Occidental Petroleum Breathing New Life Into an Old Play

Sometimes you can teach an old dog new tricks, as Occidental Petroleum  (NYSE: OXY  )  has discovered in the Permian Basin. Before the rise of horizontal drilling, oil and gas companies like Occidental Petroleum primarily used enhanced oil recovery techniques (EOR) to keep the oil field going. The Permian Basin was discovered in the 1920's, and has since produced 31 billion barrels of oil and over 100 trillion cubic feet of natural gas. As time wore on, the amount of pressure in the field decreased, requiring CO2 injection to keep the hydrocarbons flowing. EOR techniques like CO2 injection generated huge streams of free cash flow for Occidental and other energy companies, but growth was minimal. 

Now the Permian Basin is once again churning out growth. From 2007 to 2013, the Permian Basin's oil production rose from 850,000 bpd to 1.3 million bpd in 2013, all on the back of horizontal drilling. By leveraging the free cash flow generated by its EOR operations, Occidental Petroleum can put its cash to good use by ramping up its capex program in the Permian. 

A shift to shale
This year, Occidental Petroleum is going to spend 30% of its $2.2 billion Permian capex on EOR operations, and the rest will go toward its unconventional Permian resources program. By expanding its Permian capex budget by $450 million versus last year, Occidental bumped its rig count up to 22 (as of its latest quarter), with 15 horizontal rigs, allowing Occidental to complete 10 more wells than last year. 

Occidental will complete 172 vertical and 172 horizontal wells this year, compared to 286 vertical and 49 horizontal wells last year. Horizontal wells target the prolific shale intervals that generate most of the production growth from the Permian Basin, which is why Occidental's Permian prospects look promising. As Occidental pours more money into horizontal drilling, it's able to generate much stronger levels of growth.

Output from its Permian EOR operations will increase by 1.4% this year, while output from its Permian resources unit will grow by 13-16%, with 20% annual growth thereafter, according to Occidental's management. This would translate into companywide 6% oil output growth and 5% total production growth in 2014. For a lesser known oil major, that is impressive considering only 22% of its capex is going toward the Permian this year. 

Beyond boosting production growth, horizontal drilling also opens up new drilling locations for development. By shifting toward horizontal rigs, Occidental is opening new plays that were previously uneconomical, untouchable, or unknown. 

Uncovering resources with additional rigs
Two-thirds of Occidental's 1.2 billion barrels of oil equivalent (BOE) in "assessed resource potential" is within the Midland Basin, with room to grow. According to Pioneer Natural Resources Co (NYSE: PXD  ) , the Midland Basin holds over 75 billion barrels of oil equivalent (BOE) in reserve potential, with the Wolfcamp intervals housing 61 billion BOE. By directing more cash toward the Wolfcamp horizons, oil producers will be able to record more of its recoverable reserves on its balance sheet. 

Just like Occidental, Pioneer Natural Resources is increasing its horizontal rig count. At the end of 2013, Pioneer was operating six horizontal rigs, and has since almost tripled that to 16 this year. With the larger rig count, Pioneer is going to complete 140 wells this year, 85% of which will target the Wolfcamp horizons. By developing the Wolfcamp D, the lowest horizon, Occidental and Pioneer are opening up an interval that could hold 13 billion BOE (according to Pioneer).

On top of delineating the Wolfcamp shale intervals, oil and gas producers are seeking to add new intervals to their inventory, such as the Clearfork or Atoka shale plays. New horizons will create additional drilling locations, potentially boosting reserves if the wells are successful, all without having to buy new acreage. 

Pioneer Natural Resources has very ambitious plans for the Permian Basin, which include adding 10 horizontal rigs a year to its operations, as long as WTI oil prices remain at $95 a barrel. With WTI trading above $100 a barrel, the economics of the Permian remain very attractive, resulting in more rigs being deployed to the area. With more rigs being deployed to the Permian, intervals like the Wolfcamp D and Atoka will be delineated faster.

Foolish conclusion
For a long time the Permian Basin was considered dead, but due to technological innovations the Permian has been reborn. Oil majors like Occidental Petroleum are able to find very profitable levels of growth by investing in the Permian, while smaller up-and-comers like Pioneer Natural Resources can make a name for themselves by rapidly expanding into what could be one of the world's largest oil fields. Horizontal drilling can do more than open up plays like the Bakken/Three-Forks in North Dakota or the Marcellus/Utica in Pennsylvania and Ohio, it can also bring old plays back to life.

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