This Oil Giant Is Making a Big Bet on the Permian Basin Next Year

The Permian Basin in western Texas has been a gold mine for the oil industry over the years. Initially discovered in 1921, the legacy oil play has churned out a whopping 29 billion barrels of oil over the past century. That said, its best days appear to be just on the horizon, thanks to the rise of new extraction techniques and technological advances that enable producers to unlock more of its oil for less money.

One company investing to make sure that the Permian's future is even brighter than its past is Chevron (NYSE: CVX). The oil giant holds one of the largest legacy acreage positions in the play, which it's starting to turn into a major growth driver. In fact, it's upping the ante on that bet by planning to pour $4 billion into the Permian Basin next year in a bid to double its output over the coming years.

Drilling down into Chevron's plans

While Chevron has yet to release an official drilling budget for next year, Reuters reports that the company plans to spend around $4 billion next year to boost output in the Permian. The report, based on comments by Chevron VP of crude supply and trading Ryan Krogmeir, who was speaking at an industry conference, stated that the capital would push Chevron's output up to 400,000 barrels per day over the next few years. That's a massive increase for a company that produced just 178,000 barrels per day from the region last quarter. It puts Chevron on pace to expand Permian output toward the high end of its anticipated 20% to 35% compound annual production growth range through 2020.

Fueling this rapid growth rate are two factors: Resources and costs. Chevron believes its 2 million acre position holds 9 billion barrels of oil equivalent (BBOE) recoverable resources, which it can extract for relatively low costs thanks to ample legacy infrastructure, innovation, and efficiency gains. In fact, at $50 oil, Chevron can earn a more-than-30% internal rate of return on its Permian wells. Given the importance of returns on capital to the oil giant, ramping its investment in the Permian makes economic sense.

The Permian powerhouse is just getting started

That said, while Krogmeier expects the Permian to be a big near-term growth driver for his company, the oil giant isn't the only one that will benefit. He stated that "the Permian is the powerhouse" of U.S. production growth, with production on pace to expand by another 1.4 million barrels per day by 2020 from its current 2.4 million barrel a day pace.

Among the many oil producers poised for fast-paced Permian growth is Concho Resources (NYSE: CXO). The Permian pure play is on pace to deliver 24% to 26% production growth this year while living within cash flow, which is a fast pace for a company that produced an average of 150,500 BOE/D last year. Furthermore, Concho Resources anticipates that it can increase its output by a 20% compound annual rate through 2020 while living within cash flow at around current prices thanks to the high level of returns and low costs of the legacy oil play. Meanwhile, the Permian's largest producer and acreage holder, Occidental Petroleum (NYSE: OXY), is working hard to lower costs so it can maintain its lead. As things stand right now, Occidental Petroleum is on pace to increase its Permian output by a 30% compound annual growth rate through 2019. That will enable Occidental Petroleum to increase total production by 5% to 8% annually, which is an impressive rate for a company that produced more than 600,000 BOE/D last quarter.

Contrast those growth rates with non-Permian producers. Canada's Baytex Energy, for example, only expects output to increase 2% this year to around 70,000 BOE/D. Meanwhile, enhanced oil recovery specialist Denbury Resources is on pace to increase production by just 2,000 BOE/D from last year's 60,000 BOE/D base. Plus, those increases are happening partly as a result of both Baytex and Denbury completing small acquisitions that added some incremental production.

The Permian story is just getting started

With crude oil starting to stabilize in the $50s, oil companies with large-scale positions in the Permian have the fuel they need to drive rapid production growth over the coming years. As a result, they have a competitive advantage in the current market environment over companies that lack exposure to the Basin, which will likely enable the haves to outperform the have-nots. Given that disconnect, oil investors should focus their attention on Permian producers, since this group has the potential to thrive in the current environment while providing even more upside should oil prices rally.

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Matthew DiLallo owns shares of DNR. The Motley Fool recommends Chevron. The Motley Fool has a disclosure policy.