Overall, 29% of all rigs in the United States are running in the Permian

Infrastructure constraints. Spot prices trading at a considerable discount to Cushing. Questions about the longevity of the oil boom.

E&Ps hear all the concerns in the Permian Basin. These “concerns,” however, are not enough to discourage producers from dialing up production in the United State’s largest producing play. Three major oil and gas players have either announced or revealed plans to increase its Permian focus within the last week, including:

  • Encana Corporation’s (ticker: ECA) $7.1 billion acquisition of Athlon Energy. Athlon is a Permian pure-player with 140,000 net acres producing 30 MBOEPD. Total resource potential is estimated at 3 billion BOE. In a conference call following the release, ECA management said it believes Permian unconventional drilling will produce more than the Bakken and Eagle Ford combined.
  • Occidental Petroleum (ticker: OXY) mentioned plans to sell its acreage in the Bakken with an asking price of $3 billion. The use of proceeds from the potential sale have not been discussed, but OXY is in the process of right-sizing its business, which includes the spin-off of its California unit. Once both courses of action are complete, OXY’s existing operations will be in the Mid-Continent and Permian. By the way, OXY is the largest Permian producer and recorded volumes of 150 MBOPD in Q2’14.
  • Pioneer Natural Resources (ticker: PXD), another Permian monster, is reportedly marketing its Eagle Ford position for up to $4.5 billion. PXD is the top producer of the Spraberry/Wolfcamp formations (92 MBOEPD in Q2’14) and will essentially become a pure-play Permian operator once its Eagle Ford acreage is divested. The company sold nearly $500 million of assets in the Barnett and Hugoton shales earlier in 2014.

Why Does Permian Interest Keep Climbing?

The Permian produces approximately 35% of America’s oil and has outpaced the Bakken and Eagle Ford in gross production growth on a year over year basis. Additionally, the Permian offers the lowest decline rates compared to its competitor tight oil plays. Its “legacy production,” as the Energy Information Administration (EIA) describes it, is supported by six stacked low-permeability formations that continue to drive growth. Production from the Wolfcamp, Spraberry and Bone Springs formations more than quadrupled from 2007 to 2013 and upped their total share of the Permian to 44% of overall production. The “other” three formations (Delaware, Glorieta and Yeso) still nearly doubled production rates in the same time period.

Despite being a drilling cornerstone since the 1940s, the Permian’s low-permeability formations have only recently begun to be exploited. Horizontal activity in the region caught traction in 2013. The Permian horizontal rig count, lower than both the Eagle Ford and the Bakken at the beginning of the year, passed both by the end of 2013. The number of horizontal rigs continued to rise in Q1’14 and accounted for half of all U.S. horizontal additions. The overall Permian rig count dominates the U.S. landscape: 556 are currently in operation, an increase of 103 (18%) on a year over year basis. Overall, 29% of all rigs in the United States are running in the Permian, a play that outnumbers the rig count of the Utica/Marcellus, Eagle Ford and Williston combined.

Will Outside Factors Limit Growth?

The United States energy boom has grown so quickly it has outpaced infrastructure in several regions. The Bakken addressed the problem by flaring off as much as one-third of its gas production. North Dakota has since enacted operating laws that force production constraints if producers fail to minimize their flaring amounts.

Similarly, the Permian’s downside lies on the infrastructure buildout. Pipeline demand is so high, Enterprise Product Partners (ticker: EPD) enacted a lottery system in August to determine access to producers. Additional buildouts are on the way: 500 MBOEPD in takeaway capacity is expected to be added by 2015.

Source: Bloomberg data compiled by EnerCom, Inc.

Source: Bloomberg data compiled by EnerCom, Inc.

The rig count growth and the lack of infrastructure has bottlenecked Permian supply, resulting in a price disparity between Midland and West Texas Intermediate spot prices. As seen in the graph above, Midland has traded at a discount to WTI for the past year. From September to January, the disparity averaged $3.24 per barrel ($96.87 to $93.63 average). Horizontal growth acceleration in Q1’14 quickly widened the spread: price differentials have averaged $8.10 per barrel ($99.46 to $91.36 average) since January 8, 2014 to present. The spread exceeded $20 for a brief stretch in August, when Midland prices dipped as low as $73.48.

Marshall Adkins predicted last year that oil prices could drop as low as $70 in 2014, making drilling and producing uneconomical for E&Ps. Wood Mackenzie said roughly 70% of United States oil is still feasible at $75 prices and the oil glut is not going to stop the production rise any time soon.

Speaking in regards to the high pipeline capacities, Edward Sherfey, an analyst for Wood Mackenize, said, “Production isn’t an on-off switch. Even if there is a sustained spread, there are other options like trucking and railing.”

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