Home » Oil’s $5 Trillion Permian Boom Threatened by $70 Crude

Oil’s $5 Trillion Permian Boom Threatened by $70 Crude

By Joe Carroll & Edward Klump – 

Oct 25, 2013 10:53 AM CT

Source: Bloomberg (Click here to read original article)

Gaylon Wampler/Corbis
Oil and gas operations the Permian Basin oil and gas field of West Texas.

Bryan Sheffield, a third-generation oil wildcatter in Texas’s Permian Basin, knows what he’ll do if crude drops to $80 a barrel: shut down half his drilling rigs and go on a takeover hunt for weaker rivals.

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Sheffield is among producers who’ve together invested $150 billion in the Permian since 2010 seeking their piece of an oil trove estimated to be worth as much as $5 trillion. As the money pours in, risks are mounting of a bust as analysts including Marshall Adkins of Raymond James & Associates Inc. forecast crude is heading down to $70 a barrel next year, a price that would slow drilling in the most expensive U.S. shale formation.

While traditional wells have been drilled in the Permian since the 1920s, producers have become giddy over the potential of the region’s vast overlapping layers of oil-soaked shale rock.Pioneer Natural Resources Co. estimated the remaining yield at the equivalent of 50 billion barrels, more than any field on Earth except Saudi Arabia’s Ghawar. The varied geology, though, makes it more costly to explore and develop.

“That’s the double-edged sword,” said Benjamin Shattuck, an analyst at Wood Mackenzie Ltd. in Houston. Multiple oil zones layered one atop another provide ample potential for riches, “but you also have to be a knowledgeable and good operator in order to drill economic wells out there.”

If oil drops another 18 percent to $80 a barrel, wells in some parts of the Permian that sprawls beneath Texas and New Mexico will become money-losers, said Tim Rezvan, an analyst at Sterne Agee & Leach Inc. in New York.

Cline Shale

Energy producers on average need oil prices around $96 a barrel to break even on wells drilled in Permian layers known as the Cline Shale and the Northern Mississippian Lime, according toMike Kelly, an analyst at Global Hunter Securities LLC. That compares to average break-even prices of around $78 a barrel in the Eagle Ford Shale a few hundred miles east of the Permian, and $84 in the Bakken of North Dakota. Some areas of the Permian need a price of just $70-$74, Kelly said.

The benchmark U.S. crude, West Texas Intermediate, dipped 4.7 percent this month, touching a 4-month low of $95.95 a barrel yesterday as rising U.S. production bloated stockpiles. Brent crude, the benchmark for two-thirds of the world’s oil, is averaging $108.58 this year and probably will fall to the $70-to-$80 range, Fadel Gheit, an analyst at Oppenheimer & Co., said without providing a time line.

Drilling Leases

Sheffield started Parsley Energy LLC with drilling leases he bought during the last oil crash of 2008, and has been focused on traditional vertical wells in shallower Permian oilfields. He estimates he’ll spend about $8 million on the company’s first horizontal well to tap one of the shale layers later this year.

Oil at $80 would mean Sheffield drills only the prospects most likely to deliver the biggest, fastest gushers. The most efficient operators can manage on lower prices, so if oil falls another $20, it will quickly weed out the higher-cost producers.

“If you look down the road, there are going to be consolidation opportunities,” said Travis Stice, chief executive officer of Diamondback Energy Inc., a Midland, Texas-based Permian explorer whose stock price has tripled since its initial offering a year ago. “I’m not sure how many small operators the Permian is going to tolerate.”

Diamondback, whose biggest shareholder is $5 billion hedge fund Wexford Capital LP, expects to double production next year to the equivalent of 15,000 to 16,000 barrels a day, Stice said during a conference call with investors and analysts yesterday. The company plans to drill 65 to 75 horizontal wells in 2014 at an average cost of $6.9 million to $7.4 million each, he said.

Flying High

For now, Permian drillers are flying high, outperforming the rest of the North American oil industry. An index of Permian-focused prospectors that includes Pioneer, Diamondback andConcho Resources Inc. climbed 81 percent this year, more than double the 32 percent gain for the broader Standard & Poor’s Oil & Gas Exploration and Production Index of 72 companies.

Athlon Energy Inc., a Fort Worth, Texas-based Permian explorer backed by private-equity firmApollo Management Holdings LP, has soared 62 percent since its shares debuted in August.

“The Permian is all the rage on Wall Street,” Global Hunter’s Kelly said about the region named for the geologic period that began 299 million years ago.

The attraction lies in an unusual geological feature known as “stacked plays,” horizontal bands of oil- and natural gas-bearing stones laid down tens of millions of years ago when much of the U.S. Southwest was an inland sea.

Apache’s Permian

Apache Corp. has identified at least 35 potential zones in its Permian holdings, and it has tested about 20 so far, said John Polasek, exploration and new ventures manager for the Permian region. The Houston-based company’s employee count in the Permian is estimated to surge to 896 by year-end from 345 in 2010, according to an Apache presentation this month.

Pioneer is selling its Alaska oil and gas fields for $550 million and plans to use the proceeds to expand its Permian drilling, the company said in a statement today.

At current energy prices, Irving, Texas-based Pioneer is earning cash profit margins of $60 to $70 a barrel on some of its Permian wells, Timothy Dove, Pioneer’s president and chief operating officer, said during Hart Energy’s Executive Oil Conference in Midland on Oct. 15.

Still, oil prices need to stay high enough to support the current rate of exploratory drilling, Dove said. A drop in prices would compel explorers to concentrate on their lowest-risk drilling opportunities, said Diamondback’s Stice.

Bad Day

A horizontal well in the stacked play known as the Wolfcamp costs $7 million to $7.5 million if everything operates smoothly, Stice said. One “bad day,” though, can send that cost skyrocketing to $12 million or more, he said. Wildcatters squeezed by slumping oil prices may lose their nerve and look to get out, he said.

“One of the downsides is you’re focusing a significant amount of capital in one hole and there’s a huge amount of mechanical risk,” said Kyle Hammond, CEO of FireWheel Energy LLC and a former Permian drilling chief for Exxon Mobil Corp.’s XTO Energy unit. “That’s terrifying to a small independent.”

To contact the reporters on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net; Edward Klump in Houston at eklump@bloomberg.net