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The Shale Revolutions Next Winner: The Permian Basin

While North Dakota and South Texas garner much of the attention by energy investors, West Texas is fast becoming the backbone of the shale story in the United States.

West Texas is home to the Permian basin, which was originally discovered nearly a century ago. It was home to much of Texas’ oil production for decades, but peaked in the 1970’s – along with many other American oil fields – and entered into a period of gradual decline.

That all reversed course over the last few years, with the familiar story involving hydraulic fracturing and horizontal drilling unfolding on the dusty plains of West Texas. And although other regions across the U.S. have nearly a decade of fracking under their belt, the surge in production (or resurgence, as the case may be) in the Permian basin has really only ramped up over the last two years.

Between 2007 and mid-2014, oil production in the Permian jumped from 850,000 barrels per day (bpd) to over 1.6 million bpd. Last year, the region accounted for about one-fifth of total U.S. oil production. That is enough to make the Permian basin home to the most productive oil basin in the United States in 2014.

Taken together, six Permian shale formations – Sprayberry, Wolfcamp, Bone Spring, Glorieta, Yeso, and Delaware – make up most of that production. More narrowly, the Sprayberry, Wolfcamp, and Bone Spring formations account for almost 75% of the region’s oil production.

More notable shale plays got an earlier start than the Permian, but that also means they may peak and plateau earlier. Some analysts expect the Bakken and the Eagle Ford to peak before 2020. Meanwhile the Permian could continue to rise through the middle of the next decade, perhaps hitting 3.5 million bpd by 2025.

It is hard to emphasize how quickly production is rising. While the Bakken and Eagle Ford are splashed across headlines, oil rigs are rapidly migrating to West Texas. Between December 2013 and May 2014, the Permian alone saw an increase in 63 oil rigs, which accounts for 50% of all additional rigs added to the oil patch in the U.S. for that time period.

The chart below shows how the Permian vaulted from being a bit player in 2011 to being the top location for drillers this year.

Horizontal oil-directed rig count, by basin

The Permian now hosts more than one-third of drilling rigs in the United States, and all of that new rig activity is leading to production gains. The Permian now produces over 1.6 million bpd and counting. In June alone, the region increased production by an additional 30,000 bpd.

“The industry appears to have accomplished a technological leap in the second half of 2013, with many public operators reporting initial production rates from horizontal wells in the Permian exceeding 1,000 boe/d,” Andrew Byrne, Manager of Global E&P at IHS Herold, wrote on the IHS Unconventional Energy Blog in March.

Some of the major companies operating in this arena will be known by investors, others won’t. But all appear to be sitting on acreage that is currently taking off.

For investors, Pioneer Natural Resources (NYSE: PXD) should be at the top of their list. The company owns the rights to 825,000 acres in the Sprayberry/Wolfcamp, and it is one of the largest producers in the region. As of November 2013, the company was producing 93,000 barrels of oil equivalent per day (boe/d), which includes a mixture of oil and natural gas. Pioneer also said late last year that the formations could hold 50 billion barrels of oil, which if true, would make it the second largest oil field in the world.  For 2014, Pioneer will use 16 rigs, most equipped with the ability to drill three-wells per pad. In total, Pioneer expects to drill 140 wells, most of which will occur in the Wolfcamp.

The only downside for Pioneer is that its stock price has performed so well over the past five years. Investors may find a difficult entry point, but given the fact that the company’s share price has steadily risen with only minor bumps along the way, there is no reason to believe the rally won’t continue as long as production keeps rising.

Another major player in the Permian is Apache Corporation (NYSE: APA), which was producing about 150,000 boe/d in the first quarter of 2014. Apache has ambitious plans for the Cline shale, with expectations to drill 35 wells there in 2014. Overall, Apache owns over 3.3 million acres in the Permian, which include exposure to a mix of different shale plays. It has over 13,500 producing wells.

On the smaller side is Energen Corporation (NYSE: EGN), an Alabama-based company operating mostly in West Texas with a market cap of $6.5 billion. The company claims to control 3.3 billion boe in its portfolio, which includes a looser definition of “proved, probable, and possible.” About 82% of those reserves are located in the Permian. Its stock price mirrors the trajectory of Permian production as a whole – relatively flat until 2013, at which point it took off. The company’s share price skyrocketed after it announced first quarter 2014 results, which included details on several successful wells drilled in the Wolfcamp. It is already producing 14,000 boe. The company says it will drill 23 wells this year in the Wolfcamp/Cline formations, with investments of $250 million.

One of the promising aspects of the Permian basin is the potential to hit multiple pay zones in a given drilling operation. For example, one drilling project could cross through several zones rich with hydrocarbons. That is something that Crude Energy, a small company based in Dallas, TX counts on. It has assets in the Permian basin, and has drilled several wells with some success. Although the company keeps much of its data private, it says that over the course of its drilling campaign, its wells have struck hydrocarbons in multiple pay zones. This allows costs to be recouped faster, with a greater return on investment. Crude Energy is not publicly traded, but does accept direct investment.

Energy investors have watched the shale landscape shift over the last several years, changing quickly from year-to-year. Many investors probably wished they had invested in the companies at the forefront of the Marcellus Shale five or ten years ago. Then, most energy investors who missed the boat on the Bakken and the Eagle Ford wished they could have gotten in early there too.

The Permian basin is currently experiencing the drilling frenzy that these other regions experienced several years ago. The window will be open for only a short period of time, before the word gets out to the wider investing world. At that point, many companies will have completed the bulk of their richest wells, and production growth will slow a bit. Their share prices will also likely be nearing high points.

Now is the time to take a look at the companies operating in this region, while there are still some bargains.

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