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Searchin’ – EOG Again Seeks to Build Its Oil and Gas Inventory Organically, This Time in the Utica

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As U.S. E&Ps deal with a slew of shorter-term challenges such as broken supply chains, labor shortages, and infrastructure constraints, they’re also paying increasing attention to a longer-term concern: “inventory exhaustion.” There is a growing chorus of analysts asserting that oil and gas producers’ inventory of top-tier drilling locations has been significantly depleted as the nation’s major unconventional resource plays mature. Many producers have continued to rein in their capital spending and husband their current resources and several have boosted inventories through bolt-on acquisitions. Premier E&P EOG Resources has taken a different approach, emphasizing organic exploration that has led to the discovery of two new significant plays over the past two years, including the recent announcement of a new Utica Shale combo play that it describes as being “almost reminiscent” of the early Delaware Basin. In today’s RBN blog, we discuss EOG’s dramatically different approach to building inventory and dive into the details of its new Utica discovery.

From the onset of the Shale Revolution, E&Ps funded double-digit annual growth that boosted output from 5.5 MMb/d in 2010 to nearly 13 MMb/d in 2019 before the pandemic-induced demand destruction disrupted the industry. Despite soaring crude prices, booming markets, and ever-improving drilling-and-completion technology, post-pandemic U.S. oil production recovery has proceeded at a much more tepid pace, frustrating politicians and consumers in the process. U.S. crude oil production may finally reach 2019’s average level next year, although the Energy Information Administration (EIA) has twice reduced its 2023 growth forecast to a current 4%, or 480 Mb/d.

Major factors in the anemic rebound include producers’ new laser-focus on cash returns, plus shortages in labor and materials, sharply higher costs and (in some areas) insufficient pipeline takeaway capacity. There are longer-term worries too — not just the uncertain timing and impacts of the energy transition, but also that, after more than a decade of aggressive development, the inventory of top-tier drilling locations in maturing resource plays appears diminished. According to one recent analysis, the number of highly productive locations in the U.S.’s top five plays have been cut in half since 2016.

Most major E&Ps have been running in place, targeting maintenance-level capital spending despite high oil prices, presumably to sustain their current inventory for a decade or more. At the same time, many have announced complementary acquisitions to expand future drilling opportunities in their core regions, a trend we have blogged about several times recently, including an analysis of Devon Energy’s purchases of Williston producer RimRock Oil and Gas and Eagle Ford producer Validus Energy, Diamondback Energy’s acquisition of FireBird Energy, and EQT Corp.’s deal for Tug Hill Operating. Consolidation does serve the purpose of extending the premium drilling window for the buyers, but it doesn’t address the industrywide issue of total inventory declining.

One industry leader has pursued a different strategy that has resulted in the announcement of two new major U.S. unconventional plays in the last two years. Since its spin-off from a dying Enron Corp. in 1999, EOG Resources has completed just one major acquisition, the $2.5 billion purchase of Yates Petroleum in 2016 that doubled its Delaware Basin and Powder River Basin assets. Instead, EOG has become one of the top performing U.S. producers through a contrarian strategy of growth through organic exploration, which — if done successfully — adds reserves, lowers finding-and-development costs, and reduces the overall cost basis of the company.

Beginning in 2016, EOG established a benchmark for high-grading its portfolio, targeting investment and development of “premium” reserves that provided a minimum 30% return at $40/bbl oil, $16/bbl NGLs, and $2.50/Mcf gas prices. The company concentrated on allocating funds to boost its premium inventory in its current core areas: the Delaware Basin, the Eagle Ford Shale, the Bakken/Three Forks play, the Denver-Julesburg and Powder River basins, and the Anadarko Basin’s Woodford oil play. Successes include the doubling of its reserve estimates and premium locations by successful exploration in the Mowry, Niobrara, and Turner Sand formations in the northern Powder River.

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Most notably, EOG has devoted a significant portion of its annual investment to exploration in what it calls the “sleepy” — or underappreciated or neglected — portions of major U.S. unconventional basins. The first major discovery was in South Texas. The company had been drilling oil-focused wells in the Austin Chalk in South Texas, but in 2018 began investigating dry gas Austin Chalk potential in Webb County, along the Mexico border. In November 2020, EOG announced the new Dorado natural gas play, estimating a massive 21 Tcf in recoverable resources from stacked pay zones in the Austin Chalk and Upper and Lower Eagle Ford in what it hailed as “the lowest cost U.S. natural gas play.” The 163,000-net-acre position, which EOG had assembled through legacy assets, organic leasing, trades, and bolt-on acquisitions, had a development breakeven of less than $1.25/Mcf and offered easy access to growing demand from Gulf Coast LNG export facilities and from Mexico. Best of all, the play easily met what EOG is calling its new “double-premium” investment criteria, which it says is the “most stringent investment hurdle rate in the industry”: a minimum 60% return at $40/bbl oil, $16/bbl weighted average NGLs, and $2.50/Mcf gas prices — each of which is less than half of today’s prices.

Year-to-date 2022 results demonstrated that focusing capital investment on “double-premium” locations significantly boosted cash flow generation, from $5.5 billion in 2021 to an estimated $7.6 billion in 2022.  EOG is allocating 67% of its free cash flow, or $5.1 billion, to return to shareholders as regular or special dividends. The remaining cash is being used to strengthen EOG’s fortress-like balance sheet (0.2x net debt to Adjusted EBITDA leverage ratio) and for low-cost property bolt-on acquisitions, which augmented a development program that replaced 170% of the “double-premium” wells drilled in 2021.

Along with those Q3 2022 financial results, EOG unveiled its eighth and perhaps most surprisingly new “double-premium” exploration play. As shown in Figure 1 below, the company said it had stealthily accumulated 395,000 net acres in the volatile oil window of the Utica Shale in southeastern Ohio — just west and north of West Virginia’s panhandle.

EOG Utica Shale Combo Play

Figure 1.  EOG Utica Shale Combo Play. Source: EOG Resources

The Utica Shale is a massive formation that covers 170,000 square miles over portions of eight U.S. states. It underlies the Marcellus Shale at depths reaching 14,000 feet on the eastern side, including Pennsylvania, but thins to 2,000-8,000 feet moving west across Ohio. Cited as the fourth-largest U.S. natural gas resource by the EIA, the Utica also has volatile oil, another word for condensate, (light-green area in Figure 1) and black oil (dark-green area in Figure 1) windows as it thins in Ohio. Development of the Utica began in 2011, shortly after the onset of the Shale Revolution, with the rig count rising to 50 in late 2014. But the rig count subsequently plunged to 10 in 2016 on the crash in commodity prices, rebounded to 30 in 2017, then cratered at four after the onset of the pandemic before recovering to its current 10, primarily located in the eastern dry gas window.

Several companies pursued development of the volatile oil window at the peak of Utica drilling activity, most notably Chesapeake Energy and EnerVest Energy Partners. But inconsistent results and falling liquids prices led to the area being neglected for several years. Then EOG’s exploration team operating out of the Oklahoma Woodford oil play began taking a fresh look at the basin using its newly developed technology, including advancements in precision targeting and reservoir simulation. The company acquired 18 legacy wells with varying geologic and production data, which supported EOG’s new assessment of the area. It began building a 395,000-net-acre position (bright-yellow areas in Figure 1) through leasing and low-cost acquisitions, including 100% of the mineral rights across 135,000 net acres. Because most producers had deprioritized the area, the total cost was just $500 million, which included an average $600/acre for the working interests, largely held by production, and $1,800/acre for the mineral rights. The mineral rights boosted the company’s revenue by 25% without increasing development or operating costs.

Over the last 12 months, EOG drilled four delineation wells on the acreage (red triangles in Figure 1), which confirmed its model and the economic viability of the area. Those first wells already earned premium and “double-premium” returns when normalized to its development plan, which assumes three-mile laterals. The most prolific well initially produced 3,500 barrels of oil equivalent per day (3.5 Mboe/d) — 2.5 Mb/d of it oil — from a 12,000-foot lateral. The company expects that ultimate recovery will be more in the range of 25% to 35% oil and similar percentages for both NGLs and natural gas. EOG is guiding to an estimated ultimate recovery (EUR) of 2 MMboe to 3 MMboe for each three-mile lateral for less than $5/boe in finding-and-development costs. The company expects most locations will generate “double-premium” returns. Most significantly, CEO Ezra Yacob descried the new Utica position as “almost reminiscent of what we saw nearly a decade ago happening in the Delaware Basin” — now one of the nation’s more prolific production areas. That’s quite a claim, and time will tell whether EOG’s play can reach the lofty production standard of the Western Permian.

In its Q3 results call, EOG explained four factors that led to the development of this resource play. The first was understanding the optimum portion of the play, which involved largely avoiding the gas window and not venturing too far into the black oil window. The second was precision targeting of the most productive rock, which EOG identified as a layer of the Point Pleasant formation, which consists of interbedded limestones and black shales that underlie the Utica Shale in Ohio. Its drilling was so accurate, EOG said, that the drill bit stayed within an 8-foot vertical range for the entire 12,000-foot lateral. The third factor was understanding reservoir pressure across its area so that drilling could focus on areas with sufficient natural gas to eliminate or minimize the need for artificial lift — that is, efforts to increase downhole pressure and push resources to the surface. Finally, the company applied its most advance drilling-and-completion designs that had been tested in similar basins such as its Woodford oil play.

For 2023, EOG has scheduled a one-rig, 20-well development program for its Utica combo play, which should result in $200 million to $300 million in investment based on its estimated $5/boe of finding-and-development costs. From there, it will assess what the go-forward plan looks like as it allocates capital between its expanded eight core “double-premium” plays. One factor in that plan will be the availability of infrastructure. EOG said in the conference call that the area in question had a surfeit of available gathering-and-processing infrastructure and expressed confidence about sufficient takeaway capacity to garner strong returns for its oil, NGL, and natural gas production. Still, RBN has recently seen a flurry of midstream activity in the region, indicating that the midstreamers are taking a hard look at EOG’s potential growth. Also, low water levels on the Mississippi River have raised concerns about transporting Utica condensate volumes to market, as we discussed recently in The Mississippi, She’s A-goin’ Dry.

Long-term, EOG indicated it would continue to fund a fairly aggressive exploration budget, which is approximately $450 million, or about 12% of total spending, in 2022. The company says it has a number of plays that are at various stages of exploration. The criteria for future development is not the volume of resources developed, but whether a play would be accretive to the overall quality of its existing inventory. For now, the addition of two new plays over two years at relatively minimal acreage costs have been an effective counter to the overall narrative of inventory exhaustion. As attention to the issue increases, we’ll be monitoring to see if other E&Ps step up organic exploration in the wake of EOG’s successes.

“Searchin’” was written by Jerry Leiber and Mike Stoller and appears as the first song on side one of the Coasters’ debut album, The Coasters. Released as a single in March 1957, the song went to #1 on the Billboard R&B Songs chart and #3 on the Billboard Hot 100 Singles chart. “Searchin’,” along with its B-side, “Youngblood,” helped launch The Coasters from the R&B market into a chart-busting rock and roll group. Personnel on the record were: Bobby Nunn, Richard Berry, Billy Richard and Roy Richard (vocals), Mike Stoller (piano), Gil Bernal (saxophone), Barney Kessel (guitar, mandolin), Ralph Hamilton (bass), Jesse Sailes and Abe Stoller (drums), and Joe Olivera (percussion). 

The Coasters was the debut album for the group of the same name. Released in May 1957 on Atco Records, the LP was a compilation of previous hit singles released by the group along with cuts done by The Robins, a group in which two of The Coaster previously participated. 

The Coasters are an American rhythm and blues/rock and roll vocal group formed in Los Angeles in October 1955, when two of The Robins signed a new record deal with Atco Records in L.A. They were named The Coasters because they went back and forth from the West Coast to the East. The original Coasters were vocalists Billy Guy, Leon Hughes, Carl Gardner, and Bobby Nunn, along with guitarist Adolph Jacobs. In 1957 Nunn and Hughes moved to New York City and joined with Cornell Gunter and Dub Jones to form an updated version of the group. Their association with the songwriting team of Leiber and Stoller was an immediate success, resulting in a string of hit records. In 1987, The Coasters became the first group inducted into the Rock and Roll Hall of Fame. In 1999 they were inducted into the Vocal Group Hall of Fame. They released three studio albums, five compilation albums, and 15 singles. Twenty-one members have passed through the group since its formation. Carl Gardner Jr.’s widow, Vera Gardner, owns the rights to The Coasters’ name. The group still tours, with no original members.

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