By Jennifer Hiller
MIDLAND, Texas, July 30 (Reuters) - Seven years ago,Diamondback Energy Inc went public with a modest parcel ofdrillable land in the Permian Basin of West Texas.
Like dozens of other Permian startups, the firm then pursueda classic wildcatter's strategy - borrowing to buy up acreage,acquire competitors and quickly boost output in the boomingshale field. Today, Diamondback is the 7th largestproducer in the top U.S. oil region, according to researcherWood Mackenzie.
But Diamondback differs from most of its peers in a crucialway - it's poised to make more cash than it spends. The firmpromised to reward investors by buying back up to $2 billion inshares and delivering $750 million in free cash flow next yearif U.S. oil prices remain at about $55 per barrel. It startedpaying shareholders a dividend last year and raised it by 50%this spring.
"That's a big pivot for our industry, living within cashflow and not being part of that 'drill, baby, drill' crowd,"Diamondback Chief Executive Travis Stice said in an interview.
Only a handful of independent shale firms collect more thanthey spend. Total overspending by a group of 29 such firmstotaled $6.69 billion in 2018, according to Morningstar dataprovided to Reuters by the Sightline Institute and the Institutefor Energy Economics and Financial Analysis. Diamondback wasamong the outspenders, but Morningstar projects it will producefree cash flow this year.
The stark challenges facing the companies that pioneered thePermian signals a seismic shift in the shale economy - driven byinvestor demands for returns and a flood of investment frommajor oil firms including Chevron, Exxon Mobil,BP and Royal Dutch Shell, with their boundlessbudgets and integrated operations stretching from the oilfieldto the service station.
To survive and thrive, independent shale drillers mustcontinue expanding production while slashing costs, returningprofits to shareholders, and expanding into new operations suchas pipelines to achieve efficiencies, according to interviewswith a dozen shale executives and financiers.
Not all will make it. Six North American exploration andproduction firms have filed for bankruptcy this year and othersare on the brink, according law firm Haynes and Boone LLP.Smaller producers on average plan to spend 20% less this yearthan last, with some slashing budgets as much as 60%, accordingto researcher Drillinginfo.
The industry's new focus on cash flow requires scrutinizingevery cost down to "pennies," Stice told Reuters, and shiftinginto what shale firms increasingly call a "manufacturing"strategy for drilling.
That means placing multiple wells on one patch of gravel andfracking them one after the next, then connecting them to apre-built processing systems that link to pipelines.
A Diamondback rig that Stice can see just behind hisbackyard will stay in that location for six months, moving 30feet at a time to drill eight wells in four oil layers stackedon top of each other like a pile of books. With horizontaldrilling technology, the rig targets oil from a few miles away,beneath a Midland, Texas, shopping mall.
"It used to be we'd do one well, and it took 60 truck loadsto move a rig," Stice said.
Now it takes four to eight hours to start on the next well.
"The guy that wins the game in manufacturing is the guy thatcan manufacture at the lowest cost," Stice said.
CASH IS KING
Shale firms used to lure investors with bold talk ofnewfound oil reserves under the ground. Now they talk about howcheaply they can get it out - emphasizing the flow of cash overthe flow of crude.
Exploration firms for decades saw their stock prices surgeon new discoveries. Investors assumed oil was scarce and priceswould rise. But the West Texas shale boom has upended thatmindset with a flood of output that has made the United Statesthe world's top oil producer, overwhelmed domestic refiners,sent exports soaring - and kept a tight lid on prices.
Today's shale investors want quick profits and have littleuse for statistics on reserves or soaring production.
Two years ago, Permian bellwether Pioneer Natural Resourcessaid it would target 1 million barrels of daily production by2026. This year, Pioneer CEO Scott Sheffield told analysts thatgoal was "no longer a focus."
Investors had warned the company that they would dump itsstock if it "added any rigs at all this year," Sheffield said inthe first-quarter call with analysts. In May, the shale companydisclosed it had laid off a quarter of its staff to save $100million and "remain competitive."
Smaller, private-equity backed firms have traditionallyassembled acreage, proved the reserves and sold out fairlyquickly to a bigger firm. That strategy needs a "completerethink," said Todd Dittmann, a managing director at investmentfirm Angelo Gordon.
Energy investors, he said, are now more interested in firmsthat prove themselves capable of the operational "blocking andtackling" needed to profitably grow production.
Small Permian producer Elevation Resources LLC would like tosell out to the bigger firms working neighboring properties -Occidental, Diamondback and Exxon - but so far has no takers. SoCEO Steven Pruett has gone ahead with a $200 million investmentto build out his operations for the long term, aiming to rewardinvestors with regular distributions rather than a lump sumpayment from a sale.
CHASING HIGHER PRICES
Stice and other shale executives are moving away fromselling their production at the wellhead, taking stakes inpipelines that allow them to mimic the majors by selling atexport hubs along the U.S. Gulf Coast, where prices can beseveral dollars higher per barrel.
Diamondback bought a 10 percent stake in two crude pipelinesthat will start operating this year. The investment securestransportation to the export market and gives it a cut of theprofits as other firms pay to move oil along the route.
Occidental Petroleum Corp - one of the top Permianproducers, which recently bested Chevron with a $38 billion bidfor Anadarko Petroleum - has emerged as one of the topthree U.S. exporters of U.S. crude oil.
Pioneer Natural Resources moves about 200,000 barrels perday of crude to the Gulf Coast, with 80 percent of it loadedonto ships for transport to Europe and Asia, and is looking tosign long-term deals directly with foreign buyers. Selling oilat higher international prices has earned the firm an additional$600 million over the last five quarters.Peter Hays, a Houston lawyer who represents Permianproducers, said the focus on cost-cutting and accessinghigher-priced oil markets has his clients revamping theirprocessing and pipeline contracts. They are adding provisions tolimit costs and add flexibility to move products by whicheverpipeline route fetches the highest price, he said.
"A decade ago, the average gas-gathering and processingagreement was 20 pages," he said. "Now, they are 80 to 100pages."
(Reporting by Jennifer Hiller in Midland, TexasEditing by Gary McWilliams and Brian Thevenot)
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