American Oil and Gas Reporter - June 2017 - 81

Permian Economics Tightening Some
HOUSTON-Exploration, drilling and
production companies that acquired Permian Basin acreage in the red-hot landgrab market of 2016 now face the challenge of maintaining premium valuations
while meeting high-growth expectations
amid recovering service sector costs, concludes research by IHS Markit.
"The Permian is the hottest basin going
in 2017 because of its deep inventory of
profitable locations under a lower oil price
scenario," relates Sven Del Pozzo, CFA,
director of energy company and transaction
research at IHS Markit. Del Pozzo authored
the report, Permian E&Ps: Execution Risk
Looms in 2017; The Land Grab Has Taken
a Pause, Now Who Will Create Value?
"This profitability has driven many
companies to acquire acreage in the Permian land-grab, but now the pressure is
on for these companies to create value to
maintain premium valuations," Del Pozzo
considers. "Most of these acquisitions
were almost entirely equity financed at
notable premiums by companies that were
highly regarded because they were already
in the Permian, making seemingly expensive deals affordable without immediate dilution of shareholder value."
According to IHS, despite the Permian's

continued economic attractiveness, rising
service sector costs will raise average
capital expenditures more than 15 percent
a well during 2017. Costs will continue
to place upward pressure on break-even
costs averaging $5 a barrel in the Permian,
indicates Imre Kugler, senior consultant
at IHS Markit, and author of the analysis
titled Plays and Basins: Increasing Service
Costs Push on Break-evens.
"The economics for the Permian are
still impressive at $41 a barrel (weighted
average) for a $55 a barrel West Texas
Intermediate price projection, but costs
are rising, mostly for service sectorrelated costs of drilling and completion,
proppant, sand and a tightening rig market
as utilization rates increase," Kugler says.
"While Permian and Anadarko Basin
plays remain in the money, so to speak,
lofty acquisition values become more
difficult to pay off when the plays require
nearly $50 a barrel WTI to produce a 10
percent internal rate of return."
Many companies are able to offset
rising service sector costs with increased
productivity, particularly in the early life
Permian plays, while more mature plays
outside of the Permian have reached a
plateau, with economics primarily altered

by cost, Kugler relates. "Fortunately for
operators outside of the Permian, the lack
of infrastructure bottlenecks will place
less cost pressure on the Bakken, Wattenberg and Eagle Ford plays.
"Oil price stabilization is creating
greater confidence, and pumper calendars
are filling quickly," characterizes Thomas
Jacob, research consultant at IHS Markit.
"In the Permian, in particular, we see
significant expansion in drilling and completion activity. As a result, we at IHS
Markit estimate the play will increase its
proppant consumption from 20 percent
of the U.S. market in 2014, to 37 percent
of the market in 2017."
Additionally, Jacob says, an increase
in the number of wells fractured in 2017,
and higher assumptions regarding the
mass of fracturing sand in each well for
fourth-quarter 2016 and beyond have led
to an astounding 62 percent increase in
North American frac sand demand in
2017. "This year, mine-gate sand prices
are expected to increase by roughly 50
percent," he maintains. "In particular,
fine-grade sand prices are increasing most
significantly. The market share of finegrade sand increased from 60 percent in
2014, to 80 percent in 2017."
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JUNE 2017 81
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American Oil and Gas Reporter - June 2017

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