EOG Resources (EOG 0.16%) was on a mission in 2015. According to comments made by CEO Bill Thomas on the company's third-quarter conference call, EOG's "goal this year has been to transition the company to be successful in a low commodity price environment." To achieve that goal it had five objectives, with Thomas detailing the company's progress on the call.
Objective one: Maximize return on capital invested
In regard to this first objective, Thomas said:
We have maximized return on capital invested by directing capital to our best plays, the Eagle Ford, Bakken and Delaware Basin. We are having a record year of well productivity improvements and cost reductions. ... As a result of these efforts, our largest and best assets now generate over 40% direct after tax rate of return with $50 oil. Making a solid return in horizontal oil at $50 is an excellent achievement.
Most analysts expected low oil prices to be the death of shale drilling, but that certainly hasn't been the case. While drilling has clearly slowed, drillers like EOG have focused their efforts on improving their craft and the results have been nothing short of remarkable. EOG's drilling returns in the Delaware Basin, for example, are better today than they were when oil was $95 per barrel.
Source: EOG Resources Investor Presentation.
Objective two: Improve well performance through technology and innovation
One of the ways it has improved its returns is by using technology and innovation to increase its production. Thomas noted that "the new work we are doing on targeting means that EOG continues to drill the strongest horizontal wells in the industry." By targeting specific sections of a reservoir, EOG is able to hit more of the hydrocarbon sweet spot and therefore extract more oil out of each well. An example is shown on the slide below.
Source: EOG Resources Investor Presentation.
While EOG is an early leader on well targeting, it is far from the only company to find success. Newfield Exploration's (NFX) CEO Lee Boothby mentioned on the company's conference call that it was specifically "targeting of the most effective drilling zones within" its shale plays. This was helping the company to deliver better initial production rates, which was a key to Newfield Exploration's ability to outperform production expectations and raise its full-year production guidance. Another important result of targeting that Newfield Exploration pointed out is that when combined with a few other factors it will likely increase the estimated ultimate recovery of hydrocarbons from the wells, which is a key factor in boosting drilling returns.
Objective three: Achieve significant cost reductions through sustainable efficiency gains
Another big focus of EOG Resources has been to reduce its costs. Thomas detailed that progress by noting:
On the cost side, we're making substantial improvements. Year-over-year third quarter per unit lease operating expense was down 17%, per unit transportation was down 11% and total G&A was down 6%.
Whereas well targeting improves the returns earned on drilling new wells, these cost reductions improve the cash flow margin the company can capture on legacy wells. That helps to mute some of the impact of lower oil prices.
Objective four: Take advantage of opportunities to add drilling inventory
One of the hallmarks of EOG Resources' plan this year was to drill just enough wells to offset the production decline of legacy wells. However, while it held back on production growth, the company still wanted to grow its future drilling inventory by adding additional drilling locations to its portfolio. Over the past few years, its goal has been to grow its inventory at twice the rate of drilling and, according to Thomas, "2015 is no exception. This is a record year for adding high quality drilling potential." Overall, it added 3,000 future drilling locations to its portfolio both through exploration as well as through tactical acquisitions.
Objective five: Maintain a strong balance sheet
The final objective, and maybe the most important, was that it wanted to accomplish its 2015 objectives -- including growing its drilling inventory -- without blowing out its balance sheet. According to Thomas, the company did just that because it maintains "one of the strongest balance sheets in the industry." That's clear from the slide below where it has the second lowest leverage ratio among its peers.
Source: EOG Resources Investor Presentation.
Because EOG Resources maintains such a low leverage ratio, it has been able to focus its time and efforts on achieving its operational and growth goals instead of being focused on improving its balance sheet just to survive the downturn, which is where many of its peers devoted their time this year.
Investor takeaway
The bottom line here is that EOG Resources has accomplished all five objectives necessary to transition the company to run on lower oil prices. Further, the work it did in 2015 really positions the company to deliver strong growth and exceptional returns when the oil market begins to improve.
