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Morningstar | Reducing Concho's FVE After Incorporating Higher Permian Decline Rates

We are trimming our fair value estimate for Concho Resources to $94 per share, which means--in light of the recent slump in crude prices--that it is one of the few exploration and production firms that does not currently look undervalued (see "Most E&Ps Undervalued After Slump in Oil Prices").

The decrease was partly triggered by marking our model to market to account for the recent decline. However, we have also moderated our well performance estimates slightly after taking a closer look at the decline curves associated with Concho's recent vintages. The firm's average initial oil production rate per 1,000 lateral feet has improved steadily in the past four years. But after a year or so of production from each well, we see volumes dropping off more quickly than we previously expected (resulting in lower projected cumulative recoveries and weaker returns).

It is worth noting that there was a step change in productivity in the early part of 2019, with extremely high initial rates in the Delaware Basin, primarily due to the startup of the Dominator and Eider projects. The Mabee project in the Midland Basin is tracking ahead of the firm's historical decline curves as well. If this is truly indicative of Concho's potential, the firm could easily trump our revised forecasts.

However, it is too early to tell if these outstanding projects are outliers. Other 2019 developments, such as Marion Bench and Calverley, are in line with our forecasts thus far. In addition, other operators--such as Occidental and EOG--have demonstrated that there is little economic benefit associated with huge initial rates, as subsequent declines tend to be much higher as well. We plan to monitor these results, but for now, there is insufficient evidence to incorporate higher average initial production rates in our base case.