increased 27% for the third quarter and 31% for the first nine months.”

Eagleford is great

“In the Eagle Ford, I can characterize our current activity in three points. One, the Eagle Ford is on track for multiyear growth; two, we continue to make enhancements in completion; and three, the Eagle Ford is the industry’s best crude oil asset and we’ve captured the sweet spot”

Still generate positive returns on capital even at $40 oil

“At $80 oil, the eagle ford will still generate direct after-tax rates of return in excess of 100%. At less than $40 oil, we would still achieve a minimum 10% direct a-tax rate of return.”

Problems with using Texas Railroad Commission’s data

“we would caution those who used monthly Texas Railroad Commission’s state data as a measure of company current production and a forecasting tool for future production. Remember, the State Data tends to lag and it’s potentially incomplete on a month-to-month basis for a variety of reasons.”

Sufficient cash flow for growth at $80 oil

“At $80 oil, we should have sufficient cash flow to fully fund our Eagle Ford, Bakken and Delaware Basin plays and sustain double-digit oil growth through 2017 and beyond. We plan to invest in our highest return crude oil plays and reduce our activity in our combo plays. We still expect to be a leader in organic growth — crude oil growth next year.”

We would cut back spending in some combo plays in an $80 oil environment

“What we would cut back on is the combo plays certainly the Barnett Combo, some of our drilling in South Texas, in the Mid-Continent, in East Texas and even in the Permian where we have the Wolfcamp Combo. We would not spend as much money in those.

But we need to be thinking that we would fully fund the Eagle Ford, the Bakken and the Delaware Basin plays and that we would have very strong double-digit production growth next year, oil growth and we would continue to be a leader in organic oil growth in the U.S.”

Not really interested in making acquisitions of distressed companies

“the acquisition businesses as you all know, historically, there is a lot of competition in M&As and acquisitions and usually they turn out to be very, very low return. So we are going continue to maintain our focus on growing the company organically through exploration and low-cost, acreage acquisitions in that process”

World oil supply demand is not an area we have a lot of expertise in

“We are pretty good at some things, but the world oil supply demand situation is not an area that we have a lot of expertise in. And a special insight and we read a lot of the same reports and follow the same analytics that many of you do and we are going to kind of leave it up to them, to kind of give direction to others, a lot of opinions out there on what oil prices could do.”

The company is an organic prospect generating machine

“the company is a very prolific organic prospect generating machine. And we think it’s — we can continue to do that as very, very low cost. As we — in the last few years our exploration costs have been relatively low in the company and a very small part of our budget.”