SCOOP / STACK

[dan_s]

May 23: JP Morgan SCOOP/STACK Tour: Key Takeaways from Field Trip and Houston Bus Tour

What is a highly economic U.S. onshore resource that sits at the low-end of the U.S. cost curve, with significant running room, stacked pay potential, and a wide array of inventory catalysts? While the knee-jerk answer of the Permian Basin is correct, the STACK play in Oklahoma is emerging as a worthy second fiddle, we think. The key takeaway from our field trip was growing confidence that operators in core acreage could shift to development activities in 2017/18, which we believe has positive implications for companies such as CLR, DVN, and NFX as well as ENBL and ENLK on the midstream side. Meanwhile, we see meaningful inventory catalysts in 2H16 as the industry tests tighter spacing, staggered laterals, and stack pay potential through several pilots. The play looks to be highly service intense, requiring increased proppant loads and the latest technology toolkit (diverters) from OFS, which favors stocks such as HAL. In this note, we highlight key conclusions from our SCOOP/STACK focused trip as well as our Houston bus tour.

STACK play poised to shift into development mode. The market does not ascribe much value for plays that have not yet been de-risked, but early identification of a new economic resource can lead to outsized returns. In order for a company to receive significant value for a new play or drilling concept, investors need to be convinced of the economic returns of the play, repeatability, and inventory running room. Under our returns framework, we believe the STACK play has the potential to be the next franchise asset in U.S. E&P, joining plays such as the Permian Basin and Wattenberg. The key unknown heading into our trip was the potential of the industry to deliver repeatable results. We did hear commentary about variability in parts of the play, but operators in the core (DVN, NFX) articulated their growing confidence about the repeatability of drilling results and plans to shift into development mode starting in 2017.

Landing zone seen as key enabler of repeatable results: DVN has identified five unique landing zones in the Meramec, with three in the Upper Meramec (100, 200, and 300 series) and two in the Lower Meramec (400 and 500). DVN estimates the industry has drilled approximately 140 Meramec wells and 10 Osage wells. The lion’s share of prolific wells results, including DVN’s, appear to have been drilled in the Upper Meramec 200 series interval, once again illustrating the importance of correctly landing the lateral. NFX noted that the consistency it has seen across its acreage is greater than any resource play that the company has participated in thus far, which includes the Eagle Ford and the Bakken.

A plethora of 2H16 inventory catalysts: XEC is participating in two Meramec spacing pilots, including the DVN Alma downspacing pilot that is testing 5 wells per section in the Meramec. Per our meeting with DVN, it appears that the initial production data from this pilot is meeting expectations. The company also has an aggressive 8 well spacing pilot called Leon-Gundy, which is testing stacked/staggered spaced Meramec wells (10 wells per section) and stacked pay potential in the Woodford (9 wells per section). XEC indicated that it plans to finish completion operations on the Leon-Gundy test in Q316, with data likely available in early 2017. DVN is also testing the effectiveness of up to 8 well stacked/staggered patterns in the Meramec. Meanwhile, MRO is set to release well results from up to 4 extended laterals in the Blaine County core near NFX’s prolific Scheffler well, which delivered an IP-30 of 1,843 Boe/d (77% oil), on its Q216 call.

Select Midstream operators well positioned for attractive STACK growth. Despite significant producer activity that validates the STACK’s attractive economics, we believe that some midstream investors do not fully appreciate the growth opportunity set for those with underutilized infrastructure and the right producer relationships to capture incremental growth capex opportunities. We look for this theme to more fully emerge heading into 2017 as producers discuss plans to move into development mode for the play. In our view, the three clear winners from growing STACK production include: ENBL, ENLK, and ONEOK, with some benefits for TRGP, MPLX, and DPM. For production specific catalysts tied to the strongest producer customer relationships for each name, we look to CLR for ENBL, DVN for ENLK, XEC for OKE, and NFX for MPLX. Additionally, conversations with producers indicate that Targa is making strong inroads into the play to win market share.

ENBL holds significant leverage to future STACK/SCOOP volume growth. Enable’s ~1.6bcf/d Anadarko system overlays the STACK/SCOOP, and with almost 200mmcf/d of underutilized processing capacity directly connected to the play, is best positioned, in our view, to serve incremental gathering, processing and takeaway from the basin without significant capital outlays. The interconnected super-header system connects eight ENBL processing plants (with two Anadarko plants adjacent to the header) and provides unmatched flexibility, reliability, and optimization opportunities. To facilitate additional volumes, ENBL plans to expand processing capacity by ~400mmcf/d with the Bradley II (mid-2016) and Wildhorse (2017) plants. ENBL also possesses leverage to intrastate and interstate takeaway needs as well.

Oil Services equities pricing in a robust recovery; someone forgot to tell the E&Ps. While much of our discussions were certainly recovery-focused, we came away with our skepticism of the consensus call for a robust one getting under way near term intact. Capital efficiency remains the mantra of the day, and E&Ps nearly universally are utilizing the slowdown to refine best practices to drive higher production per well and lowering costs. Though estimates of the of the cost savings drivers range, a rough ballpark of half cyclical (i.e., pricing deflation) and half structural (doing it better) appear reasonable. There were a few anecdotes of potential rig adds in 2017, but hardly enough to justify current equity valuations, in our view. On a more positive note, the increased focus on technology and data collection/analytics as a means to drive more productive wells dovetails nicely into a more technology-driven NAM market, and a particular opportunity for the diversifieds, in our view. At this point in the cycle, both sides are mostly reticent to lock in terms, though we heard some anecdotes of discussions and the occasional agreement (including a 12-month rig contract signed at an "attractive rate" in the Utica).

Halliburton's base case for a slow, W-shaped recovery; HAL remains our preferred U.S. vehicle and a top pick. The U.S. onshore leader continues to benefit from the “flight to quality” for service providers (with top line outperforming rig count) and we think the company is aggressively pursuing market share at this point of the cycle. HAL believes $50-55 WTI is insufficient for a broad-based recovery (+$60 needed), and instead its base case is a modest recovery characterized by fits and starts. The company believes the “landing zone” for U.S. onshore activity is likely around midyear, with potential for modest uplift in 2H16. While HAL thinks the pumping hp attrition story is underappreciated, it also emphasized the working fleet today remains well underutilized and would fill the initial demand before pricing could improve to incentivize fleet reactivations. Sand usage remains the lone bright spot in the downturn; HAL noted while the rig count is down 80% off peak, its sand usage is down only single digits. HAL remains our preferred vehicle for U.S. onshore oil services exposure.

Downstream and Chemicals: While PSX’s tone on downstream was favorable on gasoline demand dynamics, the company acknowledged that gasoline supply, distillate fundamentals and light crude differentials were all headwinds. That said, it did not expect to see industry run cuts unless crack spreads go below $10/bbl. For Chemicals, PSX remained upbeat on full chain margins, given healthy demand dynamics, but acknowledged that supply/demand could be lumpy for a period of time, given the number of project start-ups. Enterprise reiterated its bullish view on NGL prices and struck a cautious tone on ethylene supply/demand, suggesting the importance of downstream polyethylene integration, where PSX should see some protection.