Steve Pruett, president and CEO of Elevation Resources LLC, spoke with Jessica Morales at Hart Energy’s recent DUG Permian conference and exhibition. Pruett looks at what he thinks should make the industry optimistic in the Permian while at the same time, remaining cautious. He also discusses infrastructure and what Elevation Resources is looking ahead to.

Jessica Morales, Hart Energy: Prices are up. The Permian is the hottest patch in the world right now. What should make us optimistic and what should keep us cautious?

Pruett: On the optimistic side, the higher prices support broader development. When prices collapsed as low as $26 a barrel in February of 2016, the rig count dropped. Only tier 1 acreage was being drilled and acreage was being released. With higher prices into the $60s, at least with the benchmarks into the $70, tier 2 acreage can be developed and plays like mine are more viable. Once we are de-risking that asset others can follow up by manufacturing it.

Now on the negative side, we are a victim of our own success. We are developing bottlenecks and getting crude and natural gas out of the Permian Basin and thus our differentials—in other words what we get paid relative to the benchmarks—have widened.

While WTI might be at $72 a barrel, we are still getting paid $62 a barrel in the Permian. We have not at the wellhead, which is where we sell our crude, enjoyed the full uplift that we have seen in WTI and much less Brent—which has eclipsed the $80 mark on days.

Hart Energy: You’ve produced horizontal success in the Permian since the company was formed in 2013, particularly in the Central Basin Platform. What has been the key to that success?

Pruett: We went into an old oil field and there is a saying among geologists: the best place to find oil is where oil has been produced. That’s the lowest risk. However, what we brought to this old field which was developed in the ‘40s by some of the majors was modern technology. Horizontal drilling coupled with multistage hydraulic fracturing, along with our analysis of the geology. The stresses on the rock and the best intervals to land in created the success in the Devonian reservoir which was a conventional reservoir developed as far back as the ’40s on a vertical sense. While we were doing that we examined the other rocks in the stratigraphic column and noted the Barnett was oil bearing and taking a key from the Scoop/Stack and the Barnett development in the Fort Worth Basin.

RELATED: The Permian Barnett Shale

It was an experiment worth trying. There was a lot of oil there and the question is would horizontal drilling, multistage sand fracks with slick water extract that oil and with proper landing zone in the brittle rock proved that it was commercially attractive. From that, we have a new play. It was the willingness to use the data that was available and having a private equity sponsor that was willing to take the risk with us that enabled us to test these ideas and turn them into commercial discoveries.

Hart Energy: Tell us about technology advancements and how Elevation Resources uses that and data to be successful.

Pruett: Part of it is our processes: horizontal drilling and hydraulic fracturing. Those are [the] processes, but the specifics of how we drilled through the abrasive chert or this abrasive Barnett is a matter of iterating on different bit technologies. For example, we discovered a bit used in Alaska to apply to drilling our chert reservoirs that were chewing up bits like chewing gum. We went through 30 bits on our first well and by our fifth well, we had five bits to drill 18,000 feet. So, it’s iterating and collaborating with people in other basins to understand what they did to solve their problems than trying those techniques out in our field.

Our field is unique to others. Although, some of the principles around fracking laminated systems have been proven in the Wolfcamp and in the Scoop/Stack play in Oklahoma. So, it’s borrowing technology that other people have applied in similar circumstances. You have to understand the rocks first before you start grabbing other ideas rather than just randomly testing harebrained ideas. You have to have some basis for it and the rocks are generally that common basis.

Hart Energy: How have horizontal drilling techniques changed to make operating at $50-$60 a barrel oil more efficient? How low can prices go and you still be successful?

Pruett: People talk about breakeven margins and there are a couple of different ways to look at them. One is lifting cost breakeven and our lifting costs are, let’s say $6 a barrel. So, we can continue to produce oil. But, more importantly for someone who is drilling and expanding capital, we need a return on capital margin and that number has typically been thrown around as $20 to $40 a barrel.

But, make no mistake our rate of return is highly sensitive to oil price. With the current strip, our rates of return are more than 100%. When oil was in the $40s our rates of return were 30%, which wasn’t as attractive and that is just for the well. When you start layering in all the infrastructure costs for water supply and disposal, oil and gas gathering—all of that matters—and then production facilities such that at $40 a barrel, it’s really not attractive to invest money. We were in that awkward zone in the $40 to $50 range where costs were rising back to boom-time levels of $100 a barrel, so this move from $50s to $60s is really helpful because that’s generally all flowing to the bottom line now and return on capital to our investors. It allows us to make the infrastructure investments that we need to keep producing, fracking, and to keep expanding our base of operations.

Hart Energy: Let’s talk about infrastructure in the Permian Basin.

Pruett: There are two ways to think about infrastructure. One is macro and that is pipeline takeaway capacity to the Gulf Coast which is primarily where our product is flowing—not so much to Cushing anymore. Along with that, gas takeaway, NGL takeaway because our gas is produced wet but it’s processed and then separated. The NGL has to get to the Gulf Coast where [it’s] consumed and the residue gas has to get somewhere all over the country or to Mexico which is an evolving market. Again, with our success of producing more than 3 million barrels a day in the Permian and almost 10 Bcf [billion cubic feet] a day of gas, there expected strains on takeaway. Fortunately, we haven’t experienced that yet, given that we are on the Central Basin Platform in the middle of all the pipeline infrastructure we are advantaged relative to let’s say the western southern Delaware which there is less infrastructure in. Ask Apache about that.

Then the second one is the micro infrastructure in our field. That includes gas gathering, gas lift systems, water disposal and supply, and ultimately oil gathering and takeaway. That is a significant investment as we turn from delineating this discovery, drilling and understanding the limits of the reservoir which we found none thus far. We go back in and manufacture an infield drill or pad drill. Then we can scale up our infrastructure particularly related to water because we will be consuming more water as we expand. Shorten the number of days drilling and expand the number of wells fracked at one time. Likewise, we will need to treat produced water and recycle that. As we get larger we will produce more oil, for example, and then the trucks won’t be able to keep up with it. Then we need pipeline connections, lacked units and direct connections to pipelines so that we don’t have trucks running in and out of our field at all hours of the day and night gathering our crude.

Those were all the micros and those are also elements or results of our success and scaling up the project means we need more water [and] more trucks hauling oil. But, we really need pipelines to take the oil away and we are going to need more gas processing capacity in the area and that’s been a strain as well on our gas gatherers and purchasers.

Hart Energy: Can you give us your thoughts on the Permian Basin and any excitement you hear pertaining to it? What do you and your company look forward to?

Pruett: We look forward to turning from delineating this exciting discovery into manufacturing; seeing our costs come down and our repeatability on the number of days of drilling; getting more into a rhythm will be positive; and then ultimately, because we are backed by institutions primarily on the east and west coasts, it’s returning their investment and going on and doing it again.

Perhaps I will end up in the public arena in some way. There are some positives of being public, but we have been fortunate to have a private equity sponsor in Pine Brook Partners that was willing to take a bet on us and take risks in order to develop this exciting discovery.