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Producers Striking Oil In San Juan, But Fail to Arrest Gas Declines

WPX Energy (NYSE: WPX ) and Encana (NYSE: ECA) have recently increased activity in the San Juan basin directing drilling towards the oil rich Gallup formation. The Gallup formation became a twinkle in San Juan producer’s eyes as early as 2009 and 2010 as low natural gas pricing forced the heavily gas weighted producers to examine their portfolios for liquids rich opportunities.  By 2012, producers drilled more than 50 horizontal wells targeting multiple formations across the basin testing plays with varying degrees of success

As can be seen in the map above 2012 wells (Orange) were drilled across a wide extent of play, but by 2013 producers began to narrow the focus of drilling to the Gallup formation near intersection of San Juan, Rio Arriba, and Sandoval County New Mexico. The core of activity encompasses an area of approximately 300,000-400,000 acres.  While the total play may encompass a much wider area, the core is concentrated between ECA, 176k net acres in Gallup, and WPX recently expanded its acreage position in the play adding 26,000 acres for a total of 74,600 net acres.

ECA and WPX have shown enthusiasm for the play recently as horizontal oil results have begun to trend higher over the last several quarters. As of August 19, well production data from the state of New Mexico indicated more than 50% of the wells drilled in the play since January of 2013 have yielded an initial 30-day production rate in excess of 250 B/d of light crude and 900 Mcf/d of liquids rich gas.

As can be seen in the chart above, ECA and WPX have represented the majority of the drilling in the basin to date and with little industry chatter beyond these two players, it will likely fail to materially impact the basin dynamics for natural gas. San Juan natural gas production has been in a long steady decline as conventional production from the Mesa Verde formation and CBM production follow their natural decline curves due to low natural gas prices.

Though the play may be economic for WPX and ECA, it is unlikely to change the fate of San Juan gas production, which BTU Analytics estimates will continue to decline over the coming years. However, the small increase in drilling has had a dramatic impact to local oil production, which has doubled over the last 12 months from 8 Mb/d to 16 Mb/d. Continued oil drilling in the basin will likely pressure local differentials until the start of the Western Refining (NYSE: WNR) TexNew Mex Reversal and Extension slated to begin commercial operations in the 1Q2015. The 16″ pipeline should provide more than sufficient capacity for producers in the region but, with the ramp in Permian production, will there be an outlet from the Permian basin for that crude?

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Anthony (Tony) Scott has built an in depth understanding of the North American energy market by providing investment advisory services and leading teams of analysts focused on the North American energy complex. Mr. Scott has conducted hundreds of consulting engagements assisting producers, marketers, midstream, refiners and private equity understand how rapidly changing natural gas, natural gas liquids, and crude oil markets in North America would impact their assets.

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