Need for improved economics, opportunities puts spotlight on Permian

IN APRIL 2015, when oil saw a slight price uptick to $56 per barrel, Bentek Energy pointed to the Permian Basin in West Texas as "among the most favorable areas on the continent to drill" for oil, natural gas liquids, and natural gas. Overall, prices for each commodity tumbled, but the Permian showed greater resilience, the firm said.

"Unlike other US producing basins, the Permian Basin is less exposed to adverse market conditions because of its more favorable production economics as well as its close proximity to major markets," Bentek senior energy analyst Ross Wyeno said at the time; however warning that the play was "not immune to adverse market conditions" and that a crude price drop to "less than $40 per barrel for a sustained period" would put Permian production at risk.

Fast forward 10 months. While the definition of a sustained period is subjective, prices have, in fact, dropped below the $40 mark. Well below. How favorable is the Permian now? Cue the eerie guitar from How Soon Is Now? by The Smiths. The band sits among the most important alt-rock bands to emerge from 80s, but you may be hard-pressed to find anyone who wants to revisit the decade-especially anyone from the oil and gas industry.

As I wrapped up a call with Irene Haas, senior vice president and senior equity analyst at Wunderlich Securities Inc. on January 21, she summed up the state of things: "I've been in this business forever and I didn't think I'd be revisiting the 80s...I don't like big shoulder pads, I don't like big hair, but [in terms of prices] that's what we have."

Looking for a bright spot, I asked Haas for a quick take on the Permian's place in this downcycle. In a note to investors weeks earlier, she offered thoughts on Permian deals by Concho Resources. "These transactions show that there is still healthy interest in the Delaware Basin and that the price tags have not changed much despite a sub-$30/bbl environment."

On the January call, Haas said: In 2015, "the rest of the universe crumbled, but the Permian is still highly desirable." It's true of the Midland Basin, and of the Delaware Basin, she said, where there are still transactions taking place. The potential remains, too, as there is still a lot of private money "sitting on the sidelines looking to acquire." Part of the reason, she said, is the multiple pay nature of the Permian. You can envision a pretty long production history, she said, noting that "each horizon is a little different...it's flexible."

Haas' view echoed recent analysis by IHS. "In an energy market struggling from oil price declines and anemic financial returns, the Permian Basin is the only US unconventional liquids resource seeing significant year-over year, per-well productivity gains. The Permian is single-handedly helping to sustain activity and has caused the region to become a hotbed of consolidation," the firm detailed in a January statement.

This performance has not gone unnoticed by operators or the markets, IHS said, with the markets showing a preference for Permian deals. In 2015, more than 35% of deals were Permian-focused.

"More than 1,000 operators have generated new volumes from the Permian since January 2014, but just 10 operators are responsible for more than 50% of the combined liquids production in the play," said IHS senior manager Reed Olmstead. "At the other end of the spectrum, more than 650 operators are generating less than 3,000 barrels per day in the play. Due to the performance of the play and the interest and activity in it, IHS expects consolidation to increase before the second half of 2016 at a rate greater than other domestic plays. "The Permian keeps rising to the top when you look at cost and performance. Permian deals skyrocketed in 2015, passing all other plays," Olmstead continued.

So who's buying and what will they spend?

"We anticipate that much of the activity in the coming months will be driven by operators of all sizes, who are already operating in the basin, but focused on leveraging acquisition attempts for a variety of strategic purposes," said Jerry Eumont, IHS managing director and a co-author of the analysis.

Operators with a greater presence in the basin appear poised to acquire smaller, pure-play operators, IHS noted, but expect new entrants to be active, as well.

Considering all Permian deals, the Midland Basin has seen slightly higher 1P reserve valuations recently, bringing the play average up from $13 per 1P boe of reserve to nearly $18. By contrast, IHS said, Eagle Ford 1P reserves have seen recent valuations closer to $15/boe. And, offered Eumont, companies looking to do business in the Permian "may pay even higher prices in the future" as premiums don't appear to have topped out.

We don't know where prices will go. We have to adjust to the new reality, Haas told me, but details are up in the air. "All the deals that were started last year and concluded now like Concho...they still look like last year's pricing scenario." We don't have a clear idea to start a discussion about prices when deals conclude in 3-4 months, she said.

From her understanding, there are still people willing to bid betting that oil will return to $70. "If you use a $50 price deck, it's very hard to cough up that kind of money. It all depends on your long-term outlook."

In terms of Capex, we're sitting in waiting, but she believes cuts may be "a little worse in 2016" versus 2015. Producers will likely make cuts all over, but the Permian, while not immune, would still likely "float to the top of the pecking order because of the more attractive economics."