Listening to the smartest guy in oil last week -- Mark Papa, ex-CEO of EOG Resources (EOG) -- I'd like to title this column "Kicking and Screaming." That's because what I have suggested in the past as the trajectory of U.S. oil and gas exploration and production companies (E&Ps) through the next stage of the oil bust, and what Papa also suggested, is likely to happen in the next six to 12 months. Papa's outlook on the industry is also a great indicator on his old company, still one of my favorites, and a reason to continue to accumulate its shares, particularly after the quarterly report.
At the CERAWeek conference, Papa had this to say about U.S. shale players:
"I would predict in the next six to 12 months, you're going to see a decimation of the industry ¿ just bodies (companies) all over the place ¿ a lot of bankruptcies, Chapter 7's and Chapter 11's."
We have also been looking for exactly this kind of resetting and been surprised by the resilience in the industry -- even in rare occasions through bankruptcy -- to continue to pump. Increasing efficiencies, an unbelievable slashing of spending, a still robust secondary market for shares and fresh bonds even after multiple downgrades and the banks' incapacity to "yank away the cookie jar" in revolver credit lines has continued to support many companies I still believe are terminal and "walking dead."
Concho Resources (CXO) was the boldest during conference calls to take a stab at 2017 production, projecting double-digit growth after only marginally slacking off in 2016. These kinds of projections are fantastically received on Wall Street and Concho is one Permian player that has rallied strongly since lows in January. I'm reminded of the joke about the marketer who claims to sell everything below cost. How do you make a profit, you ask? "Volume!!"
This is why Mark Papa sees only destruction ahead. Balance sheets and math can only be ignored for so long, and the last month has seen quite a few once proud and strong U.S E&Ps forced into off-cycle asset sales, dividend cuts and secondary offerings no one ever expected they would need to do. For many, that kind of added liquidity is only a wick extender on a time bomb that will inevitably go off, as oil prices stay below $50 a barrel. With this bust now nearing its 15-month anniversary, those fuses are growing shorter.
Now, look at Papa's old company, EOG. On the company's conference call, EOG stressed its "upgrading" process to what it has termed "premium." In essence, the company is going to focus on acreage that can generate a return of 30% on $40 oil -- and literally ignoring the rest. This isn't a short-term plan for the next year, either, it is the company's claimed new future strategy.
EOG estimates it already has 10 years of such "premium" wells available and expects to continually increase that number. It is holding production flat for 2016, give no guidance for 2017, and won't play the game of raising production just for the sake of share price, waiting for others to "burn themselves out" as the global oil markets slowly rebalance.
Wall Street hates this idea. EOG has been getting hammered since this "premium" well strategy was announced, along with its flat projections on production.
Well, Wall Street may hate it, but I don't. The drop in EOG's stock price below $67 again is a gift for the long-term investor. Papa may no longer be running this company, but his smart spirit has been left behind. From a core asset and financial standpoint, this is precisely the right strategy to get through the oil bust and be one of the strongest survivors.
I'm adding to my EOG position. Mark Papa is still the smartest shale player and every time he talks, I'll listen.