Oil’s $5 trillion Permian boom threatened by $70 crude

By Joe Carroll & Edward Klump
Bloomberg News

Bryan Sheffield, a third-generation oil wildcatter in Texas’ 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.

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.

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While traditional wells have been drilled in the Permian since the 1920s, shale producers have become giddy over the potential of the region’s vast overlapping layers of oil-soaked shale rock. Pioneer Natural Resources Co. (PXD) 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 to Mike 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.

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The benchmark U.S. crude, West Texas Intermediate, dipped 5.1 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 $108.59 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.

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.

Cash Squeeze

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. (FANG), a Midland, Texas-based Permian explorer whose stock price has tripled since the initial offering a year ago. “I’m not sure how many small operators the Permian is going to tolerate.”

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 and Concho Resources Inc. (CXO) climbed 80 percent this year, more than double the 33 percent gain for the broader Standard & Poor’s Oil & Gas Exploration and Production Index of 72 companies.

Bullish Investors

Athlon Energy Inc. (ATHL), a Fort Worth, Texas-based Permian explorer backed by private-equity firm Apollo Management (APO), has soared 64 percent in the 12 weeks since its shares debuted.

“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 gas-bearing stones laid down tens of millions of years ago when much of the U.S. Southwest was an inland sea.

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Apache Corp. (APA) 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.

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, said Timothy Dove, Pioneer’s president and chief operating officer, said during Hart Energy’s Executive Oil Conference in Midland, Texas, on Oct. 15.

One Bad Day

Still, oil prices need to stay high enough to support the current rate of exploratory drilling, Dove said. There will be more pressure to make every well a gusher if prices continue falling, said Diamondback’s Stice.

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. (XOM)’s XTO Energy unit. “That’s terrifying to a small independent.”