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Payback periods lengthen in Northern Midland Basin

29th November 2015

Nascent Spraberry play encouraging, but stacked pay and steep learning curves in basin suggest more time needed to properly risk company acreage

Permian Basin
Permian Basin

An analysis of oil and gas company plays in the Northern Midland Basin - a sub-basin of the prolific Permian basin - indicates that few of the basin’s corporate sub-plays are currently economically viable even at current costs, according to analysis from IHS (NYSE: IHS), the leading global source of critical information and insight.  
In its IHS Northern Midland Basin Company Play Analysis, IHS estimated payback periods indicate that, owing to steep decline rates, only a handful of areas can recover half of completed well cost in six months or less under a $50 per barrel well-head price. And even at a $65 per barrel well-head price, IHS said most areas require more than six months to recover half of well cost. After 12 months, nearly one-third of the company sub-plays modeled by IHS recover half of completed well costs.  
“Steep production declines for Northern Midland Basin operators greatly increase the economic relevance of maximizing a well’s longer-term recovery. This means production performance six to 12 months after coming online, rather than the typical operator emphasis on peak-month production rates that can often be misleading,” said Sven Del Pozzo, director, company and transaction research at IHS Energy, and author of the IHS Northern Midland Basin Company Play Analysis.
“After six to 12 months, production is not typically high enough to recover the remainder of completed well costs within a time frame that would satisfy investors,” Del Pozzo said. “Therefore, today’s investment decisions depend more on commodity prices after six to 12 months, optimization of artificial lift, and generation of economies of scale.”
Since oil prices weakened, Del Pozzo said, across the play operators have largely ceased horizontal development of deeper targets, including the Wolfcamp C and D benches and the Cline Shale, in favor of shallower Wolfcamp benches that originally kicked off the play, while more recently testing the Spraberry.  
Among Midland Basin operators, IHS said, Pioneer Natural Resources, RSP Permian Inc., and Diamondback Energy are the companies most exposed, in terms of acreage, to Midland County (including its border region with Ector County), where well performance is typically impressive in stacked pay zones.

“This is Pioneer’s most prolific county,” Del Pozzo said, “together with the border region of northwest Glasscock County, and its valuation is critical to our year-end 2014 appraised net worth (ANW).  We estimate 60 percent of Pioneer’s acreage value, and one-third of the company’s total appraised worth, is located in the Northern Midland Basin.”

Pioneer’s core acreage is appraised at $32,000 per acre, under a rising price scenario that reaches $85 per barrel flat in 2023, after rising in $5 per barrel annual increments starting at $50 per barrel in 2016.

“In Upton County, well performance by the various operators was remarkably consistent in the county, but Pioneer’s was the best,” Del Pozzo said.

The equity market recognizes the outstanding potential of the area, with Diamondback and RSP Permian operating in close proximity, and leading their peers as measured by enterprise value-per-acre, the IHS report said. Diamondback’s and RSP Permian’s

Spraberry play is economic even at current oil prices, superior even to their Wolfcamp development in the same area, Del Pozzo said.

Diamondback has a “monster” Spraberry well in the Gridiron area, with cumulative production of more than 250,000 barrels during a period of about 15 months, and the well also has a stacked Wolfcamp B partner with outstanding results. Several miles away, there is another Gridiron well that is remarkably prolific, IHS said.

RSP Permian’s Spraberry performance is impressive. Its Middle Spraberry wells make up a small proportion of its total horizontal well count to date, but the Middle Spraberry peak-month oil production is the company’s most prolific, ranging between 20,000 and 25,000 barrels. In addition, RSP Permian’s equity financing of its merger and acquisition activity continues to create shareholder value, IHS said.

In recent years, ExxonMobil has methodically increased its Permian exposure via a number of deals, mainly with private entities lacking detailed public disclosure. While the IHS report acknowledges the play is immaterial to Exxon’s current enterprise value, based on its production history to date, IHS believes ExxonMobil is also on a learning curve in the play. The company has some highly prospective acreage, but requires a price in excess of $65 per barrel of oil price to be economic, based on the analysis of approximately 20 horizontal wells, some of which flank Diamondback’s outstanding wells.

Recent play entry by QEP Resources and Encana suggests a steep learning curve, and IHS analysts believe these companies’ highly prospective acreage would be best developed if it were gradually de-risked to ensure optimal development. In Glasscock County,

IHS said Laredo Petroleum trades at a large discount relative to the IHS valuation of the company’s assets, while Apache’s acreage seems less prospective. Howard County wells are impressive, the IHS report noted, but not repeatable for all.

Anecdotal evidence for Howard County operators suggests greater geologic complexity, requiring more science to better unlock its value, but results have been impressive thus far, especially considering it is farther from the center of the basin. Strong well performance suggests an active land market in the county, the report noted. However, IHS analysis demonstrated that Tall City Operating was shown to have uneconomic wells on average, prior to its recently announced acquisition by a private Chinese entity.

“Encana’s southern Howard County wells have impressive peak-month oil production of 30,000 barrels to 35,000 barrels, which is drawing great interest in the Wolfcamp/Spraberry’s southern expansion in the County,” Del Pozzo said.