Oil major ready to make profit in Permian


Euro majors have scaled back their traditional high carbon portfolios to evolve their product line to meet the low carbon climate targets of the Paris Agreement. This is driven by a combination of internal conviction at the management level, investor repulsion for the “damage” that hydrocarbons are doing to the planet and the fear of a climate dispute hitting them.

We’ve seen this trend accelerate in recent years with Shell (NYSE: RDS.A), (NYSE: RDS.B) making the most recent splash last week by offloading its previously major acreage of Delaware in the Permian basin. BP, (NYSE: BP), TotalEnergies, (NYSE: TTE) and Equinor, (NYSE: EQNR) have taken or committed to divesting low carbon assets.

The strength of this strategy remains to be seen from a business perspective, as these companies focus their efforts and allocate capital to green energy companies that do not have a long-term track record. In a Oil price article last month I noticed that there are flaws in the history of green energy that a transition will be smooth and easy.

In this article, I’ll discuss some aspects of what this acquisition may mean for ConocoPhillips and conclude with an estimate of the impact on its share price.

The agreement

This week ConocoPhillips, (NYSE: COP) and Shell has reached an agreement to transfer title to the Permian acreage from Shell for $ 9.5 billion in cash. Using simple calculations, the Delaware footprint of 225,000 acres equals $ 42,000 and changes per acre. A little steep these days, but COP defended it on the basis of existing production. Easily justified, but we’ll stick to simple math.

COP The deal was widely praised by the market, and COP stock rose 25% in one week, topping many others. It should be noted that this was a fairly good week for the oil market where news generally focused on supply drops in the US and Europe, and the associated high prices that scarcity inflicts on commodity prices. raw.

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We believe this will add value to ConocoPhillips beyond the linear addition of current acreage and production to its previous portfolio. Shell’s acreage makes its former position in Delaware all the more valuable as we will discuss.

What the market usually does not take into account

There is no doubt that Shell sold to meet climate-related imperatives. This is of course their call, as misguided as one might think. The question we are going to ask and then answer in this article is what could have been the “behind the scenes” calculation that allowed COP to shell out $ 9.5 billion in cash for this area of ​​Delaware.

Reservoir management

Oil companies can now, using seismic data and advanced processing software, realistically construct an “image” of underground layers from which to plan the most efficient drainage of the reservoir (s). In the area above, imagine that one of the Permian’s common targets, the Wolfcamp, extends north to south (or vice versa depending on your perspective). If you are a Shell engineer planning a well, you need to plan the overall trajectory taking into account the COP area greater than yours because you cannot cross the line. Obviously, the merging of properties allows the COP asset development team to plan their well paths without this particular constraint. Among the advantages that this confers:

  • Avoid defects in the tank which can lead to delays / drilling problems. The faults are associated with geo-directional difficulties – keeping the downhole assembly facing the target, loss of circulation, and hole collapse. Anyone can be catastrophic and result in flat weather or re-drilling.
  • Minimize tortuosity. Curves and bends in a well path increase mechanical risk exponentially. The blocky and connected area favors the minimization of these “doglegs”.
  • Optimal targeting of the well path for maximum reservoir drainage. Visualize the tank in 3D and you will see the impact it could have on the final recovery of the area.

Permeability and porosity

If you have read more than one of my articles, you have come across these terms. Discussions that include permeability and porosity can get really wobbly regarding these factors of well production. For this article, we’re just going to highlight them with a brief description for each. Permeability is the flow characteristic that describes the ability of rock to circulate fluids to the wellbore. More perm is always better than less perm. Porosity is a measure of the empty space in the rock that allows hydrocarbons to accumulate. More porosity is always better than less porosity. The relevance of the value that Shell’s acreage has brought to COP is the ability to plan the path of the well in areas of maximum permeability and porosity of the reservoir, again using the highly realistic images of the underground environment that are possible today. This will improve final recovery in addition to any stimulation treatment applied.

Housing outputs

Wells start vertically most of the time anyway. When they reach a certain depth, there is a starting point where they start the horizontal leg. This is called the casing outlet, from which the rest of the well is called the “open hole”. Ideally, the casing exit occurs in the sweet spot of the tank and places the best part of the tank closest to the vertical section. This reduces mechanical risks and helps ensure that the best part of the reservoir will remain available, regardless of how the well is produced. The wells are selectively opened to promote maximum drainage from the furthest point and to minimize water intrusion which can block oil.

Cube style development

I doubt this term is foreign to you because over the past five years it has become a common reservoir drainage strategy. We’ll cover it here briefly for completeness. The cube makes it possible to design well paths to minimize the impacts of fracturing from well to well, and harmonics from one well to another mainly.

XOMXOM

Cubes also offer multilateral opportunities, as shown in the chart above.

Side length

Just a quick note here because this concept is quite well understood by now. A few years ago, the Permian laterals were 5 to 6,000 feet long. Today they typically travel 9, 10, 11, 12,000 feet and in some cases reach 15,000 feet. It should be obvious to you how Shell acreage can positively impact this aspect of reservoir development.

Climb

Another feature of this transaction, and the one discussed in the slide above. What does it mean? This can have a number of impacts when contracting with suppliers for pumping, sand, water services, etc., and centralization of the supply base. Oil and gas volumes too. The carriers are looking to fill their lines, so having additional production and the promise of increasing it as new wells are developed can give the COP an advantage in negotiations. I will stop here. At this stage of maturity, the trend is towards asset consolidation which lends itself to a state of “oil manufacturing”, where processes are streamlined and inputs standardized. Kind of like car manufacturing when you think about it.

Level I area

Finally, there is the question of the quality of rock. Not all rocks are created equal in terms of drilling capacity, reservoir connectivity and thickness, oil quality, pressure, and other characteristics that establish the level of a reservoir. For example, take the Wolfcamp-A in the Permian. It sits above Wolfcamp-B, C and D. These are generally classified as lower level than A because they require additional drilling to mine. They may also lack some of the attributes of A, as well as have lower porosity and permeability due to diagenesis. Foot for foot apart, these horizons will generally yield less than the Wolfcamp-A, stretching the payouts and possibly making them unprofitable to drill.

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By purchasing the acreage from Shell, COP obtained additional Tier I acreage. This will lower their costs relative to their peers and allow them to continue operating in times of declining prices. During the period we just released, where low prices were dominant, most of the time only level I acreage was drilled.

Your takeaway meals

As you can see, the valuation of this deal is not limited to the price paid for the square footage. We believe the large block footprint of COP’s acreage, reinforced by assets obtained from Shell, will be more than accretive once the deal is concluded. In addition, we believe that the COP share price will react favorably.

At close of business last week, COP was trading at an EV / EBITDA of 5.9X using Q-2 2021 numbers. It’s ridiculously cheap and is expected to propel the stock higher when the company releases on November 2. The 200,000 BOEPDs of production associated with Shell’s acreage likely add $ 3.0 billion in annual EBITDA, pushing the multiple further down to 5X. A figure that will not be reflected in earnings until the deal closes later this quarter.

A multiple of 7X that we believe the stock is currently heading towards would put the stock price in the $ 95 to $ 100 range. Given its reserves, daily production, and the stock prices of competitors like Pioneer Natural Resources, (PXD) $ 174 ish, and EOG Resources, (EOG) $ 84 ish, this range could be easily exceeded in the market. currently existing support.

By David Messler for Oil Octobers

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