The Letter to Stockholders is available in two formats.
From Mark G. Papa, Chairman and Chief Executive Officer, February 24, 2012:
Steady as a Rock
Be the first to identify and develop crude oil and liquids-rich shale reservoirs using the same horizontal drilling and completion techniques that transformed North American natural gas resource plays.
This has been our primary focus in recent years as EOG developed a more heavily weighted crude oil and natural gas liquids portfolio, while maintaining our core natural gas assets. When EOG began its transition to liquids from unconventional rock, we seized a first-mover opportunity to dominate these types of plays and capture higher margins. Now that we have realized our goal of building an extensive crude oil and liquids-rich drilling inventory, EOG is recognized worldwide as an expert in the identification of rocks with crude oil potential.
- The keystones of our successful strategy are:
- Capturing first-mover opportunities and quietly accreting large acreage positions in world-class crude oil shale plays in the lower 48 states;
- Using horizontal drilling and innovative completion technology, largely created and enhanced by our employees, to tap the rocks and maximize productivity;
- Staying away from joint ventures and similar relationships that would dilute EOG’s ownership and our intellectual capital in our liquids-rich plays; and
- Continuing to maintain conservative financials and a low debt level.
We expected that once the gas to liquids transformation was complete, EOG’s financial metrics would strengthen. In 2011, EOG posted very strong financial results and generated exceptional year-over-year production growth dominated by crude oil, condensate and natural gas liquids.
Our earnings per share increased by 551 percent in 2011 compared to 2010, while cash flow from operating activities grew 69 percent. In addition, our earnings before interest expense, income taxes and depreciation, depletion and amortization rose by approximately 87(2) percent for the same period. As our crude oil and liquids mix increases over time, we expect this strong financial performance to continue.
North American wellhead revenues were comprised of 72 percent liquids and 28 percent natural gas in 2011. This compares to 53 percent from liquids and 47 percent from natural gas in 2010. Total company liquids production increased 48 percent last year, driven by a 52 percent increase in crude oil and condensate production, all organic.
Why EOG is Crude Oil Driven
Many pundits were surprised in 2011 when the world’s demand for crude oil increased for the second consecutive year. This uptick occurred despite volatility and instability in certain European countries, a slowdown in China’s economy and continued financial uncertainty in the United States.
At EOG, we expect worldwide crude oil demand to grow 1 million barrels per day (MMbld) per year from the current level of 89.5 MMbld. Total global crude oil supply, particularly from non-OPEC countries, grew only marginally in 2011, and the OPEC economies are finding that their break-even price is higher than it was several years ago. It is our opinion that, even taking into account the increased shale oil drilling from recent discoveries in the United States, the existing reserves cannot keep pace with future crude oil demand. Thus, we expect the price of this commodity to rise, and we are well positioned to benefit from the upturn.
Conversely, EOG remains bearish both on short-term North American natural gas prices and demand. The success of the industry in drilling shale gas formations has created a tremendous supply of natural gas in the United States without a commensurate spike in demand. During the very cold winters of 2008, 2009 and 2010, and several recent warmer-than-average summers in heavily populated areas of the United States, demand was stimulated. However, the winter of 2011-2012 has been relatively mild, resulting in lackluster residential and commercial heating demand.
It is EOG’s expectation that it may be at least several years before the long-term future for North American natural gas will look more optimistic. At that time, an increase in demand likely will be driven by recently proposed federal government emission regulations that may require some electric power plants to convert from coal to clean-burning natural gas.
A Cadre of Superior Crude Oil Assets
In 2007, EOG began drilling and developing its first sizeable oil and liquids-rich assets, the North Dakota Bakken and the Fort Worth Barnett Combo. Leveraging off of this success in recent years, EOG brought economies of scale to bear, acquiring large acreage positions at attractive first-mover costs in four key North American oil and liquids resource plays. In the South Texas Eagle Ford, we hold a premier 572,000 net acre position in the crude oil window and rank as the single largest crude oil producer in this area. In the Bakken/Three Forks, EOG is one of the state’s top crude oil producers. We are the dominant acreage holder in the liquids-rich Barnett Combo and the largest producer in the play. Finally, EOG holds strong positions in the liquids-rich Permian Basin West Texas Wolfcamp and New Mexico Leonard/Bone Spring Sands plays.
From 2007 to 2011, EOG increased overall total company crude oil and condensate production at a compounded annual growth rate of 38 percent. Total company crude oil, condensate and natural gas liquids production also has increased by 38 percent compounded over the same period.
While EOG’s economic returns in each of these prolific shale plays are attractive, we are particularly proud of our flagship, the South Texas Eagle Ford. Here, EOG has captured the largest U.S. crude oil discovery, net to any one company, in the past 40 years. In early 2012, EOG raised the estimated reserve potential(1) in this premier asset from 900 MMBoe to 1.6 BnBoe, net after royalty. We believe EOG’s Eagle Ford asset offers the best investment economics of any largescale hydrocarbon play in the world based on ratios of production rate to well costs and net reserves to well costs.
For the most part, the largest assets in EOG’s crude oil portfolio are located primarily in Texas and North Dakota, two states that provide a positive regulatory environment related to crude oil development.
With several years of solid experience, EOG is out in front of the industry, capitalizing on its firstmover advantage in the capture and development of crude oil from unconventional rock. The technical acumen we have gained is driving EOG’s momentum.
Against a backdrop of constrained worldwide crude oil supply and demand fundamentals, EOG has adopted a three-pronged approach to define our next generation of drilling prospects. First, we will continue to explore for and move quickly to acquire large acreage positions in new horizontal oil and liquids prospects onshore North America where we believe a number of significant fields have yet to be discovered.
The second part of our strategy is to improve the productivity from our existing North American resource shale plays, which, by their nature, have low recovery rates. While the technology to capture a greater percentage of these resources in place is in the early stages of development, EOG is focusing on two methods to meet this goal: drilling wells with denser spacing patterns and testing secondary recovery methods.
The third prong of our plan is to search for and identify new international horizontal oil opportunities, move quietly to capture them and then apply our expertise to unlock their potential.
EOG already is making progress in pursuing select international oil projects that meet our established North American strategy. In the United Kingdom’s East Irish Sea Conwy field, following the successful discovery of 20 million net barrels of potential(1) crude oil reserves, EOG has initiated a development program to bring production on-line early in 2013. In Argentina, where EOG has acquired exploration rights to approximately 100,000 net acres in the oil window in the Neuquén Basin, we began drilling our first exploration well targeting the Vaca Muerta shale in early 2012.
With regard to our North American natural gas strategy, EOG intends to invest the minimum amount of capital necessary to hold the majority of our large dry gas core shale assets in areas such as the Haynesville, the Horn River and the Marcellus until prices improve. We plan to be patient, recognizing that it may take a number of years for these prices to meet EOG's economic development threshold.
Because EOG is very bullish on crude oil, we have partnered with two other E&P companies to develop the Kitimat LNG export facility in British Columbia. A final investment decision on this project, in which the price of LNG would be indexed to crude oil, is expected to be made in the second half of 2012.
Financial Strength
A hallmark of EOG’s reputation is being financially conservative. Despite our plethora of drilling and investment opportunities, EOG sets balance sheet limits to manage the outside volatility inherent in a commodity industry. For year-ends 2011 and 2012, we established a maximum net debt-to-total capitalization limit of 30 percent. We ended 2011 at 26(2) percent and intend to maintain the 30 percent limit at year-end 2012.
Another metric of EOG’s financial discipline is reflected in its common stock dividend philosophy. Following an increase in 2011, EOG’s Board of Directors again increased the cash dividend on the common stock in February 2012. Effective with the dividend payable on April 30, 2012 to holders of record as of April 16, 2012, the quarterly dividend on the common stock will be $0.17 per share, an increase of 6.25 percent over the previous indicated annual rate. The indicated annual rate of $0.68 per share reflects the 13th increase in 13 years.
Our Extraordinary People
Recently, EOG was named to FORTUNE’s 2012 list of “100 Best Companies to Work For©” for the sixth consecutive year. The comprehensive review involves an evaluation of a company’s policies and culture and a survey of company employees regarding credibility, respect, fairness, pride and camaraderie. EOG has made the FORTUNE list every year we have been eligible to apply.
EOG’s employees are remarkable. Energetic and conscientious leaders in their respective areas of expertise, they collectively fuel our success and progress. This is a highly collaborative corporate culture in which employees constantly learn from, and look out for, each other as they seek new ways to perform their work. There is a mindset at EOG that actions do speak louder than words. EOG’s employees demonstrate personal integrity and commitment with regard to safeguarding their coworkers and neighbors, as well as the environment where they work and live. We are confident that EOG’s future is in responsible, competent hands.
This Whole Industry Rocks
Because energy is such a significant part of the U.S. economic picture, it is appropriate to underscore the positive impact EOG has made as a first-mover in the prolific onshore North American shale plays.
Utilizing horizontal drilling and other technological breakthroughs to unlock resources in shale rock, EOG, together with other companies in the E&P industry, has created a 100-plus year supply of natural gas. Furthermore, this sustainable resource is likely to be available at reasonable costs for years. Conservatively speaking, EOG believes the shale revolution in natural gas has reduced U.S. energy costs by approximately $100 billion per year. In addition to the positive balance of payments and security of supply, shale development represents one of the single largest drivers of job creation in our country. According to the American Petroleum Institute, the United States natural gas industry supports over 9 million jobs and 7.5 percent of the U.S. gross domestic product.
On the crude oil side of the equation, EOG expects the shale revolution to increase domestic crude oil production by at least 1.5 million barrels per day by 2015, thereby reducing this country's need for imported foreign oil by the same amount.
EOG contends that the discovery of these massive North American crude oil and natural gas reserves is this country’s single biggest economic success story of the last five years. This economic breakthrough was achieved with neither federal grants nor special research and development credits. It was realized by the innovation and hard work of EOG’s employees and their counterparts in the E&P sector. Unfortunately, our industry’s achievement has often been mischaracterized or overlooked by the national news media. That is disappointing.
Nevertheless, EOG is proud to have played a pivotal role in this positive economic paradigm, and we are prouder still of our employees who rightly deserve the credit. Working together, we are well positioned to replicate EOG’s outstanding performance over and over again.
Footnotes
(1) Estimated potential reserves, not proved reserves.
(2) Refer to reconciliation schedules on page 113 of the 2011 Annual Report.
