In the right spots in the Permian Basin’s emptiness, every rock is coveted for what it may hold.

After 40 years of declining production, the basin has returned with gusto. In the third quarter, the Permian hosted $11.2 billion in deals, including BreitBurn Energy Partners’ purchase of QR Energy LP for $2.9 billion.

On Sept. 29, Encana Corp. made the largest transaction of third-quarter 2014, offering $7.1 billion for the Permian’s Athlon Energy Inc. Encana’s offer was a 25% premium on Athlon’s closing share price on Sept. 26. The price includes the assumption of $1.15 billion in Athlon’s debt.

Encana called the Athlon deal, which brings to the company 140,000 net acres from a pure-play Permian player, “transformative.” Indeed, production should soar as Encana plans to ramp up to at least seven horizontal rigs in 2015 from three in 2014.

But nothing is ever perfect.

Even with Encana ready to spend $1 billion on the newly acquired properties next year, it will face the same problem that Athlon did in pumping out 30,000 barrels of oil equivalent per day (boe/d)—the challenge of preserving revenues while losing $10 per barrel (bbl) to price differentials.

The Permian’s rapid resurrection has created headaches for producers. While many plays have takeaway capacity problems, Athlon and other Permian companies have had to deal with occasional price shocks as well.

Increased crude oil production in the Permian Basin has outpaced pipeline infrastructure capacity to move the commodity to refineries, causing prices for crude in the Permian at Midland, Texas, to fall below similar crudes priced at Cushing, Oklahoma.

Differentials have skyrocketed at times because of refinery issues or the difficulty of moving oil to Oklahoma or the Gulf Coast. In August, Athlon’s average oil differential to Nymex WTI jumped to $9.07/bbl in the second quarter of 2014, more than triple the $2.43/bbl differential for second-quarter 2013.

By mid-August, the WTI-Midland to WTI-Cushing discount was $17.50/bbl. A series of refinery outages in or near the Permian and along the U.S. Gulf Coast helped Midland-WTI prices to plummet. Cushing/Midland differentials narrowed to $8.90 from $9.53/bbl the week of Sept. 22 and $13.40/bbl from August to September, said Roger Read, senior analyst, Wells Fargo Securities.

On a Canadian cable broadcast, Doug Suttles, Encana’s president and CEO, said extensions and construction should increase pipeline takeaway capacity to 800,000 bbl/d by the middle of next year. “The constraints are manageable,” Suttles said.

Athlon’s solution to large differentials was to pump more oil, enabling it to beat forecasted revenues. Encana may have a similar idea.

Several infrastructure projects should allow more crude to flow from the Permian to the U.S. Gulf Coast, causing differentials to narrow, according to a September report by the Energy Information Administration.

Crude oil production has already outgrown these expansions, however, and additional pipeline buildouts are under construction.

Encana will have to find its own strategy as it seeks to benefit from an expensive deal. Based on a valuation of $80,000/flowing boe, Encana paid $2.4 billion for the production and $4.7 billion for the undeveloped acreage, said John Freeman and Andrew Coleman, Raymond James Equity Research analysts.

“Bottom line: While the price of $33,000/ acre seems high, it’s not excessive given the inventory per acre in the Permian,” they said. “Encana estimates the transaction adds 5,000 horizontal well locations, which would imply it paid about $1.4 million per inventory location.”

Encana sees the potential for about 5,000 horizontal well locations with potential recoverable resource of approximately 3 billion boe from the acquisition.

Many analysts lauded Calgary-based Encana for the deal, which moves the company within 75% of its 2017 target for liquids, years ahead of schedule. In June, the company bought out Freeport-McMoRan’s Eagle Ford assets for $3.1 billion. Its 45,500 net acres there produced about 53,000 boe/d in the first quarter.

Given that Midland Basin horizontal Wolfcamp wells have a PV-10 value of $6 million each, the transaction could end up being a great deal for Encana, especially given the company’s plans to ramp up its rig count.

For now, Permian producers are on the rocks—exactly where they want to be.

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