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Which two companies are eyeing up America’s largest untapped oil play?

The Permian Basin is much bigger than both the Bakken and the Eagle Ford plays

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

Feb 14, 2014

by Jody Chudley

The Play

Despite all the talk about it, the single biggest oil play in the U.S. isn’t the Bakken. It’s not the Eagle Ford, either, although that one’s substantial. No, the single biggest oil play in the U.S. is the Permian Basin. And it isn’t even that close.

According to the Texas Railroad Commission, the Permian Basin, which covers an area roughly 500 kilometres long and 400 kilometres wide in Texas and New Mexico, has produced more than 29 billion barrels of oil since production began in 1923. It’s not tapped out yet, either. The Spraberry/Wolfcamp formations, which are found in the Permian basin, are estimated to contain up to 50 billion barrels of oil. That 50 billion barrel figure is twice as large as the Eagle Ford and three times the size of the Bakken.

The area already accounts for roughly 20 per cent of U.S. oil production and reserves. Production in the Permian peaked at two million barrels per day in 1973 and fell to a low point of 750,000 barrels per day by 2007. Up until now most of the wells that have been drilled in the Permian have been of the vertical variety. Now, with a more complete understanding of the Permian geology, drillers are about to attack the play with horizontal wells.

But the Permian isn’t really just one play. It is more like six to 10 different plays stacked on top of one another. With all of these stacked zones, taking horizontal drilling into the Permian isn’t like finding a new Eagle Ford. It is like finding several Eagle Fords.

The Picks

Concho Resources (NYSE:CXO)
1-year total returns (C$): 26.5%

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Concho Resources is the largest pure-play in the Permian today. The company has more than 630,000 net acres spread across the Delaware and Midland basins. With current production almost reaching 95,000 barrels per day (62 per cent oil), Concho is of sufficient size to start attracting the interest of a larger producer looking to make a big splash in the Permian through a takeover.

It’s not a takeover-or-bust story, either. If Concho doesn’t get bought in the next couple of years, the company’s growth strategy should still make for happy shareholders. Concho plans to double production by 2016, which would equate to a 2 5 per cent annualized growth rate. That is impressive for a company already producing 95,000 barrels per day. But what I like most about Concho is that replicating a land position of this size in a play like the Permian is no longer possible. Despite what the media may suggest, there really are only a few major horizontal oil plays, and the land in them will only get more valuable over time.

Lynden Energy (TSE:LVL)
1-year total returns (C$): -23.7%

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Lynden Energy is a company that is sort of stuck in no man’s land. The company’s assets are located in Texas, but the stock is listed in Canada. Potential American investors are a bit put off by the listing in Canada, and potential Canadian investors aren’t as familiar with its Texas-based assets as they might be. That may be why Lynden’s shares don’t seem to reflect the value of its assets.

And there’s definitely value in them. With a 50 per cent working interest in 67,000 acres (the Mitchell Ranch) in t he Permian Basin, this little company offers an unusually large amount of acreage per dollar of market capitalization. Larger competitors are drilling up the land all around Lynden, which is effectively “de-risking” their property for them. And in addition to its large non-producing acreage position in Mitchell Ranch, Lyden has a core 6,500-acre Wolfberry project that has 1,200 boe/day of production (70 per cent oil). Based on recent transactions, it wouldn’t be a stretch to suggest that the Wolfberry project alone supports the current Lyden share price. That means investors get the Mitchell Ranch acreage for free.

The PostScript

There is a huge amount of oil in the Permian that horizontal drilling can unlock. But there’s a caveat: the Permian requires higher oil prices ($90-plus) to be economically viable. That is because the rocks in the Permian are harder, which means drilling costs more money. The play also requires handling huge quantities of water that are produced along with the oil, adding another cost. Still, the upside associated with the Permian is tremendous.

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