As the U.S. energy boom has taken off over the past several years, the term "fracking" has become a household name. But fracking, which involves pumping massive quantities of water, proppant, and other chemicals into a wellbore to unlock trapped hydrocarbons, isn't the only drilling technique responsible for the surge in U.S. oil and gas production.
Horizontal drilling, which allows operators to reach hydrocarbon formations that cannot be accessed via vertical drilling, has also played an equally important role. In fact, horizontal drilling has been absolutely crucial to the development of West Texas' Permian Basin and could hold the key to success for Permian-focused companies like Pioneer Natural Resources (NYSE:PXD) and Occidental Petroleum (NYSE:OXY).
Horizontal drilling taking off in the Permian
According to the U.S. Energy Information Administration (EIA), the number of horizontal, oil-directed rigs in the Permian Basin has risen by 63 rigs over the past five months, accounting for roughly half of the growth in U.S. horizontal drilling for oil over the period.
As the EIA notes, this rapid growth in horizontal drilling reflects operators' growing interest in tapping the so-called "stacked pay" potential that exists throughout the Permian Basin. These stacked pay formations are in such high demand because they feature multiple hydrocarbon producing zones, which can materially boost overall production levels due to the larger resource base.
In the first quarter of 2014, nearly 80% of all new horizontal, oil-directed drilling in the Permian Basin occurred in just five counties that contained these stacked pay formations, including the Spraberry, Wolfcamp, and Bone Spring formations. A number of operators see tremendous potential in these formations.
2 companies to watch in the Permian
Occidental Petroleum (NYSE:OXY), for instance, is especially optimistic about its opportunities in the Delaware Basin's Wolfcamp shale, where it estimates it has roughly 800 remaining drilling locations. During the first quarter, the company brought online 12 wells in the Wolfcamp, bringing its total to 18 producing wells.
While initial production rates for these wells averaged just around 750 boe/d, Occidental reckons it can significantly improve production rates by increasing the lateral links of its wells and improving the efficiency of its fracs. With the company planning to significantly accelerate horizontal drilling in the Permian Basin this year, oil production is expected to grow by 6%, which should generate $1.8 billion of cash flow after capital.
Combined with the spinoff of Occidental's California unit and the start-up of the BridgeTex Pipeline joint venture with Magellan Midstream Partners (NYSE:MMP) and the Al Hosn Gas Project in the United Arab Emirates this year, the company's cash flows are set to grow sharply. This will allow it to bolster its balance sheet and buy back another 40 million-50 million shares, which could be a catalyst to send its share price higher.
Pioneer Natural Resources (NYSE:PXD) is another company with a massive opportunity in the Spraberry/Wolfcamp formation, where it commands roughly 600,000 gross acres and expects to spend the vast majority of its $3 billion drilling capital budget for the year.
Pioneer's first-quarter production grew 5% sequentially thanks largely to accelerated horizontal drilling activity in the northern Spraberry/Wolfcamp, as the company ramped up its drilling program from five horizontal rigs as of year-end 2013 to 16 rigs. As Pioneer further accelerates horizontal drilling across the Spraberry/Wolfcamp in the years ahead, the share of oil and natural gas liquids (NGLs) in its production mix should rise meaningfully, boosting margins, cash flow, and return on capital.
But perhaps the most compelling reason to be optimistic about Pioneer is that the company's overall resource potential in the Permian may be as much as 22x its current proven reserves. If the company can successfully delineate its acreage and book additional resources as proved reserves, it could significantly boost its net asset value (NAV) and share price.