EOG Resources (EOG -0.48%) recently reported rather lousy fourth-quarter financial results. The company's profits plunged as it realized much lower oil prices than previous quarters. While that was to be expected the company's earnings still came in well under Wall Street's already muted expectations. However, as bad as that all sounds the company sees much better days ahead.
CEO Bill Thomas was pretty clear about that during his closing comments on the company's fourth-quarter conference call. He left listeners with six key takeaways about the current oil market and how EOG Resources plans to use it to its advantage in the future.
No. 1: The price of oil must go higher
Thomas closed his remarks with a macro view of the oil industry. He noted some positives on the horizon such as Congress possibly lifting the oil export ban and the growing U.S. economy. He then dove right into his thoughts on the current and future price of oil. Thomas made it clear that he doesn't think the current low price will last, instead he was adamant that,
EOG will be very focused this year on preparing for the recovery in oil prices. The current supply demand imbalance is not very large. And current prices are far short of what is necessary to sustain the supply need to meet world demand growth. When prices recover, EOG will be prepared to resume strong double-digit oil growth.
Basically, he thinks the price of oil is currently unsustainably low and therefore will head higher in the future. Once that happens EOG Resources will turn its growth engine back on. However, in the meantime the company is putting the brakes on growth as it won't grow its production in 2015. That's something the company can afford to do because of the next five points he made.
No. 2: Returns always come first
Thomas said that EOG Resources is, "intentionally choosing returns over growth." It's something the company has always done, but until now it had been very profitable to grow. Now that it's not as profitable the company is pulling back as its main focus is, and always has been on returns. He went on to say that, "year end, year out EOG consistently approaches capital planning by focusing on returns. 2015 is no different."
No. 3: No growth for the sake of growth
He then went on to hammer home the point that the company has halted growth not because it has to but because it can. He said that,
While EOG is one of the few companies that can earn a healthy return at today's oil prices, we are not interested in growing oil into a low-price environment. As we compare today's oil prices to our expectations for a more balanced market, it makes economic sense to slow production until an industry wide supply response is realized and prices respond accordingly. This strategy maximizes the value of our assets and it's the right strategy to create long-term shareholder value.
The company has data to back up this claim. As the following slide notes the company can earn an adequate return on drilling across much of its asset base at today's $55 oil price.
Source: EOG Resources Investor Presentation.
However, its returns are even better at a $65 oil price. Given its outlook that the price of oil needs to be higher it's simply going to sit back and wait for that to happen.
No.4: Financially strong
One of the reasons why EOG Resources can afford to wait is because of its balance sheet. Thomas said that the company's "balance sheet places EOG in a strong position", which is evidenced by the company's investment grade rating. Further, it has one of the lowest leverage ratios among its peer group as we see on the following slide.
Source: EOG Resources Investor Presentation.
Thomas then noted that the company intends to, "use our financial flexibility to take advantage of opportunities to grow our inventory by acquiring low-cost high-quality acreage." This is strength that not all energy companies have at the moment as so many drillers used debt to grow production. This has the industry quite over levered and has some worrying that there could be a massive default wave to hit over the next year. EOG Resources plans to use its financial strength to take advantage of the weakness of its rivals by acquiring oil acreage from those that need to sell in order to pay down debt.
No. 5: Deferred gratification
One of the more creative things EOG Resources is doing in 2015 is drilling wells but not completing them. That's because completion costs, which includes the actual fracking, typically represents 60%-65% of the overall cost. However, there is a view within the industry that those costs will come down dramatically within the year. Once those costs come down, and the price of oil comes up, EOG Resources will "be ready to return to double-digit oil growth" as it will simply start completing the 350 wells it expects to drill but not complete next year. As this next slide notes, the incremental returns it can earn could be well worth the wait.
Source: EOG Resources Investor Presentation
No. 6: We'll be even better on the other side
The final point that Thomas made was that the company, "fully expect[s] to emerge from this commodity-priced down cycle in a stronger position than we entered it." One of the reasons for this is because the company has "more opportunity than ever to lower finding costs and developing costs and improved returns." In addition to that one of the biggest opportunities that EOG Resources could seize is to acquire drilling acreage at fire sale prices. Because of its balance sheet strength EOG Resources is in a prime position to acquire these assets, which could add to a drilling inventory that's already expected to last the company the next 15 years.
Investor takeaway
The price of oil might have ruined EOG Resources' fourth-quarter results, but it has done nothing to dampen its long-term outlook. Instead, the company views the current price as being unsustainable so it's preparing for higher oil prices in the future. It's a move that the company expects will create a lot of value for long-term investors.
