Eagle Ford Is About to Hit a Wall

The Energy Information Agency has released very pertinent information for investors in U.S. drillers. The Eagle Ford is one of the most popular U.S. plays, and falling production from previously drilled wells is taking its toll on net oil production growth. Considering falling growth, it is time to reevaluate just which companies are trading at too high of a valuation.

The numbers
In November 2013 oil production from legacy wells decreased by 81 thousand barrels per day (mbpd) relative to the previous month. This is a serious threat considering oil production growth from new wells was only 105 mbpd. Seeing as legacy net oil production decreased by 30 mbpd from 2012 to 2013, within a year's time the Eagle Ford could see falling total oil production.

Source: U.S. Energy Information Agency

Eagle Ford drillers
EOG Resources (NYSE: EOG  ) is one of the biggest Eagle Ford drillers with 173 thousand barrel of oil equivalent (mboepd) net production on June 30, 2013. Decreasing the number of required drilling days helped to cut its average well cost from $6.8 million in 2012 to $5.8 million by the second quarter of 2013.

Even with improvements in operational efficiency, its bottom-line oil production will not be able to increase at high rates for ever. The problem is that Wall Street may be pricing too much growth into the company. It trades at a price-to-earnings ratio around 49. Compared to other drillers in the Eagle Ford, EOG Resources is very expensive.

ConocoPhillips (NYSE: COP  ) is a major upstream player. It is heavily invested in the Eagle Ford with Q3 2013 production at 126 mboepd. It is important to note that its third-quarter production only increased 4% above its second-quarter production. 4% production growth is better than nothing, but it is not amazing.

On the plus side, ConocoPhillips has a number of growth projects in the Canadian oil sands that will come online in the next couple years. Also, the company is trading at a P/E ratio around 12; a valuation that is far easier to swallow than EOG's.

Marathon Oil (NYSE: MRO  ) is another major Eagle Ford player with Q2 2013 average net production of 80.1 mboepd. Similar to ConocoPhillips, Marathon Oil's quarterly production growth rate is declining. Its Eagle Ford production grew 21% from Q4 2012 to Q1 2013, but it only grew 11% from Q1 2013 to Q2 2013.

To help de-risk itself from the U.S. it has a number of exploration programs off in Kurdistan, but such drilling is risky due to friction between the Kurdistan government and the Iraqi government. Thankfully the market is not pricing Marathon for massive future growth, as it trades at a P/E ratio around 13. Marathon's total debt-to-equity ratio of 0.34 is also on the lower side of the scale, meaning that falling Eagle Ford growth is less likely to pound Marathon's stock. 

Chesapeake Energy (NYSE: CHK  ) is an Eagle Ford driller with a history of issues. In Q2 2013 it was able to reach 85 mboepd in the Eagle Ford with a number of rigs in the oil-rich window. It is slowly bringing itself back to profitability by shifting as much of its capex as possible into oil-rich plays and selling off assets, but the company still has a high total debt-to-equity ratio of 1.02.

Wall Street expects that the company will earn $1.66 per share in 2013 thanks to strong oil prices. For risk-adverse investors, though, it is still difficult to justify Chesapeake's valuation considering its high debt load. 

The bottom line
The Eagle Ford's net oil production growth is falling. Based on current decline rates it is possible to see net negative oil production within a year. Making exact projections about the day and hour when net oil production will turn negative is not the point. The point is what growth premiums are being paid for assets relative to their growth prospects.

EOG Resources could receive a rude awakening when investors realize high production growth rates cannot last forever. Diversified players like ConocoPhillips and Marathon Oil are in a different situation, as they are already valued more conservatively. For risk-adverse investors, sticking with the bigger companies like ConocoPhillips and Marathon Oil is an attractive option thanks to their relativity low valuation and acceptable debt loads.

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