EOG Resources Inc. CEO Mark Papa predicted Friday that natural gas prices in the second half of 2007 will be “disappointing” because of higher liquefied natural gas (LNG) imports and rising domestic production. To compensate, the Houston producer will hedge more of its production and sell some shallow gas holdings in Appalachia.

The normally sanguine CEO sounded less optimistic about gas prices in the coming months as he answered questions from energy analysts during the company’s quarterly conference call.

“I’m still bullish about gas, but as we look at things right now…I’m less bullish than I would have said a year ago,” Papa said. He said rising LNG imports are colliding with stellar gas production in North America. “We have to face up to the fact that the Barnett by itself is powering some of the supply growth, and the supply growth has surprised me. I didn’t think it would be as robust as we have seen. But I still think it’s a more narrowly bullish story…I am less pessimistic on gas growth.”

The rest of this year, “the wild card will be winter weather…”

To improve EOG’s position, the company is “likely to hedge gas more heavily in 2008,” said Papa. “We’re not nervous, but it reflects the fact that our stock was punished more heavily because of our relatively unhedged position. In my opinion, our superior per share production growth has been consumed by shorter term gas prices, and hedging may help those concerns.”

EOG already has hedged about 12% of its 2008 gas, and Papa said he hopes to have 30-35% hedged before the end of the year.

The company also is moving toward a more oil-weighted mix following initial success from a “burgeoning new domestic oil play in North Dakota,” Papa noted. EOG drilled one well in the Bakken oil shale early this year, but it now expects to have about 18 wells in place by early 2008. “It’s hard to find oil in North America, but we may have found a sweet oil project in North Dakota…”

The emerging Bakken play and the Barnett Shale “will drive our production increases through at least 2009,” he said. But as it shifts its mix to more oil, make no mistake, EOG has no plans to cut back on its domestic gas activity.

Gas prices may be lower, but “based on the increased momentum of our production growth, we are raising our full-year 2007 total company growth target from 10-11.5%,” said Papa. “One-hundred percent of this growth is organic, which is significant for a company our size.”

EOG’s gas production in the United States jumped 24% from a year ago, “with particularly robust growth” from the Barnett Shale, East Texas, Rocky Mountain and Midcontinent areas. Excluding the Barnett, EOG also scored with total U.S. and Canadian oil and gas output up 7% in the first six months.

“EOG has collected a stable of domestic gas assets that are second to none,” Papa told analysts. “The Barnett Shale continues to overachieve regarding our expectations,” and its rate of return “is likely the highest in North America.” EOG has had “eye popping results” from its Barnett wells in Johnson County, TX, but it also is in the “first inning of development” west of the core and in Hill County.

In the Barnett Shale, EOG improved its well completion technology, which led to higher initial production rates and potentially higher recovery efficiencies, particularly in Johnson County, TX. In East Texas, a new natural gas processing facility added capacity for EOG’s output from the Branton Field where eight wells are producing about 14 MMcf/d net.

Production rates have been high enough that EOG has elected to build some of its own intrastate piping and midstream gas processing infrastructure in Texas and oil infrastructure in North Dakota.

“This is a new strategy for EOG,” said Papa. “We have not previously been in the gas gathering and pipeline business. But it makes business sense to control the infrastructure,” and eventually set up a midstream and pipeline master limited partnership (MLP).

“This offers possible arbitrage opportunities down the road,” said Papa. This year, EOG expects to spend “in the range of $150 million or so” on midstream assets.

“What’s getting us out in the midstream is that primarily, we’ve got brand new assets in North Dakota and in the Barnett where there was no infrastructure,” he said. “So, we had a choice to have a third party come in and build or build it ourselves.” If the Bakken play is as big as EOG expects, and if the Barnett production continues to grow, “that will decide whether we ultimately spin off into an MLP.”

Because of its growth in its core holdings — and because of the lower gas prices — EOG plans to sell its Appalachian shallow gas assets and associated 18 MMcf/d of current gas production by late this year or by early 2008. Following the sale, EOG is targeting an average of 9% total production growth for 2008.

“We’re going to focus our capex [capital expenditures] on larger, potential plays than in Appalachia,” Papa told analysts. “The shallow gas assets represent a small piece of the portfolio, less than 1% of total production…We’ll receive more from the assets than is being reflected in the stock price right now.”

In the quarter, EOG’s U.S. gas volumes grew to 960 MMcf/d from 776 MMcf/d a year ago. Canadian gas volumes also were up slightly to 232 MMcf/d from 225 MMcf/d. EOG’s total gas volumes for the period, including output in Trinidad and the United Kingdom, jumped to 1.464 Bcf/d from 1.291 Bcf/d in 2Q2006.

Net income was $306.1 million ($1.24/share), down from $329.6 million ($1.34) in 2Q2006. The quarterly results included a previously disclosed $44.1 million ($28.4 million after tax, or 12 cents/share) net gain on the mark-to-market of financial commodity price transactions. During the quarter, the net cash realized related to financial commodity contracts was $18.6 million ($12 million after tax, or 5 cents/share).

U.S. gas prices averaged $6.80/Mcf, ahead of $6.33 a year earlier, and in Canada, gas prices averaged $6.70 from $6.28. Composite average gas prices reached $6.78/Mcf in the quarter, which was up from $6.28 in 2Q2006.

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