The Permian Basin in the heart of America’s oil industry, straddling the borders of Texas and New Mexico, is the hottest oil property in the world right now. The Permian is one of the most prolific oil and natural gas basins in the US and has been a central plank in America’s energy resurgence, particularly through the supply of shale gas from the basin. Despite the area having produced billions of barrels of oil it still has undoubted potential to come up with major new discoveries – highlighted by the US Geological Survey’s identification of almost 20 billion untapped barrels of oil in November 2016. Late last year Apache also announced new oil potential of 2 billion barrels in the Alpine area of the Permian Basin.
ASX-listed Winchester Energy (ASX:WEL) is the latest junior oil and gas explorer hoping to make it in one of America’s most mature oilfields. Established in 2014, Winchester’s primary focus is on its oil and gas leases in the Permian’s Eastern Shelf, looking to develop Cline shale unconventional oil opportunities at shallow depths combined with conventional oil targets in the Ellenberger formation slightly deeper and shallower plays in the, Strawn Canyon, Cisco and lower Wolfcamp.
Led by managing director Neville Henry, Winchester has a wealth of industry experience across the board. Henry has 40 years’ experience in the worldwide oil and gas sector, he’s led major exploration teams and played an integral role in Anadarko as the company leapt from production of 25,000 barrels of oil per day (bopd) to 400,000 bopd. Henry’s co-founders and non-executive board members Peter Allchurch and John D. Kenny both have equally impressive CVs and bring years of knowledge and know-how to the company. Henry partnered with CFO Hugh Idstein who spent 20 years with Black Stone Minerals (NYSE:BSM) before establishing several start-up exploration and production companies both private and public and brings strong US financial experience to Winchester.
Henry says the Permian can still offer attractive opportunities and is currently seeing the best activity of any basin in the US. He says the Eastern Shelf was also a straightforward choice for entry.
“The Permian has produced over 50 billion barrels of oil equivalent in its life and still is estimated to have over 20 billion barrels of oil equivalent to go. We decided to focus on the Eastern Shelf because there hadn’t been much exploration or drilling since the early 90s, it hadn’t seen a surge in new drilling despite $100 oil, yet it had multiple fields found before 1990 and had production from levels as shallow as 4,000ft down to 8,000 ft,” the Winchester MD explains.
Winchester is taking a novel approach to producing oil in the Permian. After the oil price fall in 2014, Henry led a programme of acquiring over 15,000 net acres at low cost, bringing total acreage to 19,109 net acres in Nolan County, Texas. By December 2016, drilling results have resulted in five producing vertical oil wells operating at gross oil production of 462 bopd. These types of wells are very cheap to drill and complete (around US$800,000) and are a key factor in Winchester being able to hit production despite being less than three years old.
“The journey was quick in our case of not having bought production. We always thought getting in at the ground floor in exploration and production and trusting our skillsets would be a much better return on investment for our shareholders than buying into existing production.”
The net acreage consists of three large leases over a 10,000 acre trap and thanks to Winchester’s structural modelling, 3D seismic interpretation and in-depth well data from existing wells, there is potential to drill 125 vertical wells across the ‘best’ 5,000 acres in the trap area. The company anticipates that the best vertical wells will produce, at capacity, up to 250 bopd.
Three additional wells are in the process of being drilled and completed and its nine vertical wells to date are all in the White Hat lease, and these discoveries are sandwiched between the Suggs oilfield (10 million barrels of oil produced) and the substantial Nina Lucia oilfield (140 million barrels of oil produced).
In addition, despite the global oil industry having faced severely depressed pricing since the heights of $100 oil, Winchester has favourable well economics at today’s low prices. The company’s economic modelling suggests that even at $45 per barrel (p/b), production of 100 bopd will return around a 79% internal rate of return (IRR). If the oil price were to rise to $55-65 and beyond that rate increases substantially.
Despite predicting marginal increases for global oil prices in the next two years, Henry’s primary concern will be to reduce the cost of new wells and boosting productivity at each well. The MD is anticipating progress and growth in every quarter from here on in.
Bringing the cost of new wells down from the current price of $800,000 will be important to Winchester’s profitability. Winchester has worked hard with its partnered drilling company Carl E Gungoll Exploration (CEGX) over the last 18 months from a technical perspective to bring drilling costs down by 40%, Henry believes if the companies enter a long term programme he can probably ‘knock another couple of hundred thousand off the price’.
Henry will also be concentrating on the use of new technologies to improve productivity at each well. Winchester has employed and has experimented with an electronic tool called Plasma Pulse from Russia and is considering nano-particle technology to separate bound water and bound oil to improve recoveries. The plans are also to incorporate short radius multi-lateral drilling in wells where the formation is tight and he believes this will improve the poorer performing wells.
“We are on the edge of these technologies but they are not expensive processes to improve. Maybe we can get from a 10-15% recovery factor to 20%. We are leveraged to the oil price and if we can drive our costs down from $800,000 that will improve the economics by a considerable level.”
Investors have been conditioned to expect high capital costs and long term return plans when they are approached for oil and gas plays, Henry says he has been so surprised at the reaction of investors when he explains how they can see a return within 4-6 months.
“If the well is 200 bopd we will pay out in four months. Over the last 10 years’ investors have been conditioned to support projects by providing large debt structures to support expensive drilling with long payouts. It is bit of a surprise for them to see the returns we can achieve.”
“We went from debt-funding thinking when the recent oil price crash. Winchester decided to focus on vertical wells and looked for more cashflow generative situations because I knew we wouldn’t be able to secure significant funding until we showed production and positive cashflow.”
Winchester’s target is drill 100 wells over the next few years, Henry notes he would like to gradually increase drilling such that cash flow will support one well a month. The statistical average initial production for each vertical well is expected to be 100 bopd, ranging from 50 bopd at one end to 200 bopd at the other. Winchester hasn’t seen hyperbolic declines at the wells either.
“From that point of view it is like a resource play. We can drill lots of wells, we can look at the statistics – if the average is 100 bopd then the numbers are pretty aggressive with a good IRR.
“If we can hang in there for the next two years and oil prices recover to the $70-80 range the company will be tremendously valuable.”
Winchester has recently announced successful spudding for its eighth vertical well in the White Hat oil lease. The company has a 50% working interest, with CEGX holding the other 50%. The new White Hat 21#5 well is nearby to the existing White Hat 21#4 well which currently produces 230 bopd. 21#5 will target oil in the Ellenburger Formation at a proposed total depth of 7,100ft.
With very low drilling costs and ambitious plan to access more than 100 wells in the next few years Winchester’s small-scale approach to the Permian mega-basin could prove to be a masterful stroke. If that is coupled with a recovery for global oil prices, Henry and his co-founders could really be onto something.