Did Energy Intentionally Save Its Best for Last?

I'm willing to wager that, for most folks, the name Enron conjures up unpleasant notions of corporate malfeasance, fraudulently pumped-up businesses, seedy accounting practices, corporate officers cooling their heels behind bars, and the ultimate death of Arthur Andersen, once the lion of public accounting firms.

Lousy parentage, great kids
It clearly was all that. But I think it's more than a little intriguing -- albeit lesser known -- that the infamous Houston company's progeny continues to include a pair of ultra-solid energy companies: Kinder Morgan Energy Partners (NYSE: KMP  ) and EOG Resources (NYSE: EOG  ) . If you're inclined to believe my Foolish colleague Isac Simon and me, you're among those who counts the two companies as the ideal ways to play the natural gas and oil booms, respectively. 

Isac's recently filled you in on the goings-on at Kinder Morgan, including its progress toward the imminent purchase of El Paso (NYSE: EP  ) . The combination will form the biggest midstream operation this side of Russia's giant Gazprom. In view of that background, I'll devote the remainder of my time and space to a similar update on EOG.

It almost certainly hasn't escaped your attention that moribund U.S. natural gas prices have taken the first-quarter measure of noteworthy exploration and production operations like those of ExxonMobil (NYSE: XOM  ) and Chesapeake Energy (NYSE: CHK  ) . That sort of struggle was hardly the case at EOG, however. In his company's post-release call, CEO Mark Papa told us precisely why: "For the first quarter, 80% of our total company wellhead revenues emanated from liquids. In North America, 85% of wellhead revenues came from liquids. Of these liquids revenues, 87% are from crude and condensate and only 13% from NGL's." 

A major bump
The result was a net income jump to $324 million, or $1.20 a share, up from $134 million, or $0.52 a share. Even if you back out $565 million in asset sales, along with other items, earnings per share were still $1.17, essentially in line with the $1.16 Wall Street expected. The crude and condensate volumes that Papa described climbed 49% year over year to an average of 140,800 barrels per day, with a mean price that was up 15%.

Internationally, EOG has operations in Argentina, China, Trinidad and Tobago, the U.K, and Canada. In North America, the company is fortunate to have plunked itself down in North America's hottest crude oil and liquids plays, including the South Texas Eagle Ford, the North Dakota Bakken, the Fort Worth Barnet Combo, and the Permian Basin Wolfcamp and Leonard shales, among other locations.

All the right spots
Looking at its especially active U.S. liquids plays, beginning with the Eagle Ford, Papa said, "[W]e continue to see an improvement in well performance from recent wells compared to wells completed just a year ago. This is likely due to better fracks and better placement of our laterals. This is occurring across essentially all our acreage." In the highly attractive Bakken Three Forks -- EOG is the largest Bakken oil producer in North Dakota, its core -- "[W]e've recently generated exciting and very significant results in three different parts of the play, indicating we have more potential upside growth opportunities than we've previously indicated."

The company also controls 240,000 net acres in Wyoming's Powder River basin. In that active venue, EOG has recently completed a pair of horizontal wells in the Turner sandstone area, encountering an average of 310 barrels per day of oil and 1.9 million cubic feet of rich gas per well.

I'll end this whirlwind tour of a portion of the company's operations by noting that in Argentina, which suddenly has become as oft-ballyhooed as the Kardashians, EOG has recently completed its first vertical well in the potentially huge Vaca Muerta Shale. According to Papa, the still new well "looks strong."

The Foolish bottom line
By now I trust you get the picture. Despite its somewhat dicey pedigree, it would necessitate a yeoman's effort to locate an exploration and production operation with the record of virtually unmitigated success turned in by EOG, the third-largest U.S. independent. It's a company that I consider capable of dressing up any portfolio, one that at the very least warrants a spot on all Foolish versions of My Watchlist.

Fool contributor David Lee Smith doesn't have financial interests in any of the companies named in the article above. Motley Fool newsletter services have recommended buying shares of Exxon Mobil and Chesapeake. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (1) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 10, 2012, at 10:05 PM, enronbuddy wrote:

    So I'll be upfront....I think KMP/KMR is a terrible investment for a multitude of reasons. My analysis on how the dropdowns are a raw deal for the limited partners is below. So Dave...What am I missing? The math is pretty simple.

    Drop Down quick math

    Here is how it works. KMI goes out and buys itself a nice pipeline. Let’s just assume, it has a price/ free cash-flow ratio of about 7. So they pay $100 for the pipeline, and it generates about $14 of cash-flow a year. If the remaining life of the pipeline is 20 years, that would be $5 a year in depreciation, and let’s just say $2 a year for overhead…hopefully enough to pay for some top notch accountants and chip in a few pennies for Rich’s annual salary. So the profit on this pipeline would be $7 a year, less some interest expense, say $3…rates are low, so a net of $4.

    But, being ever so generous and magnanimous, Rich decides that rather than keep all of this money to himself, he would like to share it with his LP buddies at KMP/KMR. So, he decides to let them in on the deal by selling them the pipeline into the brilliant structure that is the MLP. First off….at what price? At book value? $100? That doesn’t sound fair….after all, poor Rich put a lot of effort into acquiring this pipeline….how about $102 (he did have to get down on his knees after all-at least that’s what I read). This sounds fair right? So KMI sells the pipeline to KMP for $102…of course, since KMI has a 2% ownership in KMP, they pay their share…about $2. They take the $100 from the MLP, and pay off the debt incurred to purchase the pipeline in the first place.

    So…now what does the math look like for KMI? As 2% owner in ~$14 of free cash flow a year, Rich takes his $0.28 a year and buys a lollypop…right? Well of course not. As GP, he is entitled to about half of that. So He gets his $7, but depreciation is negligible as is interest expense….he’s only in for $2 after all. By transferring the assets to the LP, KMI has actually increased their cash flow over had they simply held onto the pipeline by transferring all of the cost to the LP, yet still hanging onto half of the cash flow. That Rich Kinder is such a magnanimous bastard….that’s why you all love him right?

    Sure…why not…let's look at KMP’s income statement now and see why you love him. KMP now owns the same pipeline, but is only entitled to $7 of free cash flow.(That pushes our ratio from 7-“pretty good”, to 14-“are you stupid really?” Subtract out the depreciation and some interest expense and yep….no profit. But that’s ok…nothing else they own is profitable either….”profit isn’t important…We are an MLP” as in “More Lube Please??”…that is what it stands for right? All it takes is some pretty simple math to see that even with the tax advantages of an MLP, with a 50% IDR tier like Kinder Morgan, all assets would be better off in a standard Corporate structure. Sure…Uncle Sam might get 35% of your profit (oh right…there is no profit), but that is far better than what is effectively a 50% tax on cash flow…regardless of profit. One day, a professional analyst capable of elementary school math is going to take a look at KMP/KMR and call it what it is…. A mechanism to let Rich Kinder legally bone his LP patsies. Yes…that means you KMP/KMR.

    But… But…But…. Rich has made me a lot of money. Just look at the 10 year returns? True… I will grant that Rich Kinder is really good at one thing…and it’s not running pipelines. Nobody, not even Ken Lay or Bernie Madoff has been more successful at finding idiots to spend billions of dollars on what appears to be worthless and unprofitable securities. Again…yes, I am talking about you…. Anybody who owns this stock clearly lacks the ability to read a financial statement, or even do elementary school level math. Don’t be too ashamed….very few can do both.

    I have no doubt that this insanity can continue for at least a few more years, but it will collapse in the end (when is Rich retiring??). Shares outstanding and debt continue an upward trajectory, and yet profits are elusive. Simply put, there is no mathematical reason for KMP to exist. You have no rights, protections, or recourse against the GP’s blatant conflicts of interest, and only half of the cash flow from assets, even though you pay 98% of the cost…. All nicely divulged in the annual report you have never bothered to read. You couldn’t stop these dropdowns from happening even if you wanted to any more than you could have stopped the construction of REX, or any of the other terrible investments your beloved GP has made on your behalf. He could force you to buy the same pipeline for $150…$200…$1000…. regardless of its value (maybe $40). Some day…when the market runs out of morons willing to soak up the $billions of new shares issued each year to keep this crap box afloat, it will sink like a rock. Then….. Rich’s buddies at the bank….you know the ones who you owe $16.7 Billion as of 1Q2012…. (and billions more as you overpay for dropdowns over the coming years) Those guys will be the new owners of your unprofitable pipelines. Fortunately for them you put up 50% equity….they might not even lose a dime. Wanna guess who they will hire to run them? Probably the same guy who helped them rack up billions in fees skimming profits off gullible and powerless MLP owners. KMP/KMR owners…welcome to MATH…it’s a kinda great invention!!

Add your comment.

DocumentId: 1884930, ~/Articles/ArticleHandler.aspx, 7/25/2014 5:59:15 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement