By May 12, 2017 Read More →

Red hot Permian Basin economics tighten due to rising CAPEX costs

Permian Basin

Permian Basin Patriot Energy photo.

After land rush, execution risk, rising costs loom for Permian Basin exploration & producers

Exploration and production (E&P) companies that successfully acquired Permian Basin acreage in the red-hot ‘land-grab’ market of 2016, are now faced with the challenge of maintaining premium valuations while meeting high-growth expectations in a rising cost environment, according to new research by IHS Markit.

“The Permian is the hottest basin going in 2017 due to its deep inventory of profitable locations under a lower oil-price scenario,” said Sven Del Pozzo, CFA, director of energy company and transaction research at IHS Markit.

Del Pozzo says Permian profitability has driven many companies to acquire acreage during a frenzied land-grab, but now the pressure is on for those companies to create value to maintain premium valuations.

“Most of these acquisitions were almost entirely equity financed at notable premiums by companies that were highly regarded because they were already in the Permian, making seemingly expensive deals affordable without immediate dilution of shareholder value,” said Del Pozzo.

Despite the continued economic attractiveness of the Permian Basin, rising service sector costs will raise per-well capex by more than 15 per cent during 2017.

“After the group posted stellar shareholder returns in 2016, we believe differences in management, asset quality, company size and cost control — all have potential to cause stock performance to range more widely in 2017, especially as costs rise,” Del Pozzo said.

Costs will continue to place upward pressure on break-evens averaging $5 per barrel in the Permian, according to Imre Kugler, senior consultant at IHS Markit, and author of the analysis entitled “Plays and Basins: Increasing Service Costs Push on Break-evens.”

Many companies are able to offset rising service-sector costs with increased productivity, particularly in the early life Permian plays, while more mature plays outside of the Permian have reached a plateau, with economics primarily altered by cost.

“The economics for the Permian are still impressive at $41-per-barrel (weighted average) for a $55-per-barrel WTI price-projection, but costs are rising, mostly for service sector-related costs of drilling and completion, proppant, sand and a tightening rig market as utilization rates increase,” said Kugler.

“While Permian and Anadarko Basin plays remain in the money, so to speak, lofty acquisition values become more difficult to pay off when the plays require nearly $50-per-barrel WTI to produce a 10 percent internal rate of return.”

Fortunately for operators outside of the Permian, the lack of infrastructure bottlenecks will place less cost pressure on the Bakken, Wattenberg and Eagle Ford plays.

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“Oil price stabilization is creating greater confidence, and pumper calendars are filling up quickly. In the Permian, in particular, we see significant expansion in drilling and completion activity. As a result, we at IHS Markit estimate the play will increase its proppant consumption from 20 percent of the US market in 2014, to 37 per cent of the market in 2017,” said Thomas Jacob, research consultant at IHS Markit.

Jacob also said an increase in the number of wells fracked in 2017, and higher frack-sand-mass-per-well assumptions for fourth-quarter 2016 and beyond have led to an astounding 62 per cent increase in North American frack-sand demand in 2017.

“This year, mine-gate sand prices are expected to increase by roughly 50 per cent,” he said, “and in particular, fine-grade sand prices are increasing most significantly. The market share of fine-grade sand increased from 60 per cent in 2014, to 80 per cent in 2017.”

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