A rare glimpse into the strategies of several private oil operators in the Permian Basin portrays a measured move towards greater horizontal drilling, with requisite funding increases coming from such varied sources as farm-out agreements, private-equity funds, the high yield debt market and good old cash flow, attendees at Hart Energy’s DUG Permian conference in Fort Worth learned last week.

Endeavor Energy Resources, which was founded in 1979 by Autrey C. Stephens and family, ranks in the top 20 oil producers in Texas with production (65% oil) running at 42,000 barrels of oil equivalent per (boe/d), said Joel Castello, reserves and acquisitions manager with Endeavor. It focuses mainly on the Midland Basin, where it has 381,000 net acres (Martin, Howard, Midland, Glasscock, Upton and Reagan counties), although it also has a substantial, 97,000 net acre position in the Delaware Basin.

Endeavor is transitioning to greater horizontal drilling, both in its operated activities and through an agreement under which XTO Energy Inc. is farming into 34,000 acres in Midland County. Endeavor has an 8-rig fleet comprised of six vertical and two horizontal rigs, with contracts placed for two additional horizontal rigs, one of which will be a walking rig. With a $550 million capex budget for 2014 funded by cash flow, bank debt and a 6% high yield issue, it plans to drill 127 wells, including 13 horizontal wells.

The farm-out agreement is a seven-year “drill to earn” with XTO to develop 34,000 acres to the west of Pioneer Natural Resources Co.’s (NYSE: PXD) DL Hutt C#1H “discovery well” in Midland County. Under the terms, XTO will earn a majority working interest in each horizontal Wolfcamp well drilled and completed at its sole cost, while Endeavor will retain all rights above and below the Wolfcamp. The first well by XTO was expected to spud in late May, with the program growing to five rigs by early 2015.

There is the potential for 400 horizontal wells under the program if all locations are drilled. In addition to potentially booking reserves and generating cash flow at no capital cost, Endeavor stands to benefit as drilling by XTO proves up horizontal drilling locations in the offsetting leasehold retained by Endeavor. The program is projected to increase Endeavor’s net production over current levels by about 30%, according to Castello.

“Endeavor remains open to similar types of joint ventures in the future with other companies,” he added.

Castello did not predict, however, that Permian development would be all plain sailing. With forced pooling not allowed in Texas, forming voluntary drilling units may face obstacles, “and you could see a little slowing of activity due to the land-intensive and time-intensive nature of putting these drilling units together,” he said. With 7,500-foot laterals frequently used to develop a three-section drilling unit, for example, an issue could arise if certain operators fail to join the unit. Assuming eight such wells drilled in either direction, a 16-well development could also cost $150 million, which may be beyond the financial reach of smaller operators.

By contrast, HEYCO Energy Group Inc. has, since the early 1980s, focused its operations mainly in the Delaware Basin, with particular emphasis on the Bone Springs sand. HEYCO holds roughly 80,000 gross acres/30,000 net acres that are prospective for the Bone Springs, according to president George Yates, who estimated an inventory of around 350 gross/100 net horizontal locations on a risked basis. This year’s operated program will include seven horizontal wells targeting the Bone Springs.

“The economics of the second and third Bone Spring sands are just terrific, with out-of-the-ballpark numbers,” commented Yates. He estimated the payout on wells to be about one year. Funding comes from internally generated cash flow and traditional bank lines.

HEYCO’s deep roots in the Permian have given it the means to pursue outside opportunities, one of which is HEYCO LNG, noted Yates. The LNG facility, which produces 150,000 gallons per day (gal/d),is due to start up in the first-quarter of next year in the Eagle Ford, with the Permian favored for its next LNG production facility. The Eagle Ford facility will be dedicated to the energy sector, including serving drilling rigs and frack spreads that are dual-fuelled. The facility will be expandable up to 300,000 gal/d.

Brigham Resources LLC, based in Austin, TX, has a dual business strategy. In exploration and production (E&P), it identifies and develops early-stage domestic resource plays; and in minerals it acquires nonproducing mineral interests that are in established resource plays “just ahead of the drill bit.” It is backed by three private-equity sponsors—Warburg Pincus LLC, Pine Brook Partners and Yorktown Partners LLC—who in April of 2013 provided a $650 million equity commitment following the principals’ previous success at Brigham Exploration Co.

Gene Shepherd, Brigham’s CEO, described the first strategy as one of building a “portfolio of projects within a targeted risk profile.” He gave two examples.

One such profile would be to “build acreage positions in projects that have outstanding resource play attributes but that lack the horizontal drilling success that make those plays so highly competitive,” he said. As an example, he cited his former firm’s entry into the Bakken in the Williston Basin in 2005. Also falling into this category is his firm’s current position in the southern Illinois Basin, where Brigham has just over 47,000 net acres and is targeting the New Albany Shale.

An example at the other end of the firm’s targeted risk profile would be to build acreage positions in projects that have outstanding resource play attributes and have already experienced some level of horizontal drilling success. “Obviously, these plays are very, very competitive; it’s expensive to build acreage positions in these types of projects.” Brigham’s current southern Delaware Basin acreage position, comprising a little over 48,000 net acres, falls into this risk category, he said.

“We believe that the Permian Basin will be one of the biggest, if not our single biggest, focus area,” commented Shepherd, noting that the company’s Permian team is led by Ricky Cox, who previously was the Texas asset manager with Concho Resources Inc. (NYSE: CXO) Zones being targeted in the southern Delaware Basin include the upper Wolfcamp (A and B), lower Wolfcamp (C and D) and second Bone Spring sand. Plans are for 25 gross horizontal wells to be drilled in Reeves and Pecos counties in 2014.

In opting to focus on the Delaware over the Midland Basin, Shepherd said Brigham perceived the latter to be somewhat more competitive, and its strategy gravitated more toward earlier stage basins, such as the Delaware, which he estimated was six to twelve months behind the Midland Basin. In its acreage acquisition, 95% of acreage had come from another operator. “It comes back to this issue: There are a number of operators that have just chosen not take their play horizontal.”

In terms of the advantages of being a private company, Shepherd cited the lack of public disclosure requirements, which can “be such a huge distraction for management” and may involve almost having to share proprietary information with competitors. In addition, being private allows business decisions to be made based on “long-term value creation considerations” rather than shorter-term factors, including investor focus on near-term production levels.

A disadvantage of being private is a higher cost of capital, noted Shepherd. “The Permian-focused public companies are trading at significant premiums to the valuations that are being achieved in the current acquisition and divestiture (A&D) markets. This can represent a significant cost of capital benefit for the public companies that we are competing with.”

However, as the universe of publicly traded Permian-focused E&Ps grows, “the arbitrage opportunity between the public and A&D markets is narrowing.”

Industrywide, what clouds could darken the outlook?

Endeavor’s Castello cites the “very expensive and commodity price-sensitive” nature of horizontal drilling in the event of a downturn from what has been a period—of more than three years-- of near-$100 per barrel oil. Energy has traditionally been cyclical: “It always has been, and it always will,” said Castello, who then urged attendees to remember Sir John Templeton’s quote:

The four most expensive words in the English language: “This time it’s different.”