EOG Removing Gas From Its Name

Jim Brown
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EOG Resources, formerly Enron Oil and Gas, reported earnings inline with estimates at 18-cents but cut their growth forecasts for 2011 and 2012 to 9% from 13%. Shares of EOG declines -$9.10 to $88.45.

EOG is facing multiple problems and I have reported on them multiple times because all the gas producers are facing the same challenges. The current price for natural gas is not profitable for these producers. The horizontal wells are expensive and completing a well today is a problem. There is a severe shortage of hydraulic fracturing equipment and higher service costs for multiple reasons. These equipment shortages are not expected to clear up any time soon. The equipment shortage means those service companies with the equipment are charging more for their services. Also the current uproar about fracturing damage to groundwater is causing each company to be much more cautious in their operations and that also costs more money. Time is money in the gas patch.

For those lucky enough to complete their wells the $3.50 for gas is only marginally profitable and potentially unprofitable if the well does not flow as strongly as expected. The rapid depletion rates are also a challenge when the initial flow does not payout the well.

The EOG CEO said, "Part of this is very simple. At current and projected gas prices, we have no interest in growing gas volumes." This is the same thing Chesapeake said when they reported earnings.

All the gas producers are frantically looking for a way to shift into liquids production because those prices are currently at two-year highs. Drilling for oil has the same risk and expense as gas but the long-term payout is better. The initial flow rates are not as large but the depletion rate is slower and the price of the product is 24 times higher.

Chesapeake said they were going to ramp down gas production if prices did not improve by 2011. That is exactly what they need to do. They need to close the valves until the excess production fades and inventories in storage shrink. Like OPEC the gas producers need to pick a price (individually of course not as a group) and then close the valves when they can't get that price for their gas. Nobody is forcing them to sell gas. Currently they are doing it out of desperation and that is why it will take a long time before the strategy will work.

EOG said they were going to be forced to sell $2 billion in assets to fill the hole in their cash flow from the decline in gas prices and increase in drilling costs.

These companies are definitely on the right path. Shifting their focus out of being primarily a gas producer and changing to a liquids producer is the right move. Unfortunately they are being forced to drill on their gas leases in order to save the leases. Once they have a producing well to anchor the lease they can move on to other projects and come back to that lease when prices increase.

While they are drilling the anchor wells they are hemorrhaging cash. This is why almost every producer has been selling partnerships worth billions of dollars to companies and countries that sometimes are thousands of miles away from North America. They are desperate for those financial infusions and those overseas companies are desperate for an education into the magic of shale gas drilling.

EOG actually reported a 30% increase in crude oil and natural gas liquids for the quarter. They are going in the right direction. Revenue increased +57% and total volume increased 11.7%. 72.4% of that was gas and 27.6% liquids. Liquid production was up +30% to 77,400 barrels per day. They expect that to increase another 53% in 2011. They expect 65% of 2011 North America revenue to be from liquids.

I believe we are being given a buying opportunity on EOG but I don't want to rush into a new position. We need to see where this news settles out and then make a rational decision.

Jim Brown

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