Funds Pull Back From Permian As US Shale Oil Firms Go Into Overdrive

NEW YORK, June 16 (Reuters) - Cash, people and equipment are pouring into the prolific Permian shale basin in Texas as business booms in the largest U.S. oilfield. But one group of investors is heading the other way - concerned that shale may become a victim of its own success.

The speed of the recovery in the U.S. shale industry in the past year has surprised oil investors after a global supply glut led to a two-year crude price slump and bankrupted many shale firms.

Eight prominent hedge funds have reduced the size of their positions in ten of the top shale firms by over $400 million, concerned producers are pumping oil so fast they will undo the nascent recovery in the industry after OPEC and some non-OPEC producers agreed to cut supply in November.

The funds, with assets of $286 billion and substantial energy holdings, cut exposure to firms that are either pure-play Permian companies or that derive significant revenues from the region, according to an analysis of their investments based on Reuters data.

The Permian, which stretches across West Texas and eastern New Mexico, produces about 2.5 million barrels of oil per day (bpd), accounting for more than a quarter of overall U.S. crude production.

"We'll have to see if these U.S. producers have the discipline to not go crazy and keep prices where they keep making money," said Gary Bradshaw, portfolio manager at Dallas-based investment firm Hodges Capital Management.

Hodges Capital owns shares of Permian play firms including Diamondback Energy Inc, RSP Permian Inc and Callon Petroleum Co. Bradshaw's firm has maintained its exposure to the Permian.

There is no sign that shale producers will restrain production. They redeployed rigs and personnel quickly since prices began strengthening in 2016 and made shale profitable again; rig counts have risen by 40 percent this year in the Permian, which accounts for about half of all U.S. onshore oil rigs.

Hedge funds pulled back in the first quarter, according to the most recently available regulatory filings, and the stocks have continued to struggle as oil prices have come under renewed pressure.

The value of these funds' positions in the 10 Permian companies declined by 14 percent, to $2.66 billion in the first quarter, the most recent data available, from $3.08 billion in the fourth quarter of 2016.

Hedge funds have continued to reduce their exposure to energy stocks in the second quarter, said Mark Connors, global head of portfolio and risk advisory at Credit Suisse, though he could not provide figures specific to shale companies.

Margins Squeezed

Fund managers interviewed expressed concern that volatile oil prices along with rising service costs and acreage prices are not reflected in overly optimistic projections for the Permian.

The funds analyzed include Pointstate Capital LP, a $25 billion fund with 16 percent in energy shares, and Arosa Capital Management, a $2.1 billion fund with more than 90 percent of assets in energy stocks. Pointstate and Arosa declined comment.

"Margins will continue to be squeezed by a 15 to 20 percent increase in service costs in the Permian basin," said Michael Roomberg, portfolio manager of the Miller/Howard Drill Bit to Burner Tip Fund.

A Reuters analysis of 10 Permian producers, including several that almost exclusively operate in Texas, carry an average price-to-earnings ratio of about 35, compared with the overall energy sector's P/E ratio of about 17.8.

"These are not great returns, but the problem is the market is rewarding them," said an analyst at one of the hedge funds on condition of anonymity, because he was not authorized to speak to the press.

Concerns about lofty land prices are driving some of the pullback by hedge funds, according to two fund analysts who could not speak on the record. Values for Permian acreage have increased 30 percent from two years ago, according to Detring Energy Advisors in Houston.

The 10 Permian stocks analyzed have, on average, dropped 18 percent so year, compared with the broader S&P 500 energy sector's 13 percent fall.

Permian production is expected to reach 2.47 million bpd by July, a 330,000 bpd increase from the beginning of the year, according to the U.S. Energy Department.

Last month the Organization of the Petroleum Exporting Countries (OPEC) and other key producers, including Russia, extended a historic output cut agreement to combat a global glut.

However, production from non-OPEC countries, especially the U.S., continues to rise and weigh on prices. U.S. crude prices on Wednesday hit a six-month low just above $44 per barrel.

Reuters analysis shows many shale companies reduced hedges in the first quarter, leaving them vulnerable to falling oil prices.

Still, fund managers say compared to other U.S. plays, the Permian still has the lowest break-even costs.

"In terms of the time horizon, the economics of the Permian are so good they’re going to keep on drilling," said Colin Davies, senior analyst at oil services company AB Bernstein.

(Editing by David Gaffen, Simon Webb and Marguerita Choy)