Navigating the frenzy: 4 ways the Permian is leading US upstream M&A

April 2017 | Yasmine Zhu

The Permian took the lead in US upstream M&A in 2016, with deals amounting to fivefold the sum of those in the Eagle Ford and Bakken. A closer comparison between these three plays shows that the rise of the Permian is not coincidental. The Permian has experienced huge improvements in well productivity and benefited from low crude price differentials. Its fragmented leasing landscape enables operators to capture operational synergies through M&A deals. Finally, its large undeveloped reserves have positioned operators for sustainable growth in a “lower for longer” environment.

After a quiet year in 2015, M&A for US upstream has finally started gaining momentum. With WTI price between USD45 and USD55 for 66 out of the 82 days in Q4 2016, operators have been able to hedge their production for the next 6–12 months. The expectation of a stable oil price environment has also given companies confidence that their asset purchase will be a sound long-term investment. In response, 2016 saw a record 385 deals worth a total of USD69 billion—more than double the USD32 billion in 285 deals a year earlier. If we look at the allocation of deals between key light tight oil (LTO) basins, it’s clear that the focus has shifted from the Bakken and Eagle Ford to the Permian, particularly to the Delaware sub-basin. What transformed the Permian into this white-hot market?

Exhibit 1: The rise of the Permian in US upstream M&A

Source: PLS

To answer this question, we compared the Permian with the other two largest LTO basins in the US—the Bakken and Eagle Ford. The Permian has demonstrated its upside both in productivity and cost savings, making it one of the top choices for companies wanting to gain sustainable growth potential.

1.) Technical improvements unleash Permian well productivity potential

While more mature plays like the Bakken and Eagle Ford have established preferred well design practices, the Permian is relatively open for testing different well designs and techniques that may maximize productivity. Average well lateral length in the Permian has grown by 8–13% p.a., while the Bakken and Eagle Ford have seen marginal lateral growth of 0–5% in the last three years. The Permian is also the leader in testing high-density fracs; average Delaware wells more than doubled their proppant loading per lateral since 2013, compared to a less-than-50% increase in other LTO basins. Those technical improvements reflect a better understanding of the Permian formation as operators try to access resources, and we believe it will lead to permanent productivity gains. From 2014 to 2016, we have seen 15–25% y-o-y initial production growth in the Permian’s core areas, compared to zero to single-digit growth in the Eagle Ford and Bakken.

2.) Abundant infrastructure and proximity to markets ensure the Permian maintains a low price differential

The Permian used to be constrained by pipeline takeaway capacity, which caused local crude price to fall below similar crudes priced in Cushing, OK, by USD4–20/bbl in 2014. But with a rapid buildout of midstream infrastructure in recent years, the Permian has gained direct access to downstream markets on the Gulf Coast and in Cushing. Operators can capitalize on a higher wellhead price with almost zero price differentials to WTI. In comparison, Bakken crude is sold at a constant discount of USD5–10/bbl because of its high transportation cost.

3.) As a less concentrated basin, the Permian offers greater opportunities to capture operational synergies

As a basin with a long history of conventional production, the Permian has more legacy landowners and mid- to small-size operators than other unconventional plays. In 2014, Top 10 operators only represented 55% of total basin production, compared to 74% and 69% in the Eagle Ford and Bakken. This fragmented competitive landscape has encouraged a lot of in-basin deals. For example, Concho spent around USD2 billion last year through several deals to acquire acreage—all adjacent to the firm’s existing leasehold. In another case, Noble Energy acquired Clayton Williams Energy—not only for adjacent acreage position, but also oil, gas, and produced water gathering infrastructure, which can be better exploited with scale. By enhancing their footprint, operators have been able to reduce cost, capture operational synergies, and simplify supply chains. Indeed, 19 out of the top 20 M&A land deals in the Permian in 2016 are between those in-basin asset owners, with the only exception being the new entrant PDC Energy.

In Exhibit 2, we traced the acreage sizes that are economic under the prevailing price from 2014 to 2016, and how key factors like oil price, differentials, productivity, and cost have impacted the economic acreage. In the Permian, with help from productivity improvements and well capex reduction, the economic acreage bounced back to 66% of the pre-crash level in 2014. By contrast, the Eagle Ford and Bakken were hit hard by the oil price drop and could only recover 20-40% of what they had in 2014.

Exhibit 2: The Permian's economic acreage recovers to 66% of its pre-crash level

Source: Energy Insights NASM Model

4.) Besides vast acreage, the Permian enjoys bulk reserves that have yet to be developed

The Permian is famous for its stacked plays. The thickness of the Permian’s stacked formations is believed to be 4 to 6 times the thickness found in the Eagle Ford or Bakken, indicating substantial reserve size. More importantly, the basin is quite young in its unconventional drilling activities. The cumulative unconventional crude production to date in the Permian is just half that of either the Bakken or Eagle Ford. With plans in the works for tighter well spacing, there are considerable top-tier reserve sizes yet to be tapped in the Permian.

Exhibit 3 shows a continuum of breakeven prices of various light tight oil assets in the Permian, Bakken, and Eagle Ford. A third of Permian resources take the lead with breakeven prices lower than 2016’s average WTI price. Another third of the assets could be economic under a USD55/bbl price. In sum, the undeveloped oil reserve size that is economic under USD55/bbl is double the size of the reserves that would remain economic under the same conditions in the Bakken and Eagle Ford combined.

Exhibit 3: Permian undeveloped reserves on core acreage double that of Bakken and Eagle Ford

Source: Energy Insights NASM Model

In addition, an easing capital market facilitates land deal momentum in the Permian. Many of the 2016 transactions in the Permian are backed by private equities or funded by equity and debt markets. Among the top nine upstream equity offerings of USD1 billion or more in 2016, six of them were raised by operators in the Permian. By contrast, the Eagle Ford and Bakken have limited support from the capital market.

Given the fact that more than 700,000 net acres of land were traded in the Permian in 2016, the war for the best acreage will only become more competitive. Acreage price in the Permian is sky-rocketing, from less than USD10,000/acre at the beginning of 2016 to an average of USD30,000–50,000/acre by the end of 2016. How much return on investment these deals could provide in the long run will depend not only on oil price but more importantly on companies’ development plans. On the production side, besides tighter spacing and better well design, it is important to use bolt-on leases to support longer laterals. For example, with a consolidated lease after the acquisition of Devon assets, Pioneer was able to extend to 10,000-ft laterals in Midland with promising results. On the cost side, as more rigs are coming back to the Permian, basin players should be prepared for a rise in field services costs. Vertical integration is one strategy to consider. For instance, Pioneer has its own pressure pumping fleets, as well as its own sand mines.

Looking forward to 2017, upstream M&A shows no signs of cooling down. Starting with ExxonMobil’s billion-dollar transaction, M&A in the Permian has already reached USD10 billion in January alone. However, land acquisition is just the beginning. Maximizing operational gains will be the key to proving the Permian assets’ cost-effectiveness.


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About the author

Yasmine Zhu is an analyst in McKinsey Energy Insights' Calgary office.

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