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It's awfully hard to find a fault with EOG Resources (NYSE: EOG ) right now. For every dollar it generates in revenue, it's creating an astounding $0.53 of operational cash flow to fund new investments. This is turning EOG into an absolute growth machine, and the company expects to be the United States' largest oil producer by 2017. As great as the company is, though, there is one question that lingers for long-term investors like Warren Buffett: Does EOG have a life after shale? Let's look at EOG's portfolio and see how long the shale party will last and what it can do in the future.
Sprinting in circles
Before diving in too deep, let's put ourselves in the right mind-set. We're Warren Buffett clones -- or at least we wish we could all be -- so we're looking for companies that we can buy and hold forever. This means that any company you buy has to have earnings power for decades to come. For investors in the energy space, the long-term viability of an oil and gas company is going to come down to this. How much oil and gas is on the books? How fast will the company go through it? And can it readily find more?
Two very important metrics to answer these questions are proven reserves and decline rates. Proven reserves refers to how much oil and gas a company can feasibly extract from the land it leases and generate a return. Decline rate is how fast a well's production depletes from the moment it's tapped. In the case of EOG Resources, it has about 1.8 billion barrels of proven reserves. Of those reserves, 91% of them are in shale, and its primary operations are currently in the Eagle Ford and Permain Basin in Texas, and the Bakken formation in North Dakota.
This brings us to the next metric: decline rates. While EOG does publicly disclose the decline rates for its wells, data from Howard Weil puts one-year decline rates in the Permain at greater than 60%. Bakken and Eagle Ford wells aren't that much better, either. Accoding to the US Energy Information Administration, replacing legacy well losses represents at least 70% of the new production for all of these shale plays.
What this means is that to even maintain production, any driller needs to spend large amounts of capital on new wells. This is potentially a large concern for EOG and other shale-centric players. Despite that massive amount of operational cash the company generates, it needs to pour an equally large amount back into capital expenditures.
This is what will make shale drilling so challenging for EOG further down the road. In 2013, the company drilled about 579 wells. Based on the one-year decline rates for these wells, it will need to drill 434 wells just to maintain its current production. This is a rough approximation, of course, because well characteristics can change and new technologies could boost production rates. Overall, though, it does lend perspective to the challenge that shale drillers like EOG will face as it grows production.
According to EOG, the company has a drilling backlog of about 15 years, but that's based on the the total amount of wells it drilled in 2013. We can probably expect the total well count to increase over time, and it will therefore take less time to drill through that backlog. At the same time, it still has a large portion of its acreage in the Permain Basin that hasn't been fully evaluated, so that backlog could get larger.
However, unlike some of its peers, such as Anadarko Petroleum (NYSE: APC ) and Devon Energy (NYSE: DVN ) , EOG doesn't have any sizable assets outside of shale production. Devon and ConocoPhillips (NYSE: COP ) are using shale oil to significantly boost overall production in the short term, but they are both also dedicating some cash to develop longer-life assets, such as Canadian oil sands. Anadarko is doing something similar with natural gas exploration off the coast of Mozambique. These projects take lots more upfront capital than shale wells, but they will generate cash over a much longer time horizon and don't need as much capital to maintain production.
For EOG to live beyond its current asset platform, it will need to seriously consider some assets beyond shale production that can generate a more stable cash flow much like these other companies have.
What a Fool believes
There's no doubt in my mind that over the next few years, EOG Resources will continue to be a top oil producer and a top energy stock thanks to the growth in shale. Looking at a much longer time horizon, though, there are some uncertainties for EOG that are a little bit more glaring than some of its peers because it is essentially all-in with shale assets, so investors with that Warren Buffett investment time horizon may think twice before hitching the cart to EOG. Ten to 15 years is a long way out, and so far the company's management has proved by moving into shale that it knows where to find growth. For investors, watch out for any acquisitions outside of shale. These assets could very well be what EOG sees as its future beyond shale.
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