There's a land rush on in the Lone Star State.

Oil exploration and production companies have piled into the Permian — a rich formation beneath Texas and New Mexico — because they can produce crude there more cheaply than in many other U.S. basins. Those low break-even costs for drillers are top of mind, with U.S. crude oil trading near $50 a barrel, about half the price it fetched at the peak of 2014.

But the rush threatens to push up the cost of doing business in the Permian as drillers compete to book the best workers and oilfield services companies. Demand for those employees and services could eventually exceed capacity — perhaps as early as next year.

Drillers will also need to start producing acreage swiftly and efficiently after shelling out princely sums for land.

"The question is who can insulate themselves best from the inflation?" said Lloyd Byrne, an analyst at Nomura Group's brokerage Instinet. "We think it's going to become a big-company game."

Prices have skyrocketed in two parts of the Permian, the Midland and Delaware basins. The average price for the three most expensive deals in the Midland Basin this year was nearly $49,000 per acre, compared with an average of $38,300 per acre for the top three purchases in 2014.

The run-up has been even more spectacular in the Delaware Basin. RSP Permian (RSPP) paid $48,157 per acre in the region's most expensive deal this year. Primexx Energy paid just $14,615 per acre in the Delaware's biggest acquisition of 2014.

Oil companies are using similar drilling methods in the two basins, but the Delaware is less developed than the Midland, said Andrew Dittmar, mergers and acquisitions analyst at PLS, a Houston-based oil and gas research firm.

"People knew there was a lot of oil in the Delaware before, and it took a while to crack the nut to get it out," he told CNBC. "They've cracked the code on the Delaware, and they're getting some really strong results there."

Diamondback Energy (FANG) is one company chasing Permian gold. On Wednesday, the driller paid $2.43 billion to purchase two companies and their land in the Delaware Basin, making it the third largest deal ever struck there. In 2014, Diamondback was also behind the year's third largest deal by price by acre.

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Immediately squeezing profits out of those acquisitions is critical for companies like Diamondback and Parsley Energy (PE), said Instinet's Byrne.

Right now, the shares of both companies trade at a high multiple — or premium based on expectations of future growth. After making pricey purchases, they need to execute their drilling operations well in order to deliver that growth.

Both Diamondback and Parsely have executed well in the past, according to Byrne.





However, if too many drillers are simultaneously trying to make good on their expensive purchases in the Permian, all that activity could inflate wages and oilfield service costs, analysts warn. That would put pressure on drillers' profit margins, which are already slim.

Laid-off workers may not return to the oil patch until they think the recovery has legs, and those who do return may demand higher pay or better benefits, according to John Daniel, senior research analyst for oil services at Simmons & Company International. Many of those workers may have found work elsewhere, he wrote in a research note.

It's possible that oilfield services companies will bring in equipment from other areas where oil output remains depressed, but the Permian will likely experience at least a mild bottleneck, said Pearce Hammond, co-head of exploration and production at investment banking firm Simmons & Co. Service providers can then charge more, which will cut into drillers' profits.



Pipelines may also struggle to carry all that crude out of the Permian. Currently, oil transporters have spare capacity there, but some see that pipe space running low by late 2017 or early 2018. That would force drillers to put oil on rail cars — a more expensive option.

"It depends on how fast the Permian ramps, and it depends on how fast projects get done, but either way, we see a need for more long-haul pipe to get installed in the Permian," Hammond said.

The companies poised to do well as challenges mount in the Permian are larger drillers with advantages in other areas of the industry, Byrne said.

For example,Anadarko Petroleum (APC) has pipeline and storage operations that will help it transport its Permian haul, while EOG Resources (EOG) owns mines that provide the sand it needs to carry out hydraulic fracturing, the process of releasing oil and gas from shale rock by blasting water, minerals and chemicals underground.

Ultimately, some small players will likely sell their positions in the Permian because they can't compete, Byrne said.

Investors, too, are considering where their money can be better spent. Capital One analysts report the buzz at the bank's annual energy conference was not swirling around the Delaware or Midland basins, but North Dakota's Bakken shale formation.

"Although we are still bullish on the Permian, conversations with investors suggest that some have gotten more cautious on the basin given lofty acreage valuations in the last several months, growing concerns around infrastructure bottlenecks and price differentials" Capital One analysts said.



Basins beyond the Permian may start to look more attractive with oil prices on the rise following an agreement by OPEC and other producers to cut output in a bid to balance an oversupplied market.



Still, others say the oil well economics in the Permian are too good to ignore for those with the ability to stomach high land prices. Drillers are now exploring more remote parts of the Delaware, including a southern section called the Alpine High, where Apache Corp (APA). says it has found 3 billion barrels of oil.

"The bottom line is in the Delaware, you are seeing the opening up of new economic benches, and those haven't been as heavily drilled recently, so it's a basin that is opening up very rapidly," said Dittmar.

— Editor's note: This story has been revised to reflect that LloydByrne is now an analyst with Instinet, the equities execution services arm ofNomura Group.







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