WHILE OIL HAS RALLIED SMARTLY THIS YEAR after plummeting last fall, there has been no corresponding comeback for its cousin, natural gas. To the contrary, gas prices have sunk to seven-year lows as supply threatens to exceed storage capacity and overwhelm demand.

At first blush, that sounds like miserable news for EOG Resources (), a Houston-based natural-gas producer spun out of Enron in 1999. But EOG's three-year effort to pump up its production of crude oil -- in part by using the same horizontal-drilling technology that has made it one of the largest independent gas producers in the U.S. -- looks expertly timed.

have fallen more than 30%, to around 70, from an August 2008 high. They could rally to above 80, a gain of more than 15%, in the coming year.

EOG boasts 8,689 billion cubic-feet equivalent of energy reserves. The vast majority is natural gas, which accounts for more than 80% of annual production. Management is aiming for a 50/50 North American production split by 2013 between oil and natural-gas liquids, on the one hand, and natural gas. That's a smart move, since oil will probably continue to trade at a significant premium to gas. "Over the long term, oil's run should be more consistent," says Chairman and Chief Executive Mark Papa.

The shifting emphasis is propping up slowing production growth this year. EOG is looking to up overall production by 5.5%, or close to 350,000 barrels of oil-equivalent a day, after several years of double-digit annual growth. In the second quarter, U.S. crude production jumped by 21% and production of natural-gas liquids by 56%, helping the company beat profit estimates. Production of natural gas was flat. Oil and natural-gas liquids counted for 25% of overall revenue last year, up from 20% three years ago.

Canaccord Adams analyst Irene Haas repeated her Buy rating on EOG following the latest quarterly report, encouraged by the company's success in increasing its "oilier" assets. "Once they pick a niche, they become one of the better players there," she says.

In addition to a greater focus on oil, EOG boasts what management calls "a powerful arsenal of gas assets," with stakes in most major North American fields. It is the leading driller in the largest producing field in the U.S., Barnett Shale, near Forth Worth, Texas, and expanded production there 50% last year. EOG's portfolio also boasts promising long-term growth plays in North Dakota's Bakken Shale and in British Columbia.

Papa, who has worked for EOG or its predecessors for more than 20 years, champions a conservative growth strategy. Unlike his former Enron colleagues, he has built a pristine balance sheet and controls operating and capital costs. And, unlike many other gas executives, he strives to build production internally, eschewing pricey acquisitions. Consequently, EOG's net debt-to-capital ratio of 17% is the lowest among its large-capitalization peers, while its 20% average return on invested capital employed in the past 10 years is among the highest.

Rivals such as Chesapeake Energy (CHK) and Devon Energy (DVN) are growing faster, but EOG is extracting oil and gas from its wells more efficiently. Investor Steven Rog of Rog Partners Fund notes that EOG spends $2.60 per thousand cubic feet to replace reserves, compared with $5.36 for rivals.

EOG REMAINS SOLIDLY PROFITABLE, in part because of higher oil volume and its hedging strategy. Analysts expect it to earn $682 million, or $2.64 a share, on revenue of $4.5 billion this year, compared with $1.9 billion, or $7.50 a share, on $7 billion of sales in 2008. Canaccord analyst Haas estimates cash flow of $13.10 a share, based on oil at $60 a barrel and gas at $4.25 per million BTUs.

EOG is fairly inexpensive at 5.3 times that cash flow estimate, about in line with the group's median price-to-cash-flow ratio but below its 6.7 historical average. Haas thinks the stock deserves a multiple of at least a 6.5, or $85 a share.

In 2004, EOG was the first public company to apply horizontal drilling to extract gas from Barnett Shale. Other natural-gas drillers eventually caught up, as they will in oil production. Even so, it's good to be a leader.

The Bottom Line
EOG shares could rally into the 80s from around 70 as the company tilts its production mix towards oil. A pristine balance sheet helps, too.