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Permian Pipeline Bottleneck Forces Steep Discounts

Refinery

Oil production in the Permian Basin is rising so quickly that drillers may find themselves without enough pipeline capacity to move their product.

Shale drillers large and small are rushing to West Texas, where drilling is profitable even at today’s prices. Other shale basins have lost capital and drilling rigs as industry activity becomes increasingly concentrated in the Permian.

Even as shale production contracted in most of the country, the Permian continued to grow over the past several years through the worst of the downturn. Oil production in the Eagle Ford, for example, hit a peak in March 2015 at 1.7 million barrels per day (mb/d), but has since fallen sharply to just 1.1 mb/d today. But Permian production has spiked over the same timeframe, rising by nearly 0.5 mb/d to nearly 2.3 mb/d.

 

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Production increases have continued despite the plunging rig count since 2014. Companies have become a lot more efficient, drilling longer laterals, drilling more wells per well pad, etc. Now with the rig count on the rise again, production will rise even faster. Notably, of the more than 100 percent gain in the rig count since May 2016, most of the additional rigs are being deployed in the Permian, with only marginal increases in rigs elsewhere.

 

(Click to enlarge)

The gains in output are starting to accelerate, with Permian production up 200,000 bpd this year alone. As the rig count surges and companies pour more money and personnel into West Texas, more gains are expected.

But that could create a bottleneck as pipeline companies struggle to keep up with booming output. Bloomberg Intelligence estimates that Permian production could hit 2.65 mb/d by the end of the year, but the region might only have enough pipeline capacity to carry 2.54 mb/d. That is a major problem for the long list of companies with growth plans. Related: Putin Says Russia Will Become World’s Top LNG Producer

On top of all of this, the Permian also has a growing backlog of drilled but uncompleted wells (DUCs). The DUC backlog has climbed to over 1,700 as of February, up more than 36 percent since September from under 1,300. If producers try to bring some of those wells online, production from the Permian could see sudden one-time spikes.

The result could be a sharper discount for oil produced from the Permian. The differential for Midland crude compared to the WTI benchmark is now at its widest level since September 2016, according to Bloomberg. But the growing disparity between Permian production and takeaway capacity could force bigger discounts. Oil producers will have to cut their prices if they are to succeed in getting their oil into a pipeline, which will drag down prices across the region. Paul Grigel of Macquarie Capital told Bloomberg that the discount for Midland oil could reach $5 per barrel relative to WTI this year.

“From the looks of it there could be several thousand barrels a day worth of midstream capacity shortages by the end of the year,” Mara Roberts, an analyst at BMI Research, told Bloomberg. “The rate of growth in takeaway pipeline capacity is going to be where the bottleneck is, and that will choke access to the market for producers.”

The problem for the Permian is not new. The first surge in output that really started in 2011 ran into pipeline shortages. In August 2014, for example, about 1.7 mb/d of oil was flowing from Permian wells but the region only had 1.27 mb/d of pipeline capacity. The glut forced oil into storage and also led to that enormous discount, with oil from the Permian selling at a staggering $21 per barrel discount relative to WTI, the largest discount on record for the region. Related: Saudis To Cut Crude Prices To Asia, Again

Towards the end of 2014, more pipelines came online, easing the backlog. The discount narrowed as Permian oil made its way into new pipelines, flowing to the key storage hub of Cushing, OK, and also onto refineries along the Gulf Coast.

The same thing will likely occur this time around, making the current problem a temporary one – more pipelines are in the works, which will ease the bottleneck. Enterprise Products Partners has a pipeline under construction, which will add 450,000 bpd by next year.

But the mad rush for Permian acreage that has taken place since last year will create headaches for producers in 2017. Sharper discounts will directly cut into revenue expectations. The Permian has emerged as the best place to be for shale drillers, but when everyone flocks to the same place all at once, the region suffers from some growing pains.

By Nick Cunningham of Oilprice.com

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  • Adrian on April 05 2017 said:
    Alternate headline: Permian Pipeline Pileup Precipitates Pricing Plunge, Producers Perturbed.

    Sorry, couldn't resist...

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