The Edge

US independents’ retrenchment to tight oil is paying off - will others follow?

Apache's new play in the Permian Basin announced last week is another feather in the cap for US unconventionals. It's the latest justification of retrenchment strategies back to the US for some independents, who may hold growth and cost advantages over international peers.

The Alpine High could be big, with in-place resources estimated at 3 billion barrels of oil and 75 tcf of gas; Apache has 100%. The play lies just south of the Wolfcamp and Bone Spring, the big Permian tight oil plays. Complex geology, dry gas weighting and lack of infrastructure have till now kept it in the sub-commercial bucket. Apache clearly thinks it can make money.

The Permian will be the driving force for US tight oil for the foreseeable future, with or without the Alpine High.

We forecast tight oil production will more than double from 3.9 million b/d in Q1 2017 (the cyclical low) to 8.7 million b/d by the mid-2020s. Most of the near 5 million b/d of growth is Permian – no other new play globally contributes as much to future oil supply.

The re-emergence of such bounty in unconventional oil and gas resources over the last decade forced a strategic rethink among the industry's leading companies. Domestic E&Ps hanging on for grim death as conventional US onshore plays entered terminal decline were in the right place at the right time. Companies like EOG (in the Eagle Ford and later Permian) and Pioneer (Permian) have made the most of the opportunity; each now has among the lowest cost and most attractive growth potential in tight oil.

For others, the strategic solution was less simple. Some US-based independents had diversified internationally for decades, elephant hunting in conventional frontiers or using niche skills such as mature asset exploitation. By the time of the fracking revolution, companies like Anadarko, Apache, ConocoPhillips, Hess, Marathon, Murphy, Noble and Occidental were really international E&Ps.

All owned legacy L48 acreage, but by 2011 more than two thirds of commercial reserves on average were outside the L48, based on Wood Mackenzie's estimates. In the US$100/bbl world, that didn't seem odd, since most of world's accessible yet-to-find resources were thought to be in deep and shallow water around the world. Despite successes, Wall Street always found international assets difficult to value.

All eight companies chose to retrench back to the US, allocating capital to the galloping growth rates of shale gas and tight oil. Portfolio weightings have since reversed – in 2016 almost two thirds of commercial reserves for the seven are L48.

The short investment cycle compared with offshore conventional projects and flexibility of spend, is another attraction. Wall Street's willingness to equity fund the better growth stories even through the downturn is proof of the wisdom of retrenchment strategies.

And for the 'haves' in tight oil there is plenty more growth and at relatively low cost. Half or 7 million b/d of the 13 million b/d of new oil supply globally we expect to be developed over the next ten years is from tight oil plays. These plays have an average NPV,10 breakeven cost of US$47/bbl. In contrast, under 4 million b/d is from conventional projects which have an average breakeven price of US$60-65/bbl plus. US tight oil has a big competitive advantage.

So where does that leave the 'have nots'? The Majors are very underweight unconventionals, with exceptions - ExxonMobil and Chevron, like their US independent cousins, have significant platforms which will attract an increasing proportion of spend. The rest are also-rans in tight oil.

The downturn should be an opportunity for the Majors and perhaps NOCs to move into tight oil. M&A activity has picked up in 2016, but it's the Independents so far that have capitalised on falling acquisition prices to bolster positions and capture potential value upside. The Majors have sat on the side-lines, sceptical as to the value proposition - certainly the factory process of tight oil drilling absorbs cash, and it can take years for positive cash generation.

The strategic focus for the 'have nots', including internationalising NOCs, must be to get new conventional projects lower down the cost curve, and there are signs that's happening. Even so, being absent from the biggest, low cost, growth resource theme of the next decade is bold to the point of risky.