Bakken Update's 2014 Stock Picks: The Permian Operators

| About: Laredo Petroleum (LPI)
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2014 looks to be a good year for oil and gas in the United States. There are worries too much crude will be produced, pushing prices lower. In response, we will continue to see pipelines added and rail facilities built. The start up of the southern leg of the Keystone should help. A marked rail expansion to the west coast will help ease tight logistics from North Dakota. This should support oil prices, as WTI should average $92/bbl. to $94/bbl. Oil pricing north of Cushing should improve, but better differentials will still be seen to the south. This gets even better if the operator has access to LLS markets. Laredo (NYSE:LPI) has access and should realize better differentials this year. It is also one of the better operators in the Midland Basin. It continually has higher 30-day IP rates than other operators, which should translate to better EURs. Its acreage should provide more locations, as it has some of the thickest intervals in the basin. Most importantly, its shares have pulled back on short-term news. At this time, LPI is a better value than other small cap Midland E&Ps.

The Permian was an exciting investment in 2013. It may have been the hottest play last year, and with good reason. It is the home of more economic intervals than anywhere in the United States. This is important as downspacing will be the most important variable moving oil and gas stock prices this year. Pad development will identify location spacing within each interval, and between intervals. As an example, North Dakota's horizontal intervals are the middle Bakken and Three Forks benches. In Colorado, the Niobrara benches and the Codell are the source rock. In Pennsylvania, the targets are the Marcellus and Devonian. With pad development beginning, operators will find the optimal locations for each pad. This will define acreage values, which in turn move those stocks higher. The Permian has an advantage as the number of targets are greater. The Midland Basin houses the three Wolfcamp benches and Cline as the main intervals. This area has seen significant development, initially through vertical wells targeting the Wolfberry. The Wolfberry may be the best vertical play in the United States, and it all revolves around shale thickness. The beauty about the Wolfberry, is it has allowed small operators to begin vertical programs before moving to horizontals.

It is important to note that the majority of the Wolfberry intervals are economic. This also includes the upper and lower Spraberry, the Strawn, and A/B/W. Operators are currently testing, and should have a much better idea of how large its pad sites will be by the end of 2014.

I have been positive Diamondback (NASDAQ:FANG) and Athlon (NYSE:ATHL), and still like both. Diamondback's acreage is centered around Midland County. This is its best, and maybe the best county in the basin. Diamondback focused on the western Midland Basin, with Athlon's wildcard to the east. Athlon's core is in Midland County, but Howard County will move its valuation the most. Laredo may have more upside as a series of negative catalysts have pushed back its shares. It has more value than other Midland focused operators.

Laredo has continued to be one of the Midland Basin's top operators. Its well results have outperformed, and Q3's completions were no different. It completed six horizontals during the quarter, and five had 30 days of initial production data. Two wells targeted the upper Wolfcamp. These had 30-day IP rates of 782 Boe/d and 836 Boe/d. Laredo's Wolfcamp A model produces EURs of 924 MBoe. Two middle Wolfcamp wells were completed, producing 30-day IP rates of 663 Boe/d and 605 Boe/d. The middle Wolfcamp models to EURs of 793 MBoe. There were no lower Wolfcamp wells completed in Q3, but Laredo models it at 814 MBoe. One Cline Glasscock County location was completed, and the best well to date in this interval. The 30-day IP rate was 1408 Boe/d. This is significantly higher than its 796 MBoe model. Because the Cline is deeper, it is also more expensive. Well costs are $500000 more per well, but increased depth also increases well pressures. This is why the Cline may have more upside than the Wolfcamp. Laredo also began the first of its three stacked lateral tests. This test includes the upper, middle and lower Wolfcamp. It will provide data on spacing between each interval, and define vertical spacing assumptions. Further tests will have other configurations of Wolfcamp and the Cline. Currently, Laredo has an average of 660-foot spacing within each zone.

Although IP rates continue to improve, Laredo had difficulties in Q3. These are not small issues, and should be watched. These problems moved Laredo to push Q4 production estimates to the low end of guidance. This includes a stuck pipe, a casing integrity issue and a fire all delayed or slowed production. Daily production for Q3 was 28361 Boe. This includes its divested Anadarko Basin properties. Permian production was up 17% sequentially to 24332 Boe/d. Even with the divestment, sales were still up 19% year over year. Oil as a percentage of production is up from 42% in Q3 of last year to 49% for the same quarter in 2013. Over the same time frame, price realizations are up 29%. The Anadarko sale coupled with an equity offering of 13 million shares has provided the cash needed to prefund a portion of its 2014 capital program. This does not include the $37 million allocated for Laredo's recent acquisition. The total 2014 capital program is $1000 MM. $840 MM is set aside for drilling and completion. Below I have listed how Laredo will break down its 2014 D&C.

2014 D&C Capital

Capital Program % of Cap Ex
Horizontal Development 55
Vertical Development 30
Horizontal Delineation 10
Non-Operated 5

Laredo will run 5 to 6 vertical rigs and plans to continue this program. The vertical applications extend to many zones, and Laredo will be testing the Atoka, Ellenburger and Strawn formations. 120 to 125 developmental verticals with be drilled in 2014. There is still significant upside, as vertical results should continue to improve. It is important to note, Athlon is also continuing its vertical program in Howard County. The IRRs are good enough to intermingle vertical and horizontal wells. Laredo believes vertical wells will not create issues for new horizontals. It will drill 60 to 65 horizontals this year and an additional 10 to 12 for delineation.

When looking at shale thickness, Howard and Glasscock counties stand out. It is important, because Laredo may be able to downspace its acreage better than other areas. The upper and lower Spraberry are fairly consistent from east to west. The Wolfcamp thickens to almost twice that of Midland County. The Cline is also thicker. These two intervals combine for almost 2000 feet of payzone. From north to south, Laredo's acreage is positioned over the thickest Wolfcamp and Cline source rock. When all of the vertical/horizontal plays in the Midland Basin are considered, it is not surprising that some believe it is the best play in the United States. The table below provides data on all of these zones.

LPI's Stacked Intervals

Source Rock Depth Thickness OOIP MM/Section
Spraberry 5000-7000 1500-2000 45-85
Wolfcamp 7000-8500 1200-1500 70-115
Cline 9000-9500 250-350 25-35


9500-10500 350-400 40-55
Total Payzones 5000-10500 3300-4250 180-290

Laredo's acreage has incredible source rock thickness. These intervals' total thickness is over 4000 feet. This is important, as initial horizontal development used laterals of 4000 to 5000 feet in areas like the Bakken and Eagle Ford. An operator can drill a vertical and frac straight down without a lateral leg. This is why the Wolfberry area is so important. Most of these targets can produce horizontally, providing further upside. Very large pad sites could produce a large number of locations. If so, acreage values will push upward quickly. All said, the Permian Basin could have a higher acreage value than anywhere else in the United States. The vertical program also aids in identifying geology. There have been over 800 vertical Wolfberry wells across Laredo's leasehold. 300 of these wells drilled to the Atoka. The average rate of return is +20%.

The large number of vertical locations have provided the data needed to begin its horizontal program. 79 horizontal wells throughout Laredo's acreage have proven four intervals. This includes the Wolfcamp benches and the Cline. Of those wells, 39 are short laterals and 40 are long. Based on the long laterals, 30-day IP rates for each interval are listed below.

Average Long Lateral IP 30 For Laredo's Acreage

Interval IP 30
Upper Wolfcamp 717
Middle Wolfcamp 630
Lower Wolfcamp 861
Cline 594

The lower Wolfcamp seems to be the best producer to date. This may not be true as only 4 wells have been drilled. The upper Wolfcamp and Cline have seen the most activity with 32 and 37 wells to date. It will continue to test stacked laterals, defining optimal distance. Of the 60 wells planned in 2014, 28 will test all four targets. This and other initiatives will reduce well costs 10% to 15% in 2014. Laredo's current model for the Wolfcamp and Cline provides impressive results. Below is a comparison on a 2-stream basis.

Wolfcamp/Cline Production Model (7500 Ft. Lateral)

Interval IP 30 Boe/d EUR MBoe % Oil
Upper Wolfcamp 675-754 715-800 69%-77%
Middle Wolfcamp 569-659 600-700 69%-77%
Lower Wolfcamp 574-690 605-730 69%-77%
Cline 663-828 550-690 69%-77%

The upper Wolfcamp has seen the most activity. It is possible the lower Wolfcamp will outperform as it is deeper, and should produce higher well pressures. The Cline model is the lowest of the four, but it also should outperform. Below is an Athlon's model for the west and eastern Midland Basin.

Athlon's Western Midland Wolfcamp Model (7500 Ft. Lateral)

Interval IP 30 Boe/d EUR MBoe %Oil
Western Wolfcamp 730 730 68
Eastern Wolfcamp 625 625 67

Athlon's model is fairly simple. It gives a basic say of using the 30-day IP to figure EURs. Keep in mind, this is not universal. Choke size, resource mix, formation depth, and well design can affect EURs. The reason I say this is Laredo has a large number of wells with 30-day IP rates over 1000 Boe/d. This does not mean those wells model to +1000 MBoe, but gives an idea of how these wells have been depleting to date. These models will probably change as operators produce more data.

Keep in mind that Laredo reports on a 2-stream basis. This means results are broken down into wet gas and crude. When compared to the 3-stream basis, 2-stream reports lower IP rates and EURs. This is not as important in wells that produce less NGLs, but in the Permian it can skew results. An average Wolfcamp well, depending on results and resource mix, can see improvements of 14% in 30-day IP rates and 18% better EURs. Below is a table providing a basic example of how much better 3-stream results are in the Midland Basin.

Wolfcamp 2-Stream Conversion To 3-Stream

Resource 2-Stream IP 30 Total Volume Conversion 25% Shrinkage 3-Stream Volume 3-Stream IP 30
Natural Gas 986 Mcf/d In Wet Gas 23% 704 Mcf/d 15% 704 Mcf/d
NGLs 158 Bbl./d 19% 158 Bbl./d
Crude 550 Bbl./d 77% 66% 550 Bbl./d
Total 715 Boe/d 100% 100% 831 Boe/d

The difference is significant and should be considered as operators use both types. One may be motivated to use the 3-stream total because it provides better total production numbers. By using the 2-stream, an operator could provide a higher percentage of crude.

Wolfcamp EUR 2-Stream To 3-Stream Conversion

Resource 2-Stream EUR Total Volume Conversion 25% Shrinkage 3-Stream Volume 3-Stream EUR
Natural Gas 1409 MMcf 31% 1057 MMcf 19% 1057 MMcf
NGLs 225 MBbls. 24% 225 MBbls.
Crude 523 MBbl 69% 57% 523 MBbls.
Total 758 MBoe 100% 100% 924 MBoe

The above numbers are not any specific well data, but a tool to understand the difference between 2-stream and 3-stream reporting. This affects 30-day IP rates some, but EURs can change significantly.

Laredo will realize higher crude prices due to changing logistics. It has supplied crude to the Midland local market and had it piped to Cushing. The poor differentials at Cushing (which should improve) have pushed Laredo to send barrels via the Longhorn pipeline. It already has 10000 bbls. committed. This will increase to 23000 bbls. in 5 years. This 700-mile long pipeline is operated by Magellan (NYSE:MMP) and will deliver crude to El Paso Texas at LLS pricing. Laredo has also committed to 10000 Bo/d to the Bridgetex pipeline. This will be completed mid-2014. Bridgetex is 400 miles long and delivers crude to Texas City. It is operated by Magellan and Occidental (NYSE:OXY). Laredo will received Brent pricing.

Well results continue to improve in the Midland Basin. Much of this is due to well design, as we continue to see longer laterals, shorter stage length and increased volumes of proppant. This is the same story as other US plays, but the large number of intervals continues to provide upside to Midland Basin players. Below is a table of well results throughout Midland.

Well Lateral (Ft.) Stages

Peak IP 30 (Boe/d)

%Oil County Operator Interval
Kemmer 4209H 3,733 15 712 85 Midland FANG B
ST NW 2501H 4,451 19 655 90 Midland FANG B
ST NW 2502H 4351 16 500 88 Midland FANG B
Sarah Ann 3812H 4830 18 711 88 Midland FANG B
ST W 4301H 7141 29 916 85 Midland FANG B
ST W 701H 7280 29 774 92 Midland FANG B
ST W 4302H 7071 30 438 87 Midland FANG B
Private 5041 733 90 Midland Private M. Spraberry
Janey 16H 3842 16 486 86 Upton FANG B
Neal A Unit 8 1H 7441 32 697 87 Upton FANG B
Janey 3H 4411 19 488 82 Upton FANG B
Neal B Unit 8 2H 6501 26 617 73 Upton FANG B
Kendra A Unit 1H 7411 30 677 82 Upton FANG B
Janey 2H 4572 19 391 88 Upton FANG B
Janey 4H 4564 10 454 88 Upton FANG B
Neal 8 8H 7444 644 Upton FANG B
E Bloxom (4 Well Avg.) 605 Upton (NYSE:CPE)
Giddings Estate 3049H 2628 427 88 Upton (NYSE:PXD) Jo Mill/L. Spraberry
Giddings Estate 1019H 2178 427 89 Upton PXD Jo Mill/L. Spraberry
2 Giddings Wells 5300 Avg. 669 Avg. 75 Upton PXD B
Dorcus 303SH 5000 1226 82 Upton (NYSE:SM) B
Jacee A Unit 1H 7541 632 83 Upton FANG B
Hutt C 2H 7380 1107 Midland PXD A
Hutt C 1H 7380 1402 75 Midland PXD B
Hutt C 3H 7142 1087 75 Midland PXD B
Hutt C 4H 6962 856 69 Midland PXD D
Scharbauer Ranch 202H 8342 783 73 Martin PXD B
Mabee K 1H 6671 1040 76 Martin PXD B
Scharbauer Ranch 201H 7862 662 60 Martin PXD D
Barracuda 45-4H 4560 511 Glasscock (NYSE:APA) D
Barracuda 45-2H 3780 623 Glasscock APA D
RSP 4800 576 Ector Private Lower Spraberry
SFH Unit 23 1H 7268 701 89 Howard Element A
Lavaca 38 101H 4250 709 60 Glasscock (NYSE:EGN) A
Llano 8 8A 101H 4250 683 69 Glasscock EGN A

Pioneer's above data provides models consistent with EURs of 800 MBoe in the Wolfcamp A and B. Hutt C 1H has produced 170 MBoe in 9 months. Its current model provides EURs of 1000 MBoe with a resource mix of 73% oil. PXD's ET ODaniel 1H had a peak 24-hour IP of 2801 Boe/d. It is the best B well in its northern acreage to date. The Hutt C 2H is a well that produced 115 MBoe in 5 months. Its resource mix is 74% oil. PXD labels its intervals differently than other operators. Although most operators refer to the interval below the C interval as the Cline. PXD refers to this as Wolfcamp D. It also believes there are two C intervals, C1 and C2. This causes some confusion, but I believe it is easiest to use D interchangeably with the Cline. Pioneer has a couple of D wells with good 30-day IP rates. This interval has underperformed other source rock, but is still economic. The University 7-43 10H reported the best 24-hour peak IP rate of 3605 Boe/d. This well is located in Andrews County, and provides upside to the area. Its depletion rate will be significant. PXD has another very good producer from the D in Midland County. The ET ODaniel 2H reported a 24-hour peak IP rate of 3156 Boe/d. The lower and middle Spraberry have been tested in northwest Midland County. These RSP wells had unimpressive 24-hour IP rates of 733 Boe/d (M. Spraberry) and 630 Boe/d (L. Spraberry), but the laterals were short. This is a fairly shallow play, so well costs are low improving economics. SM Energy also tested the Leonard/Clearfork shale in Andrews County. The University 29 Sawgrass 2H was a 7933 lateral with a 24-hour IP rate of 492 Boe/d and 85% oil. Reliance Energy (private) tested the Atoka, and had a 24-hour IP rate of 897 Boe/d. The Mabee 138 801H is a 4545 foot lateral and its resource mix was 74% oil. More importantly was the completion in northwest Howard County. This was a good result in the A, and very important for Athlon as the bulk of its leasehold is in that county. Occidental's Wolfcamp A test with the Hendrix 1H is also interesting. We continue to see longer laterals, and Pioneer has been doing this more than anyone in the Basin. It has three total completions with lateral lengths over 10000 feet. Two are in Irion and the other in Reagan.

Well Target Lateral %Oil IP 30 Boe/d County
Lane Trust-C/E-421HU A 7188 76 1391 Glasscock
Lane Trust-C/E-422HU C 7571 79 1406 Glasscock
Sugg-A-143-2HU A 7200 78 1351 Reagan
Sugg-D-106-2HL C 7201 66 1172 Reagan
Sugg-A-157-1H A 6128 73 1096 Reagan
Sugg-E/A197-1HU A 7470 71 1024 Reagan
Sugg-A-143-1HU A 6128 76 1096 Reagan
Sugg-A/A208-1HU A 66 843 Reagan
Sugg-A-143-3HU A 6660 73 1062 Reagan
Sugg-A-143-4HU A 7033 79 1290 Reagan
Sugg-C-27-1HM B 7740 77 1128 Reagan
Sugg-C-27-3HU A 7740 73 1107 Reagan
Sugg-A-183-1HM B 6930 80 1047 Reagan
Bearkat-150-5H Cline/D 7284 74 835 Glasscock
Glass-Glass 10-153H Cline/D 6933 1331 Glasscock
Cox Bundy 16 3H Cline/D 4382 922 Glasscock
Curry-Glass 10 151 HU A 6604 747 Glasscock
Sugg-A-142 1H Cline/D 6695 764 Reagan

The wells Laredo has drilled in both Reagan and Glasscock counties are as good if not better than those from the first table. Laredo generally reports on a 2-stream basis, so I increased the IP rate appropriately. When comparing its results to Energen we see Laredo's are significantly better.

In summary, Laredo continues to outperform as an operator. It continues to downspace acreage, and looks to have years of tests ahead. Pad drilling the Wolfcamp and Cline should decrease costs, while results should continue to improve as Laredo gets more comfortable. Its recent pullback is a buying opportunity. All of the negative announcements are short-term issues, and are not detrimental long term. I am bullish several Midland Basin names. While I believe Laredo is the best value, both Athlon and Diamondback look well positioned. Use the pullback as a buying opportunity; we should see significant appreciation over the next 12 months.

Disclosure: I am long LPI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not a buy recommendation. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results, do not take into consideration commissions, margin interest and other costs, and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market or financial product does not guarantee future results or returns. For more articles like this check out our website at Fracwater Solutions L.L.C. engages in industrial water solutions for oil and gas companies in North Dakota. This includes constructing water depots, pipelines and disposal wells. It also provides contracting services for all types of construction at well sites. Other services include soil remediation. Please contact me via email if you are interested in working with us. For more of my articles and other pertinent information on the oil and gas sector, go to