Perspectives
The first was that there were an inordinate number of financial people in the room: representatives from Wells Fargo, Citi, Chase, Frost, Credit Suisse, Goldman Sachs, and many others. The second was a sense of “realistic optimism” that seemed to permeate the room. Both were something that I had not seen in the previous 24 months but, with over 20 billion dollars of transactions in 2016, some blockbuster deals recently announced, and a rising confidence that the Permian will be the most prospective onshore basin in North America, that sense of realistic optimism is a deserved one.
This confidence has risen on the back of two years of severe cost cutting, renegotiation of contracts, and very painful downward adjustments to the price of oil. In addition, technology continues to improve with longer laterals and a significantly increased ability to break up the rock around the well bore. As I contemplated the changes the market has seen, I began to think about the next 12 months and what pressures we could see as the Permian ramps back up. There is the potential for ~100 rigs to be added in the Basin over the next 12 months, especially if the OPEC agreement remains in place. With this level of growth on the horizon, costs cannot stay low forever, which leads me to ask: “How can companies lock in their hard earned gains?”
One theme that I heard at the conference was that most fracing companies have cut their costs and their rates. The problem is the prices are so low that there are insufficient returns for capital replacement. The result is under investment in equipment maintenance and replacement, lack of spares and significant remobilization costs. Furthermore, not all fracing spreads are equal. To pump more sand and pump it further requires increased horsepower and not all available spreads are suitable for the longest laterals. This will leave some companies in the position of having outdated equipment and no funds to replace it. After all, you cannot invest if you don’t generate sufficient cash to pay for it.
I had quite a few discussions with rig owners while at the conference and many of them shared that they have cut costs and locked those cuts into long-term contracts with some of the Permian’s biggest operators. However, the rig rates are based on reduced wages for rig crews. Owners told me that they are already beginning to see remobilization of rigs and increasing personnel demands, which in turn, is putting pressure on wages and operating costs.
If costs are rising and rates are fixed, this is not a good economic scenario for rig operators. If cost pressure is coming, how can we lock in those hard won cost savings? Many operators are, rightfully so, very proud of the savings they have achieved and the improvements they have made to drilling times. Wells can be drilled quickly and efficiently and there is only so much that can be done to reduce costs in this space. However, there is likely more that can be done in the completion space as well as in logistics, permitting, and operations. New emissions regulations, which took effect on Jan. 1, 2017, will also add to costs. How can these be managed to keep costs as low as possible?
The quest for cost efficiency cannot stop at renegotiating contracts and improving drilling times, it has to continue through the full value chain. We should look for lessons from other industries like mining, which has a laser like focus on efficiency, “lean” techniques, and maximizing output from the resource base. More can be done in the standardization space. Operators told me that they have only just started scratching the surface when it comes to efficiency implementation. It is important that companies continue to drive for value improvements. The Permian needs to stay competitive in order to compete, long term, with Middle East Oil.
