Why The Shift To Unconventionals In The Permian Will Help Oilfield Services Companies

The Permian basin in West Texas is the largest and one of the oldest oil producing regions in the United States. While exploration and production activity in the region has typically been centered on conventional hydrocarbon resources, oil companies have been ramping up exploration and production of  unconventional hydrocarbons in the Permian, driven by higher oil prices as well as opportunities to significantly boost production. In this note, we take a look at why the shift to unconventionals in the Permian could bode well for large oilfield services companies such as Halliburton (NYSE:HAL) and  Baker Hughes. (NYSE:BHI).

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Unconventional Exploration And Why It Is Attractive To Oilfield Services Companies

Unlike conventional hydrocarbon wells, which are drilled using rigs that are directed vertically, unconventional hydrocarbons lie in formations such as shales and require the more complicated and expensive technique of horizontal drilling. Unconventional wells also differ from traditional wells in terms of production. While hydrocarbons present in conventional wells move to the well head naturally or with the help of pumps, production from unconventional resources is more complex since the oil and gas is typically trapped inside pores of rock and need to be stimulated using techniques like hydraulic fracturing.  Hydraulic fracturing – or fracking – involves pumping a mixture of water, sand and other additives into the wells at high pressures to create cracks in the rock and free up the hydrocarbons.

These operations make it more expensive for oil and gas companies to produce from unconventional wells. For instance, the average shale well in the Permian is estimated to cost over $5 million to drill and complete; in comparison, conventional oil wells sometimes cost as little as $1 million. ^[1] An increasing shift to unconventionals and horizontal drilling should translate into significantly higher service intensity for oilfield services companies in the Permian and drive up demand for services such as fracking.

Why Are Operators Ramping Up On Shale Exploration In The Permian?

Oil companies in the United States have been increasing their focus on liquids over the last few years in light of the volatility in natural gas prices. And of late, surging oil prices have made accessing more expensive unconventional liquids reserves more viable. The Permian, being one of the oldest and most prolific oil producing regions in the United States, has been seeing a significant increase in unconventional drilling activity.  Horizontal drilling, which is typically a leading indicator of unconventional activity, has been on the rise. The Permian had around 504 active rigs, as of early March 2014, out of which around 265 rigs were horizontally directed. This means that the ratio of horizontal rigs to the total number of oil rigs has increased from around 35% in early 2013 to over 50% currently. ^[2] Some operators such as Concho Resources Inc and Pioneer Natural Resources Co. commissioned new rigs in the region.

The Permian may be extremely rich in unconventional resources. For example, in terms of thickness of the hydrocarbon producing zone, the Bakken Shale covers 10 to 120 feet in thickness, while formations in the Eagle Ford Shale are estimated to be between 150 and 300 feet in thickness. In contrast, some parts of the Permian offer shales spanning 1,300 to 1,800 feet, which is similar to having more than a dozen Bakken Shales stacked one-over the other. ^[3] Additionally, although conventionals still account for a bulk of oil production in the Permian, many wells are in their mature stages and require expensive technologies such as carbon dioxide flooding for production. Moving to unconventionals could be a promising way for operators to boost their outputs, since flow rates from shale oil wells typically start off strong, allowing companies to quickly improve returns.

Some Risks In The Permian

There are some caveats to the bullish outlook for oilfield services companies in the Permian. Hydraulic fracturing accounts for a large part of an unconventional well’s constructions costs (roughly one-third, but this could vary depending on the geology), and is major revenue driver for oilfield service companies. However, the fracking capacity required in the Permian is likely to be lower, considering that nearly all the activity in the basin is directed towards oil, and oil wells require lower fracking capacities compared to gas wells. Secondly, a lot of the unconventional reservoirs in the basin are believed to be more difficult to access, making them potentially more expensive for oil companies to develop unless oil prices remain stable or rise.

1. The Permian basin adds to U.S. shale bounty, Financial Post, December 2013 [↩]
2. Drilling Surge in Permian Drives U.S. Oil Rigs to Record, Bloomberg, March 2014 [↩]
3. Are Permian Shales the next big thing?, WellServicingMagazine [↩]