MIDLAND, Texas—The brutal downturn has dried up activity across much of the world, but the Permian Basin is surviving quite nicely. Its enhanced economics are the reason—well costs have plummeted at the same time that well productivities have ascended to new heights.

Indeed, through the course of the downturn, the Permian Basin has achieved a tremendous economic advantage relative to other global oil plays, Jeff Tillery, managing director and head of capital markets at Tudor, Pickering, Holt & Co., said at Hart Energy’s recent Executive Oil Conference.

And the story is not yet over.

“The economic gains that the Permian Basin has achieved relative to the industry are as wide as ever and have more room to go,” Tillery said. “It's a less mature play. And, importantly, both sides of the Permian Basin have the stacked pay potential that just gives tremendous option value. It gives great running room for the industry to continue to figure out better ways to do things and increase productivity.”

But, not surprisingly, TPH expects that costs will rise going forward. Current oil service economics are unsustainable: “The reality of much of the domestic oilfield services business is there is no cash flow being generated,” he said. But, cost increases will vary widely across product and service lines. And the pace of recovery will matter.If companies turn on the capex spigot all at the same time, that will be much more inflationary than if activity increases more slowly.

While day rates can and will certainly rise on a recovery scenario, on the whole drilling cost savings are structural in nature. “The reduction in days to drill wells is going to continue as we step forward. We think additional drilling efficiencies can be achieved in the industry, and in particular in the Permian Basin,” said Tillery.

As activity rises, cost inflation is coming, but it will vary greatly by service and product lines. (Source: Tudor, Pickering, Holt & Co., Hart Energy’s Executive Oil Conference 2016)

The average Permian well today still takes plus or minus 20 days from spud to rig release. Similar wells in other basins are averaging 10 to 12 days. Over time, TPH expects that gap to close, noted Tillery. “We think effectively that almost all the drilling cost savings, in aggregate, are going to be sustainable.”

Completion costs will see inflation, however. Only about one-third of the completion cost savings realized to date will be retained as the industry recovers, thinks TPH. Two big-ticket items are frack costs and sand.

“When you think about a frack truck, every moving part has a useful life that is measured in the number of hours that it works. The fact that the industry is not spending any capital means loss of capacity. It's not going away, but it needs dollars in order to come back and be put to work.” For pressure pumping companies, that means they must raise prices to the level at which they have the incentive to start reinvesting in their businesses.

Sand costs will almost certainly rise too. The sand content per well has been going steadily upward for the past five to six years, and well laterals are getting longer. Because both factors can be directly tied to better well productivity, these trends will continue. “There is a case to be made that sand demand in 2017 doubles year-over-year,” noted Tillery.

Other inflationary areas are labor and logistics. “As we talk to CEOs out here on the services side, they struggle to hire people just today because of the wage compression that has happened in the industry through the course of the downturn.”

For instance, one operator is pumping 50 million pounds of proppant into a Haynesville well. “That's a thousand trucks,” said Tillery. “If you line those trucks up and space them 10 feet apart, that’s a little over 13 miles, a half marathon. It's a lot of people; it's a lot of trucks,; it's a lot of assets; it's a lot to coordinate.” And inefficiency can creep into the system as increased activity takes place across the sector.

“We’re looking at frack capacity going down for the industry, demand starting to go up, and sand demand doubling year over year,” he said. “It's just not an environment where costs stay flat.”

The upshot? Portions of the cost savings realized to date will carry forward as the industry recovers, mainly on the drilling side. Cost inflation is coming, however, particularly in the completions arena.

Peggy Williams can be reached at pwilliams@hartenergy.com.