Concho leaves an oily footprint

In October 2010, Midland, Texas-based independent Concho Resources Inc. closed on an acquisition it had been targeting for three years: Marbob Energy Corp. of Artesia, N.M., the largest deal in Concho’s history. This transaction expands its 100% focus on the oily Permian Basin of West Texas and New Mexico by adding total proved reserves of 63 MMboe (58% oil, 63% proved developed). Estimated unproved reserves are 166 MMboe. This doubles Concho’s core Yeso acreage, adding more than 500 locations there and adding about 1,000 locations in the emerging Bone Spring play.

Concho will retain Marbob’s technical and operational staff. Even before the deal closed, Concho had operated 25
rigs in the Permian, where the rig count is climbing on high oil prices. Its production is about two-thirds crude. Not counting the effects of Marbob, Concho has four years’ inventory of Yeso wells in southeastern New Mexico and six years of Wolfberry wells on the Texas side of the basin.

Tim Leach, a Texas A&M grad with a Bachelor of Science degree in petroleum engineering, loves the name Concho.
He has used it many times for public and private E&P companies he has formed since leaving Parker & Parsley Petroleum Co. in 1997 when the latter merged with T. Boone Pickens’ Mesa Petroleum to become Pioneer Natural Resources and moved headquarters from Midland to Irving, Texas, a Dallas-Fort Worth suburb. He had been with Parker & Parsley since 1989, serving as executive vice president at the time.

Not wanting to leave Midland, Leach formed and became chairman and CEO of Concho Resources Inc. (a different company from the current one), from August 1997 until its sale in June 2001. Next, he formed Concho Oil & Gas Corp., running it until its January 2004 sale.

Leach has been chairman and CEO of the current Concho Resources since he formed it in February 2006, and president since July 2009. Previously, he was also chairman and CEO of Concho Equity Holdings Corp. from 2004 until it was merged into another subsidiary of Concho in December 2008.

Leach explained the company’s prospects thanks to the emerging Bone Spring play and the Marbob deal.

Tim, you and Concho were all about oil before it became cool.
In a way, that’s true. We’ve had the same strategy for almost 20 years, going back to our days at Parker & Parsley. Here in the Permian Basin, where there are so many plays, you can make money – and our strategy is that making money is better than not making money. All three of our core areas are in the Permian, where margins are good right now.

Your production rose 26% in 2Q 2010 over 2Q 2009, and that is before you incorporate the Marbob assets later this year.
That’s one thing that’s unique about Concho that the market’s starting to understand – our internal growth rate. This is a year when the theme throughout the industry is going to be capital discipline, but even so, we can show organic growth on our existing assets.

We have a capital budget of $700 million without Marbob, and with that, we can grow our value at rates that exceed 20% per year from our high-rate-of-return projects in the Permian. The Wolfberry play will take 40% of the budget, the Yeso 50%, and the horizontal Abo about 6%. All together, they will generate a 70% internal rate of return (IRR).

What oil price did you use to arrive at that IRR?
We use $75. We’re hedged to protect that for the next 18 to 24 months, and with Marbob, like all the acquisitions we've done, we’ve hedged out the acquired PDP (proved developed producing) reserves for five years.One of the beauties of the last two deals we’ve done – the Henry Petroleum and Marbob deals – is that we can hedge enough to get our acquisition costs back right away. I know I can still get my money back just from the PDP acquired.

Is the Henry deal now fully integrated into Concho?
Oh, yes. It’s been about two years. We have 17 rigs working now on our Wolfberry assets, and the Henry assets were Wolfberry for the most part. All their employees came on with us. The Marbob deal will be very similar, with their employees coming onboard. They are all located in Artesia, where we’ll keep that office and expand it.

Tell us more about the Abo play.
That is about 6% of our budget this year. The Yeso properties, long a core area for us, are on the shelf in New Mexico, and the Lower Abo is one or two townships north of that. We have 55,000 net acres there and one rig. It’s a horizontal oil play, and a lot more geologically intense than the Yeso as far as picking locations. We drilled the discovery well in 2007, and now the play is moving to the northeast.

These Abo wells cost about $4 million, and the rate of return is consistent with the rest of our portfolio. The maximum number of rigs we’d run is probably two or three. It will be developed on 160-acre spacing, or four horizontals per section.

And now the Bone Spring is suddenly hot.
South of the shelf is where the Bone Spring is, and it’s an enormous play. It’s in the center of the Delaware Basin, south of our Yeso play, and it extends south into Texas, into Pecos County.

It is Leonardian in age, and the Bone Spring section is within the Leonardian rock. The shallower part is what some are calling the Avalon shale. Below that, there are three sections referred to as first, second, and third Bone Spring.

How big is this going to be?
About 250 wells have been drilled so far by the industry. There are about 5 million acres. Marbob was an early mover in the play, which is why we had our eye on them for three years. When we close on it, we’ll have four rigs in the play; about half the prospects we will have acquired are Avalon shale, and the other half are first and second Bone Spring.

What about the emerging Wolfbone play?
That is a new subplay in the very southern part of the Delaware Basin, the southern part of the Bone Spring, in Ward, Culberson, Reeves, and Pecos counties, maybe some in Loving County. The industry is drilling some vertical wells there. The completions are like the Bone Spring, with big fracs required and many frac stages.

With all this new oil development, will there be enough take-away capacity?
There’s plenty available in the Yeso, but the Delaware Basin is not as highly developed as the Central Basin Platform part of the Greater Permian, so industry is rushing to build more infrastructure, mainly gas-processing capacity.

Natural gas liquids (NGLs) are a hot topic these days. Do you foresee a glut?
A lot of our peer companies are gas producers who don’t like to talk about their gas because of the low prices, so they talk about the liquids component to their production. We have ample take-away capacity. When we model the value of our NGLs, our assumption is the price will come down some – back to historic levels from their current premium.

We sell a wet gas stream at a premium to NYMEX of about 140% or 150% of the NYMEX gas price. But we are modeling 105% to 120%.

Why the Marbob deal?
That has been our highest-priority acquisition activity for three years. In 2006, we acquired the Chase properties, and as soon as we closed that, we started talking to the Gray family about selling their half.

It’s a perfect fit for us. Roughly half the assets are in the Yeso Trend area. It’s a 30-mile (48-km) long field, and we have contiguous leasehold on that now. The other major asset was all the Bone Spring locations. This could be 100 MMbbl of unproved reserves and more than 1,000 locations. When it closes, we’ll be operating 30 rigs in the Permian Basin and making over 50,000 b/d. With the Marbob employees, we’ll have 420 people, so we are doing our part to reduce unemployment.

What about service costs?
They have bottomed out, and now there is upward pressure. But this is oily drilling, and as drilling slows down in some of the gas shales, rigs and crews, and completion equipment are moving to the Permian because their profitability is better here. It may be counter-intuitive, but a moderately weak gas price and a moderately good oil price are perfect for us.

What is amazing to me is that none of these plays we are building this company around were around 10 years ago because of the changes in technology. These are the highest profit margins I can remember, ever, even in the go-go ‘80s. I think the Permian is still a great place, as evidenced by these great new plays. A lot of new competition is coming to town as a result.