Photographer: Brittany Sowacke/Bloomberg

Oil Industry’s ‘Hottest Zip Codes’ See Bids Soar on SM Deal

Updated on
  • SM buys Rock Oil Holdings from private-equity giant Riverstone
  • Pays almost $40,000 an acre for drilling rights in Permian

SM Energy Co.’s $980 million purchase of drilling rights in the biggest U.S. crude field shows producers are willing to pay a premium for access to one of the few spots where oil exploration still turns a profit.

SM, which extracts oil and natural gas from the Rocky Mountains to the Gulf Coast, agreed to pay the equivalent of $39,543 an acre for drilling rights across 24,783 acres in the Permian Basin, almost doubling the Denver-based company’s holdings in the region, according to a statement on Monday. SM plans to deploy a rig as soon as October to drill the acquired acreage, which Chief Executive Officer Jay Ottoson called “top tier.”

After decades of neglect by international oil producers, the Permian Basin that lies beneath West Texas and New Mexico has seen a rejuvenation in the past eight years as intensive drilling and fracking techniques honed in other oil- and gas-producing regions were brought to bear on the Permian’s multi-layered stack of crude-soaked rocks. As low energy prices made other areas unprofitable to drill, explorers as diverse as Apache Corp., Cimarex Energy Co. and Occidental Petroleum Corp. have been touting plans to expand Permian investments.

The Permian’s got “the hottest zip codes in the industry," Concho Resources Inc. CEO Tim Leach told analysts on an Aug. 3 call. The Midland, Texas-based company focuses solely on the Permian and announced more drilling plans last week.

Higher Price

SM fell 2.6 percent to $30.26 at 10:39 a.m. in New York, giving back some of Monday’s 6 percent advance. The shares have risen 54 percent this year.

SM’s agreement “demonstrates continued high acreage values” in the Permian and “validates” recent acquisitions in the region by Diamondback Energy Inc. and Callon Petroleum Co., Jeff Grampp, an analyst at Northland Securities Inc., said in a note to clients. It’s also a positive development for other Permian drillers such as Earthstone Energy Inc., Parsley Energy Inc. and RSP Permian Inc., he said.

The per-acre price SM is paying exceeds the $25,000 to $35,000 range that acreage in the Permian’s Midland Basin section had been fetching as recently as May, according to estimates by Mike Wichterich, president of Three Rivers Operating Co., a private equity-backed explorer. QEP Resources Inc. forked over about $60,000 an acre to unnamed sellers for a tranche of Permian drilling rights in June, a signal that deal values in the region are at “an all-time high,” Eli Kantor, an analyst at Iberia Capital Partners LLC, said in a July 26 note to clients.

Permian Basin

Acquisition “deal values remain high and incrementally trending up, which bodes well for operators with established acreage positions,” Northland’s Grampp wrote.

SM is acquiring the Permian drilling rights through an outright purchase of Riverstone Holdings LLC’s Rock Oil Holdings LLC, the London-based private equity giant said in a separate statement. Denver-based Rock Oil was created in 2014 and has been amassing drilling rights ever since, Riverstone said.

Patty Errico, an SM spokeswoman, didn’t return a telephone message seeking comment.

The Permian Basin, an active oil-producing region for almost a century, fell out of fashion as major explorers abandoned onshore U.S. drilling to search in deep waters and overseas. Smaller domestic companies revitalized the region by adapting sideways drilling and high-pressure hydraulic fracturing to open up layers of rock that had been previously shunned as too dense or expensive to be worth exploiting.

Production Decline

U.S. drillers spent last week’s earnings conference calls talking up their acreage in the Permian and Oklahoma’s Scoop and Stack regions, areas where companies say they can still make a profit despite depressed oil prices.

The Permian generated Apache’s highest profit margins in North America -- about $17 per barrel, more than double the return of other regions, Chief Executive Officer John Christmann told analysts on Aug. 4. The Houston-based company’s only active drilling rigs were in the Permian last quarter and its only other wells to start producing oil were in the Scoop, he said. 

The Permian is one of the few places in the U.S. where it makes economic sense to add rigs, said Tom Petrie, chairman of energy-focused investment bank Petrie Partners LLC, in an interview with Bloomberg’s Vonnie Quinn and Shery Ahn on "Bloomberg Markets" on Monday. The activity still won’t be enough to reverse the broader decline in U.S. production, meaning oil prices are likely to head higher, he said. Petrie’s firm was a financial adviser to Rock Oil on the transaction.

“We need to see 50 or 100 rigs go back to work to begin to actually bring on new supply, and even that will happen with a delay," he said.