Has the Permian Basin become too hot? More companies and enormous sums of capital continue to flood into West Texas to take advantage of the most prolific shale basin in North America. Rig counts are showing no sign of slowing down and new deals in the Permian are announced on what seems like a weekly basis. However, will the Permian bubble deflate?
ExxonMobil dumped more than $6 billion in January to double its holdings in the Permian, as the oil supermajor decided to ramp up shale drilling instead of taking on more complex megaprojects offshore. But in the past, ExxonMobil has made a play for shale assets at the top of the market. In 2009, Exxon paid more than $30 billion for XTO Energy, a Texas shale gas driller, in what was widely seen in retrospect as an expensive play on a market that had already peaked.
With that context in mind, Exxon’s latest deal raises a few questions about the health of the Permian frenzy. Land prices have surged so high in the Permian Basin that some companies are starting to look elsewhere, according to Bloomberg. It is not uncommon these days to see land deals selling for more than $60,000 per acre, which Wood Mackenzie says is 50 times higher than four years ago and still 10 times higher than the Bakken today.
In the past two years we have seen the Permian benefit at the expense of other drilling areas. Places like the Bakken and Eagle Ford have been hemorrhaging rigs, jobs, and capital, and consequently have suffered a sharp decline in production. Many companies drilling in those locations decamped for the Permian Basin, and the West Texas shale basin saw a corresponding increase in rigs and drilling activity. Wall Street, desperate for profits after nearly three years of poor returns on energy investments, has been dumping money into Permian drillers. Wall Street’s pot of money seems to be endless, and they are once again dumping money into oil and gas, and the Permian in particular. Related: Energy Storage Set To Boom In 2017
But land prices might have climbed too high. For every Parsley Energy – a small driller that is going all-in on the Permian – there are other companies taking a different approach. Bloomberg cites several companies that are passing on the Permian for less flashy locales – BP is looking to drill in Argentina’s Vaca Muerta, Newfield Exploration is expanding into Oklahoma’s STACK play, and Sanchez Energy is returning to the Eagle Ford, a shale play that has once again become an underdog.
“[C]ompanies that don’t already have a foothold are seeing valuations that are out of control,” Gabriele Sorbara, an analyst at Williams Capital Group LP, told Bloomberg in an interview, referring to the Permian Basin. “They can’t get involved.”
Other analysts agree. Peter Pulikkan of Bloomberg Intelligence says the skyrocketing land prices in the Permian are reminiscent of “the Internet circa 1998.” That could mean that companies start to scoff at the heady prices in the Permian and begin to look elsewhere. “We’re in the second inning of a Permian bubble,” Pulikkan said. “Some players are starting to look at other areas that may offer better risk-reward” ratios. Related: Is $60 Oil Within Reach?
Rising oil prices might have a counterintuitive effect on the Permian. While it might seem on its face that oil rising into the $50s and above would inflate the Permian bubble even further, it is more likely that a more stable oil market will allow other shale basins to poach drillers away from the Permian. As oil prices rise above the breakeven prices of other shale plays, the Permian becomes comparatively less attractive, especially given the high costs of entry. Oklahoma’s SCOOP and STACK plays, the Eagle Ford, and the Bakken could see their fortunes revive. A Bloomberg Intelligence survey found that less than half of the respondents thought that the Permian would attract the most M&A activity this year, down from 57 percent of respondents last year.
Moody’s Investors Service published a recent report that projected M&A deals would rise in 2017 across the oil and gas industry. Tucked into the report was another interesting conclusion: that the valuations in the Permian are getting too hot, and may not last.
By Nick Cunningham of Oilprice.com
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