EOG Resources tapping into 'spark spread'

Sam Fletcher
OGJ Online

EOG Resources Inc., a leading US gas producer, is forging a unique agreement that guarantees future gas supplies to an independent power production facility in Texas for a share of the "spark spread" between the market price for that electricity and the cost of generation, primarily fuel.

The unnamed independent power producer (IPP) will lock in fuel supplies while EOG Resources gets a crack at the enhanced earnings of what promises to be a lucrative deregulated electricity market.

"As far as we know, this is the first deal of its kind. We're in the process of drawing up a contract like nobody has ever seen before," said Mark G. Papa, CEO of EOG Resources, at the annual energy conference Wednesday sponsored by Dain Rauscher Wessels Inc. in Houston.

He would describe the IPP participant only as a large member of that industry. The deal is being done "on a trial basis," involving supplies of about 25 MMcfd of gas "for 1 or 2 years," said Papa.

He said his company also has "a couple of deals working" in which IPPs would participate in purchasing gas properties that EOG Resources would then operate. Under those potential arrangements, Papa said, the IPPs would lock in existing reserves from those fields for future supplies, while EOG Resources would reap the upside benefits of additional reserves and production it would develop from those properties.

With domestic gas supplies tightening in the face of growing demand, Papa said, "IPPs are willing to pay a premium to lock in supply. They're more comfortable knowing they actually own the molecules of gas, rather than relying on delivery contract guarantees from middlemen like our former parent (Enron Corp.)"

He sees a growing trend for such innovative deals to lock in future gas supplies. "We want to get closer to these guys (IPPs). They're going to need us, and we're going to need them," Papa told reporters following his presentation.

"Domestic gas production has been flat or declining for 7 straight years, since 1994. Domestic production decreased in 1998-1999, and it is expected to be down by 1.5% this year," he said.

Both Texas, which accounts for 30% of total US gas production, and the Gulf of Mexico, which supplies 28%, registered declines in 1998-1999. "The only state where gas production is going up is in Wyoming, which contributes 6% of US supplies," Papa said.

Meanwhile, he said, "Canadian production has been more tepid than most would have thought," despite a record increase in drilling activity in that country last year.

US drilling activity also has shown a strong increase with 1,012 rigs working last week, including 816 that were drilling for gas.

However, Papa said, "Once the rig count moves north of 600, the incremental future production per rig falls off by about half." That's partly because of the smaller reserves being targeted, he said.

Access to gas-prone areas in the Rockies and off Florida would be a key factor in bringing new gas supplies to market over the next few years, Papa said.

Meanwhile, he said, EOG Resources has locked in 70% of its drilling and completion costs through 3-year contracts signed last year and is considering a possible 1-year extension.

The company's North American gas production is now "totally unhedged" to reap the full benefits of price increases�although at today's high price levels, Papa said he's watching that market closely. EOG Resources also has revised some of its gas sales contracts to a daily vs. monthly basis to reap higher prices, he said.

At the start of this year, EOG Resources' production totaled 67 million bbl of oil equivalent, with gas accounting for 85% of that. Its reserves totaled 602 million boe, 88% gas. The company has five prospects that it plans to drill within the next months, with potentials of 100 bcf of gas reserves each net to EOG Resources, Papa said.