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The SCOOP On Oklahoma And How It's STACKing Up

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Includes: AMR, CLR, DVN, ECA, ENBL, ENLC, MRO, OKE
by: Alerian
Summary

The broad decline in the rig count in Oklahoma over the last year has likely reflected oil price volatility as well as increased drilling efficiencies. The trend in recent months for the SCOOP and STACK has been bifurcated, with the SCOOP’s rig count gaining and the STACK’s falling.

Despite headlines that may be perceived negatively, many E&Ps continue to report positive results from both the SCOOP and STACK.

Rather than an issue with geology, the struggles of STACK-focused Alta Mesa Resources have been primarily due to mismanagement and a lack of operational execution.

We interrupt your regularly scheduled Permian update to focus on Oklahoma this week. While easily overlooked by the casual observer, upstream and midstream operators in the SCOOP (South Central Oklahoma Oil Province) and particularly the STACK (Sooner Trend Anadarko Canadian and Kingfisher counties) have made waves recently. EnLink Midstream (NYSE:ENLC) lowering volume guidance in the STACK, relative strength in the SCOOP, shifts in activity, and the struggles of STACK-focused Alta Mesa Resources (NASDAQ:AMR) have generated buzz around Oklahoma. Today, we'll look at current trends in the SCOOP/STACK, analyze producer activity for a potential slowdown in the region, and discuss the impact on midstream companies.

Before diving in, it's important to note that the SCOOP/STACK are in earlier development stages than more mature plays like the Permian. This means producers are still working to appraise their acreage and optimize drilling. Additionally, in a volatile oil price environment, producers are likely to shift resources to more developed plays that may offer higher returns. These factors can contribute to near-term noise around the SCOOP/STACK apart from the long-term outlook for the play.

Oklahoma has attracted interest from E&Ps and midstream providers.

The SCOOP and STACK plays in Oklahoma have been attractive to producers over the past few years given their relatively low acreage cost (compared to the Permian) and proximity to the Cushing oil hub. While the SCOOP, STACK, and MERGE, which is the area between the STACK and SCOOP that includes portions of Grady, Caddo, and Canadian counties, represent a relatively small geographic area of Oklahoma (see map below), they have driven a steady climb in oil and gas production in the Anadarko Basin.1 Canadian E&P Encana (NYSE:ECA) cited the quality of Newfield Exploration's large position in the SCOOP/STACK when acquiring the company earlier this year. Producer interest and activity in the state has also driven midstream interest. In October 2018, Enable Midstream (NYSE:ENBL) announced that it was expanding its Oklahoma crude footprint with the acquisition of Velocity Holdings. The acquisition increased the company's crude gathering and transportation capabilities in the SCOOP and MERGE plays, enhancing its ability to capitalize on changing upstream activity as discussed below.

SCOOP/STACK rig counts are down year-over-year, but the SCOOP has seen gains in recent months.

Rig activity across the SCOOP and STACK has declined on a year-over-year basis, which is likely the result of both oil price weakness in 4Q18 and increased drilling efficiencies. According to Baker Hughes, the rig count2 for the SCOOP and STACK declined ~40% from 76 to 45 rigs year-over-year as of May 31. This drop coincides with a less than 10% decline for the overall US land rig count and declines in the Permian and Eagle Ford of ~5-6% over the same time period. The earlier development stage of the SCOOP/STACK may contribute to the larger decline in rig count. Amid oil price volatility, producers are likely to focus their resources on less prospective plays like the Permian where there is less guess work and likely stronger returns. Notably, the rig count trend for the SCOOP/STACK in the last two months has been bifurcated. Since the end of March 2019, the SCOOP has gained five rigs, while the STACK has lost eight rigs.

Given the volatility of oil prices recently, E&Ps have focused on drilling in quality areas and improving efficiency by boosting production per rig, lowering well costs, and improving cycle times. In other words, producers are doing more with fewer rigs. E&P Continental Resources (NYSE:CLR) reported in April that oil production growth from its SpringBoard project, a major drilling initiative in the SCOOP, has exceeded expectations and is achieving its 2019 objectives with 25% fewer rigs. CLR announced sequential growth in SCOOP production in 1Q19, even as production fell slightly in the STACK. Encana said it would cut from ten rigs in the STACK in 4Q18 to four over the course of 2Q19 but has also detailed strong production numbers recently. In an interim operations update released on June 10, ECA reported quarter-to-date crude and condensate production in the Anadarko Basin that represented nearly 20% pro forma growth from the 1Q19 average, which was driven by strong performance from new wells in the STACK. Another large player in Oklahoma, Marathon Oil (NYSE:MRO) cited strong results from infill drilling3 in the STACK in 1Q19 as the company continues to optimize spacing between wells.

Devon Energy (NYSE:DVN), ENLC's largest E&P customer and former parent, is maintaining operation of five rigs in the STACK in 1Q19 after dropping from eight rigs to five sequentially in 4Q18. DVN's 1Q19 volumes were better than expected despite bad weather, and the company noted STACK well results that exceeded expectations. However, DVN's management said on the 1Q19 call that it would drop a frac crew in the STACK in 2H19 and that reducing investment in the STACK would be the first lever to pull if needed to stay within its capital budget. In other words, DVN would prioritize other plays over the STACK if necessary.

From a midstream perspective, ENBL and ONEOK (NYSE:OKE) noted that they are seeing activity shift from the STACK to the SCOOP to target more liquids-rich areas during their respective 1Q19 earnings calls, which is consistent with the rig count trends discussed above. ENLC similarly indicated on its 1Q19 call that some of the rig count reduction in Oklahoma is the result of improved drilling efficiencies related to the use of multi-well pads and smaller focus areas.

Oklahoma volume growth has been slowing, but is it an issue for midstream?

According to the Energy Information Administration, May 2019 oil and gas production from the Anadarko Basin is expected to be up ~9% from May 2018. However, production has been declining in recent months from prior highs. With the rig count falling and production slipping modestly, investors are likely trying to decipher the implications for midstream. ENLC describes itself as having the largest integrated midstream business in the three core STACK counties - Blaine, Kingfisher, and Canadian. The company attracted attention when it lowered its full-year 2019 growth rate for natural gas gathering and processing volumes in Oklahoma to 10-15% with its 1Q19 earnings release after previously guiding to 29% growth at the midpoint. While growth is now expected to be more moderate than before, double-digit volume growth is still healthy. Looking out further, ENLC management remains confident in STACK volumes increasing over the long term.

In a similar vein to ENLC, OKE operates natural gas and NGL-focused midstream assets in the Anadarko Basin. On its 1Q19 earnings call, OKE reaffirmed its guidance for 2% year-over-year volume growth in the SCOOP/STACK and said producer activity in the area is in line with expectations. Despite the overall decline in rig count, ENBL's dedicated rig count in the SCOOP/STACK increased from 35 rigs in 3Q18 (first quarter with Velocity's assets) to 38 rigs in 1Q19. While the STACK has likely been more challenged than the oilier SCOOP, it's important to note that many midstream operators in Oklahoma have leverage to both plays. Of course, even more broadly, ENBL, OKE, and ENLC have diversified asset footprints and are not solely dependent on Oklahoma activity.

Alta Mesa Resources' struggles add to noise in the region.

Some of the noise around Oklahoma has been compounded by the recent struggles of Alta Mesa Resources, a STACK-focused E&P with supporting midstream assets that began trading in February 2018. Citing attractive well economics and the relatively cheap cost of acreage, Alta Mesa bet big on drilling in the STACK. In recent quarters, AMR has reduced its estimates for average well production, daily production, and pipeline volumes. This year, the company has written down assets by $3.1 billion, laid off nearly a third of its employees, and is being investigated by the SEC for potential fraud due to reporting errors. AMR's missed targets and lowered guidance are largely the result of numerous missteps by management and high spending rather than a significant geological issue in Oklahoma. Fortunately, AMR's problems do not have much direct read-through for E&Ps and midstream companies in the region.

Bottom Line

Headlines around the SCOOP and STACK may be easily interpreted by midstream investors as cause for concern, but these likely read more negatively than the reality. For example, increased drilling efficiencies and a shift to the SCOOP from the STACK soften the implications of the notable decline in the rig count over the last year. Many E&Ps continue to report positive results from both the SCOOP and STACK. Undoubtedly, the SCOOP/STACK have more variability and are in earlier stages of development compared to more mature plays like the Permian, and therefore, news flow will likely continue to be mixed. For midstream investors, there is little cause for concern given diversified asset footprints, rising activity in the SCOOP, and continued E&P optimization across both plays, allowing more to be done with fewer rigs.

1. The Energy Information Administration defines the Anadarko basin as a region encompassing western Oklahoma and the Texas Panhandle.

2. We used the Cana Woodford Basin on Baker Hughes website. The Cana Woodford largely encompasses the SCOOP and STACK.

3. Infill drilling is the practice of increasing the number of wells in an area, reducing average well spacing and speeding up expected recovery.

Disclosure: © Alerian 2019. All rights reserved. This material is reproduced with the prior consent of Alerian. It is provided as general information only and should not be taken as investment advice. Employees of Alerian are prohibited from owning individual MLPs. For more information on Alerian and to see our full disclaimer, visit http://www.alerian.com/disclaimers.

Michael Laitkep is an Energy Research Analyst at Alerian, which equips investors to make informed decisions about energy infrastructure and Master Limited Partnerships (MLPs). Mr. Laitkep seeks to promote understanding of the Alerian Index Series and support broader understanding of the role that midstream assets play in North American energy markets. Mr. Laitkep previously worked as an Investment Operations Associate at Capital Group in Los Angeles. Mr. Laitkep earned his B.A. in Plan II Honors and his B.B.A. in Finance from the McCombs School of Business at The University of Texas at Austin.