One year ago, a private shale operator was sitting in the catbird seat. As their public counterparts had been preaching capital discipline and increasing returns to shareholders, private drillers had the ability to increase near-term spending and add rigs in a depressed service price environment.
As commodity prices increased from $75/bbl to over $120/bbl in the first half of the year, well-level returns surpassed 100% IRRs.
Despite these juicy returns, public shareholders punished any operator who increased their capital budgets. The founder and largest shareholder of Continental Resources – Harold Hamm - became so frustrated that he bought the company back from the public markets for a mere 15% premium over the previous day’s closing price. Compare this to Elon Musk’s 38% premium paid for Twitter, a business whose path to positive cash flow remains murky.
However, as the geopolitical risk premium for oil relaxed, WTI ended the year right where it started – hovering between $75 and $80/bbl in the month of December.
In 2023, public operators are now reaping the benefits of their 2022 discipline. Flows of public capital are returning to the E&P space despite the reduction in commodity prices from their $120/bbl highs. Case in point, the XLE index - a market-weighted index of all energy companies in the S&P 500 – was up more than 33% during the 2022 year. Rather than spend excess earnings on drilling new wells, this group paid dividends, bought back stock, and paid down debt. Combine this shareholder-friendly behavior with a broader market pullback (S&P index down 17%) and pain in the tech sector (Nasdaq down 30%), and public operators have a compelling story to tell to portfolio managers to start 2023.
The bifurcation between public and private operators continues in 2023 on the subject of inventory: in both inventory quality and inventory depth. A leading voice in energy research estimates that in the Permian Basin, private operators represent 50% of current drilling activity, but only 20% of remaining drillable inventory. This imbalance presents a couple of different opportunities.
First, public operators with short (<10 year) inventory runways must add drillable locations in order to compete for public capital. If these companies are unable to add locations through exploration (the “E” of E&P), then they must acquire. A public acquisition target will be difficult to take down, as the relative valuations between two businesses would likely be wide.
The remaining option is to purchase a private business who has proven up an AOI and left “meat of the bone” for an acquirer to develop.
Second, public operators with extended inventories (30+ years) can realize immediate value on locations that don’t compete for capital in the foreseeable future. At a 10% discount rate, the present value of a cash flow 30 years in the future are worth less than 6% of that total today. In a world where public operators are rewarded for capital efficiency and returns to shareholders, those blessed with extended inventories can continue their 2022 habits of debt paydowns, buybacks, and dividends with proceeds from farm-ins or outright sales of these far-future locations. Given the number of inventory-constrained private operators, sellers would likely find a robust market of potential buyers and/or farm-in partners.
One final factor calculating inventory quality estimates is the ever-increasing complexity of infill development.
As greenfield inventory decreases, new wells must be drilled in locations offset by existing wells. Importantly, influential parent wells may not be in the same landing zone as the new wells as they cause destructive interference. The result is a complicated balancing act to identify the next location that competes for capital (reservoir quality vs lateral length vs well boundedness vs completion design etc.).
Quantifying inventory depth and ranking PUD locations are increasingly important topics to public operators, private operators, investors, and advisors.
Our latest technology offering, Petro.ai Cloud, contextualizes dozens of geologic and engineering inputs to deliver analytics-ready data sets to aid in this type of inventory analysis.