High per-acre costs make turning a profit in the Delaware more difficult

Capital has rushed into the Permian as oil prices stabilize and operators look for the best acreage possible. The majority of that capital has been focused in the Delaware Basin where layers of stacked pay have made acreage extremely attractive, and the cost per acre significantly higher than elsewhere in the country. While E&P companies continue to realize strong returns even as the cost to enter the basin increases, the nearby Midland may offer a better investment for those looking to drill in the Permian.

EnerCom Analytics explored what the effects of expected service cost inflation would mean for U.S. E&P companies during its March Energy Data & Trends, and while the Permian was routinely the strongest-performing basin we examined, it was the Midland, and not the Delaware, that outperformed the rest. Looking at the inputs into EnerCom’s well economic models, it quickly became clear the reason for the Midland’s outperformance of the Delaware was that per-acre cost of acquiring land in the basin. Operators pay, on average, about $20,000 per acre in the Midland, about 39% less than the $33,000 per acre being paid in the Delaware.

The per-acre costs in the Permian are significantly higher than in other plays across the U.S., but operators are willing to pay a premium for the exceptional well results reported in the basin. The per-acreage costs assumed for the other plays in EnerCom’s analysis were $3,500 for the Eagle Ford, $5,000 for the Niobrara, $6,000 for the Marcellus and $7,500 for the Bakken.

EnerCom analysis of IRRs from the Delaware and Midland show stronger returns from the Midland

Most plays are expected to remain economic as service costs increase

Based off conversations with members of the industry ranging from E&P operators, buyside and sellside analysts, and oilfield service companies, EnerCom analysts believe service costs will increase 10% to 15%, with most analysts we spoke expecting the higher side of the range. Assuming oil remains at $50 per barrel, EnerCom found that the majority of U.S. basins can absorb that type of cost inflation and still generate 20% internal rates of return (IRR), which likely is the cutoff for an “economic” well.

At $50 oil, EnerCom’s models show that the Delaware and Midland basins could absorb a 24.8% and 31.0% increase in service costs, respectively, and still generate 20% IRRs or better. As oil prices dropped, however, margins compressed quickly, and only the Midland was able to generate economic returns with the projected service cost inflation at $45 oil.

To see how much service cost inflation each basin in EnerCom’s analysis can absorb at varying oil prices, and to find out how E&P companies are already acting to mitigate cost inflation, sign up for a free trial of EnerCom’s Energy Data & Trends by clicking here.

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