Guest article by Paul Sparks, retired Senior Vice President of Resource Development at Energen and Founders Energy & Industrials Board Member.
This article was originally published on December 14, 2017.
I don’t espouse to have a crystal ball on the topic of E&P industry consolidation. But after many conversations with others in the business, I do see some clear historical parallels between the tight oil industry today and large plays in the Permian and other Basins in the past.
As the tight oil industry matures, will it remain fragmented with 50+ public Independents or can the case be made for fewer well capitalized companies driving this industry?
When you think of the shale plays you think of huge reservoirs (hundreds of thousands of acres or more), scattered leasehold with multiple operators, tremendous oil and gas in place that is very difficult to get moderate recoveries from, large facilities to handle fluids, significant opportunities to drill infill wells, an active A&D market and lease consolidation.
As I write this I am thinking back to the waterflood developments on the Central Basin Platform (CBP) of the 1950’s and the consolidation of those fields by the major oil and gas companies as large secondary and tertiary units in the 1960-1980’s (background reading). The parallels may be closer to today than what most people think, history does have a tendency to repeat itself (more history).
I don’t see a need for operators to form large unitized intervals and fields for enhanced recovery, but the other parallels are significant. The delineation of large fields like Wasson, Slaughter, Cowden, Goldsmith, Yates, Means and others took place in a similar fashion to what is taking place today; an active leasing program, exploratory/exploitation drilling, reservoir engineering advances and older vertical completion technique adjustments (shot holes to open hole acid jobs to cased frac jobs).
Today it does seem as if things move at a quicker pace and with a faster flow of information (for example, there are very few oil scouts left), but the general trends for both the CBP and the resource plays may help to illuminate the future for the next natural phase in the Permian.
The next step forward in the “shale factory” model is having large and well capitalized companies leading the way from delineation to development. Let’s look at an example for a hypothetical pure play Permian operator:
- 100,000 net acres available to develop,
- 6-8 wells/section per zone,
- 3 zones available vertically for landing targets (conservative compared to investor relations slides),
- 10,000’ lateral,
- current well costs and an allocation for facilities.
The capital demands for this operator over the life of the development (non-escalated) is most likely around $15 Billion. A capital program of $750 million per year yields a 20-year inventory.
The question becomes how much are those wells worth in year 10 to an E&P Company versus bringing that value forward to today? The ability to aggregate acreage and drill even longer laterals while optimizing completion strategy adds significant value to all parties.
The technology paradigm may be shifting from low permeability to ultra-low permeability reservoirs, but the need for tremendous amounts of capital is still a vital part of the equation. The question of what do the larger and more capitalized companies bring is salient; and from this author’s perspective advantages could include:
- Standardized processes,
- Direct sourcing of materials in the supply chain,
- Higher level analytical and technological efforts that could continue to increase rate and reserves in lower quality reservoirs (for example, consolidation expands and improves big data sets),
- Ability to grab additional downstream value via more vertical integration to the ultimate sales point,
- Scale improves ability to address sustainability,
For example, larger operators can justify the large upfront investments in technologies and infrastructure to clean brackish water and recycle produced water for use in fracturing. Whereas small players may be forced to rely more on fresh water which is not a long-term solution.
- Deleveraging balance sheets via recapitalization achieved through M&A.
What may determine if a smaller operator can go it alone is whether they are a public company or not. The public entities have historically had significant pressure from shareholders (activist and long holders alike) to show growth, take on debt and issue equity to continue to increase production and reserves. This is the age-old cycle of growth for most of the small to mid-cap companies in the space.
Now after multiple years of outspending cashflow the most operative theme is good capital stewardship. We shall see if the companies share prices are rewarded for this prudent use of capital.
While living within cashflow and spending capital on truly economic full cycle projects is good capital stewardship, it only lengthens the inventory development of proved undeveloped wells. This may be where the value is brought forward via mergers, company acquisitions or asset purchases.
Now that oil prices have started to stabilize the bid/ask spread may close to a point where deals can get done. The first transaction that signaled this may have happened earlier this year when Exxon purchased a historic Permian producer for $6.6 Billion; are there more to follow? I think 2018 will help to answer that question.
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