Permian footprint separates winners, losers

A worsening pipeline bottleneck in Texas' Permian basin is seeing investors favour more diversified independents with a smaller footprint in the area.

A year ago Permian-focused oil producers were the best bet for investors as a host of inherent advantages, such as falling production costs, were meant to ensure steady valuation upside as crude prices recovered. But that wager has started to sputter.

The breakneck speed of expansion has seen the Permian rig count increase by 30pc from a year ago to 477, while the number in the next highest producing area — Texas' Eagle Ford formation — remains below year-earlier levels. That has resulted in a shortage of pipeline capacity to move oil and associated natural gas from the basin, widening the price differential between crude from the region and WTI Cushing to around $10/bl to date for June delivery.

So acute is the constraint that EOG Resources chief executive Billy Thomas says that the Permian is likely to cap US crude output growth next year. "Permian production next year will be much slower, and so US growth will be much slower next year than it is this year." Thomas says it may be late 2019 or 2020 before there is adequate infrastructure in place to take away gas and oil.

Investors are taking note. "Allocating away from the basin or into a Permian name protected by either firm transport agreements or meaningful basis swaps is likely a necessary move," bank Seaport Global says. The bottleneck issue has weighed on the market value of pure Permian operators such as Concho Resources and Diamondback Energy. Shares of a sub-group of Permian-focused operators have gained 12pc so far this quarter, lagging a 35pc rise in the Bakken subgroup and 38pc in the Eagle Ford, Seaport says.

The bank lists Anadarko Petroleum, Devon Energy, Pioneer Natural Resources, Parsley Energy, Approach Resources and WPX Energy as among the least exposed to the Permian's "differential blowout". The most exposed are Apache, Diamondback Energy, Centennial Resources, Cimarex and Abraxas.

Operators focused on other areas such as Eagle Ford and the Bakken formation in North Dakota stand to gain. Bakken has an added advantage, enjoying "the most flexible shale oil takeaway portfolio" because of the DAPL pipeline and an underutilised rail network tied to both east and west coast refining, bank Tudor Pickering Holt says. The rail option may prompt operators to tap the Brent-linked overseas market and take advantage of the wide Brent-WTI spread, it says.

Slowly does it

Given the nuances, money managers target firms that have minimum exposure to the widening differentials, both with Permian crude and Brent, but are also low-cost operators with presence across a range of basins so that they benefit more from the price recovery — such as ConocoPhillips, Marathon Oil and Anadarko.

ConocoPhillips will go slow in developing its Delaware acreage in the Permian, with an end-of-year US unconventional target of 300,000 b/d of oil equivalent (boe/d) expected to be met from the Eagle Ford and Bakken shales. Delaware basin output is around 19,000 boe/d. "There are bottlenecks on the gas side, there are bottlenecks on the oil side, so why would you try to ramp up and produce in to that when you do not need to?" chief executive Ryan Lance says.

Anadarko plans 50pc oil production growth from the Delaware this year, but only after adequate infrastructure is built, which is allowing it to put in place a multi-year development program. Delaware output for Anadarko was 52,000 boe/d in the first quarter, against 260,000 boe/d from its Denver-Julesburg basin in Colorado. Similarly, Marathon is poised to win because Permian output is only about 4pc of its total, while costs decline in its Eagle Ford and Bakken operations.