Five reasons we might have hit peak Permania
Chairman, Chief Analyst and author of The Edge
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The US’s premier tight oil play has been the beating heart of industry activity these last few years. Soaring rig numbers, prolific production growth and the gravitational pull of a black hole when it comes to M&A. US L48 tight oil accounted for one-third of global upstream M&A spend in the last three years, with the Permian attracting US$2 out of every US$3 of that. But have we now passed peak Permania? Simon Flowers investigates.
A flurry of deals in the last month or two suggests the wind may be shifting. Three takeovers amounting to US$13.7 billion bear the hallmarks of tight oil consolidation – synergies, economies of scale and equity finance. What’s different is that the target assets aren’t Permian. Chesapeake Energy/Wildhorse Resource Development, Denbury Resources/Penn Virginia and Encana/Newfield Exploration were focused on the Eagle Ford and SCOOP/STACK plays.
Is it a blip or a sign of appetites changing? Greig Aitken, Head of M&A Analysis, and Robert Clarke, Director, US L48 Research, shared their thoughts on the five motives that drove the deals.
1. Pre-drill inventory is back in the game
The Eagle Ford is much more mature than the Permian, development having started a few years earlier. Operators have drilled up and exhausted many of the sweet spots. Wells in the tougher rocks have higher breakevens than the best of the Permian and didn’t work so well during the downturn. The recovery in oil price this year has brought much of the pre-drill inventory back into the money.
Any upside to our US tight oil forecasts is most likely to come from the Permian. ... But that doesn’t mean to say it’s the only opportunity to build a tight oil business or the only place to do the best-value deals.
2. Eagle Ford is positioned for maximum value
Midland, Texas – the hub at the heart of the Permian Basin – is 400 miles from the coast. Growth in production of tight oil and the associated gas has not only wildly beaten expectations in the last year but exceeded available takeaway capacity, too. The pipeline infrastructure hasn’t kept up and crude differentials have widened – some operators have to sell at a sizeable discount. More capacity is being built out but, in the meantime, operators have been forced to slow down and defer investment. The Eagle Ford, situated close to the Gulf Coast, has no such constraints. Operators have ready access to the market and can monetise for full value what they produce, oil or gas.
3. Diversification and managing risk
For Encana, buying Newfield gives it a big position in the SCOOP/STACK to go with its prior ‘dual lynchpins’ of the Permian and Montney. Risk is spread across three core positions broadly equal in scale, and there’s more optionality for capital allocation. Denbury, a specialist in conventional EOR, is buying into the Eagle Ford for a more diverse set of drilling opportunities. It could bring to bear its EOR expertise in the longer run. Chesapeake’s acquisition adds higher risk growth acreage to its existing mature Eagle Ford position.
4. Getting the right assets in the right hands
The Permian is a still-youthful, giant resource play increasingly the playground of Big Oil. Scale and access to capital are key ingredients to maximising production and returns. The Eagle Ford, SCOOP/STACK and the Bakken are logistically more challenging plays in which to achieve scale. Even so, the more modest growth potential can be meaningful for some independents and smaller players.
5. A question of value
The opportunity set in the Permian is in a different league to other tight oil plays and it’s difficult to compare the value propositions. But what’s evident is that intensifying competition to access the Permian in the last three years has pushed prices up dramatically, asset inflation that’s not been apparent elsewhere. The perception is that there’s value to be had away from the heat.
Permania isn't over
It’s still the hottest growth play on the planet, with production set to jump by at least 2 million b/d through 2027 more than double the rate of the other tight oil plays combined. Any upside to our US tight oil forecasts is most likely to come from the Permian. There will be more Permian consolidation as operators build scale. But that doesn’t mean to say it’s the only opportunity to build a tight oil business or the only place to do the best-value deals.