EOG Resources is a Shining Star Among Energy Inpendents
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EOG Resources (NYSE: EOG) is catching analysts' attention. Recently it was upgraded by Wells Fargo from market perform to outperform. It was also picked up for coverage by Equity Leader based on its strong position in the materials industry. Canaccord Genuity is keeping EOG in its favorite list of buy-rated energy and production stocks, along with competitors Anadarko Petroleum (APC) and Cabot (COG). Earlier this year, Deutsche Bank analysts raised their target on EOG to $130, maintaining a Buy rating on the stock.
EOG Chairman and CEO Mark Papa is largely responsible for the confidence in his company. Papa maintains an active conference schedule, and will be presenting at several upcoming industry events. He is also active on the interview circuit, recently conducting an informative interview with CNBC. This dedication to communication with shareholders and the industry at large is reassuring, and I think sets a positive example for the independent energy industry. Papa is indicating that he expects EOG’s production to reach 200,000 barrels per day by the end of 2012, up from 140,000 barrels per day at the close of the first quarter, which I suspect might be a conservative estimate given EOG’s recent growth rate.
Starting the Canadian LNG Rush
Earlier this month, EOG released its first quarter earnings report, announcing that after increasing its liquids production by 50%, its first quarter profit increased by over 100%. Its liquids production now accounts for 85% of production revenue. A large portion of this is from liquid natural gas (LNG), a resource that is fast becoming a key growth driver for EOG.
On May 22, the partners in the Canadian Kitimat Liquid Natural Gas project announced that first exports will begin in 2016 and final investment decisions will be made this year. Apache (NYSE: APA) is 40% owner of the project, while EOG and Encana (NYSE: ECA) each hold 30% interests. Joining this announcement is news that the related Pacific Trail Pipeline project gained approval from the British Columbia Environmental Assessment Office. The Pacific Trail Pipeline will move natural gas from British Columbia to the Kitimat LNG Project, and the pipeline will be operated by the partners in Kitimat under the same ownership ratios. This was a critical component to the Kitimat group’s plans and the relative speed with which the project was approved indicates that British Columbia is happy to have EOG, Apache, and Encana on board.
Shell Joining the Play – But Can It Succeed?
Prompted perhaps by the possibility of being upstaged by this group of independents, Royal Dutch Shell (NYSE: RDS-A) announced that it, too, will build an LNG plant on the coast of British Columbia, which could represent an investment of $12 billion. Due to the late start, the project is not anticipated to begin exports until 2020. Shell will have a controlling interest of 40% in the project, with the remainder split between partners Mitsubishi, China National Petroleum (CNPC), and Korea Gas. Though Shell’s planned plant would produce more than twice the Kitimat LNG plant when complete, I foresee problems with this project. CNPC is a state-owned energy company with a disastrous safety record, including a series of explosions in late 2005 at one of its petrochemical plants that killed six and caused an environmental disaster, and two 2009 pipeline leaks that caused diesel oil to spill into the Chishui River and, in a separate incident, the Yellow River.
Aside from the safety record, CNPC has a poor history of cooperative agreements. Recent spats over its operations include a recommendation from the government of Chad that one of CNPC’s refineries there be suspended and renegotiated, a reduction in crude purchases from Iran, and ongoing disagreements with Russia’s Gazprom. Inviting CNPC to participate in the LNG project brings CNPC’s penchant for disagreements with it, and though China is a huge energy consumer the scale of Shell’s LNG project and the ultimate production predictions don’t require that CNPC own a working interest. Ultimately, I think that the CNPC has the potential to provide more harm than benefit to this deal, as its recent history shows.
Outlook
Despite the hurdles Shell may face with the partners it chose, both of these LNG projects have the potential to be immensely profitable – the Kitimat more so, as it is made up of like-minded energy independents. The Kitimat project’s goal is to export LNG to Asia, where demand is high – and so are the prices, as markets there are supporting prices between $12 and $16 per mmbtu. Comparing this to a Henry Hub futures price of $2.65 mmbtu for the month of June it’s easy to understand the appeal.
The government of British Columbia estimates that the province has 14 tcf of natural gas and 124 mmbbl of oil in proved reserves, and a further 93 tcf of unproved reserves. The neighboring province of Alberta is also resource-heavy, with an estimated 38.8 tcf of proved natural gas reserves, not including the potential of coal bed methane resources, which are difficult to calculate and not currently cost-effective to extract at scale. The political environments of British Columbia and Alberta are also kinder to oil and gas investments than the Yukon Territory further north, which has other barriers to investment including a lack of year-round port access. Advances in shale gas extraction, including fracking, only recently made it possible to take advantage of Canada’s resource base, and I expect the plays in our neighbor to the north to make serious waves in oil and gas over the next decade.
EOG is up 5% on the strength of the Kitimat announcements, currently trading around $101. This gives the stock a price to book of 2.1 and a forward price to earnings of 15.7. Though the 15.7 P/E is on the high side, looking at the potential of Kitimat as well as EOG’s other strong plays I think that it’s supported by the growth potential here. Investors looking to build energy independents in their portfolios should be looking at EOG closely.
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