In the competitive world of oil and gas exploration, companies like Diamondback Energy are constantly evaluating and optimizing their drilling portfolios to maximize economic returns. One key concept that has emerged in this process is the ranking of drilling inventory into quartiles. This approach helps investors and stakeholders understand the quality of a company’s assets and its long-term strategy for value creation.

What Are Quartiles?

The term “quartile” originates from statistics, where data is divided into four equal parts based on a specific measure of quality or performance. When applied to oil and gas drilling inventory:

First Quartile (Top 25%): These are the highest-quality drilling locations. Wells in this group are expected to deliver the best economic returns due to higher production rates, lower drilling costs, or superior geological attributes.
Second Quartile (25%-50%): These locations are still high-quality, but they are slightly less attractive than the first quartile. They offer solid returns and remain a priority for development.
Third Quartile (50%-75%): These wells have lower economic returns and may face operational challenges. They are generally less competitive unless commodity prices are higher.
Fourth Quartile (Bottom 25%): These are the lowest-performing drilling locations. They may be marginally economic or entirely uneconomic at current market prices.

For companies like Diamondback Energy, first and second quartile locations are often referred to as their “core inventory”, while third and fourth quartile wells are considered non-core or secondary.

Factors That Define Quartile Quality

To determine where a well falls in the quartile system, several economic and operational metrics are considered:

1. Geological Quality

Thickness and productivity of the pay zone (the rock layer containing hydrocarbons).
Oil vs. gas mix: Wells with a higher oil cut (percentage of oil compared to natural gas) tend to be more profitable.

2. Proximity to Infrastructure

High-quality wells are often located close to pipelines, water disposal facilities, and power infrastructure. Proximity reduces costs and operational complexity.

3. Drilling and Completion Costs

Wells that are cheaper to drill and complete are ranked higher. Shallow depths, predictable geology, and efficient operations all contribute to lower costs.

4. Estimated Ultimate Recovery (EUR)

EUR measures the total hydrocarbons expected to be produced over a well’s lifetime. Higher EUR wells are typically in the first or second quartile.

5. Breakeven Prices

Locations that remain profitable even when oil prices are low (e.g., $37 per barrel) are ranked higher because they carry less risk.

Why Quartile Rankings Matter

For oil and gas companies, the quality of their drilling inventory directly impacts their ability to generate returns, free cash flow, and shareholder value. Let’s explore why quartile rankings are so critical:

1. Focus on Core Assets

First and second quartile wells generate the highest returns and fastest payback periods. By prioritizing these locations, companies can maximize their capital efficiency and profitability.

2. Strategic Asset Trades

Companies often swap or sell lower-quality inventory (third and fourth quartiles) to improve their portfolio. For example, Diamondback Energy recently traded lower-quality Delaware Basin assets for higher-quality Midland Basin acreage. This strategic move allows the company to focus on its core, high-return assets.

3. Risk Management in Volatile Markets

Oil prices are notoriously volatile. Having a strong inventory of first and second quartile wells ensures a company can remain profitable even during downturns. Lower-quality wells may only become economic when oil prices rise significantly.

4. Investor Confidence

Investors closely analyze how much core inventory (first and second quartiles) a company possesses. A large core inventory signals long-term sustainability and strong future cash flows, making the company a more attractive investment.

Real-World Example: Diamondback Energy’s Strategy

In a recent earnings call, Diamondback Energy highlighted their focus on improving portfolio quality by targeting first and second quartile inventory. Their strategy includes:

Trading Up: In a notable asset trade, Diamondback swapped third and fourth quartile drilling locations in the Delaware Basin for core Midland Basin acreage. This move improved the overall quality of their inventory, ensuring higher returns on future drilling.
Lower Breakeven Prices: By focusing on high-quality assets, Diamondback is able to maintain profitability even at lower oil prices, positioning themselves well for any market conditions.
Maximizing Free Cash Flow: Development of core assets generates more cash per well, supporting shareholder returns and future growth initiatives.

Conclusion

Understanding first and second quartile inventory is essential to evaluating an oil and gas company’s operational efficiency, economic resilience, and strategic priorities. For Diamondback Energy, this focus on core assets ensures they remain competitive, profitable, and attractive to investors.

As the energy landscape continues to evolve, companies that prioritize high-quality inventory and make strategic portfolio moves will be best positioned to navigate market challenges and deliver long-term value. Diamondback’s approach serves as a model for the industry, showcasing the importance of focusing on what delivers the greatest returns.