On her first trip back to Midland, Texas, since the oil crash analyst Irene O. Haas saw a surreal mix of new construction against a backdrop of idled rigs and equipment, she said in a July 24 report.

Midland is a city as used to the industry’s boom-and-bust rollercoaster of oil as any place in the U.S., and it’s taking the spending pullback in stride.

A long recovery and the continued foundering of crude prices bode well for deals as 2015 hedges begin to fade and new 2016 hedges are less favorable. After meeting with public and private operators Haas, an analyst for Wunderlich, came away with the impression that Midland is abuzz with potential A&D activity.

After the dead quiet in the first half of 2015, Haas said deals are coming.

“Larger and well capitalized companies are looking to buy, and private equity firms are active including a new Chinese-backed entrant,” Haas said. “The wide bid/ask spread seems to be closing the gap.”

For now, the market has to endure more turbulence. Operators are bracing for Iranian crude, rising interest rates, weak economic data from China and continual turmoil in Greece.

Even ever-faithful banks are becoming concerned.

“The mood in the oil patch is becoming guarded once more,” she said.

Still, with companies such as Diamondback Energy Inc. (FANG) being lauded for its capital discipline and wise acquisitions, the basin seems to have the potential energy of a coiled snake.

An Upside To Net Asset Value Is Possible

Midland offers one of the higher perches from which to observe the carnage.

Tudor, Pickering, Holt & Co. said some Midland Basin E&Ps have managed to beat the SIG Oil Exploration & Production Index (EPX) in 2015.

Diamondback and RSP Permian Inc. (RSPP) are the most expensive on a dollar per acre basis by factor of 2-3x while Laredo Petroleum Inc. (LPI) and Parsley Energy Inc. (PE) are the most levered now. Parsley, given hedges, should close the gap with Diamondback/RSP in 2016 if oil prices stay at these levels.

“Valuations aren’t dirt cheap but we are buyers in this rout due to our constructive view on crude oil and preference for Permian exposure,” the Tudor report said.

Investors could see an upside to net asset value (NAV) among Midland names but “you need to believe in higher oil prices,” Tudor’s report said.

“You need to be comfortable with $70 WTI long-term and be optimistic that assets will continue to get better with rising EURs, downspacing, etc.,” the report said.

Laredo Petroleum has the most NAV upside by far at more than 150% assuming $90 WTI and $4 long-term Henry Hub prices.

King Snake

Midland companies are either looking at ways to pay for drilling, make acquisitions or streamline what they have.

Diamondback is a favorite of many analysts not merely because of its strong financial performance but because it planned well for the monsoon that has soaked the industry.

Haas calls the company “the leader in the Permian if not the entire E&P space.”

The company was frugal and smart during the up market, engineering strong rates of return, cost controls and executing accretive acquisitions. Since January, Diamondback has acquired or entered into definitive purchase agreements to acquire 11,948 net acres in the Midland Basin, primarily in northwest Howard County, Texas in the Permian Basin for $437.8 million.

The transactions will increase Diamondback’s leasehold interest in the Midland Basin to about 89,216 net acres.

Tudor, Pickering, Holt’s July 27 report said that Diamondback’s balance sheet is best-in-class with liquidity available through its royalty MLP subsidiary Viper Energy Partners LP (VNOM).

“We like the company’s exposure to the Lower Spraberry play, which is quickly becoming one of the most economic oil plays in the U.S.,” Tudor, Pickering, Holt said. “With WTI now less than $50 per barrel, we think now is an opportune time for long-term investors to bulk up exposure.”

Haas said that while many companies are looking for deals, her impression was that the company is interested but looking more to define and develop its position as it increases activity in the second half of 2015.

Ring Energy Not Running Rigs This Year

At Ring Energy Inc. (REI), the company is more focused on M&A and remains free cash flow positive.

In June, Ring closed its Delaware Basin acquisition from Finley Resources Inc. for $75 million.

The company purchased 14,322 net acres in Culberson and Reeves counties, Texas. The current net production to the company from the acquisition is about 1,300 barrels of oil equivalent per day. Ring will be the operator and have a 98% working interest and net revenue interest of 79%.

Still, Ring decided to pull its drilling rigs around year-end as oil prices dropped and service costs lagged and has essentially run no rigs this year, Haas said. The company nearly resumed drilling as oil rose to $60 per barrel (bbl), but the recent fall in price has kept it on course to be cash flow positive while looking for solid A&D opportunities.

“While vertical drilling might not be sexy, we think REI's story is as pretty as they come and likely gets better going forward,” Haas said.

At RSP Permian, management plans to keep its rig count unchanged.

A month ago the company began to feel better about a recovery by December, but is no longer feeling bullish, Haas said.

“RSP continues to screen deals,” Haas said. “The company is currently running four horizontal rigs and will keep the rig count at this level unless oil prices fall again.”

The plan for Clayton Williams Energy Inc. (CWEI) is to withstand the bombardment of merger offers with public companies and joint venture (JV) offers.

Haas met with Clayton Williams’ management and said the company is looking to secure a financial partner to help fund drilling. Once concluded, the company will focus on shoring up its balance sheet and seek a partnership in growing its midstream assets in Reeves County, Texas.

“CWEI could emerge a much stronger company,” she said.

Haas said the strong will survive and thrive in the Permian, which remains the place to be.

Favorite names are Diamondback, Ring, and RSP when scrutinizing the company’s assets, balance sheets and A&D opportunities.

“We are very encouraged by CWEI's game plan and look forward to seeing drilling finance secured,” she said. “We came away from the trip believing that these companies will be able to utilize the downturn as a chance to get even stronger. As such, we remain bullish on the names going forward.”

Contact the author, Darren Barbee, at dbarbee@hartenergy.com.