EOG Resources: Moving Ahead With Railroad Demand And Cost-Cutting

Over the past several years, the U.S. has witnessed tremendous growth in oil production due to the shale revolution. This presents a good opportunity for all oil players, but the companies that have an innovative infrastructure differentiate themselves from the others. EOG Resources (EOG) derives a lot of value out of its innovative rail infrastructure. Additionally, its cost-saving initiatives help it to stay ahead.

Bullish on railroad

The existing pipeline infrastructure in the U.S. is not sufficient to move all the crude oil to the refineries. This has increased demand for rail transport from oil-producing companies. Eagle Ford giant EOG, an innovator for crude-by-rail networks, remains uniquely positioned to benefit from this growing demand.

The crude oil transport by rail has increased from 9,500 carloads of crude in 2008 to 234,000 carloads in 2012. Further increases are expected in 2013, to 400,000 carloads, leading to a robust annual growth of more than 70%. North Dakota, home to the Bakken Shale formation, had more than 60% of its daily oil production being moved by rails by mid-2013. This augurs well for EOG as it has a large acreage of almost 90,000 acres in the Bakken, coupled with wells delivering industry-leading production. Additionally, its crude-by-rail transport infrastructure provides EOG with access to both the Cushing terminal in Oklahoma and St. James terminal in Louisiana. EOG has exclusive use of the 80,000-barrel-per-day rail offloading facility at the St. James terminal. At the Cushing terminal, crude oil sales fetch WTI prices, whereas at the St. James terminal it is sold at the Brent/LLS prices. Brent and LLS are at a premium to the WTI prices. Thus, access to the St. James terminal through its rail infrastructure has allowed EOG to sell its crude at a premium of $8.19 per barrel on an average this year.

Rail transportation is costlier than pipeline transport, however, with costs ranging from $10 per barrel to $16 per barrel, almost twice that for pipeline. So moving crude by rail is profitable only when WTI is at a wide discount to the Brent or LLS. But with pipeline construction facing political challenges in the U.S., oil transport by rail can be expected to grow, as pointed out by the Association of American Railroads. And although transport volumes are subject to market spreads, the benefits of crude-by-rail are expected to remain attractive.

Another company that can benefit from improved rail infrastructure in the Bakken is CSX (CSX). CSX has one 100-tanker train carrying about 70,000 barrels of oil per day, mostly between the Bakken and the terminals in New York and Pennsylvania. However, surging production of light sweet oil in the Bakken could enable CSX to grow its rail-transport infrastructure sevenfold to about six or seven trains per day over the next two years. This will help in crude-by-rail, which accounts for 1% of CSX's business and will contribute a greater portion in the future.

Cost-cutting initiatives

A case for investment in EOG can be made because of the proactive measures the company has taken with respect to cost-cutting. This can be seen from the fact that despite being a leading player in the Eagle Ford, it has driven down costs significantly. One of EOG's cost-cutting initiatives involves its sand fracking operations. Sand is important in fracturing shale rocks to drill oil. While most players bear the cost of sourcing sand from third parties, EOG sources its own sand. The company has invested more than $200 million in three sand mines and two processing plants, aiding cost reduction. It typically uses 3 million tons of sand a year for its fracking operations. Shipping the sand via its own railroad infrastructure at Bakken and Texas saves $500,000 in sand costs for a typical well. EOG plans to drill more than 500 wells this year in South Texas Eagle Ford and Bakken combined. This could save more than $250 million in sand fracking costs. Also, the company's initiatives for its well operations save $1 million to $2 million per well compared to other players in the Eagle Ford. This could net savings of $460 million to $920 million in the play. Sourcing its own sand also helps EOG boost production from its wells. EOG has 12 years of drilling left in the Eagle Ford and Bakken; that, coupled with its sand infrastructure, should help the company in the long-term.

Conclusion

On the strength of its innovative infrastructure and cost-cutting initiatives, EOG looks a solid prospect. Investors considering EOG may be scared by its high P/E multiple. However, the number to look for is its EV/EBITDA multiple, which is in line with its peers. And when its innovative infrastructure is factored in, along with its growth prospects, it is clear that the company should command higher multiples than its peers.

Source: EOG Resources: Moving Ahead With Railroad Demand And Cost-Cutting

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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