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Clever Management Kept This Oil Independent One Step Ahead

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Long before the competition, EOG Resources (NYSE: EOG) bet that unconventional, horizontal drilling would be equally useful for oil production and set about realigning its acreage. With natural gas prices now crumbled, that prescience pays dividends. Management’s willingness to buck the trend proved a strength.

If you look back to 2009, the wisdom of EOG’s all-in decision on the future of oil shale looks less than certain, yet it’s been a difference maker for the company. While the competition scrambled to solidify competitive positions in North America’s crowded gas plays, EOG built its industry leading Bakken and Eagle Ford holdings.

The catalyst was obvious in retrospect. Natural gas pricing fell into the $7 to $8 range in 2009, but the prolific North American shale gas plays were still plenty profitable in that range and few signs of the severity of the impending price crash were evident. (See Figure 1 for a price chart of Henry hub gas pricing.) Back then, Devon (NYSE: DVN) was busy exploiting its massive Barnett reserves and the bulk of its drilling remained in gas-rich plays.

Similarly, Chesapeake’s (NYSE: CHK) 2009 drilling shows mainly natural gas activity as it competed to hold acreage through production in four of the big shale gas plays. The Barnett, Haynesville, Fayetteville, and Marcellus accounted for 78% of Chesapeake’s 2009 drilling, with other smaller gas plays accounting for most of the additional drilling.

With gas prices now collapsed, it’s little wonder that everyone’s found religion. Most producers have shifted drilling programs to liquids-rich acreage. For Devon, that’s meant more drilling in the Permian, Cana-Woodford, and Barnett combo plays. For others, the shift’s been more radical.

Count EOG among that second group. The glaring distinction with EOG is the degree to which the company bought into emergent oil shales as a long term strategy, and how early that occurred. Long before the competition, EOG’s management grew concerned that overproduction from North America’s unconventional gas revolution would rupture pricing, and made a move to acquire a strong position in emerging oil shale plays.

Even with gas strongly priced between $8 and $11 in 2008, EOG was already building and de-risking its Bakken holdings in the Williston basin. It spent 2009 and 2010 making additional land grabs and ramping that de-risking program. EOG was essentially two years ahead of the industry-wide move that eventually began in 2010.

Bear in mind that in 2009 the Bakken was still relatively emergent. EOG was one of the few large independents participating in that land grab and infrastructure was sparse and needed to be built out. Even today, limited midstream infrastructure makes getting crude out of North Dakota a challenge.

Despite plenty in the Bakken to keep the company busy, EOG still took notice of an October 2008 find made by little Petrohawk Energy (now part of BHP Billiton). Petrohawk was drilling in South Texas within the Eagle Ford shale, looking for a new shale gas opportunity.

The find was promising, but both EOG and Chesapeake saw an opportunity for liquids that Petrohawk did not, and began quietly buying drilling rights on acreage to the north and east. The Eagle Ford shale is shallower in these locations, increasing the opportunity to find liquids because the source rock should be cooler.

In April of 2010, EOG announced that it had built the largest acreage position in the Eagle Ford and completed 16 delineation wells spread over the entire trend. In just 18 months, EOG built and partially de-risked its industry leading acreage position on the cheap, essentially doubling down on its oil shale program.

Year-end 2010, EOG’s Eagle Ford production stood at 17.3 MBbld (thousand barrels of oil per day). At the close of the third quarter of 2012, production was up to 96 MBbld. The oil shale move paid off handsomely, providing rapid oil growth in a weakening gas price environment. Thanks to its quick movement, EOG’s now the #1 driller in the region with its #1 acreage position.

To its credit, Chesapeake also took notice of the Eagle Ford, building the #2 Eagle Ford position in the industry. Its drilling program is aggressive and Chesapeake’s financial position more precarious. With weaker cash flow due to its lower liquids mix and higher debt, Chesapeake needs cash to cover its intense drilling program. To defray those costs, Chesapeake’s historically looked to joint ventures. This time’s no different, with Chesapeake signing on Chinese partner CNOOC, to help pay the bills in the Eagle Ford and Niobrara oil shales.

Chesapeake chose to crash the Eagle Ford party. Devon is also reloading and crafting a path to oil like EOG. Unlike Chesapeake, Devon will concentrate on still emergent plays, avoiding premium land and its high cost. It divested non-core natural gas assets to raise cash, using proceeds to build a very large portfolio of new acreage. In the meantime, it’s ratcheting up Permian drilling and expanding its Canadian oil sand capacity to increase its liquids-mix.

Drilling costs will be paid from Devon’s industry leading pile of cash and some Chesapeake-style JVs. Devon’s enlisting Asian partners anxious to learn to exploit their own shale energy back home. Chinese driller Sinopec signed on as a partner in four emergent plays, while Japanese driller Sumitomo ponied up cash for a slice of Devon’s unconventional Permian efforts. In both cases, the Asian partners bring the wallets, while Devon provides the rigs and expertise.

While JVs reduce risk, they also reduce reward. Devon and Chesapeake defer some costs, but they also sell some upside. With its stronger oil production and better cash flow, EOG can better afford to keep its equity stake in its Eagle Ford and Bakken acres intact. EOG’s secure enough to dance alone.

Being able to see around the bend is an important quality for management. EOG took a substantial risk when it redirected its efforts toward unproven new trends in the Bakken and Eagle Ford. It now reaps the reward. Devon and Chesapeake are now scrambling to catch up and realign production toward a higher liquids mix; albeit with slightly different strategies. I like Chesapeake’s acreage portfolio better, but its debt level is a concern. Devon’s on much more solid financial ground. At the moment, neither can match EOG’s impressive momentum.


JustMee01 has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of Apache and Devon 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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