Oil prices are expected to rise after the OPEC deal and there is upside potential for production and IRRs

OREANDA-NEWS. December 14, 2016. Clearly, the alleged deal between OPEC members and other cooperative nations has generated a fair amount of optimism among market participants. However, given so many unknowns and the near term mentality of the agreement, what the future may hold with respect to production and prices is, to say the least, a moving target. Nonetheless, as prices are expected to rise, there is upside potential for production and internal rates of return (IRR), particularly in premier basins like the Permian.

To no surprise, the Delaware and Midland basins in the Permian are generating some of the best returns in the country. Platts Bentek’s Well Economics Analyzer estimates that the IRR for a typical well in the Permian Delaware is currently 37% and is generating the best returns in North America. Let’s assume the stars align and OPEC along with cooperating countries are compliant with supply cuts and prices reach \\$65/b; what does this mean for IRRs in the Permian?

If this scenario were to play out, returns in the Permian Delaware would increase 14 percentage points to 51% IRR, holding regional price differentials constant. Well economics in the Delaware surpass those of competing plays with a robust oil initial production (IP) rate of 575 b/d, \\$6.0 million estimated drilling and completion (D&C) cost and a production mix that is heavily weighted towards oil at 76%. Not only that, the Delaware’s proximity to demand centers in the US Gulf Coast area and the overall quality of the barrel set it apart from the rest of the herd.

In the neighboring Midland basin, the second most profitable play in North America, returns are currently 34% and would jump to 48% at \\$65/b WTI. Oil IP rates in the Midland are roughly 100 b/d below those in the Delaware. However, on average, the play enjoys a D&C cost of \\$5.5 million, half a million dollars less than the Delaware and also reaps the financial benefit associated with proximity to refining centers along the Gulf Coast.

So what does \\$65/b WTI mean for production in the Permian? Platts Bentek estimates total Permian crude production will average a little less than 2 million b/d in 2016. However, given \\$65/b crude prices, production has the ability to increase 120,000 b/d in 2017. From a strictly quantitative standpoint, this estimate is more than reasonable. However, in reality, this estimate is rather conservative given accelerating efficiency gains and a vast inventory of drilled but uncompleted wells.