Then & Now: EOG Drills for Oil on Wall Street Using its Stock as Currency

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Drilling for oil on Wall Street, or buying barrels rather than finding them, is a time-honored way for Oil & Gas producers to grow while managing risks. And if you can buy those barrels using your high-priced stock rather than cash or debt, so much the better.

EOG Resources Incorporated (NYSE:EOG) (Houston, Texas) did just that last September when it acquired Yates Petroleum Corporation (Artesia, New Mexico) for about $2.5 billion in a deal financed mostly with EOG's stock, which sold for about $85 per share at the time of the transaction. Investors are enthusiastic about the acquisition, driving up EOG's stock price by about $20 per share since then.

Traditionally, EOG has grown organically rather than by acquisition. Thus, it was not caught in the bidding wars that took place when crude oil sold for over $100 per barrel a few years back. Some companies overpaid for acreage and assets during the halcyon days of 2011-2014, often paying cash for properties that were worth dramatically less when crude oil prices collapsed in 2014. Overpaying for acreage is bad enough, and common enough. Many operators thought the days of $100-per-barrel oil would never end. But paying cash for assets whose value evaporated a year or two later added insult to injury.

Using stock to finance a transaction lessens the potential for heartache if crude-oil prices swoon again. EOG's acquisition of Yates, which doubled its acreage in the Permian Basin, came shortly before OPEC and non-OPEC producers decided to cut production, firming global crude oil prices. That deal also brought EOG properties in New Mexico and the Powder River Basin in the Northern Rockies.

Industrial Info's "Then & Now" series explores what independent Oil & Gas Producers have done since crude-oil prices collapsed in late 2014 to become more competitive and continue operating in a low-price environment. For earlier articles in this series, see January 4, 2017, article - Then & Now: Continental Resources Cuts Costs, Boosts Outlook, but Losses Grow, January 11, 2017, article - Then & Now: Sheffield Ends Run at Pioneer with a Bang, Leaves Company Well-Positioned for New Leaders, January 12, 2017, article - Then & Now: Cabot Oil & Gas Keeps Growing Production, Waits for Pipelines and January 16, 2017, article - Then & Now: Sanchez Slashes Capex, Boosts Production While Waiting or a Price Recovery.

Acquiring Yates boosted EOG's acreage in the Delaware Basin by 78%, to about 424,000 acres. The deal also added 138,000 acres of land in New Mexico's Northwest Shelf, which EOG officials believe they can profitably develop because the plays are shallow and because of EOG's low-cost structure and its advanced completion and precision targeting technologies.

Industrial Info's Oil & Gas subject-matter experts will hold a complimentary webinar on Monday, February 13, on Oil & Gas in the Americas. The event, which is complimentary, begins at 10:00 AM (Eastern), 4:00PM (Central European Time). RSVP here.

In announcing the Yates deal September 6, EOG Chairman and Chief Executive William R. "Bill" Thomas said, "This transaction combines the companies' existing large, premier, stacked-pay acreage positions in the heart of the Delaware and Powder River basins, paving the way for years of high-return drilling and production growth. We are excited by this unique opportunity to advance EOG's strategy of generating high-return growth by developing premium wells at low costs that enhance long-term shareholder value."

The transaction boosted EOG's Delaware Basin resource estimate to 6 billion barrels of oil equivalent (BOE), a 155% increase. It also increased EOG's projected compound annual growth rate (CAGR) of oil production by 15% to 25% over the 2017-2020 period. Shortly after acquiring Yates, EOG boosted its 2016 capital budget $200 million, to between $2.6 billion and $2.8 billion. The deal added an estimated 30,000 BOE of daily production to EOG's 551,000 BOE of daily production. EOG was the largest oil producer in the Lower 48 states prior to acquiring Yates. The transaction extended its leadership position.

Acquiring Yates added an estimated 1,740 net premium drilling locations in the Delaware Basin and Powder River Basin, a 40% increase to EOG's existing positions in those basins. EOG defines a "premium drilling location" as one that generates an after-tax rate of return of at least 30% when crude oil is $40 per barrel. EOG said it plans to begin developing some of the Yates acreage in late 2016, and it plans to add drilling rigs in 2017.

The effect of the Yates deal won't be evident until EOG reports full-year financial results later this month. The transaction was announced near the end of the third quarter of 2016. But the initial signs seemed positive judging from Thomas' comments in the company's third-quarter financial release. Although the company reported a net loss of $190 million for last year's third quarter, it made considerable progress on the cost-reduction front. Lease and well expenses decreased 18% from the comparable year-earlier quarter, the company said in its earnings statement. Crude oil production increased by 1% while exploration and development expenditures (excluding property acquisitions) decreased 32% compared to the same period last year, EOG added.

These cost reductions were not enough to overcome weak commodity prices in last year's third quarter. But firming prices in the fourth quarter, and so far in the first quarter, coupled with EOG's cost leadership, are reason to think there's a long pipeline of good news for the Houston-based independent producer.

Improvements in capital efficiency, augmented by the Yates deal, allowed EOG to project 15% compound annual growth rates (CAGR) in crude-oil production over 2017-2020 assuming West Texas Intermediate (WTI) sells for $50 per barrel. If that price goes to $60 per barrel over that same four-year timeframe, the CAGR increases to 25%. Previously, EOG forecast four-year CAGR in production of 10% when WTI sells for $50 per barrel and 20% when WTI sells for $60 per barrel.

"Even in a low commodity price environment, 2016 is proving to be a breakout year for EOG with record well productivity, sustainable cost reductions and organic growth in all our core plays, coupled with a historic (Yates) transaction that adds substantial high-return growth potential," said Thomas. "EOG's third quarter accomplishments reflect the hard work and ingenuity of our great employees and our unique culture."

EOG's outlook, already looking up, may be further elevated in the new Trump administration. One of the new president's first actions was to sign an executive order designed to expedite construction of "high priority" infrastructure like pipelines and electric transmission projects. For more on that, see January 31, 2017, article - Trump Orders Benefit KXL, DAPL and Other 'High Priority' Infrastructure Projects. As a candidate, Trump committed to boosting energy production and reducing administrative delays in permitting of energy projects. For more on that, see November 17, 2016, article - Oil & Gas Industry Cheers Trump's Election. Although the president has been silent on how he plans to increase domestic Oil & Gas production, his commitment to streamlining regulatory review of infrastructure projects like pipelines could help EOR bring more of its product to market faster.

"By growing organically, and reducing costs, EOG has positioned itself for a rebound in the crude-oil market," commented Jesus Davis, Industrial Info's vice president of research for the Oil & Gas Production, Pipelines and Terminals industries. "Using stock, not cash or debt, to fund the Yates acquisition was a smart, low-cost way to monetize the value the company has created in recent years."

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, five offices in North America and 10 international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities. Follow IIR on: Facebook - Twitter - LinkedIn. For more information on our coverage, send inquiries to info@industrialinfo.com or visit us online at http://www.industrialinfo.com.