Pioneer Natural Resources (NYSE:PXD) has made it very clear that it expects to expand oil production in its expansive Permian Basin positions. While its hefty acreage in the play will provide the oil resources, though, Pioneer's success will ultimately depend on its ability to profitably pull the oil out of the ground. Enter "well optimization."
Although Pioneer reported second-quarter net losses of $268 million, oil and gas production actually grew by 5% from the first quarter to 233,000 barrels of oil equivalent per day (BOE/D). This is largely because of its well optimization program, which -- surprise, surprise -- aims to optimize oil production while keeping costs low.
As long-term investors, the question we need to answer is if another quarter of losses will derail Pioneer's efforts to continue its well optimization program.
Expanding in the Permian
Pioneer made a splash in the second quarter when it agreed to purchase 28,000 acres in the Permian Basin from Devon Energy. Pioneer already owns some of the largest positions in the Permian Basin, the large oil reserves in West Texas, and the added acreage allows for new drilling positions and longer horizontal wells.
The purchase of the 28,000 acres is expected to close in the third quarter and will be a primary focus for development. According to the company's third-quarter guidance, of the five rigs that Pioneer is planning to add in the second half, three will be dedicated to the acquired acreage. Pioneer expects the rigs to contribute to its anticipated production growth ranging from 13% to 17% in 2017.
Despite sustained lower oil prices, there are a couple of reasons Pioneer probably feels comfortable with this direction. The first reason is its strong positions in the Permian, which has large proven reserves and relatively low production costs. The second reason is that the company has continued to maintain a strong balance sheet over the past six quarters, taking on slightly more debt while substantially improving its cash on hand. This is at least in part because of its decision to utilize share issuances -- such as its June offering that raised $827 million -- which has helped the company fund its capital program but comes at shareholders' expense due to share dilution.
These strong financial positions were also made stronger by noncore asset sales such as last year's Eagle Ford Shale Midstream sale that netted the company $1 billion in cash. This allowed Pioneer to expand its 2016 capital budget from $2 billion to $2.1 billion in the second quarter to cover the costs of the new rigs.
What is well optimization?
Well optimization alludes to Pioneer's three-year effort to optimize results from its Permian positions by altering the levels of proppant and fluids while reducing well cluster and stage spacing. Additionally, it expands the length of lateral wells. Since 2014, Pioneer has gone through three optimization phases and will bring Version 3.0 into more extensive testing in the second half of 2016.
By the end of the second quarter, Pioneer had completed 150 Version 2.0 wells in its Spraberry and Wolfcamp positions. These improvements brought an average production increase of 10% over Version 1.0 wells. In the same quarter, it brought 37 wells into Version 3.0 and plans to add 43 more in the second half of 2016.
Although well optimization increases costs, continued cost-reduction initiatives have actually brought down the production cost per barrel by 26% in the first six months of 2016 when compared with the first six months of 2015. More importantly, because Pioneer used the second quarter to improve well efficiency, it is expecting its Spraberry and Wolfcamp production to grow by 34% in 2016.
Foolish bottom line
Pioneer once again posted quarterly net losses, which are now becoming a trend. The negative earnings, driven by low oil prices and losses on derivatives, come as Pioneer continued its expansion in the Permian Basin. Additionally, the company continued to improve its well optimization program while keeping costs low. Pioneer has continued to improve well results despite low oil prices and fully expects that its cash flows in 2018 will catch up to its capital expenditures, making the company well-positioned for long-term growth.