Stacked Deck: Why Producers Like Their Odds in the Permian – New RBN Report & Model

One of the most exploited oil plays in history, the Permian Basin in West Texas and New Mexico has recently become ground zero for some of the most exciting new “unconventional” oil and gas development in North America. Horizontal drilling and vastly improved completion techniques have vaulted the Permian once again to the fastest-growing oil and gas production region of the U.S.  In today’s Permian-focused blog, we review key conclusions from RBN Energy’s latest “Drill Down” Report and Production Economics Model.

On Friday, May 18, the price for West Texas Intermediate (WTI) crude oil in Midland, TX was $94.70/bbl, or about $7.30 below the price of WTI in Cushing, OK.   It was not that long ago (last year through mid-September in fact), when that discount was only about 18 cents/barrel.  But since September 2013 the discount has ballooned out with Midland selling for $11/bbl under Cushing in March 2014.

The problem is pipeline takeaway capacity, or lack thereof.  We reviewed some of the reasons for the pipeline congestion problems in recent blogs in our Come Gather ‘Round Pipelines (in the Permian) series, including Part 1 – Price Differentials and Takeaway Capacity, Part 2 - Gathering Systems, and Part 3 – Plains Expansions.  The bottom line is that crude oil production in the Permian is growing rapidly and today there is not enough pipeline takeaway capacity to efficiently handle the volume.  Although that takeaway situation will likely correct itself in a few weeks when new pipelines come online, the underlying cause – rapid growth in Permian production – will not be going away.  In fact, that trend is picking up steam all across the Permian basin.

The Permian is not one basin, but instead is made up of several sub-basins including the Delaware, Central, Midland, Eastern Shelf, Northwestern Shelf, Diablo Platform and Ozona Arch.  Underlying those sub-basins are the stacked plays – multiple hydrocarbon bearing strata with names like Sprayberry, Wolfberry, Cline, Wolfcamp, Bone Spring and more.  Some of these stacked plays have seen production ramp up over the past two years, and others are just on the verge of a mega-growth phase.  Across the Permian, much of the game is about hitting the triple-commodity jackpot. Producers are enjoying better than expected, multiple cash flow streams from crude oil, natural gas and natural gas liquids (NGLs). 

But execution and timing are everything. True, the resources are generally known and supposedly all producers need to do is “manufacture” oil from proven reserves. But it is not so simple.   Decoding the ancient Permian to harvest tight oil remains a challenge, and very location-dependent. Unlike the Bakken, Marcellus and Eagle Ford, horizontal drilling in the Permian is only now becoming the dominant well trajectory. And each operator is using a different playbook to “break the code”.

New RBN Drill Down Report

To illustrate how producers are achieving such attractive rates of return in the Permian, our new Drill Down report gets deep into the details.  We combine a review of recent, surprisingly positive results in the Permian, along with an analysis of a representative well in one of the emerging, prolific plays – the Wolfcamp in the Midland Basin.  Using the latest version of RBN’s Production Economics Model we demonstrate how a well that cost $7.5 million to drill and complete can generate a 63% discounted cash flow rate of return by leveraging three commodity revenue streams based on production outputs of  60% oil, 18% gas and 22% NGLs.

In the first half of our new RBN Drill Down report we provide background on shale development, discuss the Permian’s geologic rewards and special challenges, review the production profile of recent wells in the region, and consider the significant work that producers have already put in to improve drilling efficiencies. We also address how the region’s burgeoning supplies of crude oil, natural gas and NGLs are getting to market, and the advantage that the Permian’s location in the industry-friendly oil patch confers.

In the second half of this report we explore the inner workings of RBN’s Production Economics Model as applied to what might be considered a “typical” (if there can be such a thing) horizontal well in the Wolfcamp shale strata of the Midland Basin. In this detailed review of well economics, we define the critical metrics used to evaluate a well’s short and long-term potential, and describe how the modeling process arrives at a very attractive rate of return.  Backstage Pass subscribers can download the spreadsheet and step through the process with us.  Armed with this tool, it is possible to assess the sensitivity of the well’s returns to changes in initial production rates, decline rates, commodity prices, drilling and completion costs, operating costs, and the mix of hydrocarbons that the well produces. The results demonstrate why drillers are deploying billions of dollars in the Midland Basin as this play heats up.

Shift to Horizontal Drilling

One of the most significant drivers of increased production in the Permian is a shift from what have been predominantly vertical wells in some plays to a much greater number of horizontal wells.   In fact, parts of the Permian have been a little late to the game when it comes to horizontal drilling. Don’t get us wrong; there is plenty of horizontal activity in this huge expanse of West Texas and New Mexico.  But as shown in Figure #1 below, it wasn’t until quite recently that it started to become the dominant approach in the Permian. Horizontal and directional rig counts—non-vertical drilling—finally began to exceed vertical rigs last fall.