4 Things Pioneer Natural Resources Wants You to Know About What's Really Happening in the Permian Basin

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Pioneer Natural Resources (NYSE: PXD) recently reported exceptional second-quarter results after production hit the high end of its guidance range and earnings blew past the consensus estimate. That said, the market pummeled the stock because the company revealed that drilling delays would cause production to come in toward the low end of its full-year guidance range. Furthermore, Pioneer noted that its wells were turning out to be gassier than expected.

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That said, CEO Tim Dove was open and honest on the accompanying conference call by directly addressing the issues and explaining what went wrong and how it will impact the company over the longer term. Here are four crucial points he made about Pioneer's operations in the Permian Basin.

No. 1: Nothing has changed

After running through the company's financial and operational results on the first part of the call, Dove turned his attention to the two production-related issues that roiled investors:

I want you to know that one of the main messages for today is that there are no fundamental structural changes to this field, that is the Spraberry/Wolfcamp horizontal field, or our business plans. The wells continue to improve. Oil production's on target per well, and we're actually benefiting from more gas and [natural gas liquids]. Our unexpected drilling and POP delays were unfortunate, but we're addressing those.

Dove made it clear that despite running into some unexpected problems, neither were due to structural changes in the geology of the field. He then spent some time on the call drilling down into each issue and how it will impact the company over the longer term. 

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No. 2: We fell behind but have fixed the problem

First, Dove tackled the drilling issue:

We did fall behind operationally on our completions in the Spraberry/Wolfcamp in large part due to unforeseen drilling delays. What happened is the delays were really the result of unexpected changes in pressure regimes in the field...The easiest way to remediate this is with a drilling plan that takes us from a three-string casing design to a four-string casing design. So that's exactly what we've done. We've solved this issue. We have addressed it, and we've done so by changing the casing design, which has proven to be very successful.

As Dove notes, Pioneer ran into a drilling problem that slowed it down. However, the company quickly identified a solution and has already implemented a new design that has proven to work. That said, Dove did note that this fix costs $300,000 to $400,000 more and increases its drilling time by five days. However, it's looking at ways to chip off other expenses to claw back the increase.

No. 3: Our wells are turning out to be gassier, but that's a good thing

The other issue that popped up this quarter was an increase in the gas-to-oil ratio (GOR), which means that natural gas and natural gas liquids (NGLs) were a greater percentage of total output than anticipated. The market interpreted this increase as a negative because gas margins are lower than oil margins. However, Dove pointed out that, while the company is "producing increased amounts of gas and NGLs in the Spraberry/Wolfcamp field from horizontal producing wells...Incidentally, they're right on track with their oil production." In other words, these wells are producing higher volumes overall because gas and liquids volumes are coming in above forecast while oil remains right on target. Dove explained why this is happening:

Our engineers tend to forecast production conservatively, especially in areas where we don't have a lot of well history. And as a result, they used historical data for all those wells through the end of last year to establish a GOR average for the plan, and these just proved to be too low compared to the actuals we're experiencing.

This issue wasn't unique to Pioneer, as fellow Permian-focused producer Parsley Energy (NYSE: PE) also noted that its GOR would be higher than expected. However, while the market interpreted this increase to suggest that wells were producing lower margins, that's simply not the case. That led Dove to point out:

This is a positive thing when the smoke clears because the increased gas and NGL production, already this year...has generated about $20 million of incremental revenue...So this is actually positive.

The positive impact of this change is also evident from Parsley Energy's revised guidance. While the company reduced its oil cut from 70.5% to 68.5% at the midpoint, that's not because oil volumes are disappointing. Instead, Parsley Energy increased the midpoint of its production guidance from 68,000 barrels of oil equivalent per day (BOE/D) to 70,000 BOE/D while still expecting to produce about 47,950 barrels of oil per day this year.

No. 4: We're on pace to come in ahead of our 10-year plan

Dove then turned his attention to the impact the drilling delays and increased GOR would have on its long-term plan to grow output to an average of 1 million BOE/D by 2026. First, he noted that while Pioneer's production would come in at the low end of its guidance range this year, that's because it chose to defer the completion of 30 wells until 2018 due not just to the drilling delay but because it's the prudent thing to do given where oil prices are these days. Meanwhile, the increase in the GOR means it's producing more on a BOE basis because of the positive impact from unexpectedly higher volumes of gas and NGLs. That led Dove to conclude that, "Despite the operational issues and the higher GORs we've encountered, there is no change to our 10-year growth target on oil." Furthermore, the company's production is on pace to be "higher than 1 million BOE in 10 years as a result."

Much ado about nothing

While investors hammered Pioneer's stock for the drilling issues and the increase in the GOR ratio, these weren't thesis-changing because the company has already fixed its drilling problem, and the higher GOR is a positive. Because of that, Pioneer's post-earnings sell-off looks more like a buying opportunity for long-term investors, as the company is now on pace to come in ahead of its 10-year plan.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.