America has not fully grasped what has happened in the hinterlands of domestic energy, where old fashioned 
American ingenuity has achieved one of its greatest triumphs.
In our first installment, we took up the idea that it wasn’t the major oil companies who re-invented the oil and gas industry—it was the independents, mainly in the Barnett Shale and the Permian Basin. In this installment, we take that idea further, examining the whys and wherefores of the independents’ comeuppance, and their continuing domination of the national energy scene.
If there is one thing that the independent oil and gas operators agree upon, it is that ingenuity trumps just about anything else when it comes to success in the oil field.
As Wallace Pratt (1885-1981) observed long ago, “Oil is found in the minds of men.” It was Pratt, the renowned petroleum geologist, whose insights changed people’s perceptions—and thereby elevated the task of oil exploration from a hit-or-miss proposition to a scientific/engineering endeavor. Pratt’s sentiments aptly describe the mindset of today’s oil and gas independents—especially those in Texas and New Mexico, where most of the industry’s remarkable transformation has been achieved.
The independent oil company with the biggest holdings in the Permian Basin—Pioneer Natural Resources—is led by a forward-thinker who reflected, recently, on the qualities that have made the independents so successful.
“Over the last 5 to 7 years, the Permian Basin has been coming on strong, because of the shale technology that started with the natural gas discoveries of the Barnett Shale,” said Scott Sheffield, president and CEO of Pioneer..
Sheffield, like every other oil executive PBOG spoke with, considers the Permian Basin a play whose sudden upsurge is attributable to the breakthroughs of independent oil and gas companies. He remarked that the Permian was one of the last basins to see shale technology—that being because the technologies that began to be utilized in the Barnett Shale were mainly thought of as technologies for developing natural gas resources exclusively. It was only later that operators found the technologies to be as effective, if not more effective, when applied in liquids plays.
“Companies were focusing primarily on natural gas, and the Permian Basin doesn’t have much natural gas shale,” Sheffield said. “That’s why others initially focused on places like the Haynesville and the Marcellus, as well as the Fayetteville and the Barnett. The Permian Basin was two to four years behind in applying shale technology to liquids reservoirs. But it has been coming on strong now. I think that about a third of the Permian’s 500 rigs are drilling horizontal wells now, and in the next three to five years, horizontal wells will likely represent two-thirds of those 500 rigs.”
Looking back even further—some two to three decades ago—Sheffield contemplates a broader vista that adds more perspective. The major oil companies were divesting themselves of domestic holdings and venturing abroad, even as early as the 1970s.
“They sold most of their assets to the independents [in the 1970s-1990s], believing that the Permian Basin was too mature. That caused the independents to really get started in the Permian and to create some very large oil and gas companies,” he said.
Recently, however, the majors have been coming back to the United States, largely to capitalize on the same kinds of breakthroughs and discoveries that the independents have achieved here.
“But they still have a long way to go,” Sheffield said of the majors. “The independents have been driving Permian development. They have split the Basin into three courses: The Delaware, the Midland Basin, and the Central Basin Platform. The Midland Basin and the Delaware Basin have primarily been independent plays for a lot longer time period. The Central Basin Platform is where all your secondary and your tertiary recovery projects are, and that is where Amoco, Shell, and Exxon were, and that’s where Oxy now operates most of that production.”
The Permian Basin holds 20 to 25 percent of all the oil in the United States, Sheffield said. That estimate is backed, to some extent, by the U.S. rig count. Currently, about 1,800 rigs are active in the United States, and 500 of those are in the Permian.
Sheffield sees a certain kind of progression that has favored the independents—a progression that involved a prodigious transfer of assets, over a long period of time.
“The other big independents in the Permian—Apache, Devon, and Concho—were created the same way we created Pioneer. That is, by buying out properties from the major oil companies over 20, 25 years, and building a company. Meanwhile, as these independents, including Pioneer, were buying up properties from the majors, they have hired personnel from the majors as well.
“Well, their people are always very well trained. And so, with their people comes a lot of their technologies. For instance, in the Midland Basin, where our biggest resource lies, where we have 900,000 acres, the geoscientists that we have hired from the majors over the last 15 years have driven Pioneer’s conclusion there are billions and billions of barrels of new resource in the Midland Basin.”
Capital has become much more readily available to the independents, too, according to Pioneer’s top executive.
“There’s probably been more capital available to independents in the last five years than there has ever been,” he said. “So the independents don’t have to rely on the majors any more, on farmouts. The independents can go to a variety of sources. To private pension funds. To the equity markets. To insurance companies. There is so much capital available, and that’s made it very attractive for independents to invest heavily in developing their assets. They used to have to rely on bank debt. Now there are options available.”
Asked what has given the independents their luster with lenders and investors, Sheffield said it was a combination of factors.
“For one, oil prices have been rising over eight or nine years, and meanwhile, returns in the business have been very good. And if returns in the business are good, then that attracts capital.”
It’s also coming from overseas, he added. “In South Texas, we have a partner from India called Reliance. Devon Energy brought in Japanese capital, on the eastern side of the Permian Basin, in the Cline Shale.”
Pioneer Natural Resources also has positions in the Cline Shale, but Sheffield indicated that that play is not the company’s prime target at present.
“We have a lot of acreage there, yes,” Sheffield said. “But we are more focused on the upper part of the Wolfcamp, where we think we are getting better wells than in the Cline Shale. Eventually, we will start developing the Cline Shale also.”
In the Wolfcamp, Pioneer is portioning off some of its 900,000 acres as territory that will be made available to potential partners. This strategy echoes what other large independents have been doing to accelerate their activities and to gain greater wherewithal.
“We’re taking the southern 200,000 acres [of their 900,000 in the Wolfcamp] and taking bids in December [2012] for a joint venture partner that will allow us to accelerate drilling in… Upton and Reagan Counties, primarily,” he said.
Overall, the Wolfcamp play—Pioneer’s and other companies’—will cover “probably more than 2 million acres,” he added.
From Vertical to Horizontal
“The majors abandoned the Permian Basin and, largely, the lower 48 states in the 1990s,” said Steve Pruett, CEO of Elevation Energy, a new E&P firm on the Permian scene. “They decided that the reserves here were not big enough to impact their bottom line. Basically, when they pulled out of the onshore basins, they redeployed their technical staff to the Gulf of Mexico or to international opportunities and they lost their presence in the onshore basins. They laid off those that weren’t relocated, many of whom became consultants or were hired by independents.
“I worked for ARCO as a petroleum engineer, and later for Amoco, both of whom were acquired by BP,” Pruett said. “Most of my colleagues at both majors left BP to join or lead independents who are active in the unconventional resource plays. BP inherited ARCO’s position in what became the Wolfberry play.”
Independents now are creating sizable companies, and doing so almost solely on the basis of unconventional assets, Pruett said.
“Clearly, [the independents] are nimble enough to be able to deploy ideas and access capital and use it over a short cycle time,” Pruett said. “They have capable people, and lack the bureaucracy that can hamstring the majors. The independents are risk takers. Not all ideas work, of course, but they have a host of ideas and are willing to give them a try.”
Perhaps just as important, the independents are willing to sell their properties after they have proven the play concept. “They’re willing to sell assets and redeploy the capital and profits somewhere else,” he said.
Pruett’s new venture, Elevation Energy, “will be backed by private equity” and is actively recruiting people right now. “The funding is there, the deal flow is there, so we intend to pursue the development of unconventional resources in the Permian Basin. It’s an attractive time to start up a company.”
Quick to Act
Echoing what others have said, Bob Dye, senior vice president for global communications at Apache Corporation, another of Texas’ large independent operators, remarked that the major oil companies were leaving North America a couple of decades ago, adding that “it had to do with the fact that the reserve sizes were dwindling and they could get better returns internationally.”
“A lot of them completely exited,” he said. “They trimmed back their holdings and left most of North America to the independents. And so we independents had to do something with this asset base. In some of these land plays, where acreage is competitive, we can make decisions quickly, and that might be why the majors left us. It’s an intensive endeavor to maintain and hold acreage.”
“The independents had always been fairly entrepreneurial,” Dye added. “They typically have a flat [lean] management structure, and make decisions quickly. We don’t have many layers.
“So the independents, in conjunction with the service companies, created some technologies. It was Mitchell Energy, along with [later] Devon, that started experimenting with horizontal drilling in conjunction with hydraulic fracturing. With any kind of disruptive technology, there are always improvements to be made that are important to the success of the effort. Mitchell [before its acquisition by Devon] was not able to do that many frac stages. Today, we can do more than 30 stages if the lateral is long enough. So what that does is it really improves the economics because you have that much more zone that is contributing, producing, to a single wellbore.”
Apache Corporation has had success with these technologies, not just in Texas and New Mexico, but in Oklahoma, in the Anadarko Basin, and in British Columbia.
“We had a hand in discovering a basin in British Columbia, the Laird Basin, and we have also had much success in the Horn River Basin, where we think we have found something in excess of 50 trillion cubic feet of resource potential.
In the Permian, Apache has identified what it believes to be 3.8 billion barrels of potential production. Within that basin, Apache is working 500 drilling locations.
“We have had kind of a meteoric activity rise in the Permian just over the last couple of years,” Dye said. “In 2010, we had about 345 employees there. Today, we have about 792. We spent about $400 million there in 2010 and this year [2012] we will spend about $2 billion. We had five rigs working there in 2010 and in 2012 it has been roughly 32. Already under lease, we have about 3.5 million gross acres.”
The Monetize Guys
“The Permian Basin is such a great place because there is so much oil in place and so many different ways to get that oil out of the ground with developing technology,” said Cary D. Brown, CEO of Legacy Reserves, which within the past month purchased more than $500 million in Permian Basin oil and gas properties from Concho Resources. “The independents have been pretty fast to react when they’ve found new technology. And quick to ask, hey, where does that apply in the world in which we live?”
It’s been a really good time for the independents, Brown said, but these times have not necessarily been a big departure from the way things were in early times in the industry. “If you look at the history of the oil business since its beginnings, finding oil has been a matter of figuring out new ways to drill for and produce it. The independents’ growth has been driven by their increased access to capital. That’s one of the reasons why we [Legacy Reserves] went public. We saw that in this business you need capital… and going public was an efficient way to get capital and put it to work.”
Like the other companies PBOG consulted for this article, Legacy Reserves is an independent oil and gas company. But it is an independent with a difference.
“Legacy is a master limited partnership [MLP] so we are really designed to own properties after they have been developed and are producing,” Brown said. “Most of what we buy is already developed. We play the game differently than the other independents who are looking to find oil and drill for it. We are on the manufacturing side of the equation. Somebody finds oil, gets it drilled up, and then we come along, operate it out and generate the long-term cash flow from those wells. We pay out most of that cash flow to our unit holders. Our ‘innovation,’ then, as an independent, has been to create an efficient way to own assets and generate cash flow. As an MLP, we don’t pay federal income taxes, and the dividends we pay out to our unit holders are not paid at dividend tax rates. Instead, we distribute cash to our unit holders along with our taxable income. This avoids a layer of taxation. If Exxon-Mobil, for instance, owned the properties that we own, they’d generate cash flow and if they wanted to pay it out to their shareholders, they’d first have to pay their corporate tax and then their shareholders would have to pay tax on the dividends received. For our unit holders, because we are organized as a master limited partnership, they can own an interest in our long-lived assets.”
Legacy also develops some of its own reserves and uses considerable techology to do so. But the company is not nearly so engaged in exploration as traditional independent operators are.
When a Legacy Reserves buys $500 million of (primarily) producing assets from a Concho Energy, what is happening is Concho is liquidating producing assets and redeploying that capital to drill new oil wells.
“We monetize for those guys who like to drill,” Brown said.
As for future prospects in this region, Brown said he is pleased to see all the horizontal drilling that is now going on. “I think there is a lot of rock in the Permian to be drilled horizontally, and to be completed with the new frac techniques, so that is pretty exciting. We think the Wolfberry play has been a good play for the Permian and there appear to be others developing.”
Where It’s Headed
Pioneer’s Sheffield, asked if he thought anyone could have foreseen, some two decades ago, the immense strides taken by the independent oil companies over this stretch, said that he did not.
“No, not at all.” He continued: “We [Pioneer] are a $16 billion company today. But Apache and Devon are $40 billion dollar companies. People would not have thought that companies like Arco and Amoco would be sold, and then all of a sudden you would have independents who are as large or larger than the Arcos and Amocos, who were sold 13 or 14 years ago.”
Asked for his predictions on where things might go, the oilman who is receiving the PBPA’s “Top Hand” award this month offered this:
“The Permian Basin declined from 2 million barrels a day production in early ’70s, to about 850,000 barrels a day about six years ago, and now it is back up to 1.3 million barrels a day and in the next seven years it should be back up to 2 million barrels a day, or more—which should be an all-time high. And there have been a lot of reports that we will be back up to 10 million barrels a day in this country, and so that means that the Permian Basin will be providing 20 percent of our U.S. oil needs.
“The Permian Basin will probably have the most growth for a long time. These other plays that are being drilled, like the Bakken and the Eagle Ford, they are not as big as the Wolfcamp and they eventually will start declining.
“But the Permian Basin will go on and grow for another 50 years.”