Pride of the Permian

In last week’s Energy Letter, I mentioned that my day job had brought me to the Permian Basin. Last October I had similar business in the Bakken. Today, I will elaborate on last week’s Permian Basin trip, and talk about some of the companies operating in the region.

Introduction to the Permian Basin

The Permian Basin is located in West Texas and eastern New Mexico. Even though crude oil has been produced there since 1921, the Permian still produces almost as much of it as the Bakken and the Eagle Ford combined. It is by far the most prolific oil producer among the oil- and gas-producing regions shown below:

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Source: Energy Information Administration

The Permian Basin has commercial deposits of oil and gas in stacked layers, at depths ranging from 1,000 feet to more than 25,000 feet. One horizontal pay zone within the Permian called Wolfcamp is estimated to contain 2 to 4 times the estimated oil reserves of the Eagle Ford or Bakken. And there are multiple commercially viable layers of oil and gas both above and below Wolfcamp.

Thanks to these stacked layers, the Permian is one of the most cost-effective oil plays in the U.S. According to the Texas Railroad Commission, it has already produced more than 29 billion barrels of oil and 75 trillion cubic feet of natural gas — volumes equivalent to 3-4 years of current U.S. consumption.

Over a third of the land rigs drilling for oil in the U.S. are deployed in the Permian, but as with other areas there has been a steep dropoff in drilling in response to low oil prices:

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Flaring in the Permian

In my day job I serve as director of alternative fuels technology for a small Arizona technology company. One of our core technologies is aimed at reducing natural gas flaring in oil fields. As shale oil production in the U.S. boomed, so did the volumes of associated natural gas. But there was often no infrastructure to process it. As a result, that natural gas was often flared.

In response to this problem, my company developed a unit that conditions flared gas to efficiently fuel a generator. If a site is using diesel for power — as many are — our solution can cut the flaring while reducing or eliminating diesel consumption. We deployed our first demonstration unit to the Eagle Ford in Texas last year. The second unit went to the Bakken, and I reported on a visit there in Addressing the World’s Flare Gas Problem. Our third unit is deployed in the Permian Basin in West Texas, and last week I made a visit to see it:

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Me at a well site in the Permian Basin, south of Pecos, Texas on Jan. 26.
Yes, that is snow on the ground and in my hair. Our target is that flare behind me.

Trips to the key oil and gas regions of the U.S. give me a chance to talk not only with the men and women who extract oil and gas but also with people up and down the supply chain: oilfield services providers, midstream companies, etc. I even sat down with officials from the Bureau of Land Management in Carlsbad, New Mexico to get their take on the current oil and gas markets — especially as it relates to the Permian Basin.

One of the things I do on these trips is to note the companies most actively engaged in a region. Occidental Petroleum (NYSE: OXY) is the most prolific producer of crude oil in the Permian. Large, diversified oil and gas drillers like Oxy, Apache (NYSE: APA), EOG Resources (NYSE: EOG) and ConocoPhillips (NYSE: COP) are all among the region’s leading producers.

But the most visible explorer in the parts I visited last week was Concho Resources (NYSE: CXO). Concho is a pure Permian play with core operating areas spanning 1.1 million gross acres within three different areas of the Permian Basin. Concho is one of the top oil producers on the Texas side of the Permian, but is the top producer of oil and third-largest producer of natural gas in New Mexico. The company operates more than 5,500 wells in the Permian and has more than 22,000 future drilling locations.

Concho has been one of the fastest-growing producers in the region, and has the largest reserves of any of the pure play Permian producers. At the end of 2014 it had 637 million barrels of oil equivalent (BOE) in proved reserves. Just behind it was Cimarex Energy (NYSE: XEC), another pure play and ubiquitous Permian producer, with 522 million BOE in proved reserves. (Expect those proved reserves numbers to drop when year-end 2015 numbers are released because of the much lower oil prices.)

Concho doesn’t release Q4 2015 earnings until Feb. 24, but its bottom line is expected to be sharply lower like those of its peers. During Q3 2015, Concho averaged 15 drilling rigs in the Permian, and for the quarter it produced ~149,300 BOE/day (65% oil) — a year-over-year increase of 32%.

Concho’s average realized price for oil and natural gas during Q3 2015 was only $33.74/BOE, compared with $67.07/BOE a year earlier. As a result net income for the quarter was $179.7 million, down from $305.2 million a year ago.

With lower commodity prices, Concho faces a cash flow deficit that it is working to plug. It recently announced three new transactions that it says will enhance its position in the Permian Basin, improve its portfolio and reduce net debt.

Concho’s balance sheet is in pretty good shape with a Debt/EBITDA ratio of 1.7, and a current ratio of 1.0. That, along with its history of strong production growth in the region, has allowed Concho’s share price to outperform the Energy Select Sector SPDR ETF (XLE) by more than 8 percentage points over the past year. Concho Resources is one company that should do well for years to come as oil prices recover.

Conclusions

The Permian Basin has been producing oil since the 1920s, and today there are more than 1,500 oil and gas companies operating in the region. High oil prices in recent years resulted in a great deal of new drilling, so nearly 100 years after it first yielded crude the region is still producing at near record levels.

The Permian has been challenged by low oil prices like every other shale basin in the U.S., but history has proven this to be one of the most resilient areas for oil production in the country. Investors who seek to add to their energy holdings at these heavily reduced prices would do well to consider a Permian producer with a solid balance sheet. Join us at The Energy Strategist as we identify the Permian producers best-placed to ride out the current volatility.     

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