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Pain in the Permian

West Texas is the beating heart of US oil. Can it survive the price bust?

The convoys of 18-wheelers ferrying equipment across the vast terrain easily outnumber all other vehicles on the road. They’ve long since overwhelmed a highway that was built for people passing through this desolate stretch of West Texas, now servicing one of the biggest oilfields in the world. Construction crews are laying down new tarmac as quickly as they can, but it’s not fast enough. Racing from oilfield to oilfield, horns blaring, the big rigs make navigating the road a sometimes-harrowing adventure for sedans like mine. And the dust: kicked up by the bustle, it coats everything.

If this is your first impression of the place, you’d think business is still booming in the Permian shale, the beating heart of the Texan tight oil industry. Along this stretch of Interstate 20 between Midland and Odessa in West Texas – the main artery running through the Permian – evidence of the bonanza is ubiquitous. Highway road signs won’t dispel your ideas about West Texas: this is the country of God – “Repent”, one of the billboards implores – of high-school football and, of course, of oil.

Pumpjacks silently nod up and down as far as the eye can see, sucking crude out of the shrub-covered Texan desert. Look more closely, though, and it doesn’t take long to see that the brutal oil-price collapse is inflicting serious pain in American oil country

Nearly every big-name oilfield-service provider has set up shop here, along with countless mom-and-pop outfitters. Some, like the trucking company Swaggin’ Wagon and the shale specialist Performance Drilling, are hiring. The Petroleum Museum – a shrine to the generations of oilmen that have shaped this region – is putting the finishing touches on an $18m upgrade. Pumpjacks silently nod up and down as far as the eye can see, sucking crude out of the shrub-covered Texan desert. 

But look more closely and it doesn’t take long to see that the brutal oil-price collapse is inflicting serious pain in American oil country. Try Helmerich and Payne’s storage yard, a parking lot for rigs: for every rig that leaves for the oilfield, many more are returning, swelling the space. At least three dozen rigs lay idle during my recent visit, a growing steel forest rising above I-20, reminding everyone that the boom times have ended. And you can’t avoid the billboards promising quick cash for distressed oil companies: “Sell us your wireline trucks & tools! Cash in 48 hours”.

The scrapper’s hammer

One place that is thriving is Terry Dickerson’s Machinery Auctioneers, in Odessa – more evidence of the region’s oil supply chain buckling under the twin pressures of low prices and falling investment. The company does bankruptcy auctions in West Texas for big rigs, hot-oil trucks, frack tanks and other bits of oilfield kit.

Its inventory is brimming. In 2014, it did $27m in sales. Last year, that figure rose to $48m and will almost certainly grow this year. The firm used to hold an auction every two months or so. It had three scheduled for March alone.

The downturn came late to the Permian, but it has come full force. During much of 2015, it looked as if the play might defy the laws of petroeconomics by continuing to ramp up production in the face of collapsing prices. Even as the rig count plunged and production in the Bakken and Eagle Ford went south, the Permian powered ahead, pulling in dollars and dealmakers. To this day, Permian acreage has lost little of its value, an example of remarkable resilience while deals have dried up elsewhere in the US.

Some hoped – and many others worried – that the Permian was a Marcellus redux. The US’ largest shale gas basin has kept pumping more and more natural gas at prices lower than anyone thought possible. The Permian looked like it had the potential to continue flooding the market, depressing the crude price in the same brutal way the Marcellus had flattened the US gas market.

“The fear factor is: are we seeing another Marcellus or Utica, where wells are producing the equivalent of 10,000 to 12,000 barrels a day?” says Pioneers Natural Resources’ chief executive Scott Sheffield. “We are not going to be producing 5,000- or 10,000-b/d wells in the Permian basin, it’s just not going to happen. And if we did, we are going to have $30-a-barrel oil for the next 10 to 20 years.” Sheffield should know. His company has spent big in the Permian in recent years and is now among the basin’s beefiest producers.

Part of the system

But that fear lingers around the world. From Caracas to Riyadh, rival producers assumed that low oil prices would force out the high-cost American upstarts, allowing more space for their own cheaper-to-extract oil. That was a central tenet of the Saudi-led Opec decision of 2014 to let the market plunge. The plan would only work if US tight oil producers – source of the bulk of global output growth in recent years – yielded in their stubborn battle to keep the pumps moving.

It has taken longer than Opec would have liked. But the sharp downturn in this West Texas oil frontier in early 2016 shows that even the mighty Permian is not immune to low oil prices. By 11 March, the number of rigs drilling for oil had fallen to 150, down by 50 in just three months, and down 75% from the 562-rig peak hit in October 2014. The Permian’s top producers are finally scaling back investment – though most of them did so only after cutting to the bone in other areas. Permian capital expenditure cuts in 2016 will be less than the 50% expected across the US, but investment will likely fall by at least a third unless oil prices recover soon. The US Energy Information Administration (EIA) says output has already flat lined. Petroleum Economist expects the Permian’s production to fall by around 30,000 b/d by the end of 2016 – a sharp reversal of annual growth in recent years of about 200,000 b/d.

The IEA says the shale industry would need six months to kick into high gear. But that underestimates the scale of it all. Capital has dried up and bankers will think twice before extending credit to shale drillers with severely damaged balance sheets

Its remarkable rise should have been no surprise, because the Permian has long been at the heart of America’s oil industry. It is vast, stretching through West Texas and into southeastern New Mexico. If a driller imagined his ideal play, this was it. The Permian is flat and sparsely populated; its climate is mostly mild; and the community and political institutions have risen up around the industry. Underground is a complex arrangement of oil-producing rock formations, some stacked one on top of the other, spread out over an area covering around 86,000 square miles, roughly the size of Ghana.

Permian production reached nearly 2m b/d in the 1970s, when the Arab oil embargo sent American drillers out to scour the US’ most prospective plays. Then came the collapse, and the Permian’s conventional fields faded into what looked suspiciously like old age. A revival seemed implausible. By the late 2000s, production had fallen to less than 1m b/d – much of it from ageing stripper wells producing less than 10 b/d.

Enter the age of horizontal drilling and fracking; techniques that supercharged the Permian. Drillers had long whispered excitedly about the Bone Spring, Wolfcamp, Spraberry and other tight oil formations in Texas’s westernmost counties. Suddenly, they had the means to crack them open. The drilling frenzy from 2009 to 2015 yielded spectacular results. Output from the Permian doubled to just over 2m b/d. It now accounts for around a fifth of total US oil production. Some consider it the second-largest oilfield in the world after Saudi Arabia’s supergiant Ghawar.

Executives at many of the Permian’s largest players remain long-term bulls on the play and argue that the industry has only started to scratch the surface of its tight oil potential. Drilling and completion costs fell by a third over the course of 2015, and they’re still dropping. EOG Resources reckons it can bring its Wolfcamp well costs down from $11.5m in 2014 to $6.8n this year. At the same time, well productivity is rising sharply. New-well production per rig has jumped from around 100 b/d in 2013 to more than 400 b/d now, according to the EIA. That makes the Permian one of the more attractive patches in an industry that is hurting.

Still, 2016 will be a year of retrenchment, not progress.

Even though costs have fallen, cash for drilling is getting scarce. So the Permian’s top operators are scaling back. Apache, one of the three biggest landholders in the play, with 3.2m acres, now has 10 rigs operating – by the summer it will reduce this to four. Apache will this year complete only a quarter of the number of wells it completed in 2015. Output, now 174,000 b/d, will start to fall off. “We are willing to let our Permian production decline until we are in a better investment environment,” the company’s chief executive John Christmann said in February.

Pioneer Natural Resources, which produces close to 117,000 b/d of liquids from the Permian, has put its mark on downtown Midland with a spiffy new $76m headquarters – a symbol of its go-big-or-go-home attitude to the play. The company is putting every chip it has on the Permian this year, cutting all of its drilling activity in the Eagle Ford to focus on better-performing acreage in West Texas.

Even so, it plans to pull six rigs out of its Spraberry and Wolfcamp operation, bringing the count down from 18 to 12 by the middle of the year. Unlike others, Pioneer reckons it will still increase its production in 2016.

Cimarex is one of the many smaller drillers being forced to rein in activity. It had six rigs running in the Permian in January and plans to reduce that to just two by June. The company expects to bring only 31 new wells online this year, down from 60 in 2015. Cimarex had no choice, says its boss Tom Jordon. “I recently heard a chief executive describe some advice that one of his board members had given him – ‘when the map doesn’t match the terrain, go with the terrain’. Here at Cimarex, we are going with the terrain,” Jorden told investors recently. “Although we have the inventory to justify the higher activity level even at current prices, we have decided to slow down and preserve our cash-on-hand. Production growth will have to take a backseat to flexibility and balance-sheet preservation.”

Looking to the future

That preservation mindset is common across the Permian. From the richest drillers to the one-man-and-his-truck hauling outfits, everyone at this point is just looking to make it to the other side of the downturn.

When that recovery does come – no one dares say “if” – the Permian will be ready to pounce. Anyone looking for the first green shoots of new US output growth will find them in the hardscrabble West Texas terrain. Permian wells are among the US’ most profitable shale wells and vast tracts of land have yet to be developed. If the Saudis or others want to find out how quickly a price rise rejuvenates American drillers, they should head to Midland.

Chevron, which has amassed a huge 2m-acre position in the Permian, could be leading the charge. The Permian is now at the centre of the company’s international tight oil strategy, which is drawing investment away from the multi-billion-dollar megaprojects that have dominated the supermajor’s portfolio for years.

Chevron says it has already identified 4,000 wells it could profitably drill in the Permian at an oil price of less than $50/b, though few of those wells are profitable with oil in the mid-$30s. That figure rises to 5,500 at an oil price of less than $60/b. By 2020, the company says its Permian shale and tight output could rise from 125,000 barrels of oil equivalent a day to between 250,000 and 350,000 boe/d. “By the middle of the next decade you could see 20%, 25% of our production in the short-cycle shale and tight activity,” John Watson, Chevron’s chief executive, said at the company’s analyst day in March. Excited talk of the Permian dominated proceedings.

Even with just small price rises, other companies see plenty of opportunity. Occidental Petroleum, the Permian’s largest producer thanks to its huge conventional enhanced-oil-recovery output, sees drilling – and thus wells – getting cheaper. The company has a rough sliding-scale view of the patch. At $40/b for WTI, Oxy sees few profitable prospects. But give it $50/b and nearly 1,200 of the 8,500 drilling locations it has identified would return handsomely. At $60/b, it’s 3,400. Thanks to falling costs, that’s 700 more wells than last year.

Concho Resources, a top-three Permian producer pumping about 95,000 b/d of oil, says that at today’s costs 5,400 of its 18,000 potential drilling locations generate more than a 20% rate of return at $40/b.

Those kinds of numbers will keep rival global producers up at night. But pinning down a price at which the Permian would roar back to life is difficult.

The point at which a well is profitable to drill is constantly changing, determined by service costs and improvements in the yield from each well drilled, among other factors. For instance, if prices shot back to $60/b, the scramble to get rigs and crews back into the field would also send service prices higher again. Cost inflation would quickly return to the shale patch.

Taken together, the data suggest that oil prices have to rise out of the $30s to see the Permian recover, but not by much. Crude prices around $45/b would likely see roughly flat production. Put the market back in the $60s, though, and activity would go full-bore, and production sharply higher.

The time needed to remobilise is another question hanging over the Permian. The International Energy Agency says the shale industry would need six months to kick back into high gear.

But that underestimates the scale of it all. Capital has dried up and bankers will think twice before extending credit to shale drillers with severely damaged balance sheets. At the same time, thousands have been laid off and many companies down the supply chain have gone bust. At the peak of the Permian’s boom, in 2014, nearly 11,000 wells were drilled in the play. Rebuilding the capacity to repeat that would not happen quickly.

But the Permian has an advantage over tight oil plays – deep-pocketed majors, with the financial firepower to quickly pick up spending, are now rife in the field.

Along with Chevron, ExxonMobil, through its shale subsidiary XTO Resources, has aggressively snapped up Permian leases, building a leading land position it has only just started to develop. Even the Permian’s top independents have been more financially prudent than many of their competitors. Pioneer and Concho, for instance, have run some of the sector’s smartest hedging strategies – they would have the flexibility to respond to higher prices.

A weary warrior

For the West Texas oil capital of Midland, that recovery can’t come soon enough. The economic pain is deepening. The Permian Basin Petroleum Index – a set of indicators that aims to capture the economic health of the industry by measuring oil and gas prices, drilling permits, the rig count, production, employment and other figures – has fallen by around 40% since late 2014 and is now at Great Recession lows.

That reduction in economic activity has hit every part of the region’s economy. January retail sales in the Midland-Odessa area were down 22% from a year ago to $0.542bn. Auto sales – nothing says business is good in Texas like a new Ford F-150 – are down nearly 40%. The Midland International Airport, a hub for executive jets when companies were flush, has seen boardings fall more than 10%. Unemployment is still low by national standards at 4.8%, but that is up by nearly half from 3.1% in early 2015.

The evidence of that is everywhere to see. Central Midland retains much of the sheen added during the boom. But entire new neighbourhoods also sprouted up during the oil boom, all built to accommodate the influx of oil workers and others chasing a gusher of petrodollars. Many now have the echo of half-finished ghost towns.

I stayed in a quiet outpost off I-20 that consisted of a couple of hotels, a megaplex cinema and a small strip mall that included a shop selling roughneck gear and a Mexican restaurant with a fading ‘coming soon’ sign. The hotel – so new the smell of fresh paint still hung in the air – was half full and rooms were going for $75 a night, well below prices that just a couple of years ago rivaled those in any major city in the world.

Mine wasn’t the only one struggling. New hotels have sprung up all over but are now nowhere near capacity. Occupancy levels fell from 85% in 2014 to 65% in 2015, a boon to those still around to enjoy cut-rate fares. In the past three months of 2015, the region’s hotels brought in half what they did in 2014, according to the Midland Development Corporation. Trailer-parks and man-camps, a mainstay of temporary accommodation for stretched boomtowns, have plenty of spare space too, emptied of the thousands that have been laid off and will be off looking for work elsewhere.

Midland and other cities around the Permian have lived, died, and lived again along with the oil price for close to 100 years. So this isn’t the first experience of boom and its faithful follower, bust. But the sheer force of the turnaround, and depth of the downturn, have been jarring even for this hardened region.

Given the strength of the region’s tight oil potential, the Permian will emerge from this one too – maybe with yet another added sheen of resilience. For now, though, such optimism is a lot scarcer than the oil.

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