EOG Resources Inc.'s natural gas production inched up slightly in 3Q2007, but no thanks to the Rocky Mountains. In September and October the independent curtailed 50-140 MMcf/d net volumes "on any given day in the Rockies," and EOG plans to shut in those same amounts through the first half of November, CEO Mark Papa said last week.

Papa, who presided over a conference call with energy analysts to discuss the Houston-based producer's quarterly results, held court on what's ahead for EOG in 2008, and he offered his forecast for the domestic gas market in the coming months.

"I'm more bullish than many," Papa said. He expects U.S. gas production this year to grow about 1.8%, Canadian output to fall "at least 4%," and liquefied natural gas (LNG) imports to be "essentially flat." The opening of the Rockies Express Pipeline Ltd. (REX) in early 2008 should help with the basis differential on prices, he said, but it won't do much for overall gas volumes in the United States.

"On domestic supply, there seems to be a lot of concern about the unquantifiable Rockies supply being unleashed with the Rockies Express...Pent-up gas unleashed by REX? I think the volume increase overall will be very small."

Gas production shows no significant gains offshore either. Papa pointed to the decline this year in domestic gas drilling offshore, which has gone largely unnoticed because the reduced volumes recently have been offset by the ramp-up of the deepwater Independence Hub in the Gulf of Mexico. The hub, which serves as a subsea system to pipe gas onshore for a group of producers, is expected to add 1 Bcf/d to U.S. volumes by the end of this year.

"Personally, I think the Gulf of Mexico rig count drop is a significant item, and a harbinger of the low rig count on the [Outer Continental] Shelf as more rigs migrate to the Arabian Gulf, where they can get better prices," said Papa. "There has been a precipitous drop to 63 rigs from 85 rigs due to the negative production on the Shelf."

All of these factors hold sway over 2008 gas prices, which are "likely to be more robust than in 2007, depending of course on the winter weather intensity," Papa said. With a mild winter, EOG is betting that $7/Mcf Henry Hub prices will continue. With a "10-year or 30-year winter, gas prices could rise to $8.50 or more." EOG has a flexible capital spending plan going forward in either scenario. At $7, EOG's production is set to grow 13% in 2008. If gas prices jump to around $8.50, EOG's volumes will gain 17%.

"If gas is $7, we will see an oversupply of the gas markets," Papa said. "Do we want to contribute by pouring more gas on to that market? Basically, if we were to have a situation there...we can delay drilling, and we probably would not want to push it that hard in 2008." In any case, "the bulk of our 2008 production growth will be generated by the Barnett [Shale in Texas]," which "continues to generate one of the highest returns on capital employed in our peer group."

EOG is forecasting 13-17% production growth through next year "without increasing our 2008 net debt." The rise in volumes will come without acquisitions or mergers, and all of it will be domestic -- "100% of EOG's total organic growth will come from the United States...There's little likelihood that EOG will pursue a merger or a disposition," other than a planned sale of its assets in the Appalachian region, Papa said.

"It's our position that we can achieve organic growth that offers a significant return to [those of] mergers or acquisitions."

However, how much EOG drills will be tied to gas prices -- and its surprising success in the Bakken oil shale play in North Dakota. In the Bakken, EOG is forecasting that year-over-year crude and condensates growth will be about 33% in 2008.

"EOG can be considered similar to a high-performance engine, either high oil or high gas," Papa explained. "Our first priority in 2008 will be to oil because most of the Bakken offers 100% reinvestment return right now." EOG has 22 horizontal oil wells in the Bakken play, which Papa said was "analogous to the Barnett, with a large amount of hydrocarbons per section."

For gas, "$8 prices also generate strong gas production growth. On the other hand, if gas prices are less robust, we'll wait for a more propitious time to put throttle down...We'll likely stay very active in the Barnett because of the high reinvestment returns and lease obligations...In this [current gas price] environment, we'd likely throttle back in the Rockies and in Canadian gas drilling. If gas prices average closer to $7, we do not intend to increase debt by increasing gas wells."

The Barnett play, however, will be the "big driver of 2008 gas production growth." This year, EOG expects to exceed 280 MMcf/d in Barnett output, and the company will exit the year at 350 MMcf/d, which is ahead of the original target, Papa noted. In 2008, EOG expects to average 450 MMcf/d, or "slightly more at the $8 [gas price] case. And it's all organically derived and quite impressive when you consider that EOG is the only large cap company with growth in the Barnett with no acquisitions."

Besides its "monster" output, EOG is implementing some cost reduction measures in the Barnett that will make a big difference to the bottom line. EOG recently purchased a sand mine, and it now is contracting with a pumping service company using EOG sand. "Under this new arrangement, we are saving about $350,000 per well versus contracting with major service companies for fracs." The cost savings is significant since ramping up a typical Barnett well costs $1-1.5 million. EOG is using the new arrangement on about 35% of its Barnett fracs, and extrapolating the cost for all of its wells, the process will save about $125,000 per well.

"This provides EOG with distinct, discernible cost advantage versus other operators in the Barnett," Papa said. "We'd likely be high [in gas production] in the Barnett even at $7 gas." If the Barnett production is taken out of EOG's production forecast, the company still expects to exit this year with 5-8% oil and gas production growth, "which is essentially spot on our 6% target," said EOG.

In 3Q2007, EOG's U.S. production rose to 997 MMcf/d from 837 MMcf/d in the year-ago period. In Canada, gas output fell slightly to 216 MMcf/d from 224 MMcf/d. Total wellhead volumes, which also include Trinidad and the United Kingdom, rose to 1,497 MMcf/d from 1,344 MMcf/d in 3Q2006. EOG's U.S. gas prices in the quarter averaged $5.56/Mcf, down from $6.21 in 3Q2006. Canadian prices fell to $5.49 from $5.65 a year earlier.

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