High costs may push away some Permian Basin investors

Newcomers to the Permian Basin may find stalled oil prices, along with high land and service costs may make the play uneconomic.  

Permian Basin a victim of its own success

The booming Permian Basin is the largest petroleum producing basin in the United States and has enjoyed a rush of capital since oil prices began to recover in February of last year.

A number of exploration and production companies have flooded the Texas and New Mexico play hoping to maximize profit in a lower price environment.  But, with the high demand for land comes higher prices, leaving little room for newcomers to profit.

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The Delaware Basin has proven to be the Permian’s hottest zone and has become a victim of its own success.  According to EnerCom Analytics’ well economic models, the internal rates of return (IRRs) in the Delaware are now lower than those in the Midland Basin due to the high cost of land.

For example, if WTI is at $45, EnerCom’s well economics models show IRRs in the Midland at 22.8 per cent while IRRs in the Delaware hit 21.5 per cent when acreage costs are factored in.

An Oil and Gas 360 report says the cost per-acre in the Delaware is 65 per cent higher than in the Midland basin.

New investors looking to enter the play are beginning to shy away as oil prices hover in the low-to-mid $40 range and in-demand oilfield service providers are looking to increase their prices.

According to EnerCom, service costs are expected to increase between 10 and 15 per cent and some E&P companies are saying they could increase as much as 20 per cent.

In the March Energy Industry Data & Trends by EnerCom, the company found that at $50 per barrel oil, most basins could absorb even the high-end of those estimates, but as prices drop below $45/barrel, E&Ps will find it more difficult to continue generating 20 per cent IRRs or better.

EnerCom’s models show that only the Midland Basin could handle more than a 10 per cent increase in service costs at $45/barrel.  The high land cost of the Delaware is pushing the IRRs below the 20 per cent IRR threshold.

Recently, Reuters reported eight hedge funds reduced the size of their positions in 10 Permian shale firms by over $400 million.  The value of the funds’ positions in the 10 companies dropped to $2.66 billion in 2017 Q1 from $3.08 billion in 2016 Q4, a decline of 14 per cent.