Tight oil's growth potential - fracturing conventional wisdom?
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Not long ago, growth was the big thing. Listed oil and gas companies set aggressive production targets to woo investors, though few succeeded in hitting them. Value then usurped volume as the industry's Holy Grail. This results season suggests growth targets are making a come back.
Pioneer has set a production target that fractures conventional wisdom. The US tight oil specialist estimates that its oil and gas volumes will increase four-fold to 1 million boe/d in the 10 years to 2026. Implicit is a five-fold jump in tight oil volumes (18% CAGR) to over 0.6 million b/d.
The plan is supported by the type of data that tight oil observers are getting used to – rapid progress on all fronts. On financing – one of the strongest balance sheets in the sector, testament to Pioneer's financial strategy to monetise assets and tap equity markets. On high-grading – the portfolio is focused on the Spraberry and Wolfcamp zones of the Midland Basin, top Permian positions. And stunning progress on productivity and efficiency – Pioneer has cut drilling costs by 25% from US$1,100/ft to US$800/ft in two years.
The real eye-opener is the exuberant confidence in the resource and how to exploit it.
The company has identified 20,000 risked locations, providing 'an endless inventory of very high quality wells'. Drilling and fracking techniques are evolving exponentially. Without getting too technical, Version 3.0 drilling designs are what will get Pioneer to its target: twice as much proppant and fracking fluid as v1.0 two years ago; fracking density twice as concentrated and stage spacing – gaps between fracks – twice as frequent. Basically more wells, and each v3.0 well will pulverise the rock near to the well bore to increase the oil flow.
The stock market is lapping it up, adding US$3bn to Pioneer's market value in the last week. But industry scepticism will abound, notably among the tight oil 'have nots'. Some IOCs rooted in conventional portfolios perceive US tight oil as a 'mystery bag' – Australian slang for a sausage in which the quality (and quantity) of meat is uncertain. And it's a fair shout for the Permian, a basin with huge in-place resources but still in its infancy in terms of tight oil development. Some may wonder at the coincidence of such a bold pronouncement so soon into a new US energy-friendly Administration.
There are numerous risks to the target.
On the oil price, Pioneer has assumed US$50-55/bbl (real) through 2026. On costs, the assumption is 10-15% inflation in 2017 (we would concur), then margin maintained thereafter. But ramping up intensity in a single, concentrated area will test the service sector's capacity. Observers will also question the effectiveness of v3.0 techniques once the focus inevitably shifts out of the sweetest spots.
The counter will be 'by then there'll be v4.0'. Tight oil operators have form in overcoming technical and cost challenges. And shale gas operators confounded the doubters when they stepped up the pace and outperformed five or six years ago.
Pioneer has thrown down the gauntlet to its fellow Permian tight oil 'haves'. Chevron is the biggest producer (just ahead of Pioneer), but EOG, Anadarko, ConocoPhillips, Devon and ExxonMobil all own sizeable positions, whilst Shell is a dark horse.
We too are bullish on tight oil's prospects, though not quite as much as Pioneer.
Our Macro Oils team forecasts tight oil production rising from the Q4 2016 low of 4.1 million b/d to 8.7 million b/d by 2026. The Permian accounts for 2.3 million b/d or 50% of the growth.
Simply assuming Pioneer's growth rates for the entire basin, Permian production would increase by 5 million b/d and tight oil in total would exceed 11 million b/d (assuming no upside for the Mid-Con, Eagle Ford and Bakken).
It may all prove to be a bluff, and Pioneer, like many before, fails to deliver. On the other hand, if they do get there and others follow, another two to three million b/d of oil supply early next decade would have profound implications.
For oil prices this may mean that the supply crunch anticipated by many would get pushed out further still. And for conventional players, who would come under even greater pressure to reduce break evens on the new projects they need to compete with tight oil and sustain their business into the next decade. Perhaps they might also rue their lack of exposure to the rampant Permian.