The Midland Basin continues to garner attention from sellers, buyers and investors alike. As industry activity has shifted away from vertical comingled wells to even more prolific horizontal targets, acreage valuations have followed suit. The median transaction in core areas has risen to $30,000 per net acre in 2014, exclusive of any additional value for proved developed producing wellbores, representing a 4x increase over the median deal in 2010 and a 50% to 100% increase vs. valuations just 18 months ago.

A combination of factors has contributed to the valuation increase, including favorable well results across multiple targets, increased competition via newly public “pure play” operators, and public investor support. With so much activity in the Midland Basin, it would reason that the Delaware Basin might be a prime spot for the next acquistions and divestitures (A&D) wave.

The valuation framework supporting current net acre prices in the Midland Basin typically ascribes development value to vertical Wolfberry and multiple horizontal targets. With operators now achieving results that indicate single well EURs could be more than 800,000 barrels of oil equivalent, buyers only need to value vertical Wolfberry and two to three horizontal targets to achieve those valuation levels. In most cases, this framework suggests upward of three to four benches as potential upside for the buyers.

The equity markets have also been supportive of recent activity. Four companies with an exclusive Midland Basin focus--Athlon Energy Inc., Diamondback Energy Inc., Parsley Energy Inc. and RSP Permian Inc.--have gone public since October 2012, and all have outperformed the broader E&P market (+126% vs. the Standard & Poor's E&P index +23%).

Until recently, several key dynamics have kept investor knowledge, and thus valuations, in the Delaware below those in the Midland Basin. Along with certain technical and operational factors, scarcity of sizable deals has limited A&D in the basin, while operator size and profile have likely been the most significant factors limiting investor knowledge and focus on the basin. Key Delaware operators, with a median enterprise value 10x that of their Midland Basin counterparts, have historically been subdued in their disclosures on basin activity and results.

Despite several key differences, there is one significant similarity that could drive near-term A&D activity: a migration from a legacy of single concept/zone drilling to the development of multiple stacked horizontal wellbores.

Horizontal drilling in the Delaware Basin is not a new concept. In fact, horizontal drilling in the Permian first kicked off in the Delaware, with horizontals making up 78% of all wells drilled there since 2010. However, the ramp in horizontal activity had been muted until recently, as the majority of activity focused on single horizon development in specific areas. New Mexico was largely Avalon Shale or 2nd or 3rd Bone Spring, while Texas Delaware was predominately a 3rd Bone Spring development.

Delaware activity has begun to change significantly over the past 12 months. New Mexico is now seeing areas with drilling in all three of the initial zones (Avalon, 2nd and 3nd Bone Spring), and operators in the Texas Delaware are now drilling Wolfcamp in addition to the 3rd Bone Spring.

Perhaps the most dramatic shift in activity is occurring in Reeves and Pecos counties. Last year there were 34 vertical and 15 horizontal rigs across the two counties. Twelve months later, the activity has almost entirely flipped, with only six vertical and a staggering 48 horizontal rigs currently drilling Wolfcamp, 2nd and 3rd Bone Spring.

Much like in the Midland Basin, the Wolfcamp has moved into the spotlight in the Delaware. Operators are targeting two to three unique Wolfcamp intervals in areas, and continue to yield greater well results.

With all of the advances and increased activity in the Delaware, it stands to reason that A&D activity and valuations are on the cusp of following the path set by the Midland Basin. Although it is early, and there is limited data to support this trend, we have observed a few leading indicators.

On the transaction front, acreage values in an isolated area of Reeves County have mirrored industry horizontal rig activity, rising from $6,000 per acre in late 2011 to more than $20,000 per acre in 2014, while the horizontal rig count in the area increased four times over the same period. Similarly, on the public equity front, the share prices of Cimarex Energy Co., Clayton Williams Energy Inc. and Concho Resources Inc., three companies with significant exposure to the Delaware, have risen by 39%, 45% and 32%, respectively, since the beginning of the year.

The combination of improved well results, increased development inventory and a receptive equity market should yield a robust A&D market able to compete with the Midland Basin.

–Travis Nichols, 713-333-7124, tnichols@tphco.com; Jeff Knupp, 713-333-7131, jknupp@tphco.com, Tudor Pickering Holt & Co.

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