Permian producers led the U.S. exploration and production (E&P) sector’s remarkable recovery from the financial crisis that was spurred by the oil price crash in late 2014. Dramatically lower costs and higher well productivity led to strong margins even at $50/bbl oil and promised bountiful returns should oil prices move higher. It’s no surprise that investors flocked to the stocks of Permian-focused producers, driving equity valuations, as measured by enterprise value per barrel of oil equivalent (boe) of proved reserves, to multiples three or four times the industry average. Recently, however, there have been growing investor concerns that logistical constraints on shipping crude oil and gas out of the region could restrict cash flows, investment budgets and output growth, and on Friday, Baker Hughes reported that the Permian’s rig count was down (albeit by only four, to 476). Since May 15, stock prices of smaller pure-play Permian producers Concho Resources, Diamondback Energy, Parsley Energy, RSP Permian, and Laredo Petroleum have fallen 10-15%. One of the larger Permian producers has bucked the trend, though: Pioneer Natural Resources. Today, we explore the drivers of Pioneer’s current valuation and analyze the factors that could propel future growth.
As we detailed in our two-part Better blog series, the 44 U.S. E&P companies we track returned to the cusp of profitability in 2017 after $161 billion in losses in the previous two years, despite realized oil prices that were 40% below 2014. These results reflected the impact of a sector transformation that included intense capital discipline, a focus on operational efficiencies and high-grading of portfolios. The high-grading included a growing focus on the Permian Basin, which attracted one-third of total capital investment by these 44 E&Ps in 2017 and a whopping 55% planned for 2018. In (I Got Crude) I Feel Good, we noted that cash flows and profits surged in the first quarter of 2018 with oil prices higher than they’d been for years. Permian-focused producers accounted for seven of the top nine companies in pre-tax operating income per boe of production, driven by steadily declining lifting costs and an average 20%-plus production growth. With oil prices continuing to rise, the outlook for even higher profits in the remainder of 2018 seemed bright.
But the strong production growth that drove the industry recovery is a wrench in the works for some of the star Permian performers. The problem is that output has outstripped takeaway capacity for crude oil, as we’ve detailed in several blogs, most recently the two-part No Time series, and natural gas (see Blame it on Texas) — and over the next couple of years could do the same to NGLs (see the two-part Cowboys and NGLs blogs). While takeaway relief may be on the way in late 2019 or 2020, many investors seem to have suddenly woken up to the fact that severe transportation constraints could result in devastatingly low regional crude oil and gas prices that will dampen cash flows and profitability. The result has been a decline in the equity valuation of some Permian-focused producers. Pioneer Natural Resources (NYSE: PXD) has stood out from its Permian peers for several reasons that have resulted in sustained investor support, including strong production growth, low costs, and a rock-solid balance sheet. And now, when infrastructure constraints are haunting many Permian producers, Pioneer has the added benefit of firm contracts to transport all of its projected production through 2021 to the Gulf Coast, where it receives advantaged pricing.