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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Permian Bottlenecks Begin To Bite

The pipeline constraints in the Permian are finally starting to bite, threatening to derail the extraordinary production boom that has been underway for the last few years.

Permian drillers are “quitting new wells at a record pace,” according to Bloomberg. The region’s pipeline network is already just about full, forcing steep and ever-widening discounts for oil coming from West Texas. The number of drilled but uncompleted wells (DUCs) remains very high, evidence that companies are drilling wells but deferring completions, likely because they have no way of shipping the oil. As a result, they are leaving it in the ground. Last week, the Permian rig count fell by four.

The EIA says that the number of DUCs in the Permian jumped by 100 in May, which is actually a bit below the average monthly increase over the past year, but still up 90 percent from a year earlier. Every month, the DUC list in the Permian jumps to a new record high.

Moreover, the price discounts and the lack of pipeline space could force companies to begin shutting down older wells. “I think without a doubt you’re going to see shut-in wells,” Judy Stark, president of the Panhandle Producers & Royalty Owners Association, an industry group, told Bloomberg.

The CEO of Pioneer Natural Resources, Scott Sheffield, said in a Bloomberg interview that the Permian pipelines would be totally full in the next three to four months, which could mean a shutdown of a growing number of wells. “Some companies will have to shut in production, some companies will move rigs away, and some companies will be able to continue growing because they have firm transportation,” Sheffield said. Related: Uncertainty Looms Large Over Latin American Oil

His assessment backs up the conclusion of an increasing number of analysts, who have described the state of the industry as one of “Haves” and “Have Nots” – those with pipeline space under contract, and those without.

Evidence of a slowdown is starting to multiply. Halcon Resources Corp.  said on Tuesday that beginning in July it will idle about a quarter of its drilling fleet because of “lower near-term realized oil prices in the Midland market.” C&J Energy Services Inc., a drilling services company, suspended plans to expand its fleet.

The pipeline problem is expected to grow worse over the course of the year and into at least the first half of 2019. Ryan Smith of East Daley Capital told Reuters that pipelines could start rejecting new customers as early as next quarter (which begins in a few weeks).

“We have started to see some producers drop rigs in the basin and would think investors will focus on these issues on upcoming 2Q calls and into the fall as E&P budgets are put together,” Barclays wrote in a note. “As a result, we think producers may slow down growth in the Permian and build up drilled but uncompleted (DUC) wells and/or reallocate resources elsewhere until the constraints are worked out.”

The pipeline bottlenecks are unfolding alongside other problems cropping up in the Permian. Barclays noted that “productivity improvements are slowing and the decline rate is accelerating in the Permian,” even as absolute production is still expected to rise 600,000 bpd year-on-year in both 2018 and 2019.

The bank downgraded its projection for Permian supply growth by 50,000 bpd this year and next because the estimated ultimate recovery from the average Permian well is not increasing at the same rate as it once was, “despite the continued increase in proppant intensity and average lateral lengths,” a situation likely the result of “parent-child well interference and expansion into less-lucrative acreage.” In other words, the shale industry dramatically ramped up the intensity with which it drilled shale wells, but they have nearly picked just about all of the low-hanging fruit in terms of productivity gains. Related: Iran Hints At Compromise To Raise Oil Output

The pipeline constraints and the subsequent drilling and completion slowdown could result in the Permian producing 200,000 to 300,000 bpd less than originally expected in 2019. Barclays says that scenario is not necessarily the most likely, but if it came to pass, it could be felt globally, pushing oil prices up by 5 to 10 percent.

Meanwhile, Goldman Sachs said that Permian-exposed refiners will enjoy a windfall from the enormous price discounts for Midland crude. The investment bank said that after its tour of the Permian it came away with “increased con?dence around the view that Permian crude differentials need to widen further.”

So, while the “Haves” should come out okay, and the “Have Nots” might be forced to curtail production, the undisputed winners of this predicament are refiners who can gain access to heavily discounted Permian oil. Goldman likes Delek US Holdings, who sources 70 percent of its oil throughput from the Permian.

By Nick Cunningham of Oilprice.com

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