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EOG Channels Enron Roots While Outperforming Chesapeake: Energy

EOG Resources Inc. (EOG), the fourth quarter’s best-performing U.S. shale producer, plans to get a record 75 percent of its North American revenue from higher- profit petroleum liquids this year as natural-gas prices tumble, branching faster into oil than Chesapeake Energy Corp. (CHK)

The company, formerly Enron Oil & Gas Co., expects to increase 2012 oil output by almost a third through boosting production from liquids-rich geological formations such as Texas’s Eagle Ford, where EOG is the biggest crude producer.

“The wind is at their back in 2012,” said Brian Lively, a managing director at Tudor Pickering Holt & Co. in Houston who has a “buy” rating on EOG shares and doesn’t own any. “I think 2011 was a big transition year. They’re set up well to be a top-tier performing stock.”

Chief Executive Officer Mark Papa, who joined a predecessor to the Houston-based company in 1981 and has accumulated about $136 million in shares, spent the past five years transforming it from getting 85 percent of production from gas to tripling daily output of oil and gas liquids such as propane since 2007.

That’s put EOG ahead of competitors such as Chesapeake, which were slower to shift to crude as gas plunged below $3 per million British thermal units last year and traded yesterday close to a 10-year low.

$98 Oil

With a 39 percent share gain in the fourth quarter as the U.S. benchmark oil price gained 25 percent to $98.83 a barrel, EOG became the top performer in the Standard & Poor’s 500 Oil & Gas Exploration and Production Index. It beat out larger rivals such as Anadarko Petroleum Corp. (APC), which gained 21 percent.

EOG is the third-biggest U.S. independent oil company by market value, behind Anadarko and Apache Corp. (APA) Independents focus on oil and gas exploration without refining or chemicals units.

EOG is poised to report fourth-quarter earnings this month of 83 cents a share, more than triple the 21 cents it earned a year earlier, according to an average of 12 analysts’ estimates compiled by Bloomberg.

After trailing Chesapeake in 2009 and 2010, EOG outperformed its rival last year and has risen 13 percent in New York this year, while Chesapeake has fallen 0.8 percent.

Papa became CEO in 1998 when EOG was still owned by Enron Corp (ENRNQ). and known as Enron Oil & Gas. He began in 2007 to shift more of the company’s investment to oil-rich assets including the Eagle Ford and North Dakota’s Bakken Shale at a time when most shale producers were still focused on gas.

Early Oil Shift

Papa’s early commitment to onshore oil helped EOG pick up acreage at lower costs than many rival producers. The company said in August that its past transactions in Eagle Ford cost about $450 an acre, compared to more than $20,000 an acre Marathon Oil Corp. (MRO) paid last year for Eagle Ford assets.

Like many of its peers that have spent billions to secure acreage in oil-and-gas-rich shale formations, EOG has been strapped for cash to develop those assets as gas prices slumped 57 percent since the end of 2008.

Papa stayed on the sidelines as producers such as Chesapeake and Anadarko sold stakes to partners in Europe and Asia in exchange for the cash to pay for drilling.

Chesapeake has secured more than $16 billion through such partnerships since the start of 2008. Papa, meanwhile, viewed selling stakes in its premium U.S. oilfields as tantamount to selling EOG’s future, the CEO said in a November interview.

Costs and Benefits

By refusing joint ventures, EOG bore all of the costs with the aim of also reaping all of the profit. Its funding gap --the amount capital spending and dividends exceed the cash generated by operations -- rose to about $3 billion in 2010, said Thomas Driscoll, a managing director at Barclays Capital Plc in New York.

“The simplest way to fix a funding gap is to do a JV,” Papa said in the interview at EOG’s Houston headquarters. “I guess at EOG we’ve never necessarily taken the simplest route.”

When the company cut production forecasts in November 2010, it raised concerns among investors and analysts that EOG lacked the resources to follow through with developing its properties. The stock tumbled about 9 percent the next day.

The company’s transition to oil has been difficult, “because it’s costly,” said Tudor Pickering’s Lively.

EOG may boost cash flow this year by increasing its oil and gas-liquids production in Texas’s Eagle Ford and Permian Basin. Improving methods of recovering oil and gas will mean higher production as the company seeks to cut costs, he said at an industry conference in Houston in November.

Recovery Factors

“Current recovery factors are quite low, between 4 percent and 10 percent depending on Eagle Ford versus Bakken, and we think that’s pretty pathetic,” Papa said. “The next revolution in the industry is going to be who can improve recovery factors from the current low levels.”

EOG planned to boost liquids output an estimated 47 percent in 2011 and an additional 27 percent this year, according to company presentations.

Thanks to horizontal drilling and hydraulic fracturing, which uses high-pressure injections of water, chemicals and sand to crack rock and release hydrocarbons, EOG’s initial oil rates at Eagle Ford wells in the fourth quarter were nearly double year-earlier levels, according to data the company released in December.

To raise cash for drilling, EOG sold at least $1.3 billion of less profitable assets last year and raised about $1.39 billion in its first new equity offering issue in more than 11 years.

Crude Versus Gas

About 75 percent of EOG’s North American revenue in 2012 will come from petroleum liquids such as crude, which made up 38 percent of production in the third quarter. By comparison, Chesapeake plans to have 60 percent of its revenue from oil and gas liquids, which will be 25 percent of production in 2012, according to a January presentation.

Cabot Oil & Gas Corp. (COG), the best performer in the Standard & Poor’s 500 index last year, has fallen 13 percent this year as more than 80 percent of its operating revenue came from gas in the third quarter.

As it has increased oil production, EOG’s funding gap narrowed to an estimated $2.6 billion last year from $3 billion the year before, said Barclays’ Driscoll, who has an “overweight” rating on EOG shares. Driscoll estimates the gap will shrink to $2 billion in 2012, and to $1 billion in 2013.

President William Thomas, who has been designated to succeed Papa next year when he retires in June, is expected to continue EOG’s move into oil.

“Reducing their exposure to natural gas a few years ago has turned out to be a very good decision on their part, given how oil and natural gas have moved in opposite directions,” said Brian Youngberg, an analyst at Edward Jones who has a “buy” rating on EOG shares and owns none.

To contact the reporter on this story: Edward Klump in Houston at eklump@bloomberg.net

To contact the editor responsible for this story: Tina Davis at tinadavis@bloomberg.net

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