This Oil Indy Is Flying High in the Eagle Ford.

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Crashing natural gas prices are driving shale drillers into oil shale plays as everyone scrambles to boost their liquid production. First movers have a decided advantage however, as much of the key acreage is already tied up. Companies like EOG Resources (NYSE: EOG) and Continental Resources (NYSE: CLR) have a strong lead in key plays. Can the competition catch up?

Unconventional horizontal drilling and fracking spurred the resurgence of the US energy sector, but also created a natural gas surplus crashing prices. Drillers like Devon Energy (NYSE: DVN), Chesapeake Energy (NYSE: CHK) and Linn Energy switched to wet gas plays to compensate. Now that the NGL market has softened as well, all eyes are focused on oil for virtually all industry players.

Chesapeake is actively drilling in a number of oil shales, including the Niobrara, Eagle Ford and Utica, a play they originally identified. The bulk of that drilling is focused on the Eagle Ford, with the Utica of eastern Ohio running a close second; 35 rigs run in these two plays alone.

One of the longer holdouts, Devon, divested a large amount of natural gas acreage, only recently repositioning itself to drill some of the newer emergent oil shale opportunities. Devon’s banking on the Mississippi Lime for its move to liquids, as well as some planned expansion of its Canadian Oil Sands projects.

Some zigged, when the others zagged.

A few however, foresaw the problem and were prepared. Long before the industry turned its attention to oil shales, drillers like EOG Resources and Continental Resources, hitched their wagons to unconventional oil shale opportunities. Their first mover status allowed them to accumulate large acreage positions in two of the more valuable shale plays in North America: the Eagle Ford in South Texas and the North Dakota Bakken.

These two plays currently provide over 81% of unconventional crude oil production in the Lower 48 (see Figure 1). This early move by EOG left the rest of the pack playing catch-up, and swallowed up a lot the prime acreage in the process.

<img src="/media/images/user_13017/eog2_large.jpg" />

Because of its oil-rich portfolio, EOG’s growing oil production faster than most of its peer group. They can afford to lean on the bit, since there’s oil and not gas behind it. EOG rode that prime Eagle Ford and Bakken acreage to impressive production gains, with oil growing at a 40% CAGR the last five years.

And more oil means more cash in this weak gas price environment. Despite providing only half of EOG’s production, oil accounted for almost 90% of 2012 revenue. Devon and Chesapeake are scrambling for liquids. In front of the trend, EOG is reaping the reward of their earlier move into oil shale plays. Let’s look at EOG’s current drilling efforts.

The Eagle has landed

Foremost among its three big drilling programs is the Eagle Ford, a relatively shallow shale deposit that stretches northeast from Laredo to San Antonio, Texas. Twenty drilling rigs are running on its industry-leading 644,000 Eagle Ford acres, tinkering with locations, fracking, and completion methods. EOG drilled 320 wells in the second half of 2012 alone. Even at this rapid pace, there’s a multiyear drilling inventory to keep the rigs busy with 3,200 drilling locations remaining.

The company’s tightening well spacing, shortening drilling times and reducing completion costs. While tighter spacing optimizes recovery of reserves, too much overlap leads to diminishing returns on investment. So far, management’s optimistic with the results, but the return on investment for these more tightly packed wells bears watching. Investors should pay particular attention to analysts’ questions on this topic.

The quality of its Eagle Ford acreage also can’t be ignored. No matter the venue, real estate’s about location. Since EOG was the early bird, it caught the worm. The vast majority of EOG’s Eagle Ford acreage was acquired on the cheap and lies in the Eagle Ford’s oil-rich window. It’s not only a large acreage position; it’s also prime, oil-rich acreage, adding considerably to value.

And the Bakken still beckons

While the Eagle Ford is the larger story behind EOG, the North Dakota Bakken’s not far behind. This is Continental’s backyard and probably the hottest oil acreage onshore North America. EOG runs 5 rigs here and its Bakken acreage is only lightly drilled. Like most operators here, drilling was spread thin to hold as much acreage by production as quickly as possible. With few locations drilled, there is abundant opportunity for more profitable infill drilling and further growth in the Bakken.

EOG’s final active region is the Permian Basin. The Permian is a large, historically prolific central Texas oil basin with some unconventional opportunities that are just starting to get more attention. Four rigs are running in the Wolfcamp shale, an emergent play that’s also caught Devon’s attention, while two more are running in the nearby Leonard shale.

How much is this lead worth?

From a purely operational point of view, it’s hard to match EOG’s progress. Continental, with its industry leading Bakken position certainly does, but its valuation is extreme. You can make a case for Chesapeake’s chances, with its rapidly accelerating drilling in the Eagle Ford and Utica. CHK shares are also interestingly cheap, but with colossal management issues, that’s not much of a surprise. Aubrey’s a buzz-kill for many investors.

Finally, despite being behind the curve, and poorly positioned in terms of prime acreage, Devon’s dirt cheap and management is sound. With some luck, Devon could craft itself in EOG’s image using some of its newly acquired acreage. It will take some luck, though.

JustMee01 has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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