So What Is the Permian Basin?
The 250-miles wide and 300-miles long Permian Basin, located in West Texas, is home to some of the biggest oil reserves in North America and is the biggest oil producing region of the U.S. According to the Texas Railroad Commission, so far, more than 75 trillion cubic feet of natural gas and 29 billion barrels of oil has been produced from here. Various producing formations such as the Spraberry, Wolfcamp, Yeso, San Andres, Bone Spring, are part of the Permian Basin. In 2010 this region produced more the 270 million barrels of oil, which rose to 280 million barrels in 2011 and a staggering 312 million barrels in 2012. According to the U.S Energy Information Administration, Permian’s oil production rose to 1.3 million barrels per day in October, easily ahead of any other oil play in the U.S. Some analysts think Permian can touch 2 million bpd in the next five years, which I believe is a realistic estimate.
Spraberry is the biggest rig field, not only in the Permian, but also in the U.S, in terms of rig count. With a total of 255 rigs being operated, Spraberry is ahead of even Eagle Ford that with 232 rigs. In this region, with 730,000 net acres, Pioneer dominates the Spraberry-Wolfcamp field. The Spraberry-Wolfcamp is a 150 miles long and 75 miles wide field with depth ranging from 6,000 feet to 11,000 feet.
Here, the company has been drilling by using horizontal rigs, that are far more efficient than the conventional vertical rigs. Pioneer currently has 5 horizontal rigs at Spraberry-Wolfcamp, which will increase to between 8 and 10 rigs in 2014. This makes Pioneer the biggest operator at Spraberry-Wolfcamp, ahead of others such as Apache (NYSE:APA) and Concho Resources (NYSE:CXO).
Meanwhile, Concho Resources is ramping up competition in the Permian Basin as the company aims to become the top producer from the region. In its recent third quarter earnings report, Concho announced that it is planning to double its production by 2016.
Pioneer is currently outlining horizontal shale assets at Wolfcamp, Jo Mill, and Spraberry in the northern part of the acreage and believes that the region could become “largest oil and gas discovery in the world.” The company believes that the area holds around 3 billion barrels of recoverable oil equivalent reserves.
Through the uptake in activity, Pioneer is eyeing a significant increase in production. However, I believe that the weakness in oil prices and the high cost of drilling in the Permian pose a significant threat to the company’s margins. Analysts have pointed out that oil prices need to average around $96 per barrel the Permian operators to break-even when they drill into the Cline Shale and the Northern Mississippian Lime layers, although in some parts of the basin, this average drops to $70-$74 per barrel.
Moreover, under ideal circumstances, the horizontal well drilling at Wolfcamp costs around $7 million to $7.5 million but disruptions, or other one-off events, can push this to $12 million or more. This makes Permian relatively more expensive for oil and gas firms than other energy plays such as Eagle Ford and Bakken.
Weakness in Oil Prices
Furthermore, the weakness in oil prices could create more problems for Pioneer. Recently, the U.S. crude oil’s price for December delivery rose to $97.17 a barrel after touching a four month low of $95.95. The demand for crude has remained weak while the supply has been increasing. If this trend continues, then Pioneer might have to revise its Spraberry-Wolfcamp expansion plans.
Moreover, with the possibility of easing of sanctions on Iran and an uptake in production from Libya, the international markets could witness a surge of supply from the Middle East. If that happens, then we might witness a drop of as big as $15 per barrel.
Notes: Permian Basin Information
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.