Priced out of the Permian
M&A has slowed in the US' hottest shale basin as investors look elsewhere for cheaper growth opportunities
Permania in the mergers and acquisitions market is finally cooling off. The world's fastest growing oilfield was also the hottest market for mergers and acquisitions, racking up more than 200 deals worth around $50bn over the past two years as companies jockeyed for prime positions in the play.
The frenzy of M&A deals has reshaped the landscape in the Permian. ExxonMobil spent close to $6bn buying the Bass family's drilling rights to cement its position as one of the play's largest acreage holders in the single biggest Permian shale deal. But the surge in deals was fuelled mostly by smaller shale-focused independents like Concho Resources, QEP and others. Some were looking for a foothold they hoped would set them up for a decade or more of steady production growth. Others that already had their slice of the Permian were buying out their neighbours to block up larger holdings. This allowed them to drill longer lateral wells, which now often stretch for more than two miles and provide better returns.
But land values have soared even as oil has stayed relatively steady in the $50s. Recent deals in the centre of the red-hot Delaware section of the Permian have valued land at more than $50,000 an acre, far higher than similar sites were going for a few years ago. Even more marginal acreage is going for well over $30,000 an acre, up on any other shale area. This is less a bet on a higher oil price than it is on the Permian's rocks and the sector's ability to wrench further economic gains from the fracking process. Buyers argue the huge growth potential and wellhead breakeven costs of less than $40 a barrel justify the valuations, though there's widespread doubt about the profitability of these operations at today's oil price when the steep land acquisition costs are taken into account.
Still, the steep price tag, and the fact that many established Permian producers have moved on from grabbing land to a focus on development drilling, has put a chill on deal-making. In the third quarter of 2017, Permian deal values plunged to just $1.3bn, down 90% from the first quarter of the year. Deal activity remained anaemic in the fourth quarter, and is unlikely to pick up in 2018.
$50,000 per acre—Cost of buying land in the Permian
With the Permian land grab now largely played out, shale deal-makers are looking to new frontiers. Oklahoma's Scoop and Stack plays look to be the biggest beneficiary and should see more cash start to flow in as companies look for promising, and lower-cost, growth opportunities.
The Scoop and Stack, in particular, have seen a strong pick-up in deals as competition in the basin hots up. A $3.8bn tie-up between private-equity-backed Siler Run II, Alta Mesa and Kingfisher led the way in the second half of 2017, which included $4.2bn in total contracts in the third quarter alone. That deal valued core Stack land at around $15,000 an acre, a third of recent Permian deals.
Strong recent drilling results should see interest in the Scoop and Stack pick up. Continental Resources, Devon and other established players in the basin have rolled out longer lateral wells and bigger fracks, dramatically improving the economics and productivity of Scoop and Stack wells. All of a sudden, the Oklahoma shales are some of the more enticing in the country, especially at an entry point of $15,000 an acre.
And crucially for deal-makers, there's plenty of room to run. Wood Mackenzie, a consultancy, says around 1.5m acres of lightly drilled Stack acreage now generate returns at less than $50 a barrel. With the recent improvements in drilling economics, Wood Mackenzie lifted its short-term growth outlook dramatically. In 2016, it saw Scoop and Stack output jumping around 90% from around 0.55m barrels of oil equivalent a day in early 2016 to close to 1m boe/d by 2019. It has since upgraded that outlook and predicts production will top 1.65m boe/d in 2019.
Other basins are also seeing a pick-up as Permian cash goes elsewhere. The DJ Basin in Colorado has witnessed a string of accords recently, the largest of which was a $0.649bn transaction that saw Bill Barrett, an independent driller, snap up Fifth Creek Energy's acreage in the basin. SRC Energy bought out a chunk of Noble Energy's DJ Basin business for around $600m. Another $210m deal from DJ-focused PDCE means transactions in the area neared $2bn in the fourth quarter alone. Those deals have put DJ Basin acreage value roughly on a par with the Scoop and Stack at around $16,000 an acre, making it far more accessible than the Permian.