Permian mega-merger expected to save Concho on oil, gas drilling costs

Houston (Platts)--28 Mar 2018 429 pm EDT/2029 GMT

Concho Resources' $9.5 billion acquisition of rival independent oil and natural gas producer RSP Permian, announced Wednesday, will give the combined company the largest drilling program in the Permian Basin and allow it to lower breakeven costs at a time of prolific industry expansion there.

Analysts cheered the deal as a sign that M&A activity in the basin that spans West Texas and southeastern New Mexico will continue to be robust as exploration and production companies, as well as midstream operators, look to leverage greater scale as a hedge against the uncertain trajectory of commodity prices.

Controlling costs, in particular, has been a key focus in the Permian as the sheer number of players there has made drilling, completion and related infrastructure more expensive. The two companies cited the potential for significant synergies from integrating assets, systems and corporate staff, with the present value of identified savings expected to exceed $2 billion.

"M&A always sparks chatter on who could be next," Wells Fargo Securities analyst Gordon Douthat said in a note to clients.

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While the Permian is largely an oil play, significant amounts of associated gas are being lifted, and the industry is increasingly looking to new gathering systems and pipelines to move that gas to the Gulf Coast for use by export facilities and petrochemical plants. Permian gas production has grown 1.2 Bcf/d since this time last year, as drilling continues to ramp up in the basin, data compiled by S&P Global Platts Analytics shows. Since the first of the year, 85 rigs have been added to the basin, bringing the total rig count to nearly 450, and informing growth in the forecast. Platts Analytics expects an incremental 1.1 Bcf/d of growth by the end of the year to reach 8.1 Bcf/d.

This growth, and the expectation of more, continues to weaken cash and futures prices at West Texas Waha. Cash basis has averaged an 81-cent/MMBtu discount to Henry Hub over this March, a 56-cent/MMBtu decline from cash trades during March of last year. Additionally, since the start of the year, the Summer '18 strip has fallen 44 cents/MMBtu, most recently trading at a $1.23/MMBtu discount to Henry Hub. Likewise, the Summer '19 strip has declined 53 cents/MMBtu to trade at a $1.50/MMBtu discount.

More M&A activity in the Permian also is expected to impact the oil sector. Analysts have suggested it could mean surging production on top of the record 10 million b/d of US crude output seen recently. Further US growth could drag down oil prices.

Experts say when acreage changes hands, production usually does not remain the same. Instead, operators set to work improving per-well yields through efficiencies and better completion designs. At the same time, producers may drill even more on their retained and new assets.

Concho and RSP Permian cited their complementary asset bases as a key driver for the all-stock transaction, which includes RSP Permian debt and is expected to be completed in the third quarter.

The deal will add about 92,000 net acres to Concho's existing acreage position in the Permian for a combined position covering more than 640,000 net acres. In the fourth quarter of 2017, production on RSP's assets totaled roughly 55,500 b/d of oil equivalent, of which approximately 80% was crude oil and 20% natural gas.

The transaction, which is subject to the approval of both Concho and RSP shareholders and certain regulatory approvals, adds 2.2 billion boe of resource potential, of which more than two-thirds is premium resource and will allow the new Concho to run the largest drilling and completion program in the Permian with 27 rigs, the companies said in a statement. Concho will continue to be headquartered in Midland, Texas.

"As the industry migrates from resource capture/discovery into manufacturing mode, we have argued the strong industrial logic for shale M&A to lower corporate breakevens and enhance geographic footprints into more blocky acreage," J.P. Morgan analysts, including Arun Jayaram, said in a note to clients. "Concho just announced such a deal with an M&A transaction for RSP Permian, which has a premium asset base in the Midland and Delaware Basins."

--Harry Weber and Liz McFarland,

--Edited by Kevin Saville,

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