Pioneer Natural Resources: Investing in operational efficiency during the down market to survive and then thrive
A winning strategy consisting of innovation, spud-to-POP optimization, and vertical integration.
Not just surviving the glut, but thriving
Unconventional oil and gas producers in the United States experienced tremendous growth during the shale gas boom of the early 2010’s. Now, however, oil is worth less than half of what it was 18 months ago (Exhibit 1a) [1]. This has forced producers to consolidate their positions and reduce investments to weather the down market. Among the large independent producers, Pioneer Natural Resources (NYSE: PXD) has shown a remarkable ability to not only sustain but to increase its share price despite continued assessments that the oil energy markets are unlikely to recovery any time soon (Exhibit 1b) [2, 3]. Reviewing Pioneer’s operations and business models reveals some interesting features that enable them to increase their operational efficiency, improve their social license to operate, and position themselves to aggressively capture value when the market picks up again.
Sustainably cutting costs
The basics of the business model for an unconventional exploration and production firm (i.e., an oil and gas firm that uses hydraulic fracturing to tap previously unusable coal bed methane and shale gas reserves) is to cost effectively discover, drill, fracture, produce, and deliver hydrocarbon resources to the market. Each step along this process requires numerous inputs from a robust supply chain, high operating proficiency, and a bit of luck.
One key aspect of Pioneer’s drilling operations is optimizing the time it takes to drill a well (including the associated laterals), stimulating the well through fracturing (typically using gel fracturing techniques with sand proppants), and completing the well for production (video description below). A metric used to describe the time it takes from the commencement of drilling until the well is completed and hydrocarbons are flowing to the surface for collection is the “spud-to-POP” time. During Q3 2015 Pioneer reported that it was able to reduce the spud-to-POP time for a 3-well pad to an average of 25 days compared 34 days observed at the beginning of 2015 [2]. They attribute this reduction to innovations in their well casing design and a growing familiarity with drilling in specific formations that has led to a sort of standardization of drilling practices for key intervals within a basin [2].
One benefit of reduced spud-to-POP times and standardization of the drilling process are resulting in an annually compounding 25% reduction in drilling and completion costs [2]. A second benefit is that the company’s lease operating costs of a barrel of oil equivalent (BOE) have also been reduced by 18% from the same period last year [4]. Additional development of novel technologies like dissolvable plugs and a continued focus on completion optimization are expected to reduce drilling and completions costs further in Q4 2015 [2]. Pioneer is experiencing substantial benefits to its business model by pursuing both the innovation of key components and overall process optimization gained from specialized (and well compensated) operators who are perfecting their skill through repetition.
Vertical alignment driving future operational efficiencies
Pioneer is also pursuing a vertical integration strategy to control both access to and cost of key fracturing ingredients. In particular, Pioneer acquired a sandstone mining operation in 2012 (now called Premier Silica) to supply sand proppant suitable for fracturing operations to the most important basin in Pioneer’s operations portfolio, the Permian Basin [5].
Pioneer has also taken the most progressive stance among its peers to secure water for drilling and completions operations.
Water resources are limited in the Southwestern United States. Gel fracturing uses a lot of water. Pioneer is the only company that is committed to pursuing novel water reuse and sourcing strategies [6]. This approach provides at least three benefits. First, it reduces competition with 
municipalities and ranchers for scarce fresh water resources, thus enhancing Pioneer’s social license to operate. Second, development of water conveyance infrastructure and use of unconventional sources of water enables Pioneer to set itself apart from its competitors who are increasingly relying on expensive chemical treatment methods from third party oil field service firms instead. Third, access to state of the art produced water treatment and reuse assets and the ability to convey fluids without the use of trucks in the Permian Basin means that Pioneer will save big on disposal and trucking costs when the market is up and wells are drilled with greater frequency. Pioneer’s supply chain vertical integration and subsequent investments in its infrastructure during the down market will enable it to execute its business model with a robust supply chain and low cost operations unmatched by the majority of its peers.
Resources
[1] Krauss, Clifford. “Oil Prices: What’s Behind the Drop? Simple Economics.” The New York Times. 5 Oct. 2015. Web. 7 Dec. 2015. URL: http://nyti.ms/1HUKGuG
[2] Pioneer Natural Resources. 3rd Quarter 2015 Earnings. Web. 7 Dec. 2015. URL: http://investors.pxd.com/phoenix.zhtml?c=90959&p=quarterlyearnings
[3] Friedman, Nicole. “Oil Plunges to Near Seven-Year Lows.” WSJ. 7 Dec. 2015. Web. 7 Dec. 2015. URL: http://www.wsj.com/articles/oil-trades-lower-after-opec-meeting-1449490677?cb=logged0.3327947666402906
[4] DiLallo, Matthew. “5 Things Pioneer Natural Resources’ CEO Wants You to Know.” The Motley Fool. 25 Nov. 2015. Web. 7 Dec. 2015. URL: http://www.fool.com/investing/general/2015/11/25/5-things-pioneer-natural-resources-ceo-wants-you-t.aspx?source=eogyholnk0000001&utm_source=yahoo&utm_medium=feed&utm_campaign=article
[5] Premier Silica. Web. 8 Dec. 2015. URL: http://www.premiersilica.com/index
[6] Pioneer Natural Resources: Water Management – Our Operations. Web. 8 Dec. 2015. URL: http://www.pxd.com/operations/water-management/operations
Photo Credit: Pioneer Natural Resources website and www.energylandscapes.net.
Video Credit: Marathon Oil.
You picked an interesting company. I wonder why other smaller independents have not thought about moving vertically into sand and water as well. Perhaps they lack the competencies in those business, or are unable to raise the capital requirements. It is definately a source of Pioneer’s competitive advantage and has allowed them to ride out this low price environment.
Pioneer has had a strong performance relative to the average independent oil and gas producer in 2015. You mentioned drilling and completions optimization and water/sand usage as success factors to their operating model. I am curious where the majority of their competitive advantage lies. My assessment is that the innovation in drilling/completions cycle is driving their competitive performance right now. Their choice to vertically integrate and utilize more socially responsible water usage will position them to gain a competitive advantage in the future. The significant costs with fracturing is the drilling of the well due to the large capital nature of a drill rig.
Regarding the vertical integration, I am curious how much of the process and capital they own versus contract out. It would seem that the sand and water material for fracturing would be lower in terms of priority compared to the other higher capital intensive aspects of drilling and completing a well. Are you aware of them owning and operating the entire drilling regime?
This is a really fascinating assessment. In a commodity business, it’s often the case that the lowest cost producer wins in the long run, particularly due to its ability to weather the downturns as the one we are in now. It’s interesting to see how this company achieves its position as one of the lowest cost companies through its operating strategy and what seems like discipline (and a bit of luck). One of the key reasons why cost has been able to be reduced is because of new technology that allows horizontal drilling, which Pioneer seems to utilize. The question is how and if Pioneer will be able to maintain its cost competitiveness relative to its competition as more competitors adopt new technologies.