Stick with Permian Basin

[dan_s]

Deutsche Bank - Equity Research - North America

Permian Basin - A Winning Season And Out Front For A Repeat Performance
Initiating Coverage of FANG and PE at Buy, LPI at Hold. U/G RSPP To Buy
By any measure, 2015 was a winning year for the Permian Basin as volume growth surpassed the Eagle Ford and Bakken, M&A was fairly active, the resource base expanded, successful equity issuances reduced leverage and increased acreage positions, and most important, the equities outperformed peers. Although it’s tough to repeat as champ, we anticipate more of the same in 2016 with the resource further unfolding and cost structure improvements stabilizing margins for the current low price environment while also setting up the basin for a faster recovery in the next up cycle. We initiate coverage of FANG/PE at Buy and LPI at Hold. Upgrade RSPP to Buy from Hold.

Some Things Change, Some Things Don’t – Sticking With The Permian
While the Permian hasn’t gone unscathed by lower commodity prices and we saw the impact of the downturn during our recent visit (rig supervisors are now Uber drivers), the basin has proven more durable than other oil driven basins. In an environment where margins are hurting and producers are under pressure to show growth with the least amount of balance sheet risk, all points lead back towards the Permian for outperformance as the basin offers the best combination of resource expansion (downspacing, Spraberry), margins ($21/boe Permian vs. $19/boe non-Permian), and volume growth in our view. While acknowledging the equity performance of the basin producers reflects a portion of this outlook, we like the set up into 2016 on both a relative (WTI remains $40-50/bbl) and absolute (WTI improves to $60+/bbl) basis. Additionally, the Permian continues to be ripe for consolidation with a large, fragmented, and high quality inventory base in a friendly oil field environment. This has kept valuations holding steady above $20k/net acre (unadjusted) for large core acreage acquisitions, the same as the $90/bbl 2014 environment, which we see as supportive for the equities and further consolidation.

Basin Challenges – There’s Still A Lot To Be Determined
Although equity valuations remain the challenge we see on the screen every day (14.3x average 2016 EV/DACF ex-PXD vs. 10.6x broad group average), there are still basin challenges we are mindful of that could come into play during 2016. From a well performance standpoint, we’ve seen a fair amount of uniformity in results, but we’re just in the early stages of horizontal development and there’s a risk that with further testing, formations and well flow rates may not be as prevalent across counties, leading to a more distinct bifurcation in acreage positions (we believe FANG, RSPP, and PE hold the leading amongst smid-caps). Last, while not as pressing an issue due to the activity slowdown, we see infrastructure build out still moving forward as producers look to minimize reliance on trucking (more weather risk and lower realized price) and improve margins.

Initiation of Coverage: FANG, PE – Buy, LPI – Hold
Adding to our existing Permian-focused coverage group (CXO, EGN, RSPP, XEC, PXD, ECA, EPE) we are initiating coverage of Diamondback Energy (FANG) and Parsley Energy (PE) at Buy and Laredo Petroleum (LPI) at Hold, and we are upgrading RSP Permian (RSPP) from Hold to Buy. Additionally, while we like both sides of the Permian, our current preference lies in the Midland as the catalyst calendar lines up better following a strong performance out of the Delaware in 2015. Please see company details starting on page 19.

Valuation and Risks
We value the E&P’s on NAV assuming long-term commodity prices of $75/$3.75 with our Permian focus group having ~16% upside to price targets. Key risks for the basin include execution of development projects, type curves below expectations, and delineation (geologic) risk.

[dan_s]

The Permian Basin and SCOOP/STACK (in Oklahoma) seem to be the only two areas that can generate decent returns at today's oil price. The exception may be the very best acreage in the Eagle Ford, where EOG is reporting double digit RORs.