The Permian Basin of western Texas and southeast New Mexico, one of the oldest and most prolific oil and natural gas area in the United States, has seen a renewal of interest in recent years. Since the 1920 discovery well drilled into the San Andres formation, the basin has produced over 30 billion barrels of oil and will produce an estimated 2.4 million barrels of oil and 8.4 billion cubic feet of gas per day this month, according to the U.S. Energy Information Administration. Most of the current activity is focused on the two largest basins, the Delaware and Midland Basins. The Central Basin Platform separates these two basins, and has been the primary focus of conventional oil development. The San Andres formation has been the primary development target, and has recently seen a revival with horizontal drilling.
The San Andres Formation
Recent activity in unconventional plays in the two main basins has overshadowed the legacy conventional production from waterfloods and carbon dioxide floods, primarily in the San Andres. Major San Andres fields have produced for decades on the central Basin Platform and the Northwestern Shelf from vertical wells that produced from porous carbonate sections over 1,000 feet thick in some areas. In many areas, the San Andres has a well-defined transition zone with higher water saturation that historically was shunned by vertical well development. This transition zone has recently experienced horizontal development activity and carbon dioxide flooding to recover the residual oil, and is referred to as the ROZ Play (“Residual Oil Zone”). The ROZ is typically played on the flanks of the huge legacy fields, and with prodigious amounts of water produced along with the oil, economics can be challenging in a low oil price environment. As a tertiary development play, the ROZ does not compete on a return or capital allocation basis with the robust unconventional development plays in the two major basins.
Horizontal drilling to develop the San Andres has also been pursued outside of the ROZ play. Over the years, marginal vertical wells were common due to the heterogeneity (unpredictable variability) of the San Andres. Horizontal development can overcome the heterogeneity with the extended penetration over a wider area to intersect the more prolific sections of the reservoir. San Andres horizontal drilling (“SAHZ”) has been was sporadically pursued since the 1990’s, but activity recently picked up with almost 200 horizontal wells drilled since 2009. The SAHZ has been under the radar because of the more highly publicized unconventional plays by public companies, and the fact that primarily private companies are active in the SAHZ. The majority of the marginal San Andres acreage is controlled by smaller companies subsisting on legacy vertical production and hoping for the day a more lucrative development opportunity presents itself. Application of new horizontal drilling and multi-stage fracture completions is that new development opportunity.
One public company reporting the most activity in the SAHZ is Ring Energy, Inc. (NYSE: REI) who recently acquired 33,000 undeveloped acres for $500/acre. To date, Ring has drilled ten horizontal wells in the San Andres. According to a recent investor presentation, a typical well with a one mile lateral costs $2.0 million to drill and complete with an estimated ultimate recovery of 256 thousand barrels of oil equivalent. Assuming $45 oil and $2.50 natural gas, REI expects a 129% IRR. These returns compare favorably with the unconventional plays in the two major Permian basins. The advantage of the SAHZ is that acreage and wells are relatively inexpensive compared to the deeper unconventional targets in the basins. As a relatively shallow play, the SAHZ utilizes simpler less expensive drilling rigs not in demand by the unconventional players, so SAHZ developers may evade the cost inflation creeping into the most popular plays in the area.