Pushback On EOG's "Shale Works At $30 Oil" Hypothesis

HOUSTON –

By Joseph Triepke

View the original article on Oilpro.com.

A key lesson successful investors learn early on is the value of pushback on new ideas. Investors that don't learn the value of pushback don't last long.

For every stock, there is a healthy debate being waged in the market on the prospects of the underlying enterprise. The stock price is the scorecard for the outlook tug-of-war. In essence, successful investing in the stock market stands on three pillars:

• empathizing with both sides to gain a deep understanding the debate;
• knowing how other investors are positioned; and
• correctly weighing the merits of both sides.

When analysts introduce new ideas or concepts, the smart ones look for the pushback, trying to understand why people disagree. Agreement is far less productive. The hard part of this approach is checking one's ego at the door - some of the smartest investors I know are the most humble people you will ever meet and some of the worst I know are the most arrogant.

The same approach should be applied in the evaluation of corporate claims and strategy.

On Friday, we wrote about a new idea EOG Resources, the de facto shale leader, introduced to the market. In a nutshell, the company's claim is that its premium US shale development activity can generate decent returns at $30 oil prices into the foreseeable future thanks to advances in resource targeting, rock quality, and lessons learned over the past 10 years.

The idea triggered an expansive debate, which we view as much more valuable than expansive acceptance. As we noted in our original story, EOG's new concept is a plan to adapt to low oil prices. Only time will tell if EOG can execute, but understanding the pushback on the idea is just as important as understanding the idea itself.

Today, we wanted to highlight one experienced Oilpro's rebuttal that was particularly well thought out and should not be ignored. What follows is Mike Shellman's pushback in his own words compiled from several comments and conversations since we published the EOG story on Friday.

Unconventional shale oil CANNOT compete with Russia and OPEC's giant conventional reservoirs in terms of profitability, nor sustainability; it declines too quickly and costs too much. This "in your face" attitude by the shale oil industry toward OPEC, the latest case being EOG's, is stupid. It just pisses them off more and causes them to dig in deeper on production levels. Hoping for price cuts from OPEC, then thumping it's chest about making money at 30 dollars a barrel, sends a lot of confusing messages around the world. It smacks of desperation to me. EOG lost a lot of money last year with hedges north of 45 dollars. So too did every shale oil company in America lose money last year. Blaming OPEC for all this is an emotional inability to look at the facts. The facts are not in what the shale oil industry says about itself, the facts are in the 10K's they must file with the SEC.A smart conventional oil investor friend of mine sent me this email this morning. This data is taken directly from EOG 10K's:

Begin:

• Despite all the talk of technology, etc, the real measure of any business is an accurate measure of its future cash flows, and then application of an appropriate discount rate to those future cash flows, minus the debt. EOG, like all other oil and gas producers, is required to disclose estimates of future cash flows in their annual 10K reports. They employ an independent engineering firm for this purpose.

End

That is a negative, yes. EOG is the best shale oil operating company in America. If anybody can pull through this mess it will be them. But make NO mistake about it, even the best shale oil company in the world is in very serious trouble at the moment. This recent plan it has gets kinda wobbly looking when you actually look at it. We cannot keep ignoring this stuff.

From another buddy of mine this week comes another take on the futility of shale at $30:

Begin:

End

These guys are getting desperate. I think because no shale oil company can qualify for additional lending based on the 65% yardstick of PV10, it is back to trying to raise money again by promoting stock to grandmas and grandpas. I think there is evidence this might even be working?

EOG stated it could reduce costs, maintain production (essentially) and even deleverage. Right. It's important to recognize that this latest round of rhetoric, and bluster, fails to address the issue of existing debt. I think these shale guys want a do over.

I like EOG and hope they succeed, but at a development pace that is conducive to price stability, not production spikes. Oil price volatility will be the death of the American oil industry and it is up to companies like EOG to control production spikes and help keep oil prices stable. EOG led the way in LTO oversupply and that is the primary reason we are in a nine line bind now, all of us; LTO oversupply. I don't believe a vowel of what the shale oil industry says anymore and so myself and several much smarter friends try and stick to the numbers, and not the hype. EOG states it is going to slow development and not bleed as much cash in 2016. That's a necessity, not a plan. My smart buddy up hole thinks they are still going to gush cash this year (and by the way, his numbers do not even include G&A or interest expense!). EOG has been drilling in the lower EF and geo steering in 10 ft. windows for years. It's sweet spots are pretty well delineated. Go to Cheapside, Texas (now called Richside) here:http://wwwgisp.rrc.state.tx.us/GISViewer2/ and decide how much saturation drilling it can still do. It is already drilling wells 18H and higher on their 1000 plus/minus acre units. Again, we don't "save" our best locations for last in the oil industry so we can drill them when oil prices decline 70%, I assure you. CAPEX costs can't come down too much more, I don't think. OPEX costs have come down very little.

Mega frac's cost mega bucks. They make for bigger IP's so shale companies can create bigger EUR's to make themselves look healthier than they are and to meet lender covenants. Higher IP's appear to be resulting in steeper declines and not much more UR, not enough to pay for the mega frac's. The funky EUR stuff is going to come out, big time, pretty quick.

These shale guys are NOT making money and the interest meter on their massive debt never stops. The PV10 value of their reserves are now vastly insufficient to be able to still borrow money; many of the best shale companies barely have assets equal to total debt. They owe lots of money and by 2018 that is all come to head, big time.

This ship has some big holes in it and is taking on water; what else is the captain going to say to it's passengers? Abandon ship? Some folks are getting ahead of themselves; EOG had a plus 40 dollar hedge and lost money last quarter. Now it says it can make money at 30. If anybody thinks EOG has been "saving" its good locations for high grading, or super high grading, whatever they want to call it, that is ridiculous. Oil companies don't drill the worse stuff first and save the best for last. I drive thru the guts of EOG's operations all the time; they have been hammering that stuff down there for years. There are stinkin' shale wells everywhere. Look at a TRRC GIS map for Karnes County.

Shale oil that declines at the rate of 73% the first 3 years of production cannot compete with the rest of the world's conventional fields. Haven't we just learned that?

The horse is gone and over the hill; closing the barn door now by slashing CAPEX costs is a day late. And several hundred billion dollars short. And when these shale companies have to come off the drilling hamster wheel, and those steep declines on exiting wells really kick in, hold on to your knickers, boys.

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