The Fuse

Permian Could Lead U.S. Shale Output Higher

by Nick Cunningham | September 29, 2016

More than two years of low oil prices significantly slowed shale drilling in the U.S., as the rig count plunged to levels not seen in years. U.S. oil production has as a result fallen by more than 1 million barrels per day (mbd) since peaking at 9.7 mbd in April 2015. But not every shale basin has been hurt equally; some have fared worse than others. The Permian Basin in West Texas has emerged as the most attractive shale basin in the U.S., even with oil prices wallowing in the mid- to low-$40s per barrel.

So far in 2016, the Permian has seen a rebound in its rig count, a rising number of wells drilled, and soaring land prices as capital has flowed into the basin.

So far in 2016, the Permian has seen a rebound in its rig count, a rising number of wells drilled, and soaring land prices as capital has flowed into the basin. The surging rate of production seen in recent years has leveled off, but unlike other prominent shale regions such as the Eagle Ford and the Bakken, output has not declined. Now, armed with more rigs and more companies looking to drill, and renewed optimism about the trajectory of oil prices following the OPEC deal, the Permian could see even a better performance.

Rig count on the rise

The U.S. rig count has rebounded sharply from its nadir hit in May at 404 rigs, rising to 511 rigs for the week ending on September 23. Of those 107 additional rigs, the Permian accounted for 64 of them. The Eagle Ford in South Texas—once one of the hottest shale basins in the country—has only seen 6 rigs added back into operations since May.

Shale drilling across the U.S. has become dramatically more efficient over the past two years, and the Permian is no exception. The average rig can produce more than 540 barrels per day in the Permian this year, up from less than 200 back in 2014. The EIA expects the Permian to see oil production rise by 22,000 barrels per day in October to hit 1.99 mbd, which would be a record high.

The excitement in the Permian was crystallized by the announcement from Apache Corp. in early September that it made one of the largest oil discoveries in years.

The excitement in the Permian was crystallized by the announcement from Apache Corp. in early September that it made one of the largest oil discoveries in years. Apache’s “Alpine High” project could hold 3 billion barrels of oil and 75 trillion cubic feet of natural gas. To accelerate development of the prospect, Apache upped its planned expenditures for the year by $200 million to $2 billion. The announcement was followed by a lot of fanfare—it was an unusually large discovery that was made all the more remarkable because it occurred when oil prices averaged well below $50 per barrel.

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Permian’s stacked plays

Companies find the Permian more attractive than some of the competing shale basins around the country due to its stacked formations. In the Permian, a company can drill down vertically through multiple shale plays, layered one on top of the other. This allows a company to tap multiple sources of oil and gas with a single vertical well. “What you can’t find in most plays is the Permian hydrocarbon column,” Bruce Cox, global head of energy acquisitions and divestitures at Credit Suisse Group AG, told Bloomberg in mid-September.

Companies find the Permian more attractive than some of the competing shale basins around the country due to its stacked formations.

The ability to hit multiple shale plays with fewer wells drilled improves the productivity of the basin, allowing companies to produce and sell more oil and gas. In other words, the Permian has lower breakeven costs than other shale basins. Bloomberg estimates there are more than a half-dozen oil fields there with breakeven prices below $30 per barrel.

With oil prices in the mid-$40s and the Bakken and Eagle Ford languishing, the shale industry is rerouting rigs, personnel, and capital to West Texas. That has brought about the side effect of higher land prices in West Texas. With so many companies pouring money into the basin, the cost of acquiring acreage has soared. In June, Colorado-based QEP Resources paid about $60,000 per acre for the drilling rights in the Permian, possibly the highest price for acreage ever paid in the basin.

“When oil prices were high, there was a high supply of acreage with economic drilling opportunities,” Ron Gajdica, co-head of energy acquisitions and divestitures at Citigroup, said in a Bloomberg interview. “Now, in a $40-$50 oil price environment, acreage with economic locations is scarcer. There are only a limited amount of opportunities and many of them are in the Permian.”

Drilled but uncompleted wells

Even when output was on the upswing, a growing backlog of drilled but uncompleted wells (DUCs) emerged. Exploration companies drilled wells but deferred completions, waiting out the oil price bust. The broader phenomenon occurred across North America, but the Permian is home to the largest number of DUCs in the United States, which stood at 1,348 as of August 2016.  Those wells represent a large source of production that has yet to come online, but will likely hit the market as oil prices start to rise.

New drilling

“Worryingly for the cartel, production in the West Texas region has already started to increase sequentially.”

The rise in the rig count suggests companies are already getting back to work in the Permian. But the nascent oil price rally, sparked by the unexpected cut in production announced by OPEC on September 28, could be very beneficial to shale drillers in the Permian, opening up more parts of the basin to drilling.

“Worryingly for the cartel, production in the West Texas region has already started to increase sequentially. Stated differently, OPEC has declared a truce on oil prices. But relentless improvements in shale technology will keep Saudis awake at night wondering if they have made the right choice,” Bank of America said on September 29 following OPEC’s announcement.

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