Opinion

Private Operators are Stepping Up in the Permian


In the Permian Basin, arguably the most important driver of oil production growth in North America, a puzzling trend is developing. As the basin experiences acute service-side bottlenecks and takeaway capacity concerns, activity levels continue to rise as does interest from private operators.

It is no secret that the basin has been facing severe challenges in recent months. The rapid rise in activity in 2017 has created concerns for most well-established E&P players. In our opinion, the most significant of these is the insufficient pipeline takeaway capacity, which is already causing wide spreads in local price differentials. Frac sand supply delays, stretched in-basin logistics, labor shortages and lagging pressure pumping supply should not be underestimated, and each bottleneck raises concerns about the potential of Permian oil production in the short and medium term, along with the severity of associated costs escalation. These challenges come on top of pressure from the investor community for organic growth.

Remarkably, horizontal rig counts in the Permian have actually been growing gradually since the beginning of 2018. In fact, horizontal permitting activity, which is often viewed as a leading indicator of short-term activity, increased in an even more impressive way, renewing an all-time high level in 1Q18. As many as 1,978 horizontal permits to drill were approved in the Permian Basin from January to March 2018, which corresponds to a 22% growth sequentially and a 37% growth on an annual basis. 

Figure 1 shows that some of the largest public operators are indeed responding to their investors' call for organic growth, as their contribution to total permitting activity has been declining in recent quarters. Moreover, the share of permits approved to smaller public operators (primarily well-established pure-play public companies like RSP Permian, Parsley Energy or Jagged Peak Energy) has not changed since 3Q16. It is therefore mainly private operators that have been gaining this segment of the market share systematically since mid-2016: it is the only company group on a growth trend during the last four quarters, reaching an all-time high of 25% in 1Q18. While permitting activity must be viewed as a noisy predictor of future drilling (since some companies seek to build inventory through permitting rounds for several quarters of future drilling), it is important to note that similar trends in the contribution of different company types can also be seen in the drilling and completion markets. 

Another interesting trend is the rise in the number of new private entrants, which is returning to pre-downturn levels. Figure 2 shows the number of private operators by the year of their first permit to drill approval. This count can be viewed as a barometer for the level of interest in the Permian Basin across small private companies. Back in 2012-2014, we observed 24-32 private players entering the basin each year. As oil prices collapsed, it became increasingly difficult to attract private capital for new entities, so the number of new entrants declined to only 11 companies in 2015. As the industry became convinced of the potential of the Permian in a low-price environment, the number of new private entrants recovered to 18-19 per year in 2016-2017. 

The level of interest reached a new high level in the first four months of 2018 with as many as nine private companies receiving their first horizontal permit approval. In fact, the number of new private entrants has been increasing continuously for four consecutive quarters, from three companies in 1Q17 to nine players in 1Q18. Thus, there are reasons to expect that the annualized estimate of 27 new private entrants in 2018 will end up on the conservative side. Yet, even this conservative estimate will bring the level of interest back to pre-downturn levels. 

Let us now turn to production levels from private players. Their contribution to oil production from horizontal wells in the Permian Basin remains low at 17.7% as of March 2018, although it is on an increasing trend from 12.1% since September 2016. The mismatch between these higher activity levels relative to their production could be explained by varying well design, completion techniques and acreage quality. As can be seen in Figure 3, the lower contribution to production can largely be explained by the fact that the portfolio of private operators is biased towards less productive sub-basins: Central Platform and Midland South.

Nevertheless, we observe a strong recent expansion in the share of private operators in Midland North, where modern shale activity has largely entered into the development phase. Around 19% of light tight oil production in Midland North was operated by private companies as of March 2018. The share of private operators has been growing gradually on the Texas side of the Delaware Basin since 3Q16, while their share on the New Mexico side has not changed much in recent months.

It is important to keep in mind that this discrepancy does not exclude the possibility of outstanding well results from private operators. In fact, let us consider the example of one of the most rapidly growing private operators in Permian Delaware, Mewbourne Oil Company, which is also the only private operator producing more than 50 MBbld of oil in the Permian as of February 2018. The company has been focused on the Bone Spring and Wolfcamp development in Lea County lately, but it is actually Eddy County where Mewbourne was able to achieve the most impressive well results relative to its peers. In fact, Mewbourne's OWL DRAW 22 27 B2BO 002H well, completed within the second Bone Spring zone in November 2016, delivered a staggering 220 thousand barrels of oil over the first six months. This was sufficient to place it at the top of the list of wells with the highest 180-day IPs in Eddy County, which are displayed in Figure 4. 

Only in January 2018 did the well move to the fourth position in the ranking as three of Occidental Petroleum's (Oxy) Cedar Canyon completions from the summer of 2017 reached 230-241 MBbl of oil production over the six-month period. The chart also shows that it is not uncommon for Mewbourne to enter the list of top performing wells, as the operator is represented by three wells in the list, the same number as Concho Resources. Only Oxy and Cimarex Energy have more significant representation with five wells each. All wells from the top-20 list target second or third benches of Bone Spring.

We believe that mixed news flow about the Permian Basin will persist in 2018-2019, as the timing of this growing interest from the private community coincides with the severe bottlenecks and takeaway capacity concerns. For instance, a significant number of recent entrants have not secured pressure pumping contracts yet, and they might be the ones who will have to delay some frac jobs due to the lack of spare capacity in pipelines. When it comes to the medium-term perspective, we are yet to see the impact of development well configuration in many parts of the Permian Basin. On average, it is private operators who are lagging behind. In some cases, dispersed acreage positions with checkerboard lease patterns prevent operators from placing optimal laterals. The current state of the Permian Basin, seen from our perspective, therefore calls for a further consolidation. We are convinced that more deals like the recent Concho-RSP merger are needed and are bound to happen in the future as operators start thinking about optimal long-term development and the competitiveness of the Permian Basin in the global context.



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