By Alison Sider
Investors helped turn West Texas' Permian Basin into America's
fastest-growing oil field, but their confidence is cracking over
whether drillers can keep production rising.
Questions mounted last week after Pioneer Natural Resources Co.
reported that its Permian wells are producing more gas and natural
gas liquids such as propane than expected. That worried investors,
who care a lot more about oil.
Shares of Pioneer and other Permian producers tumbled as a
result. Pioneer ended the week down 16%, while Parsley Energy Inc.
and Concho Resources Inc. both declined more than 9% over that
stretch.
The main issue for Wall Street is whether the Permian, where
nearly half the rigs drilling for oil in the U.S. are located, will
continue apace or will fall short of the expectations of investors,
who in recent years crowded into companies drilling there.
"The Permian is going to have some growing pains," Scott Hanold,
an analyst at RBC Capital Markets, said this week.
The concerns aren't universal, and some say they are overblown.
"I don't think anything has changed in the Permian. It's the lowest
cost, best basin to be in, with the best rock," said Bill Costello,
portfolio manager at investment firm Westwood Holdings Group. "If
people are going to give me the opportunity to buy more, I'm going
to buy more all day long."
Some Permian stocks have partly recovered since last week's
plunge. Cimarex Energy Co. was the S&P 500's biggest gainer
Wednesday, rising about 7.5% after it reported more oil production
than expected.
But the selloff, and analyst notes that followed, reveal that
some investors are questioning whether they were overly confident
in the resilience of the Permian, and perhaps overpaid for it.
Most wells produce natural gas as a byproduct alongside oil, and
that gas output tends to rise over time. That is because as a
reservoir is depleted, its pressure drops and gas vapors separate
from liquid -- reaching the "bubble point" at which natural-gas
production accelerates.
Pioneer last week indicated that some of its Permian wells are
reaching this point sooner than it anticipated.
"Why everyone's so concerned is that it could mean at some point
in the future, that oil declines are steeper than what company and
the investment community thought they would be," said Ben Shattuck,
research director at consultancy Wood Mackenzie. "It raised that
big question mark."
John Groton, director of equity research at Thrivent Financial,
which owns shares of Pioneer, said the issues were a hiccup, "not a
harbinger of the end for the Permian." Still, he said, "It never
goes as smoothly as people think it will." He added: "There were a
lot more people who had priced Pioneer for perfection than I had
realized."
Some skeptics have long suspected that the ultimate
recoverability rates of oil from tightly packed U.S. shale rocks
might be lower than many drillers were forecasting, and that the
process to extract it would ultimately be too expensive a
proposition.
U.S. shale producers use a process known as fracking -- blasting
water and sand through rock to unleash vast quantities of oil and
natural gas. Because of the unusual geology in the Permian, which
consists of stacked layers of oil-bearing rock that can be tapped
simultaneously from a single site, Wall Street widely believed
these companies could turn a profit even at lower oil prices.
Shares of companies in the Permian held up better than their peers
while oil prices plummeted starting in 2014.
Quarter after quarter, producers demonstrated that they could
break even there at lower and lower oil prices as they learned to
extract more oil from each well. They drilled sideways through the
rock layers -- in some cases as long as 2 miles.
Their success meant they were able to tap investors for more
cash when they needed it. Companies that weren't in the Permian
wanted to be there, and were willing to pay up for land.
Producers in the region have raised $27.5 billion since the
start of 2015 by selling new shares -- 44% of the cash raised that
way by North American oil-and-gas companies since then.
The premium for shares of Permian producers compared with oil
companies that focus on other regions shrank by 14% after Pioneer
reported its results, Morgan Stanley analysts said Monday.
"Investors didn't receive the beat-and-raise quarter that they
saw in" the first quarter, Cowen analysts wrote in a note this
week, describing the selloff as a "Permian Panic: When 'safe
stocks' fail."
Even before second-quarter results, there were signs that
investors' enthusiasm was ebbing. When QEP Resources Inc. last
month announced a deal to spend $732 million to buy drilling land
in Martin County, Texas, its shares fell.
Also last month, someone who described himself as a former
Pioneer petrophysicist raised alarms in a post on LinkedIn,
predicting that "ALL oil shale wells...will die a disappointing and
gassy death."
Pioneer didn't respond to requests for comment on the post.
It is up for debate what Pioneer's announcement last week that
its Permian wells were producing more gas means for future oil
production.
Scott Rees, chief executive of Netherland, Sewell &
Associates, Inc., an independent engineering consulting firm that
has Pioneer as a client, said that when production reaches this
point, it doesn't mean that oil production is about to drop
off.
So far, Pioneer said the oil output from its wells isn't
dropping -- it is on track with what its engineers predicted.
Analysts and some investors say all that gas is basically a free
byproduct that will make the wells more valuable.
Parsley Chief Executive Bryan Sheffield echoed that point when
he said last week that the company's wells were still producing as
much oil as expected.
"Oil volumes are in-line with expectations, so the extra gas is
truly additive."
Pioneer Chief Executive Tim Dove told analysts that oil was
"absolutely meeting our expectations on a per-well basis, and
adding more gas and [natural gas liquids] to the mix is a positive
in terms of revenues and reserves without even affecting oil."
"This is a good thing," he said.
The explanation didn't seem to help.
"While it is only one day of trading, the underperformance of
high-quality Permian stocks has left some [portfolio managers]
asking about where to reallocate capital within the sector,"
Goldman Sachs analysts wrote last week as share prices tumbled.
--Ryan Dezember contributed to this article.
Write to Alison Sider at alison.sider@wsj.com
(END) Dow Jones Newswires
August 09, 2017 20:57 ET (00:57 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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