EOG Resources: More Oil, Quicker Oil, Cheaper Oil
Oil Company Invests in Railroads and Sand Mines to Maximize ROCE
Enron Oil and Gas split from Enron in 1999 and became EOG Resources, Inc (EOG). The company is one of the largest independent oil and gas companies in the United States (independent oil and gas companies do not integrate the refining of oil into gasoline as part of their portfolio). EOG has been able to out perform its competitors by successfully cutting costs and finding innovative ways to increase oil and gas production.
EOG’s goal is to to deliver the highest shareholder appreciation measured by total shareholder returns and to be the most profitable independent exploration and production company in terms of return on capital employed (eogresources.com).
EOG strives to achieve their goal by cheaply drilling and completing their wells, quickly bringing them on production, maximizing production from each well, and minimize the production costs of each well. They strive to maximize price earned for each barrel of oil by delivering to underserved markets, and to deliver the a high rate of return on each dollar spent by shortening their drill to production cycle.
Low Costs –A key to gaining a competitive advantage in North American shale plays is to lower the cost of each well drilled. The total cost of wells drilled can fall anywhere between $5M and $15M. EOG has done two things in particular that are unique and have given them a competitive advantage. They’ve invested in railroads and sand mines.
In 2012, EOG built a rail spur and off-loading terminal in St. James, Lousiana which allowed them to access new refining markets to unload their Bakken oil (Bakken is an unconventional oil field in North Dakota). The new markets allowed them to earn a premium on their oil versus selling it at often glutted oil hub of Cushing, Oklahoma.
EOG also invested in three sand mines and two processing plants in northern Wisconsin. Sand plays an integral part in the production of oil and gas from shale plays. Shale plays are very impermeable and need to be hydraulically fractured and propped open with sand in order for the wells to produce enough oil to make them economical. Depending on several variables such as the specific geologic characteristics of the formation, the length of the well, and the completion design, companies may use anywhere from 3 million pounds of sand to more than 15 million pounds of sand in each well. The cost of sand makes up a large majority of the total completion cost for a well, so having access to cheap sand greatly reduces costs.
Agility – Another key component of EOG’s operating model is their agility. In terms of barrels of oil equivalent per day (BOED) per employee, they are at 200. Using this metric, EOG has the highest production per employee of it’s peer group. A couple other number for reference are ConocoPhillips at 86.5 BOED/employee and Marathon Oil Corporation at 129 BOED/employee. Their decentralized organization with a small number of employees allows them to efficiently execute their strategy.
Aligning the Business and Operating Models
EOG has aligned its operating model very well in order to achieve the highest return on capital employed. The sand mine cut costs by approximately $500,000 per well drilled. Along with very low overhead due to their low number of employees, and other cost saving operational improvements such as pad drilling, their well costs are among the lowest in their peer group.
EOG has done a great job of aligning their model to minimize the denominator in the return on capital employed equation by cutting their costs; however, their operating model also helps them increase the numerator. By finding new markets to earn a premium on their oil, they are increasing return on the same amount of capital employed. Their small employee base and decentralized structure also allows for quick decision making, which is key for success in the rapidly evolving unconventional oil and gas sector. Many of the learnings from one well can easily be applied to the next well drilled, whereas some of their larger competitors fail to learn and adapt as quickly. This agility has been key to maximizing the amount of oil produced from each well and minimizing the time it takes to produce it, both effectively increasing returns.
EOG understands the business it is in very well and has ensured that its operating model fully supports its number one goal of increasing return on capital employed. It has become an top player in unconventional oilfields and will continue to lead the way in maximizing returns as long as it sticks to its agile core operating model.
Student comments on EOG Resources: More Oil, Quicker Oil, Cheaper Oil
Great post, Jeff. It was very insightful on the business model of EOG. I thought the backward integration of owning sand mines is an interesting competitive strategy. You noted cost efficiency as a key differentiator and I would love to know how EOG is navigating the current environment. Are they still profitable if oil continues to hover the $40 mark for the next couple of years? If not, what other areas have opportunity for higher cost efficiency? Also, on the topic of having the highest BOED in the industry, how do they structure their organization to make the decentralized model effective? I’ve always assumed drilling operations to be labor intensive work.
My original post was lost somehow so here is a summary.
Thanks for your comment Jenny! It will be hard for any O&G company focused on Shale plays to make money in the current environment from new wells due to the high capital costs. However, the current base production (wells already producing) will be an area of focus to decrease their lifting costs. A depressed oil price environment is one that is ripe for contract renegotiations with service companies which can reduce these costs.
In terms of their high BOED per employee metric, it is likely achieved from reducing hiring and keeping middle management at a minimum. For EOG, their responsibility per employee is likely higher than at larger firms with comparable production rates.
This is a great post, Jeff, and especially topical given the current state of affairs in the oil & gas industry. Having focused on the oil & gas industry while working inf finance, I totally agree with you that, as a result of a disciplined operating model, EOG has been one of the star player’s in the oil & gas industry, investor perception on their stock has been one of the least negative relative to its peers. In addition to their ability to increas returns through investment in railroads and sand mines, EOG has strategically positioned itself by operating in basins with some of the lowest cost crude oil areas. EOG operates in the Eagle Ford, Bakken and Delaware basins and even at the current low oil prices, the company is able to generate positive returns.
If the oil price hovers at the current level, I would be curious to know whether you think the company will continue investing in exploration prospects, which ultimately will drive future value? Additionally, do you think they will undertake any form of asset sales in other more higher cost basins and consolidate their positions on 3-4 lower cost oil & gas basins?
Very interesting post Jeff, especially given the current oil price environment.
One thing that jumped out at me was the apparent misalignment between the company’s core business model goal of being a pure-play E&P producer with a focus on high return on capital versus the company’s investments in infrastructure such as railroads and sand mines. While in hindsight, these investments had huge payoffs to EOG given supply constraints in both railroad shipping and frac-sand as U.S. unconventional drilling and production exploded, I wonder whether this large capital outlay in non-core assets is really in keeping with the company’s core competencies — in particular given the fact that these assets should have a lower cost of capital than an independent E&P producer and thus the market may be undervaluing them as part of the broader company.
In the current environment, with significant oversupply of frac-sand (company’s like U.S. Silica and FMSA are getting crushed in the public markets), and now that railcar capacity has been built out and significantly outstrips demand — do you still think these elements of the company’s operating model are aligned with the business model, or do you think they actually reduce agility and burden the business with unnecessary non-core assets? Do you think these could and should be spun-out similar to how many independent’s have been spinning out their non-core midstream assets to raise cash necessary to continue funding their ongoing drilling programs?
What prevents other company to purchase sand mines and rail roads? I assume rails roads are limited so it is hard to buy. If you were to join one of EOG competitor what changes would you make? What % of revenue ot EBITA was the spendings on sand mines and rails roads?