The Permian Basin in western Texas and southeast New Mexico has long been the workhorse of America's oil industry. The legacy oil field has given the country more than 35 billion barrels of oil equivalent (BOE) production over the past 90 years to power the economy. However, there's plenty of oil still in the ground, with one estimate suggesting that there's more than 150 billion BOE of recoverable resources remaining.
More importantly, over the past few years, producers have figured out ways to extract more of the oil trapped within the region's tight rock formations at ever-lower costs. Because of that, the Permian is on pace to continue its torrid growth pace for at least the next decade. It's a long-term trend that has the potential to fuel enormous growth for investors in one of the basin's leading drillers: Pioneer Natural Resources (PXD 1.61%).
Flipping on the accelerator switch
For decades, producers working in the Permian drilled vertical wells to suck the oil out of small underground pools spread across the Basin. Due to the higher costs and limited cash flow, the industry couldn't do much more than tread water as new wells mostly just offset declining and depleting production from legacy fields. However, starting in 2011, producers began drilling horizontal wells, which the industry had used with tremendous success in other shale plays. The results, as the following chart show, were nothing short of remarkable:
What has been so amazing is that production growth from the Permian has continued despite the crash in oil prices over the past few years. That's due to a combination of efficiency gains and innovations, which have combined to deliver a stunning improvement in well costs and productivity. As a result, leading drillers in the Permian are earning excellent returns at current oil prices. For example, Pioneer Natural Resources expects to capture internal rates of return ranging from 50% to 100% at $55 oil and $3 natural gas this year. Meanwhile, leading shale producer EOG Resources (EOG 0.68%) said that during the first quarter its direct after-tax rate of return for Permian wells was 70%.
Because of these exceptional returns at lower oil prices, the industry sees no end in sight to the Permian drilling boom. In Pioneer Natural Resources' estimation, the play's production can grow at a 300,000-barrel-a-day annual pace over the next several years. That puts it on pace to go from a current rate of about 2 million barrels per day up to as much as 5 million barrels per day by 2025.
Leading the charge
One of the drivers of that projected growth rate is none other than Pioneer Natural Resources. Already the second-largest oil producer in Texas behind EOG Resources, Pioneer recently launched out on an ambitious 10-year plan to boost its daily production up to 1 million BOE by 2026. That's quite a leap for a company that only produced at a quarter of that rate last quarter. However, Pioneer believes it has the resources -- financial and oil in the ground -- to grow by a more than 15% annual clip over the next decade while living within cash flow starting next year. The only kicker is that oil prices need to average at least $55 per barrel over that time frame.
With crude currently in the upper $40s, that certainly seems like a stretch, though it is worth pointing out that oil flirted with the mid-$50s for most of this year before a recent pullback. It's also worth noting that the company's plan doesn't factor in any additional cost savings or productivity gains from further industry innovation, which could push its cash flow breakeven level even lower.
That potential to outperform isn't impossible given that improvements are coming at a breakneck pace these days. For example, EOG Resources recently unveiled record-shattering well results in the Permian thanks to innovations that optimized productivity. Meanwhile, Pioneer continues to push the envelope to improve outcomes. For example, it is now on version 3.0 of its well completion optimization program, which is vastly outperforming wells completed with version 2.0 and has, therefore, become the new standard. Furthermore, the company and its peers are running new pilot tests to drive additional improvement. These changes could lead to further reductions in wells costs so that Pioneer could achieve its ambitious growth plan at a much lower oil price than its current outlook.
Either way, what's important to note is that Pioneer fully expects to grow output and cash flow at a healthy clip for at least the next decade. If the company can achieve its bold goal -- whether through higher oil prices or future innovations -- it would put Pioneer in an elite class. It's a level of excellence that has historically fueled market-thrashing gains for investors.