RealMoney

Oil and gas producers are moving beyond the Permian Basin in West Texas as crude oil prices rise and the commodity glut in the Permian Basin continues to mount. We favor diversified shale players who are also active in Oklahoma, particularly those operating in the SCOOP and STACK oil plays, such as EOG Resources (EOG) and Alta Mesa Resources (AMR) , which have direct access to pipeline capacity and enjoy international market pricing.

For reference, the STACK play is a geographic area located in the Anadarko Basin area of Oklahoma, which it stands for Sooner Trend Anadarko, Canadian and Kingfisher, which in turns means that the geological formation is located in the Anadarko basin, mainly located across the Canadian and Kingfisher counties in Oklahoma. The SCOOP play stands for South Central Oklahoma Oil Province, which is a play also located in the Anadarko Basin.

While the Permian Basin in Texas and New Mexico has experienced explosive growth and it remains the fastest-growing shale basin, congested pipelines and shortages of labor, such as trucking, are hurting profits, making other fields like the SCOOP//STAK attractive alternatives. Pipeline construction in the Permian has not kept pace with production, leading to bottlenecks that are now making it difficult for some producers there to move their oil to market. 

Crude oil for delivery to Midland, Texas, where the local price of crude is set, has recently sold for $12 to $15 below the price of crude for delivery in Cushing, Oklahoma, they pricing point for West Texas Intermediate (WTI). This discount reflects the added cost some face getting oil to refineries and export facilities out of the region using trucks and trains. This is not a problem in Oklahoma as investment in infrastructure has been made over the years.

In contrast, some of the oil fields that are growing, notably the Eagle Ford, where Carrizo Oil & Gas (CRZO) holds significant acreage, had experienced their own bottleneck problems before prices started dropping in 2014.

Thus, the question for many producers has shifted from how much capital they should allocate into the Permian Basin, to where else can capital be put to work.

EOG Resources, one of the leading large cap shale producers, is not only active in the Permian, which accounted for 39% of its existing production of 5.4 million barrels a day, but also in Colorado, North Dakota and Oklahoma. In Wyoming, EOG has built up large lease holdings and expanded production over the past two years. EOG is up 11% for the year, substantially outperforming the SPDR Energy Sector ETF (XLE) .

While top-tier acreage in the Delaware Basin, the west-most part of the Permian Basin, has sold for over $33,000 an acre over the last year, acreage in the SCOOP and STACK go for half of that, giving investors an opportunity for attractive returns.

As for Alta Mesa, the company is a leading developer of the STACK oil window, with over 130,000 net acres, 25,600 barrels a day of production, with wells delivering over 77% of internal rates of return (IRR). The company has reliable access to midstream infrastructure, particularly due to their co-investment in the Cimarron Express pipeline, which will have an initial capacity of 90,000 barrels per day, and is expandable to over 175,000 barrels per day. The new pipeline is expected to be completed in mid-2019.

Alta Mesa is down over 50% for the year on the back of analyst downgrades due to unmet production targets, we think the stock has been sold off enough that there is only upside from here as management executes is growth strategy, particularly the development of its midstream operations. On top of that, it is very difficult to short a stock below $5 for liquidity reasons, thus is safe to say that large short sellers are probably out of the name, and on to the next one.