These 2 Permian Drillers Are Leaving Bigger Names in the Dust

The Permian Basin is coming back to life. Here are two companies that are leaving bigger competitors in the dust.

Jul 16, 2014 at 11:09AM

Permian Oil Growth

Courtesy of EIA

It's here. Ready or not, the Permian Basin of West Texas is the next big shale play. One estimate, based on data from Drillinginfo, shows production in the Permian Basin growing by almost 50% between 2012 and 2014, and if the estimates of some large-cap oil and gas companies are correct, the Permian has a very long way to go from here. 

There is, however, still legitimate debate as to whether the Permian will be as profitable as is the Bakken or Eagle Ford. Some less bullish companies, for example EOG Resources (NYSE:EOG), believe that while Permian horizontal operations will be very profitable, horizontal drilling here will not equal the volume of the Bakken or the Eagle Ford.

EOG is joined somewhat by the supermajor oil companies, most of whom have been lukewarm about shale drilling all along. For example, one analyst at Chevron's analyst day wondered why, despite the company's leading position in the Permian basin, Chevron was not as 'gung ho' as some independent companies. 

That the integrated names are not rushing headlong into the shale should be no surprise; an important tenet in the strategies of these companies is staying diversified. In other words, the big integrated oil companies have their eggs in many baskets, and shale drilling is therefore just one part of their broader strategy.

Adam Levigne Permian Pic

The view from 10,000 ft: An aerial view of the Permian Basin.

There is a good handful of companies that are far more optimistic on the Permian. First and foremost should be Pioneer Resources (NYSE:PXD). With a market cap of over $31 billion, Pioneer is the largest of the Permian bulls. The company's geologists believe that the Permian Basin is not only a major shale play, but is also now the second biggest oilfield in the world. 

Pxd Sprayberry Oil

Pie chart by Pioneer Resources Investor Relations

The above pie chart sums up Pioneer's rationale: The Spraberry/Wolfcamp (which represents the Permian's shale rock) could have reserves of 432 billion barrels equivalent. This would make it equal to three Eagle Fords. And this is not unreachable oil, either: Pioneer reports internal rates or return, or IRR, of over 100% in the A and B sectors of the Wolfcamp, which together account for over half of the company's total West Texas production.

That rate of return is comparable to that of most of the Bakken and Eagle Ford. Accordingly, Pioneer has devoted itself to a 35-rig drilling plan in 2014, which should achieve 21%-27% production growth through 2016. 

Junior growth
The 'law of large numbers' dictates that larger companies find growth more difficult than do smaller ones with the same circumstances. With that in mind, consider Concho Resources (NYSE:CXO), which is about half Pioneer's size by market cap. Management of Concho has set an ambitious goal for itself: to double production in three years while, at the same time, growing drilling inventory, expanding profitability, and maintaining a strong balance sheet. 

Concho employed an impressive 20 rigs in the Permian Basin, and is set to grow production by somewhere between 20%-24% this year. I believe that growth will accelerate in coming years thanks to expanding inventories. 

Foolish takeaway
There's no guarantee that the Wolfcamp/Spraberry will be the next Eagle Ford; uncertainties loom regarding excess capacity of light sweet crude in the US, a situation which will likely be upon us in just a few years. If lawmakers approve crude oil exports, no one will benefit more than those companies involved in horizontal drilling in the Permian Basin. While there are quite a few choices available, I believe that Pioneer and Concho Resources are good places to start looking. 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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