Please ensure Javascript is enabled for purposes of website accessibility

Why Apache Corporation Could Be a Big Winner in Shale

By Matthew DiLallo – Jul 20, 2016 at 4:23PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Plunging drilling costs in the Permian Basin and the SCOOP play of Oklahoma put the leading independent exploration & production company in a position to thrive.

Image source: Apache Corporation.

Analysts from energy research group Wood Mackenzie recently released a report detailing the game-changing reduction in costs shale drillers captured in recent years. The report noted that drillers cut the cost of new supplies by as much as 40% in the past two years alone. That not only makes shale viable in the current environment of low oil prices, but also poises it to fuel big winners when prices improve. In fact, the report pointed out that Apache (APA -0.75%) would likely be one of the winners. The reason it can win boils down to two critical characteristics: structural cost declines and controlling the right rocks.

Permanent cost reductions

Like most drillers, Apache has aggressively driven down costs during the downturn to mute the impact of low oil prices. In early 2015, for example, it laid off 5% of its workforce; it followed that up by cutting another 38 jobs earlier this year at its North Sea operations. Meanwhile, it worked directly with suppliers to obtain lower pricing on services and supplies. These initiatives pushed the company's gross overhead costs and lease operating expenses down 19% and 21%, respectively, year over year, while drilling costs dropped by an even more remarkable 45%.

That decline in drilling costs is particularly noteworthy because over half of the cost savings are structural in nature:

Image source: Apache Corporation investor presentation.

Unlike the savings from service cost deflation and headcount reductions, which are likely to reverse when oil rebounds, a combination of design and efficiency savings has permanently reduced Apache's well costs.

An example of a permanent cost reduction is the switch toward drilling longer laterals. In the Midland Basin, for instance, Apache recently drilled a 1-mile horizontal well for less than $4 million and a 1.5-mile horizontal for less than $4.5 million. The company can (in this case) drill a 50% longer well for only 13% more capital, therefore lowering the total cost per foot.

The right rocks matter

For an oil company, two inputs are required to calculate drilling returns: drilling costs, and the estimated ultimate recovery (EUR) of oil and gas. That latter input plays right into Apache's hand: It has a prime position in the Permian Basin of Texas and the STACK and SCOOP plays of Oklahoma, which have a higher volume of recoverable hydrocarbons due to geology and greater quantities of oil and gas saturating the rocks.

For example, while crude oil soaks the Bakken shale of North Dakota, leading Bakken leaseholder Continental Resources (CLR 0.04%) only expects to produce an average EUR of 850,000 barrels of oil equivalent over the lifetime of a well drilled today. However, in the STACK and SCOOP plays of Oklahoma, Continental Resources projects EURs of 1.7 million BOE and 2 million BOE, respectively. Because Continental Resources expects to extract double the hydrocarbons per well, it is no surprise that its returns at a $50 oil price are 90% in the STACK versus 45% in the Bakken.

Meanwhile, wells in the Midland Basin are generating a more than 1 million BOE EUR for leading producer Pioneer Natural Resources (PXD -0.09%). Furthermore, thanks to well design changes, Pioneer Natural Resources' most recent wells are outperforming its 1 million BOE EUR expectation by as much as 90%. Again, that is a function of the enormous volumes of oil and gas saturating these rocks: Pioneer Natural Resources estimates that the Spraberry/Wolfcamp shale layers alone contain more recoverable hydrocarbons than all but one of the world's oil fields. That bodes well for Apache, because it has a leading acreage position in the region.

Investor takeaway

In shale drilling, a prime position in the best plays and low structural costs are what matter most. Apache has both, which puts it in the position to thrive as industry conditions improve over the next year.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Apache Stock Quote
Apache
APA
$46.43 (-0.75%) $0.35
Continental Resources Stock Quote
Continental Resources
CLR
$74.27 (0.04%) $0.03
Pioneer Natural Resources Stock Quote
Pioneer Natural Resources
PXD
$254.14 (-0.09%) $0.23

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
356%
 
S&P 500 Returns
118%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.