The North American oil and gas industry’s main engine—unconventional shale—may be stressed as operators face diminishing resources that can be extracted economically at “conservative oil pricing,” said analysts from Simmons Energy, a division of Piper Jaffray.

Simmons senior research analysts, Kashy Harrison and Ryan M. Todd, issued a report March 13 based on reserve reports in quarterly filings from a number of E&P companies.

Out of the three main takeaways from their analysis, the most important was that unconventional shale is “showing signs of stress as 35% to 40% of the assessed E&Ps disclosed performance-related reserve writedowns.”

The Simmons analysts noted the sub-surface stress across the major Lower 48 oil basins at reserve writedowns ranging from 3% to 25%, depending on the company’s size. Though they don’t consider the writedowns as game-changers for forward supply in the near term, the analysts said they still matter.

“[The writedowns] potentially represent another indicator of diminishing resource potential capable of being economically extracted at conservative oil pricing,” wrote Harrison and Todd in the report.

Increasing costs represent another threat to shale producers, according to the report.

An average 10% year-over-year rise in the cost to add/convert reserves (ex revisions) has degraded operators’ efficiency. Further, the Simmons analysts believe about two-thirds of the increase is due to higher lateral adjusted exploration and development (E&D) costs, “implying that remaining portion could have been driven by completing slightly less productive wells.”

Simmons defined E&D costs per lateral foot as E&D costs (less capitalized general and administrate expense/interest if applicable) divided by net wells drilled/completed (35% of cost allocated to drilling; 65% of cost allocated to completions) divided by lateral length.

“Moving forward, should subdued oil pricing and capital discipline persist for an extended period of time, we anticipate improved efficiencies as operators high-grade their portfolios and benefit from deflationary cost tailwinds,” the analysts said.

The third concern involves implied acreage valuations, which are “particularly anemic using the latest PDP PV-10 data,” according to the analysts. However, they also noted this could be viewed as a positive “if one believes rapid consolidation is imminent.”

Capital And Cash Flows Per Capital Invested (Source: Simmons Energy, a division of Piper Jaffray)

Simmons found that, based on $52.50 West Texas Intermediate oil and $2.75 Henry Hub natural gas, proved developed producing values in various reports implied Permian Basin acreage values of around $21,000 per acre.

This implied acreage value in the Permian was “less than the trailing five-year A&D transaction comp average of about $23,000/acre, well beneath recent corporate transaction comps at about $45,000/acre, but above the challenging 2018 A&D market at about $15,000/acre.” The analysts noted that in the current environment where consolidation is needed, this may be viewed favorably.

An overall look at capital efficiency (proved developed and undeveloped reserves operating margins) placed Diamondback Energy Inc. as a leading operator, according to the report. On the valuation front, the analysts said another E&P stood out.

“From a valuation perspective, one operator that screened at a notable discount to historical Permian transaction comps while possessing a favorable story was Callon Petroleum Co.,” the analysts said.