Here's What Is Really Happening In The Permian Basin

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What we’re seeing is that [Permian Basin] wells drilled this year are continuing the trend of being better than they were the year before, across the whole Permian – the New Mexico Permian and the Texas Permian. Average per-well peak rates for the New Mexico Permian since 2014 have gotten better every year, averaging about 20% better every year. But more importantly, on a cumulative basis, the same amount of time it used to take to produce a nominal break-even per well was five years [in 2014], and today it’s 9 months. - Allen Gilmer, Founder and Chairman of the Board of DrillingInfo

As I wrote in my piece last week, there is no doubt that activity in the booming Permian Basin is slowing down, and in fact has been gradually slowing throughout this year. But as I also noted, that does not mean that, as some in the energy-related media are claiming, that the most active drilling basin in the world is "dying," "on its last legs," or even "peaking."

It means the rate of growth, while still robust, is proceeding at a slower pace than it did during 2018, when the U.S. domestic industry added a record 2 million barrels of oil per day of production. To put some more meat onto the bone of that thesis, I was able to secure some time with Allen Gilmer, whose company, DrillingInfo, keeps close tabs on everything happening in the Permian and the country's other major play areas.

The answer quoted above was to my first question, related to the growing current conventional wisdom among some critics of the industry that per-well productivity was somehow crashing in the region. Related to the same question, Gilmer also talked about the tendency of such critics to hyper-focus on a small subset of exploratory wells being drilled by many companies:

"Are there areas where some operators have drilled aggressively trying to identify minimum spacing? Absolutely," he said. "We are starting to see deterioration of those on the spacing side in the same zone, but those are tiny experiments that represent tiny fractions of the Permian Basin as a whole."

Gilmer's and DrillingInfo's findings on this question are also supported by the findings of another recent report, from Rystad Energy, which also finds per-well recoveries in the Permian continuing to grow during 2019, contrary to many analyst and media reports.

On the claim that some Permian producers 'paid too much' to acquire acreage in the Permian:

"[One] thing that some analysts seem to get wrong is that they seem to fundamentally misunderstand what the eventual producing units will look like. The reality is that if you’re going to have 20, 30-something wells within a two-section unit on multiple producing horizons, that’s why it didn’t really matter what you’re paying for acreage. Because the acreage cost is only about 10% to 20% of your drilling cost."

DrillingInfo has seen these kinds of deals as one of the factors that have led to a boom in what Gilmer refers to as "horse-trading" of acreage between producing companies:

"Out there in the Permian, if you can get a 10,000-foot lateral your return will be a 3 to 7 PV10 multiple over what you get on a 5,000-foot lateral. Today, 5,000-foot laterals are kind of break-even deals, but at 10,000-feet they’re all of a sudden massively valuable. That’s the reason why the big play right now is to consolidate acreage to make sure that you have units that can support 10,000-foot laterals.

I pointed out that that was one of the big drivers behind the April/May battle between Oxy and Chevron  to acquire Anadarko :

"Absolutely – interstitial acreage is what we call it. And right now, we are doing a land-office business in land in West Texas and Southeast New Mexico that, when you superficially look at it, nobody would expect...they would look at a map and say all the big blocks are already put together. But it’s really all about this horse-trading to be able to go out there and trade acreage in two-, three-, and four-way trades to become capable of having high-grade locations that are valuable enough to drill in a world where oil prices are so volatile."

Gilmer pointed out that one reason why so many analysts acquire false beliefs about the relative health of the Permian play is due to a tendency to take poor results achieved by one operator and assume they apply to all producers across the Basin.:

"We still have this issue where we have the best operator producing 30-40% more for the same dollar drilled in the same producing zone than the worst operator."

But hasn’t that always been the case everywhere? Gilmer says, not exactly.:

"That’s always been the case in the unconventional plays, and it’s always been pretty much ignored.

Conventional plays are different – it didn’t matter who drilled the East Texas field first, whether it was Dad Joiner or Humble Oil, because conventional plays treated everyone the same.

“But unconventional plays treat you fundamentally different. Skill actually matters. Engineering skill, testing, what have you. It’s funny to me – I’ve had talks with several of these analysts in which they poo-poohed the technology that goes into drilling the wells, claiming it was just a question of how much sand you put in there and how long your lateral is. They completely miss the nuances of all of these variables and the non-linear aspects in all of this. They miss the fact that there are operators that can make a lot of money on drilling the same well another operator can’t. Frankly, they can't get their heads around a demand-driven oil and gas industry rather than a supply-driven one."

Do these fundamental misconceptions about the nature of shale plays help explain why operators are finding their access to capital markets increasingly restricted?:

“All these things come together to make a very interesting investment environment. It’s not buying bird’s nests on the ground, it’s not buying commodities. People who really know what they’re doing are going to make a fortune in this stuff, and the people who don’t know what they’re doing are going to waste a lot of capital. I spend a lot of time listening. I hear a lot of people holding forth on the end of hydrocarbons because they don't know much about the dynamics of a rapidly changing industry. The loudest are typically the ones that really don't understand this. The sad fact is that the public companies have to dance to these loud voices. They will be danced straight into the ground unless some real wisdom emerges in those that call the music.

"What the industry needs is for a few of these operators to get to a place where they are generating substantial free cash flow and prove the critics wrong. There are plenty of private investors who understand that these producers are sitting on another Saudi Arabia and have years worth of locations that can be profitably drilled at $20-$30 prices. Most of it is economic at $40/bbl  - you just need to be able to go out there and do it the right way."

So, bottom line, the Permian Basin is not "dying," "on its last legs," or "peaking." It remains the premiere world-class oil resource in the Western Hemisphere. If it is suffering from anything, it is from a lack of understanding by many analysts, media observers and perhaps most-importantly, investors, about what is really fundamentally taking place in West Texas and Southeast New Mexico.

That's a story that the industry itself is going to have to a better job of telling, because no one else is going to do that on its behalf.

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