The Executive Oil Conference, in its first unfolding at a new venue and a fall (not winter) date, fetched a full house and showcased some influential voices.
MIDLAND, TEXAS—As the organizers of the Executive Oil Conference noted shortly after the conclusion of their Oct. 15 event, the EOC “allowed some 1,000 attendees the opportunity to hear from public and private producers about how they are making new horizontal technologies work for them to wring yet more oil out of the Permian.”
The reported attendance of 1,000 seems no exaggeration. Seats were in short supply, at least during the morning sessions, and support staff was kept busy setting up additional chairs as the event was in progress.
This show hit at a time when Wall Street interest in the Permian Basin seems to have reached an unprecedented high level. At both the EOC and at the PBPA’s Annual Meeting, which came just over a week later, speakers had no shortage of quotes from the major financial markets extolling the value of the Permian Basin as an investment. It seems that the Permian has come into its own after several years of the Barnett Shale, the Bakken Shale, the Marcellus, and the Eagle Ford garnering top headlines. Now the Permian is the talk of the energy investments community, and these two shows were the places where the outside world got its best chance to rub shoulders with and hear the views of the movers and shakers of the nation’s hottest resource play.
This year’s EOC was the first held in October (normally it’s in February) and the first held at the Midland County Horseshoe.
As those EOC organizers summed up in their followup notice:
“The Permian Basin continues to surprise on the upside after more than 50 years of production, and the best is yet to come. This play has strong legs thanks to its multipay potential that ranks it among the world’s top three oil fields.
All told, from every vantage point that speakers could mention—rig count, reserves, rising production, well locations, economics—the Permian Basin stands out as the premier oil province in the U.S., and indeed, one of the very best in the world.”
In what remains of this report, we are not attempting to convey every major point of the conference but rather simply provide some snippets of what some of the speakers had to share. We begin with the roundtable discussion among “Top Guns of the Permian.” Panelists were Travis Stice, president and CEO of Diamondback Energy; Kyle Hammond, director and CEO of FireWheel Energy; and Bryan Sheffield, president of Parsley Energy.
The moderator put this question to Stice: “I’d really like to explore that vertical to horizontal transition more, here in the Permian Basin. Because it appears that rig count is literally down, but it appears that vertical rigs, Wolfberry rigs, are laying down, and in exchange, we are picking up a few more horizontal rigs. So I wonder if you might share some perspective on that, at least what you see in the Midland Basin.”
Said Stice: “I get the question asked a lot about ‘Why are you drilling so many horizontal wells?’ And I actually got to the point where I turned it around and I said, ‘Why are you drilling vertical wells?’ As I look at Diamondback’s acreage position, I look at it as simply as I can. There are three things that drive our decision to drill horizontally. The first is our project rate-of-return perspective. I generate 40-50% rate of return on horizontal wells. The second thing is the cost to develop that. There’s a simple way of explaining the measure that I use which simply takes the investment cost over the net reserves [here Stice went into deeper details about cost analysis]… But the cost to develop, for horizontal vs. vertical on a by-acreage basis, is substantially lower, which is a good thing. And then the third thing is just a measure of capital efficiency, which is profit over investment. Profit over investment for horizontal wells is materially higher than what I could do from vertical. So those three things, simply said, kind of make up our strategy for drilling horizontal.
Kyle Hammond responded to the same question: “We’re not a vertical player, not right now, so I’m not having to go through those decision points, as far as whether we are going to drill vertical vs. horizontal. We’re going to focus on pure horizontals for the next 12 to 18 months, in the Cline Shale. And so I’m not going through how to compare rates of return on a vertical basis, or horizontal. We’ve got a small thing that we’re going to do, that has nothing to do with a shale play, that will be horizontally drilled but also will be a vertical thing. There’s going to be applications for both, and where you have the options of accessing the reserves with both, then that’s where engineering and geology come up with a plan that is most efficient.”
Moderator: “So if we make this transition to horizontal, the question that comes up is: ‘How do smaller independents compete against much larger firms?’ You know in the Permian, there has been a fair amount of consolidation out here, you’ve got the majors active, you’ve got some very large, very successful independents. And then on the other hand you’ve got the MLP’s gathering up all the conventional properties. So what is the space in which private independents can compete, and how would they do so?
Sheffield: “We’re one of those private independents and for three years private equity groups were knocking on our door saying, “Hey let’s do a deal.” I kept pushing back and pushing back and I think it’s happened to a lot of my peers out there in Midland. They’re banging on their doors, and eventually you start warming up to them, and you start realizing you need them because you can’t just press your company against debt and keep borrowing and keep borrowing. There are independents out there that do have a section or two out there. You take the benches and multiply it by locations, you might need $200 million to develop that one section that’s in the core in Midland County. You gotta break out of the mold, the independents have got to break out of the mold, just like we did. I was talking to a guy last night and he’s never done a private equity deal and he just closed one. The guy last night actually told me that he operates his own wells on one area… It sounds like private equity groups are bending the rules a little bit, letting go of the negative controls a little bit, and I continue to see this because more independents are going to open up to private equity groups.”
Hammond: “I love talking about small independents. There’s a huge disparity in what “small” is but one of the benefits of being small is you can actually hire and target highly technical people that are very, very good at what they do. And I would say there’s a wide array of small independents in Midland that have no interest in drilling a horizontal well. One of the benefits of horizontal wells is you can access a lot of rock and get really good returns. One of the down sides is that you are focusing a tremendous amount of capital in one hole, and the mechanical risk is huge. If you’ve ever been stuck out in horizontal, that mechanical risk comes at you extremely fast. And so when you’re focusing a significant amount of your capital in one well, that creates a little bit of terror in a small independent. I feel it every time we put the bit in the ground. That being said, for the guys with the technical skills, there is a wonderful opportunity for those who do not want to drill horizontal wells and [yet] have acreage or HBP—or small partials—that they want to get drilled… And then there are gonna be some guys that have no interest in drilling but they want to partner with private equity type firms, someone that can bring capital and expertise, and it’s going to be a win/win for both parties.”
Stice: “Let me just tag onto something Kyle said about the risk you take in drilling horizontal wells. You can drill a vertical well out here in the central Permian Basin for somewhere around $1.7 to 2 million. The really bad thing on a vertical well is you might end up spending $2.5 to 3 million. Well, when you’re drilling a horizontal well that can be $7.5 million, a really bad day on that horizontal well can run you up to $10 to 12 million. So there’s a lot of people that look at that risk profile and the economic drain that’s required to drill on horizontals and they say ‘Well, I don’t know if I want to take that risk.’
And the other thing to elaborate on what Kyle said, was that if you don’t have the technical excellence or the capability to execute on these complex well pads, then you are taking on a bigger financial risk. At Diamondback Energy we spend about $1 million/day for horizontal wells. If we don’t execute on that very, very carefully then we can destroy a lot of value for our shareholders. It is a different game, and accessing capital is a bigger issue if you push all your chips to the center of the table and drill horizontally. There’s really only one reason to take the company public, and that’s access to capital markets. If you look at what Diamondback Energy has done in the last year, we’ve raised over $550 million of equity to fund our drilling efforts, just in the last year alone.”
Moderator: “I think in at least two cases, we have panelists that have worked for much larger organizations that are now working for small or start-up companies essentially. I wonder if we could compare and contrast. What advantages did you take away from the larger organization? How does being smaller provide a competitive advantage?”
Hammond: “In my career as I segue from an engineer to a manager to a high-level manager to an executive, everyday I ask myself the question: Is this something I should be doing? Is this something I should outsource, do myself? How deep into the weeds should I get, how high level should I stay?”
Moderator: “What really is the long term game plan for your company? Do you grow? Do you sell? Is there an exit point? How do you see the future?
Sheffield: “Well, let’s talk about the employees first. We’ve grown from two employees to now, where we’re at 90, and it’s all happened in five years. I’m putting so much work into HR, so much work into recruiting these people, and it’s very hard to let go of that. It’s part of your machine. It’s not been easy and we’ve gone from one rig to nine rigs and it’s taken time and now we have this machine running. Why let go of that machine? We’re making return on our money consistently. We just inherited the horizontal play that’s right underneath us and my wife would love to pass it to someone else! So our goal is to continue to grow, compete with the Diamondback guys and the Pioneers, Conchos… we’re all friendly here. It’s a great business to be in.”
Moderator: “I didn’t ask about IPOs, but that’s an option I guess eventually for two of you. What are the options you see out there?”
Hammond: “In the space that we operate in, the private equity funded space, there’s always an exit out there somewhere. Basically I would say to design from the get-go for an exit opportunity. Something that we’ve seen in the last two years is that space transitioning somewhat to where private equity companies would come in and take an acreage position, delineate with a few wells, create some value, and then pass the overall acreage risk on to a different buyer—to companies who are looking for acreage and looking for opportunities. One of the things that we see, is that that appetite has somewhat been sated throughout the Permian Basin and most of the companies that operate out here. They all have projects, they’re all drilling to the extent that their capital can provide. So one of the things we’re looking at is drilling more wells and having a longer-term outlook in staying in business longer. But I would tell you that our exit opportunities are asset-focused. I can see transitioning our assets to a different owner at some point in time. But we intend on our team staying together and continuing in other opportunities and cycling those through. Because we like doing what we’re doing. The public option? I’ve been in both and I know which one I enjoy more. [laughter] So I like where we’re at.”
Moderator: “Travis will tell us how much fun that public option is.”
Stice: “Let me just back up… and talk about… [the period] before we took the company public. We ran a parallel process which was not uncommon, which was to market the company in its entirety. So prior to the IPO we marketed the company. We didn’t get a number that we thought was representative of its true value and thank goodness, as it turns out, we took the company public and have been successful in the public arena since that time. But I can’t run a company and I don’t manage a company towards an exit point. So I’m not managing a company to get to a certain level or certain acreage position to flip or sell the company. Certainly at any given moment, I represent my shareholders, and at any given moment somebody could call and say “Here’s a number” and I’d have to evaluate that number and present it to my board [for their evaluation]… So that option is always there but it’s not something I manage the company towards. I manage the company on two things: execution and transparency. Transparency externally, at events like this, and internally. We manage it on low-cost operations and by building a company that way, regardless of what the future holds, we feel like we generate the best value for our shareholders.
I do think that the Permian Basin over the next period of time, I don’t know what it is—three months or three years?—you’re gonna see companies that have taken their company public. I do think there’s a consolidation effort or consolidation opportunity that presents itself by taking companies that are in the $2-2.5 million market cap size like Diamondback and adding 2 companies together where one plus one equals three. I think that addresses a couple of things. It addresses the capital efficiency, human resources issues that you’ve heard Kyle talk about. I think at the end of the day, the company that has executed the best on its capital plan is the company that’s gonna be the natural survivor and the natural consolidator.
But the other thing is that once a company has gone public, then your currency or stock price is equal and you know what your company is worth on any given day. I don’t know how many pure play, mid-size companies the Permian Basin can support but I do think that if you look down the road, there’s some consolidation opportunities out there.”
Concho’s Choices
C. William Giraud, senior vice president and chief commercial officer for Concho Resources, held center stage for some 20 minutes as he discussed his companies activities and strategies in the Permian.
Said Giraud: “It’s amazing what’s going on in the industry. You can pick up a Wall Street Journal and read about it. There was even an article today in the New York Times about Permian oil. That’s new and it’s exciting that it’s getting out into the public. If you look at where it’s coming from, it’s really coming out of three different bases in the U.S.: the Bakken, the Eagle Ford, and the Permian. I think the percentage growth rates in the Bakken and the Eagle Ford are higher but the Permian has grown from a much larger base. If you look at the history of the Permian oil production, it peaked out at somewhere around 2 million barrels/day in the ‘70s. Then it went on a low slow decline, troughing somewhere in the 2005, 2006 range. So that’s where this picks up. It got down to about 850,000 barrels/day and you can see [he references a chart] it has started to turn around… I think if you ask people today where we sit right now, they’ll tell you it’s somewhere in the 1.3 million per day [range]. The big question is, where does it go from here? I think it’s a more conservative estimate that we’re gonna get back to 2 million per day in the next four or five years…. But the punchline is, we’re going to add a million barrels per day here in the Permian in the next five years. That’s really exciting. Now we’re going to talk about quarterly rig count, starting at about 2011. If you remember in late ‘08 or early ‘09, Permian rig count was down in the hundreds, and then it started a pretty rapid climb back up and got up to 500 rigs in the second quarter of 2012. We’ve actually seen a decline since that time, but today almost half the rigs in the Permian are horizontal. That has huge implications on capital efficiency and production efficiency as well. One obvious question is, “Who’s doing all that work?” Concho is the leader in who’s drilled all these wells since 2009. If you’re paying attention to what public companies are talking about today in terms of the direction of the horizontal rig count, I would expect the list to change (on the chart) but I would not expect Concho’s position at the top to change.”
The Water Question
A panel was gathered for the purpose of addressing questions about water supply and water use. Panelists included Stanley Weiner with STW Resources; James Welch with Water Solutions for Halliburton; and Brent Mulliniks, President of AES Water Solutions.
Weiner: “Our main goal is to preserve the fresh water reserves we’ve got out there in West Texas. The size of the systems that we can do [are these]: our regular size would be about 3700 barrels/day; if you want 7200 barrels/day we put two trailers in tandem. We’re making proposals right now for 20,000 barrel systems which would be five to six of our trailers and we’re doing them as low as 1,500 barrels/day for New Mexico… We’ve got several business models: we’ll sell you equipment outright if you want to set up your own water department yourself; we’ll also purchase the equipment upfront. We’ll design, build on, and operate it. We’ll process your water on a per barrel basis… If we don’t meet your specs, you won’t pay for the service. We’ll also partner with you. We own part of the technology, we’ll operate it for you, we staffed for that and that’s what we do. We’re setting up a facility right now where you can bring your produced water to it, whether you pipe it to us or you truck it to us. You can pay us a disposal fee for getting rid of it for you. What we’ll do is clean it up and put it back on the market and sell it at a fresh water station. We also just installed a 700,000 gallon/day system at the golf club here in Midland. That’s about 16 to 17,000 barrels/day, and we’re cleaning up Santa Rosa water. Santa Rosa is a brackish aquifer. I think the count right now is about 8 billion barrels of produced water per year in the state of Texas. We introduced evaporation covers to the oil and gas market out here about two-and-a-half years ago. On a 400×400 frac pond, you’ll lose 3,000-plus barrels/day to evaporation, so we’re putting those [covers] in all over West Texas and getting excellent results.”
Welch: “The year 2012 was kind of a kick off year for Halliburton. We introduced our H2O Forward process and our goal is to condition produced water flowback for reuse and recycle. We find the justification in our process by eliminating the transfer of water, the water hauling. Our idea is to launch mobile systems and treat the water in place. When we condition the water, our objective is to put the least amount of energy in it. We’ve been able to formulate fluid systems using 100 percent produced water at 280,000 TDS. It’s been a good start for us but it is a process.”
Mulliniks: “AES is a full fledged water management company. The key system here is [that] water runs the oil and gas industry. We’re seeing bigger fracs, we’re seeing more developments in these basins. So we’re looking at the resource of the water. We store the water, we actually water transfer through pipe and poly flat hose. We handle the flowback side of it, the recycling side of it, and water mediation. We recycle the water in what we call the cradle-to-grave situation. What we’re seeing in the industry is the move towards using more produced and more frac’d flowback water. We think that’s a must because we’re water sourcing in these basins. As these basins develop bigger fracs, [they’re] looking for the water to use to frac these wells. We also focus on the quality of the water. You’d be really surprised at the amount of suspended solids we get out of the flowback water, and produced water is unbelievable… We are looking at trying to get larger volumes on a portable system up to the 20-30,000 barrel type range per day—one that meets the frac industry’s demand. You look at some of these fracs who are frac’ing 100,000 to 150,000—now upwards of 200,000—barrels per frac per well and in the Basin we’re frac’ing somewhere around 400 wells per month. So where is all this water coming from? We need to look at quality of water and the volume that the industry really needs.”
Moderator: “Can a small operator can afford to recycle?”
Welch: “When we look at cost, we feel like the justification process is offset by the logistics and water management. When you have to source water from a location and move it by trucks and pay by the hour, there’s a lot of cost that accumulates into that. If you can keep that water in site and recondition it for its purpose, that’s where your saving and your justification comes from. Whenever we’re doing that analysis and we’re looking at opportunities, we want to make sure that we draw those whole system costs out. I think one of the largest challenges we have is in the storing of water. Either the flowback or the treated produced water. To that end, Texas Railroad Commission gave us some opportunities where we can now commingle water. If you’re a certified recipient of water permitted by the state you can accept the liability of that water. So the operator is relieved from the cradle-to-grave liability that has been a historic liability for operators in water management. So if you’re a small operator, this gives rise to commercial entities that accept the liability for receiving that water and can process this water and deliver a treated product back to you.”
Then there’s this, on the Permian being “all the rage for investors right now on Wall Street.” This is from speaker Mike Kelly, VP and Senior EMP Analyst at Global Hunter Securities:
“We break up the Permian into three main areas: the Delaware Basin to the west, the Central [Platform] which is central, and the Midland Basin to the east. Most of the activity from the horizontal perspective is in the Delaware Basin and the Midland. That’s really a function of both the Delaware and the Midland being deeper than the Central Basin Platform. It’s more a perspective from horizontal resource plays—deeper, higher pressure, higher temperature, a little bit more thermal maturity—and that’s where the horizontal unconventional activity is really focused. The Midland is broken up into four areas here: the Wolfcamp to the south and we kind of segregate off the Wolfcamp as we go a little bit further north into the Central, we call that the Northern Wolfcamp Area. And the Cline is to the east. To characterize one of these areas as the Wolfcamp, though, really doesn’t do justice as to what is going on in this area. The critical factor to keep these stocks going in our opinion as analysts is the delineation of multiple zones here. We don’t just have one Wolfcamp formation being targeted out here. This [chart he is referencing] is provided by Pioneer, and they see up to four different distinct Wolfcamp zones. Multi-zone potential really does act as an acreage multiplier. Multi-zone potential results in a tremendous amount of inventory if this does come to fruition. An acreage of 87,000 acres is a good chunk of land, but nothing like Pioneer with 900,000 acres. But this 87,000 acres is said to have the potential for over 3,000 wells here. With that in perspective, they’re running a five-rig program and knocking out one well per month, per rig. So if that’s 60 wells per year that represents 50 years’ worth of inventory. That type of visibility is what Wall Street craves and loves and that’s why you see guys trading at all-time highs on both price bases and evaluation. There are three wells that look like they are million-barrels-plus potential and those are probably the best wells drills and played today. Eighty percent of horizontal production growth since 2005 has come from the Eagle Ford and the Bakken. We don’t think those two plays are going to be alone for long. In our estimates the most oil production in the next five years is going to come from the Permian. A total increase of 2.9 million barrels per day.”
Answering the question of “What drives asset prices today?” Bruce Cox, managing director of the Energy Group for Credit Swuisse Securities (USA) LLC, had this to say:
Cox: “Why do the vast majority of people out there, very smart people that have money and people that want to make investments in real companies, why do they want to be in the Permian? I am tackling that from two aspects, one being the buy-side: people that are investing directly in the public companies, taking equity positions in companies, or backing management or portfolio of management teams as well as the analysts. What do the analysts say about the Permian? Also from the perspective of how that trickles down into a lot of the private deals and private activity that goes on within the Permian. I think generally both the buy-side and research analysts say it is a favored basin. While everybody’s looking, I think there’s going to be a lot of capital chase in these types of opportunities. From an analyst standpoint, they bought into the opportunity and economics that goes along with it. But most importantly, they don’t actually view the Permian as having the best economics. They can go to portions of the Eagle Ford, the Marcellus, and other areas and actually throw off better and higher yielding economics from a well standpoint. But you can’t find a place that’s got the size and the opportunities of the Permian. The amount of oil and gases that come out of the Permian, the amount of capital that’s going to be required to develop that and bring that to bear, is going to be very impactful. The Midland horizontal, Delaware horizontal, and Permian vertical combined are expected to generate 1.8 million barrels of production growth into 2018. The crazy thing about this is that we’re still early. Every time I see these reports, every six months, I see them getting bigger and bigger.”
The last speaker of the day—and there were several more than we’ve cited here—was Kristen Holmquist, director of NGL analytics at Ponderosa Advisors LLC. She spoke on “Midstream Challenges: Rail, Pipe, or Truck?”
Said Holmquist: “The production of crude oil has dramatically increased in the past two years. The question that we’re currently researching is ‘Will there be a market inflection point for crude oil?’ ‘Will we see a point where supply of crude oil starts to exceed demand of crude oil, and that the growth rate of crude oil production will have to slow down as a result?’ So this is something that we just started doing analytics on, so I’m going to present the broad argument in favor of the fact that there will be the inflection point for crude oil as we move forward. What will happen as we see crude oil supply continue to increase is that demand will increase. The easiest demand is the demand that can get filled in the quickest amount of time and that costs the least amount of money. So it’s relatively easy to take crude oil from parts of the country such as the Permian and get it to the U.S. Gulf Coast. That’s a relatively low investment. When we go all the way to what I consider the hardest, let’s just go with new refineries. New refineries not only are hard to get approved, they’re hard to get permits for, and they’re also very expensive to build and they take a long time. I have exports as the hardest because currently there’s a federal law banning exports of crude oil so it takes a law being passed in Congress, who can’t even seem to run the government on a daily basis. In my opinion this is actually an extremely difficult thing—just as difficult if not more so than exporting natural gas, just for different reasons. So if we look at the potential demand, we can see that right now Pad 3 imports about 3.5 million barrels per day of crude oil and exports have started to take care of some of the over-supply situation in the market.”