- Concho's continued strong reserve-replacement ratios are ahead of many peers in the Permian.
- The Delaware operators, with mid-cap Concho a leader, have room to run, with Southern Delaware activity ramping up.
- Permian players have tailwinds on oil supply/demand fundamentals that are trending for potentially decades ahead.
- Concho management shows a good balance between aggressiveness on growth and execution fronts, but prudence in their general modus operandi.
In the Permian Basin, pure-play Concho Resources' Delaware Basin position is strong and becoming stronger. For a $12 billion-capitalization firm, it is nearly the largest acreage holder in the Delaware Basin with 345,000 net acres, just behind larger peer Anadarko Petroleum (APC) with 350,000 net acres. Some E&P firms are splitting up the intervals or layers like Wolfcamp A-D within the Delaware and Midland Basins, calling this "effective acreage." I mention this because I will be using traditional acreage vocabulary, and Concho is straightforward in its statement of positions.
Concho cites 605,000 net acres in the Permian Basin. Concho (CXO) has been an early mover in the Delaware, and because of its willingness to take risks early on, it has been rewarded, as have shareholders. In its third quarter, it explains that in 2.5 years, the Delaware has become its biggest producing area.
Since its last reporting in 3Q 2013, Concho has performed as planned and continues with its 25% CAGR estimates through 2016, from 33.6 million boe 2013 production to 67.2 million estimated in 2016; first quarter 2014 guidance states 98,000-101,000 boepd. Overall, it operates 34 rigs, thirty of which are horizontal, for an 88% horizontal-to-vertical ratio. Concho reported net income of $106 million; EBITDAX (non-GAAP) of $464 million; and adjusted net income (non-GAAP) of $95 million.
As mentioned, Concho has been drilling horizontally in the Delaware for several years. Its CEO Timothy Leach offered the following in its conference call (Feb 20th):
"We have methodically increased our horizontal program over the last 3 years. Becoming the Permian Basin's #1 horizontal operator didn't happen overnight. We drilled a lot of horizontal wells all over the Permian and progressively moved up a very steep and expensive learning curve. But over the course of this transition, we've managed to deliver on our guidance year in and year out."
(click to enlarge) (Source: Concho fourth quarter earnings presentation)
The firm has identified over 22,000 drilling locations, which is double that of 2012. This it attributes to geographic expansion, multi-zone delineation and increased well density. Concho plans to reduce its leverage from 2 times EBITDAX in 2014 to less than 1.5X by 2016. It is levered more similarly to smaller E&P Permian firms. Bringing down debt will provide more flexibility and better return metrics.
The other noteworthy metric from Concho is that proved reserves of .5 billion grow 6 times for net recoverable resources of 3 billion. Compare that to Pioneer (PXD), with the largest Permian-focused reserves in the Midland/Permian-wide area, wherein 900,000 acres will provide 9.6 billion boe of net recoverable resource potential in 2014, up 2.3 billion from 2013. (See "Scaling Up in Shale Oil Plays...") Pioneer is roughly three times the size of Concho, with the absolutely spectacular Midland Basin acreage. Thirty-three billion dollar Apache (APA), with diversified Permian acreage, last offered estimates of 3.8 billion of new resources, as noted in my last article about Apache. Thus, Concho is a smaller player with big player reserves.
Concho has added new zones for targeting in its Northern Delaware acreage. The addition, the Brushy Canyon zone, of the Delaware Sands shows results from 6 wells with at least 30 days of production. The Brushy Canyon zone is the oiliest and lowest-cost zone Concho is targeting in the Northern Delaware Basin. 850 drilling locations were identified at year-end 2013.
Of its capital plans, Concho will direct ~$630 million to its Northern Delaware acreage, which includes Lusk, Deep, and Red Hills production areas in New Mexico. The Avalon Shale and 2nd-3rd Bone Spring intervals are its primary target zones:
(click to enlarge)
(Source: Concho earnings call presentation, Feb 19, 2014.)
Between the New Mexico acreage and Brushy Canyon, the movement towards higher oil ratios in its portfolio becomes apparent. It is only just getting started in advancing its horizontal development in the Midland Basin. Its focal points are Wolfcamp A and B, and the lower Spraberry, with currently 7 rigs running. It will allocate ~$350 million toward its Midland acreage in 2014. Initial wells results from 12 wells offer a 30-day IP rate of 614 boepd, comprised of 75% oil. In this area, it continues to optimize completions and extend laterals. Concho understands all the manufacturing techniques and tools and applies them, given its early experiences in the Delaware and practices adopted by peers in the Midland.
(Source: Concho earnings call presentation, Feb 19, 2014.)
In its Southern Delaware acreage, standing at 140,000 net acres, strong well performances are apparent. From an average of 21 wells, 30-day IP rates were 984 boepd, with 80% oil. Its targets are mainly the 2nd Bone Spring and Wolfcamp A. In all the main areas -- the Northern and Southern Delaware and Midland Basins -- Concho looks to have good contiguous acreage, which explains why it can experiment with lateral lengths, even citing a successful ultra-long lateral of 11,300 feet. (So ultra-deepwater exploration has its equivalent onshore now, the ultra-long lateral. If anyone doubted that economics trumps geology in shale oil development, that title went to economics, although the geography has to cooperate.)
The Delaware Basin was estimated to hold around 8 billion boe of recoverable reserves. Given the reserves proposed by Concho and the activities of Apache, Occidental (OXY), and others coming on line, those estimates could easily be surpassed. The 50 billion estimate of the Spraberry/Wolfcamp in the Midland Basin is certainly showing signs of being increased. While the Northern Delaware has been a driver for Concho's success, the Southern Delaware holds potential to add to its growth prospects. In Pecos County, for example, major Eni (E) has joined small-cap Quicksilver Resources (KWK) in a $52-million transaction for 50% of 52,500 gross acres.
(Source: PXD Investor presentation 5/29/2013)
As of February 24th, Concho's stock climbed ~3.4% to $118.59, likely reacting to billionaire-investor Baron's endorsement on CNBC, and settled down 2% to $116 in mid-morning trading the 25th. It was at a high of $122 in mid-October 2013, when many Permian E&Ps were running high, and a low of $78 in early May. A Permian-focused analyst suggests a $140 price target, and I cannot disagree with that stock price later in the year. From Jan 2, 2013 to Feb 24, 2014, its stock has risen nearly 40%. However, in 2013, by year-end (early Dec.) it was 28%. Its reserve-replacement ratio is 266%, which is trending higher than other peers. Proved reserves of 503 million boe were 13% higher in 2013 over 2012; Production in 2013 increased 20% over 2012 production. Its PV-10 of proved reserves at year-end 2013 was $9.0 billion over last year's $8.3 billion, with an average realized price of WTI $93.42 per barrel.
(Source: Yahoo Finance)
As investors look to the data, they should not be afraid of sciences costs. These are important hedges to make sure appropriate returns to capital occur. I noticed one top producer minimizing their sciences allocations in their IR presentations because they were likely dinged for it in stock price. I believe using the available technology when needed is the right approach. It can avoid costly mistakes. Mr. Leach's explanation also offers color on the rationale behind spending on science:
At the same time, we can apply science and geology to further define and expand our resource and inventory potential. For instance, we're using science to: 1) extend the productive boundaries on our acreage; 2) delineate additional zones; and 3), increase our well density. Ultimately, we rely on the drill bit not only to prove up our inventory, but also identify more resource opportunity along the way.
When we apply this framework to our assets, which is based on our current interpretation of the data and science, we believe that our net recoverable resource potential is at least 6x our year-end '13 proved reserves of 0.5 billion barrels.
Concho has upside potential in the Permian that is under-recognized on some fronts, but "somewhat" recognized on the metric of current stock price. However, given prospects in the Midland and Delaware Basins, it has upside potential that mirrors leading Permian firms with good acreage, very good execution skills, and deep experience in the Permian. These factors also play favorably in Concho's valuation and future return prospects:
- Intentions to reduce debt;
- Continuous strong reserve replacement and recoverable reserves estimates;
- Adopting and applying best practices in the field; and
- Further developing Southern Delaware and Midland Basin acreage.
Concho Resources offers few downsides outside of commodity price risk or a slack in economic demand, but it has hedges in place to allow for that risk. With the U.S. shale oil activity required in the next decades ahead, Concho and its investors stand to benefit. Risks to OPEC supply continue to echo the need for the U.S. as an oil market stabilizing force. There should not be any serious policy headwinds, as part of the U.S. economic recovery is dependent on the unconventionals revolution underway.
Final note on effective acreage: I am not a fan of the "effective acreage" messaging, wherein firms attribute each interval of the play, like Wolfcamps A-D, within, say the Delaware Basin, and then appear to have more acreage. If it is meant to provide accurate specifics as to the actual acreage within an interval for estimation reasons, fine then. But firms should state the effective acreage and then also indicate total area acreage together. To the untrained eye, it could be misinterpreted.
Additional disclosure: My CXO holding is miniscule, thus incentives are not material to this article. Please conduct your own due diligence when deciding to invest in a stock. This article is for informational purposes only.