2 Stocks for Playing America's Hottest Oil Patch

Why Pioneer Natural Resources and Concho Resources have a massive opportunity in west Texas’ oil-rich Permian Basin.

Jul 26, 2014 at 11:00AM

As US crude oil production has surged by more than 50% since 2008, leading shale plays like the Eagle Ford and Bakken have become household names. But fewer people are familiar with another massive oil-rich formation in west Texas called the Permian Basin, which is pumping more oil than both of these plays.

Let's take a closer look at what helped revive the decades-old basin and why Pioneer Natural Resources (NYSE:PXD) and Concho Resources (NYSE:CXO) may be two of the best stocks to benefit from its continued growth.

West Tx Oil

Photo credit: Flickr/Paul Lowry

Permian dominance
According to a recent note from the US Energy Information Administration (EIA), Permian Basin crude oil production reached a record 1.35 million barrels per day last year, up sharply from just 850,000 barrels in 2007. That makes it the largest crude oil producing region in the US, surpassing the Eagle Ford and Bakken and even the offshore Gulf of Mexico region.

The reason behind the Permian's comeback, in one word, would be: technology. Specifically, the wide-spread application of advanced drilling techniques like horizontal drilling and hydraulic fracturing have breathed new life into the play, allowing operators to tap previously inaccessible formations.

They've also helped open up entirely new plays within the Permian, one of which – the Spraberry/Wolfcamp – could be the second-largest oil field in the world. Indeed, the increase in Permian production has been concentrated mainly in six emerging plays including the Spraberry, Wolfcamp, Bone Spring, Glorieta, Yeso, and Delaware, according to the EIA report. Pioneer Natural Resources and Concho Resources stand out as two potentially huge winners in these plays.

A Permian Pioneer
Pioneer is the big daddy in the Spraberry/Wolfcamp, where it is one of the largest acreage holders with roughly 730,000 net acres under its belt. In total, the company holds some 900,000 gross acres in the Permian with over 7,000 producing wells. But that's just a fraction of the more than 35,000 remaining wells it estimates it has in the Permian.

What's more is that Pioneer reckons that its net recoverable resource potential in the Permian is about 22x its current proven reserves. In other words, it may have massive untapped oil potential that isn't yet appreciated by the markets. If the company can prove up even a small fraction of its resource, it could significantly boost its net asset value and share price.

Going forward, Pioneer plans to continue drilling aggressively in the Northern Spraberry/Wolfcamp area, with roughly 65% of its $3.3 billion capital budget for the year allocated to the area. While the company doesn't look like a bargain, trading at nearly 5x book value and more than 31x forward earnings, successful development of its Spraberry/Wolfcamp resource base offers big potential upside.

Concho Resources
Concho Resources is another leveraged way to play the Permian's massive potential. The company commands roughly 600,000 net acres, with much of it concentrated in the play's most promising locations like the Delaware Basin. Like Pioneer, Concho believes its resource potential to be much higher – about 6x more – than its year-end 2013 proved reserves of 500 million barrels equivalent.

Again, like Pioneer, significant upside exists if Concho can prove up and ultimately produce just a fraction of this resource. Meanwhile, the company is firing on all cylinders from an operational perspective, with production continuing to grow rapidly and costs continuing to fall. Its first-quarter net horizontal production from the Delaware Basin jumped 82% year-over-year to 42.3 Mboe/d, while well costs have fallen meaningfully from $5.6 million at the end of last year to around $5 million currently.

Going forward, the company has an ambitious plan to double its annual production to more than 67 million barrels of oil equivalent by 2016. If it can achieve this target, it should drive significant margin expansion and cash flow growth due to the Delaware Basin's high oil content. This would help the company bridge its cash flow deficit, reduce its leverage, and improve its balance sheet.

Investor takeaway
With Permian Basin production expected to continue growing at a strong pace over the next few years, investors would be wise to take a closer look at Pioneer Natural Resources and Concho Resources – two pure-play Permian operators with vast, high-quality acreage positions in some of the most promising emerging plays within the Permian and big upside potential from further development.

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Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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