Why did EOG's earnings fall so sharply in 2002?

The main driver was lower commodity prices. The average North American wellhead natural gas price fell 32% to $2.60/Mcf, and crude oil and condensate prices were roughly flat. Net operating revenues fell $560 million, while production stayed about level. Operating expenses also dropped, but not by enough to offset the revenue decline. The year also included a $48.5 million mark-to-market loss on derivative contracts.

Is EOG's debt level becoming a concern?

Leverage increased in 2002. Long-term debt rose to $1.145 billion from $856 million, and the debt-to-total-capitalization ratio reached 40.6%, up from 34.3%. EOG's credit facilities contain a maximum 65% debt-to-capitalization covenant and a minimum EBITDAX-to-interest coverage of three times, and EOG says it was in compliance with both. Its debt is primarily fixed rate, and management says it has significant flexibility to adjust spending if prices stay weak.

How is EOG managing commodity price risk for 2003?

EOG uses price swaps and collars. As of March 13, 2003, it had natural gas collars covering about 125,000 MMBtu per day for most of 2003 and gas swaps of 100,000 MMBtu per day for March through October, along with crude oil swaps of roughly 2,000 to 5,000 barrels per day. EOG does not designate these instruments as accounting hedges, so changes in their fair value flow through reported earnings.

Where is EOG's growth coming from?

Growth is concentrated in Canada and Trinidad. Canadian production rose 22% in 2002 on a record 1,089 well drilling program, and Trinidad volumes rose 17% after production began from the U(a) Block. Management plans to keep focusing on North American shallow gas and expects to devote more capital to international projects, including new Trinidad fields such as Parula, which is scheduled to start production in 2004. In the U.S., the company is drilling in the Devonian trend in West Texas, the Hugoton-Deep play in Oklahoma, and a South Timbalier 156 Gulf of Mexico discovery that is expected to begin sales in the third quarter of 2003.

Are there pending legal or transactional matters investors should know about?

Several matters are open. EOG is a defendant in a Civil False Claims Act lawsuit over alleged royalty underpayments on federal and Indian lands, and it says it has substantial defenses. EOG is also expected to sell part of its interests in Caribbean Nitrogen Company and Nitrogen (2000) Unlimited, with closing targeted for the first quarter of 2003 and no expected gain or loss. In addition, EOG is a potentially responsible party in some CERCLA proceedings. Management does not expect these matters to have a material adverse effect on EOG's financial position, though the royalty case carries potential treble damages if EOG is found liable.

EOG 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 13, 2003. Cited figures are marked; the original filing is the authoritative source.

EOG Resources' 2002 Form 10-K shows a year of sharply lower commodity prices colliding with a still-growing production base.

Net operating revenues fell 34% to $1,095 million^a from $1,655 million, driven by a 32% decline in the average North American wellhead natural gas price to $2.60/Mcf. Production held roughly flat at about 1,086 MMcfe per day, with growth in Canada and Trinidad offsetting declines in the United States. Operating income fell to $181 million from $675 million, and net income available to common shares dropped to $76 million ($0.65 diluted EPS) from $388 million ($3.30) in 2001.

The 2002 result also absorbed a $48.5 million^b mark-to-market loss on derivative contracts. Balance sheet leverage rose meaningfully. Long-term debt increased to $1,145 million from $856 million, and the debt-to-total-capitalization ratio climbed to 40.6% from 34.3%.

Operating cash flow fell to $669 million^c from $1,197 million, and capital spending of $836 million exceeded cash generated from operations, which is why borrowings rose. Management budgets $800-950 million of exploration and development spending for 2003, excluding acquisitions, and says it expects internally generated cash flow plus financing alternatives to cover investing needs. Ongoing items to watch include the pending sale of part of EOG's stakes in two Trinidadian ammonia ventures, a Civil False Claims Act royalty lawsuit, and the Enron bankruptcy-related charges recorded in 2001.

For investors, the filing is a story of a natural gas-weighted producer whose earnings are highly sensitive to price. Shareholders are exposed to a weaker 2003 price outlook, but EOG has hedged part of its 2003 gas and oil volumes with collars and swaps, and it is pushing growth through lower-cost Canadian shallow gas drilling, Trinidad projects, and new discoveries in the Gulf of Mexico and Texas.

02—Key points

Key Highlights

Net operating revenues fell 34% to $1.095 billion in 2002 from $1.655 billion in 2001, mainly because the average North American wellhead natural gas price dropped 32% to $2.60/Mcf.
Net income available to common shares fell to $76.1 million ($0.65 diluted EPS) from $387.6 million ($3.30 diluted EPS) in 2001, and the year included a $48.5 million mark-to-market loss on commodity derivatives.
Total production was roughly stable at about 1,086 MMcfe per day, with Canadian volumes up 22% and Trinidad volumes up 17%, offsetting a 7% decline in U.S. natural gas production.
Long-term debt rose to $1.145 billion from $856 million, and the debt-to-total-capitalization ratio increased to 40.6% from 34.3%, as capital spending exceeded operating cash flow.
Operating cash flow dropped to $669 million from $1.197 billion, while total exploration and development spending was $836 million, down from $1.163 billion.
The 2003 capital budget of $800-950 million (excluding acquisitions) is designed to be funded mainly from internally generated cash flow, with a stated emphasis on North American shallow gas and Trinidad development.
EOG's proved reserves at year-end 2002 were 4,091 Bcf of natural gas and 85 MMBbl of liquids, about 49% in the U.S., 19% in Canada and 32% in Trinidad.

03—Questions

Frequently Asked Questions

Why did EOG's earnings fall so sharply in 2002?
The main driver was lower commodity prices. The average North American wellhead natural gas price fell 32% to $2.60/Mcf, and crude oil and condensate prices were roughly flat. Net operating revenues fell $560 million, while production stayed about level. Operating expenses also dropped, but not by enough to offset the revenue decline. The year also included a $48.5 million mark-to-market loss on derivative contracts.
Is EOG's debt level becoming a concern?
Leverage increased in 2002. Long-term debt rose to $1.145 billion from $856 million, and the debt-to-total-capitalization ratio reached 40.6%, up from 34.3%. EOG's credit facilities contain a maximum 65% debt-to-capitalization covenant and a minimum EBITDAX-to-interest coverage of three times, and EOG says it was in compliance with both. Its debt is primarily fixed rate, and management says it has significant flexibility to adjust spending if prices stay weak.
How is EOG managing commodity price risk for 2003?
EOG uses price swaps and collars. As of March 13, 2003, it had natural gas collars covering about 125,000 MMBtu per day for most of 2003 and gas swaps of 100,000 MMBtu per day for March through October, along with crude oil swaps of roughly 2,000 to 5,000 barrels per day. EOG does not designate these instruments as accounting hedges, so changes in their fair value flow through reported earnings.
Where is EOG's growth coming from?
Growth is concentrated in Canada and Trinidad. Canadian production rose 22% in 2002 on a record 1,089 well drilling program, and Trinidad volumes rose 17% after production began from the U(a) Block. Management plans to keep focusing on North American shallow gas and expects to devote more capital to international projects, including new Trinidad fields such as Parula, which is scheduled to start production in 2004. In the U.S., the company is drilling in the Devonian trend in West Texas, the Hugoton-Deep play in Oklahoma, and a South Timbalier 156 Gulf of Mexico discovery that is expected to begin sales in the third quarter of 2003.
Are there pending legal or transactional matters investors should know about?
Several matters are open. EOG is a defendant in a Civil False Claims Act lawsuit over alleged royalty underpayments on federal and Indian lands, and it says it has substantial defenses. EOG is also expected to sell part of its interests in Caribbean Nitrogen Company and Nitrogen (2000) Unlimited, with closing targeted for the first quarter of 2003 and no expected gain or loss. In addition, EOG is a potentially responsible party in some CERCLA proceedings. Management does not expect these matters to have a material adverse effect on EOG's financial position, though the royalty case carries potential treble damages if EOG is found liable.

04—Continue

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