Over the past year the strategies of integrated oil companies such as Chevron (NYSE: CVX) and ExxonMobil Corp (NYSE: XOM) have diverged from those of independent producers such as Chesapeake Energy Corp (NYSE: CHK) and Devon Energy Corp (NYSE: DVN).

As we noted in The Future of Shale Gas Is International, the Super Oils have invested heavily in natural gas–Exxon in US unconventional plays and Chevron in Australia and Asia–moves that counter field depletion and a wave of resource nationalism. With balance sheets that are stronger than some sovereign nations, these energy giants can afford to invest for the longer term.

US independents, on the other hand, many of whom spearheaded the shale gas revolution, are increasingly shifting their production mix and capital spending to oil, condensate and liquids-rich unconventional fields.

EOG Resources (NYSE: EOG), for example, recently posted its first quarter where revenue from its oil operations accounted for more than 50 percent of total sales and has put some of its noncore shale gas assets on the sales block.

Meanwhile, Chesapeake Energy Corp, the second-largest producer of natural gas and most active US driller, announced ambitious plans to double the company’s liquids output to 100,000 barrels per day by the end of 2012. Management expects this production growth to propel Chesapeake into the ranks of the top 10 US liquids producers. With the No. 1 or No. 2 acreage position in five major liquids-rich unconventional plays, CEO Aubrey McClendon believes the firm has the scope to double its output again to 200,000 barrels per day in 2015.

Although these strategic shifts stand out in the competitive landscape, EOG and Chesapeake are far from the only firms that are following this course of action. One of the biggest takeaways from presentations at the Barclays Capital CEO Energy-Power Conference in September was that depressed prices were prompting many natural gas-focused producers to beef up their oil exposure.

Much of this interest has focused on the emerging Eagle Ford Shale in Texas and the Bakken Shale, a low-cost play that, as my colleague Elliott H. Gue noted in Oil Shale versus Shale Oil, offers producers internal returns of more than 100 percent. But mergers and acquisitions (M&A) have also picked up in the Permian Basin, a vast play stretching from southwest Texas and into southeast New Mexico, which offers a little something for everyone.

Prolific Permian

One of the most prolific US oil plays, the Permian Basin is home to 20 of the country’s top 100 producing oil fields, a remarkable recovery after many in the industry had given it up for dead only 10 years ago.

Drillers sank the first wells in the Permian in the early 1920s, but the field’s heyday didn’t come until the 1940s and 1950s, when prolific output from the Spraberry trend helped to fuel the Allied effort in World War II. At the height of its glory days, wells in the Permian yielded initial production (IP) rates of more than 600 barrels of oil per day (bbl/d), but by the 1990s IP rates had dwindles to a measly 40 to 70 bbl/d. 

Source: Permian Basin Petroleum Association

But recent advances in drilling techniques and technology, coupled with oil prices elevated not by an OPEC embargo but by rising demand, have revivified this legacy play.

In 2009 Occidental Petroleum Corp (NYSE: OXY) was the leading producer in the Permian Basin, extracting the equivalent of 201,000 barrels of oil per day from the play. About 60 percent of this output comes from enhanced oil recovery (EOR) projects in the mature areas of the Permian, an approach that involves injecting carbon dioxide (CO₂) into the field to increase well pressure and output. Kinder Morgan Energy Partners LP (NYSE: KMP) is another important player in the Permian’s EOR projects.

Although increased CO₂ availability in the Permian should enable both operators to increase output from their EOR operations, exploration and production (E&P) are ramping up investments in a handful of established and emerging unconventional plays.

Linn Energy LLC (NSDQ: LINE), for example, has completed four acquisitions in the Permian Basin’s Wolfberry trend thus far in 2010, making the area the company’s largest operating region. Meanwhile, Apache Corp (NYSE: APA) acquired BP’s (NYSE: BP) oil and gas operations, acreage and infrastructure in the Permian for $3.1 billion, and Concho Resources (NYSE: CXO) purchased the assets of Marbob Energy, an early mover in some of the play’s emerging areas, for $1.25 billion. Natural gas-focused pipeline operator and E&P outfit El Paso Corp (NYSE: EP) also forked over $180 million for 123,000 acres in the Permian’s Wolfberry trend during a record university lands sale that benefits the University of Texas and Texas A&M systems.

Much of the uptick in M&A activity has focused on the Wolfberry trend, a lower-risk play in the Midland and Central Basin portions of the Permian that includes two formations: the shallower Spraberry and the so-called Wolfcamp, a deposit that’s about 10,000 feet below the surface. While the Wolfberry’s attractive economics and reliable results make the play attractive for natural gas-focused producers seeking to diversify their portfolios, a profusion of smaller operators also make the region ripe for consolidation.

In contrast, larger operators are driving development in the Permian’s emerging Bone Spring play, an area to the west of the Wolfberry that extends into New Mexico. Roughly 250 wells had been drilled in the area as of mid-September, targeting the Avalon and/or Leonard Shale, with production rates ranging from 300 to 600 bbl/d.

Third-quarter and fourth-quarter results from EOG Resources and Devon Energy should reveal more about how this emerging shale play is shaping up. Concho Resources, another leading acreage holder in the Bone Spring, has focused its drilling activity in other regions while its rivals de-risk the play.

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