Permian Basin Stacked Pay

And…..these guys were spot on, and the Permian is indeed the gift that just keeps on giving, and giving, and giving — like no other oil province in the world. Over two years ago:

Explaining The Permian Scramble

Christopher HelmanForbes Staff GUEST POST WRITTEN BY James L. Rice III and Katy Lukaszewski The authors are attorneys at Sidley Austin LLP

This article is more than 2 years old.

Today’s Permian M&A deal by Carrizo Oil & Gas is a perfect illustration of what contributor Jim Rice, partner at Sidley Austin, writes about below. Carrizo has agreed to buy 16,000 acres in the hot Delaware basin from private equity-backed ExL Petroleum for $750 million, or about $22,000 an acre (plus kickers if the price of oil goes up). This is a bet-the-farm move. Carrizo aims to raise $250 million of the purchase price by selling new equity — at a time when shares trade at a 5-year low! It will also raise cash by selling assets it had acquired years ago in once-hot spots like the Marcellus and Niobrara. Why might it be different this time? Because the Permian is the gift that keeps on giving. -C.H.

By James L. Rice III and Katy Lukaszewski, Sidley Austin LLP.

Oil production is surging in the Permian basin of west Texas and southeastern New Mexico. Output has doubled in the past five years to 2.4 million barrels per day, a quarter of U.S. supply. Drillers are piling it. Over the past year the M&A deals have been coming so fast in the Permian basin of Texas that if you blink you’ll miss one.

Company after company has piled in, paying more than $20,000 an acre for drilling rights. And that’s just the ante. As oil companies delineate more and layers of oil-soaked rock beneath the Permian, their inventory of drilling locations has exploded. In time, each square mile out there could see 30 wells drilled into it, at a cost of hundreds of millions of dollars.

Operators say big parts of the Permian are economic to drill even at $40 a barrel. Which is why we’re seeing more and more companies shedding producing assets in other geographic areas via wholesale basin exits to generate proceeds that they are plowing into largely undeveloped Permian positions.

This kind of intense region-specific investment activity is, of course, not unprecedented in the U.S. oil patch – the shale boom (spurring frenzied land acquisition activity in the Marcellus, Eagle Ford and Bakken shale basins, among others) of ten or so years ago is only the most recent example. But it is the sheer volume and size of recent Permian transactions, in such a relatively compressed timeframe, and with every indication being that there will likely be more big deals to come, that really sets the current Permian story apart.

The equity markets love the Permian thesis. E&P company boards and their management teams are “streamlining” their portfolios with massive divestiture programs to free up investment capital for Permian deals. Private equity shops active in the E&P space are harvesting investment after investment in undeveloped Permian acreage and then just as fast, re-upping with Permian management teams to get back in the game. Newly formed SPACs are jumping in with both feet. It appears that hardly anyone is sitting this one out, pricey though the ante may be.

It’s hard to watch this seemingly manic activity and not think of terms like “herd mentality” and “bubble.” After all, the oil industry has long attractted wildcatters and gamblers. While a little skepticism is healthy, given low oil prices, with the Permian it’s arguable that the industry isn’t looking to draw to an inside straight — rather it’s already been dealt a full house, straight from the deck.

The case for the Permian starts with the sheer size of the basin – 75,000 square miles, or about 48,000,000 acres (that’s about the size of Nebraska). The Permian is a “stacked pay” basin, where subsurface productive intervals lie atop one another like a stack of pancakes. Not each interval is productive, nor is any particular interval likely to be as productive as another, but opportunities do exist to extract more oil and gas from a given acre than in a single-zone scenario.

In all resource plays, the thickness and overall quality of the underlying rock will vary and there will be “sweet spots” or “core” areas. The Permian Basin is no different, but the vastness of the resource is echoed in the outsized “core” area of the Permian relative to the other oily resource basins in the U.S. – the Bakken in North Dakota and the Eagle Ford in South Texas. Most industry participants believe that the Permian core, in terms of acreage, is probably ten times the size of the core areas of each of the Bakken and the Eagle Ford.

The skeptic could be forgiven for failing to be impressed solely by the massive scale of the Permian opportunity given the crushing blows suffered by E&P investors who were long on the industry when commodity prices commenced their slide downward in late 2014. The doubters will focus on a range-bound crude oil price scenario playing out against a backdrop of escalating oilfield services costs, and the specter of OPEC taking another shot at driving the U.S. onshore drillers out of business or, worse yet, OPEC’s not being able to support oil prices through production curtailments. Yet, as Permian Basin development has ramped up, the results in the field are promising enough to suggest that a more optimistic view may be warranted regardless of what OPEC may do or the upward trend in services costs. And this perspective actually is reflective of an unprecedented sea change taking place in the macro environment, courtesy of the full house hand the U.S. E&P industry now has to play.

Specifically, over the last few years there has been almost a Moore’s Law effect at work in terms of the drilling and completion (D&C) process. These advances – multi-well pad drilling, two-mile horizontal wells, high-volume multi-stage fracking and advances in subsurface geosteering technology, to name just a few – have resulted in operators’ being able to bring down substantially per well D&C costs while at the same time, achieving better production rates and higher per well ultimate reserves recoveries. And while it’s true that the oilfield service providers are now regaining some measure of pricing power they had prior to the recent industry downturn, the escalation observed is simply a return to normal profit margins from what was essentially a zero-EBITDA environment for the U.S. onshore services sector over the last few years.

The upshot of this leveraging of technological advances to achieve better well performance with less capital investment is, that for the foreseeable future, the operators in the Permian should be able to produce “low cost barrels” relative to oil production worldwide, which would be economic even at lower commodity prices than the crude oil prices prevailing today – a fact not lost on OPEC. When coupled with ample Permian pipeline take-away capacity, both installed and announced, easing downward “basis differential” pressure on the realized product price, it looks like the Permian Basin can be developed profitably for years to come, handily delivering full cycle returns that justify the steep cost of entry.

As Permian production continues to accelerate, it may be that it’s the onshore U.S. E&P industry, not OPEC, that crowds the high cost barrels out of the market, which makes the Permian-obsessed executives in oil capitals like Houston, Denver and Midland a force to be reckoned with not just on Wall Street, but around the world.

Written by James L. Rice III and Katy Lukaszewski, Sidley Austin LLP.

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