EOG Resources, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 5/5

A major independent oil and gas company known for its focus on shale oil and natural gas extraction, primarily in the United States, emphasizing technological innovation and cost-effective production.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

EOG Resources, Inc. is a leading independent oil and gas company focused on shale extraction in the United States and select international locations. This report will assess its moat, understandability, balance sheet health, and provide a detailed overview of its business operations.

Business Overview

EOG’s primary activities revolve around the exploration, development, production, and marketing of crude oil and natural gas. It focuses primarily on unconventional resources, particularly shale formations in the United States and some international markets.

  • Revenue Distribution: EOG’s revenues are derived from the sale of crude oil, natural gas, and natural gas liquids (NGLs). While EOG sells most of its natural gas production from the wells at market rates to end users, most of the oil production goes to its parent company. This results in an uneven distribution, where most revenues are derived from oil. They also engage in commodities trading to manage price risk, but that activity is limited. They have long-term delivery commitments for all gas sales, and prices are typically market prices or tied to market indices.

  • Industry Trends: The oil and gas industry is characterized by price volatility, influenced by global supply and demand, geopolitical factors, and economic conditions. The transition to cleaner energy sources is another major trend impacting future demand, as evidenced by EOG’s ongoing R&D on carbon capture, but the global economy will need conventional energy sources for the foreseeable future. The industry is also driven by innovation and technological development. The most important trend that is going to impact EOG is price volatility. The recent rise of prices might be transient.

  • Margins: EOG historically operates at good operating margins, although they are subject to fluctuations according to commodity prices. EOG’s ability to generate free cash flow from their operations depends on their ability to keep their finding and development costs low while extracting at high rates.

  • Competitive Landscape: EOG operates in a highly competitive sector, with both smaller producers and large integrated firms also operating in its plays. This has changed with consolidation within the oil and gas space. EOG differentiates itself via a focus on technology innovation and low-cost extraction methods.

  • What Makes EOG Different: EOG’s emphasis on drilling and production efficiencies sets it apart, including technology-driven improvements in well design and completion, allows them to extract oil and gas at a very low cost. They are a leader in shale development and utilize real time data. Also, they are leaders in technology development. They also have an attractive operating structure, where they sell oil production to its parent company, mostly at market prices, which will probably allow them to keep growing as a business.

Moat Analysis

EOG’s moat rating is 3 out of 5, signifying a narrow moat that is defensible in certain areas.

  • Intangible Assets: EOG has a technological advantage and a long track record for innovation, but their patents and intellectual property may be challenged by competitors, making it a narrow moat with regards to that.
  • Low-Cost Production: EOG’s superior operational efficiency and technology leadership, especially in high-yield shale formations like the Permian, create a cost advantage. However, this advantage is still dependent on a commodity and can be imitated.
  • Switching Costs: While not a switching-cost moat business, oil and gas are used in every aspect of society. The company has long term contractual agreements, which can be considered sticky.
  • Network Economics: While not a network-based company, EOG has created a complex and interconnected business operation, which it has fine tuned over the years.
  • Scale Advantage: EOG benefits from being a large independent player. It has the capital to invest heavily and to take on risks that smaller companies can’t. It also has a greater bargaining power for its supply chains. Although other big players such as Exxon and Chevron can do this as well.

Risks to the Moat

EOG faces some significant risks that could erode its moat:

  • Commodity Price Volatility: EOG’s business is directly tied to the highly volatile prices of crude oil and natural gas. Prolonged periods of low prices could significantly reduce profitability and force EOG to curtail production. These prices are also affected by geopolitical instability.
  • Regulatory Changes: New governmental or international regulations related to environment and energy policy can increase operating costs and limit production. There’s also the potential for carbon taxes.
  • Environmental Concerns: The business is subjected to increasing pressure from investors, the public, and regulators to invest in more carbon-friendly energy sources. That would require them to make huge investments, and there’s no guarantee that those will pay off in the long run.
  • Technological Disruption: Competitors may develop new extraction technologies that outperform EOG’s methods, reducing its cost advantage. This might occur, even though they are very advanced in technology themselves.
  • Operational Failures: EOG’s operations face the risk of failures, malfunctions, and human error at scale.
  • Geopolitical Risks: EOG has some international exposure, primarily in Trinidad. These operations are exposed to any political and economic turmoil in those regions.

Business Resilience

EOG, despite its narrow moat rating, possesses decent resilience due to its operational efficiency and prudent financial policies. While a price drop can lead to large losses in their balance sheets, it also gives them a lot of space for long-term sustainable growth.

  • Capital Flexibility: In the event of market downturns, they can severely reduce their capital investments, and they have a track record of doing so. It can react quickly to market volatility.

  • Diversified Portfolio: Although very concentrated in the US, their exposure to multiple plays reduces the risk of total business disruption.
  • Strong Balance Sheet: EOG’s balance sheet is strong and relatively unburdened with debt, allowing it to weather through downturns and make strategic investments in the future.

Financial Analysis

EOG has a solid financial position, characterized by strong liquidity and low debt.

  • Revenue Growth: EOG has achieved substantial revenue growth over the last few years due to an increase in production and pricing, as well as the effect of acquisitions.
  • Profitability: The company’s operating and profit margins are susceptible to commodity prices and have risen in recent years. In 2023, EOG has posted record revenues due to those trends. Operating profits are about 50 percent of revenues.
  • Cash Flow: Operating cash flows are positive and allow EOG to pursue additional investment and shareholder returns. Net cash flow from operations totaled more than $11 million in 2023.
  • Capital Structure: The company has a high equity ratio and a low level of debt, with most of the debt being held by the parent company. It’s worth noting that even though they may be a good option for growth, it might also be a potential conflict of interest.

Understandability

EOG’s business is moderately complex (3 out of 5), requiring a solid grasp of the oil and gas industry.

  • Operational Complexity: While EOG is primarily engaged in oil and gas extraction, its operations involve a number of complex processes, including surveying, geological analysis, reservoir engineering, production, distribution, and regulatory compliance, making it difficult to understand fully by outside investors.
  • Financial Complexity: EOG is affected by fluctuations of commodity prices and operates with multiple derivative and hedging contracts, which is difficult to model fully. Moreover, the intricacies involved in oil taxation are a layer of complexity.
  • Market Dynamics: Understanding the global supply and demand for oil and gas is essential to understanding EOG. This adds an additional element of difficulty to the business.

Balance Sheet Health

EOG’s balance sheet is robust, meriting a 5 out of 5.

  • Low Debt: Their low levels of debt, primarily composed of unsecured and unsecured notes, leave them a lot of headroom to take on debt in the future if the need arises.
  • Strong Cash Position: They have a history of good cash flows. This allows them a lot of wiggle room in both good and bad years.
  • Assets: The company’s assets are mostly composed of drilling equipment, and exploration and development properties. These assets are usually worth a lot if oil and gas are selling at high prices. But if they are not, they represent potential losses in the balance sheet.

Recent Developments

In their most recent earnings call for 2023, EOG indicated it will continue to focus on profitable drilling and is not interested in raising production if not profitable. They also emphasized their commitment to returning cash to shareholders and their intention to improve operations by making more efficient use of their data. EOG announced they plan to expand into different areas of the country, such as the South Texas Basin. And that they have increased their drilling in the Delaware and Midland Basins, while increasing their horizontal well count.

The company is facing increasing pressures over climate change, which might lead to governmental regulations that would hamper profits. Also, their production is very sensitive to price volatility, meaning they will have to carefully manage their financial situation, to avoid being negatively affected by market price fluctuations. It was further noted that the price difference between oil and gas is likely to increase as well. Furthermore, their operations might be affected by a global economic recession that might reduce demand for their products.

Conclusion

EOG Resources presents a compelling case for a value-focused investor seeking a company with a solid business model and strong fundamentals. The company’s focus on low-cost operations and technology offers a sustainable competitive advantage, making its moat narrower, yet solid. They have maintained great returns on invested capital over the last few years. However, they face challenges from price volatility, regulations, and climate change. Investors will find that this business requires a deep understanding of the oil and gas space to fully understand and take advantage of the potential value drivers. Overall, EOG has the potential for long-term growth but will remain highly subject to fluctuations in commodity prices.