EOG Finally Succumbs to Well Cost Pressure

We are lowering our fair value for EOG EOG to $97 per share from $112, after taking a second look at the firm’s fourth-quarter results. The increase was mainly driven by lower near-term commodity prices and higher-than-expected cost inflation. For 2023, management anticipates a 30% increase in capital spending ($6 billion versus $4.6 billion). Some of that reflects increased activity levels. EOG hasn’t been afraid to pursue moderate volume growth this year, even though flat production or something very close to it has become the norm for public oil and gas companies in the past couple of years. Management is targeting 3% oil growth in 2023, and total volumes are expected to increase by 9%. To get there, it will run two incremental rigs and bring on line an incremental 80 new net wells spread among the Eagle Ford, Permian, Dorado, and Powder River plays. In the Eagle Ford alone the firm is aiming for 155 net completions in 2023, compared with 103 in 2022.

However, even after accounting for increased activity, the new budget implies well costs have risen by about 10%. That isn’t a huge surge, given most peers are projecting comparable or higher inflation. However, we were previously assuming EOG’s scale, bargaining power with suppliers, and vertical integration would continue shielding it from cost increases; the new budget shows there are limits to its advantages in those areas (we modeled only a 5% increase in 2023 well costs and were thus underestimating its exposure to rising steel, labor, and fuel costs). This does not affect our competitive assessment of the firm, as we have long held the view that the cost advantage underpinning EOG’s narrow moat is primarily driven by its high-quality low-basis acreage, and that thesis is intact. However, it does mean that the firm will be investing at least $1 billion-$2 billion more capital in the next couple of years than we were previously modeling.