3 Oil Stocks Whose Vertical Moves Pay Dividends in a Horizontal World

Source: Pioneer Natural Resources investor presentation. 

Hydraulic fracturing gets most of the credit and too much of the press for unlocking our massive shale oil and gas reserves. Few realize that we've been fracking for more than 60 years. Even fewer know that what really changed the game in America was combining fracking with horizontal drilling.

Because of this, energy companies live in a horizontal world. However, some of the best investments these companies are making today are vertical moves. I'm not talking about drilling, either. The companies that are among the best in the business are those that are pursuing vertical integration to save money and fuel profits for investors.

Serving up savings and profits
Oil-field service giants like Baker Hughes Incorporated (NYSE: BHI  ) make billions each year by assisting oil and gas producers in drilling efforts. However, by cutting out this middleman, oil and gas companies like Pioneer Natural Resources (NYSE: PXD  ) and Oasis Petroleum (NYSE: OAS  ) have found an important way to cut costs, which enables these companies to keep more profits for investors.

Pioneer Natural Resources began its vertical push in 2009 when it acquired an oil-field service pumping division in Colorado. It has since built up that division into the 13th-largest service company in America in terms of horsepower. The company uses that power to keep its well costs in check. It then invests some of the savings in science so that it can better develop its massive resource base in Texas.

We find a similar story in the Bakken Shale, where Oasis Petroleum has quietly invested to build its own service business. The company can save about $500,000 per well by using its in house Oasis Well Services business. Because of this savings, as well as transitioning to pad drilling and other efficiencies, Oasis Petroleum has been able to drop its well costs from $10.5 million in 2012 to a target of $7.3 million in 2014. Bottom line, by vertically integrating and building an oil-field service company both Pioneer Natural Resource and Oasis Petroleum are able to keep costs down by cutting out middlemen like Baker Hughes, which is increasing profits.

Photo credit: Oasis Petroleum investor presentation (link opens a PDF).

Packing sand
Oil-field services are just part of the vertical integration efforts for U.S. producers. Another step some companies are making is to invest in a frack sand mine. Both Pioneer Natural Resources and EOG Resources (NYSE: EOG  ) have company-owned frack sand mines. In some regards, this is cutting out two middlemen as oil-field service companies like Baker Hughes typically contract frack sand volumes from sand mine owners and then sell the sand as part of a drilling package.

Last year, Pioneer Natural Resources purchased one of the largest industrial sand mines in the U.S. for $297 million. Not only does that secure Pioneer's supply of sand, but it helped to lock in its costs. Last year, proppant suppliers were one of the surprising winners in the stock market as surging demand from an increase in proppant volume per well spurred growth.

Photo credit: Pioneer Natural Resources investor presentation. 

EOG Resources also sources its frack sand from company-owned mines. Like Pioneer, it has invested several hundred million dollars to lock up its supply. However, these mines are saving the company about half a million dollars per well. That really adds up for a company drilling more than 600 wells each year.

Railing profits
One of the reasons EOG Resources purchased a frack sand mine was because it had already begun to invest in rail infrastructure to ship its oil out of places like the Bakken Shale. It was an early mover in the crude-by-rail phenomenon. Unlike a lot of its peers, EOG owns the rail loading and unloading infrastructure to get its oil out of producing regions and into premium priced markets. Because it doesn't rely on a third-party provider, the company can keep more of the profits.

Last year, alone EOG Resources was able to earn an $8.19-per-barrel premium for its oil over the U.S. benchmark WTI. That's in addition to the cost savings from self-sourcing frack sand. These two factors have enabled EOG Resources to turn its drilling rigs into money-printing presses.

Investor takeaway
The move to horizontal drilling changed the game in America as it enabled companies like Pioneer Natural Resources, Oasis Petroleum, and EOG Resources to get oil and gas out of tight shale formation. However, the next phase of that game change came as all three pursued vertical integration efforts.

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