Oil production in the Permian basin continues to rise, helping the U.S. to break production records with each passing month. U.S. oil production hit a record high 10.67 million barrels per day (Mbd) in June, while more recent weekly data suggests production likely stands at around 11 Mbd today. The Permian has been the main driver of this explosive growth in the last few years.
However, the high concentration of drillers in one area has led to soaring land prices and a series of constraints in the supply chain. A growing number of companies have already started to look elsewhere because West Texas has become too crowded.
The pipeline constraints in the Permian have led to steep discounts for oil in Midland, Texas compared to WTI in Houston, a differential that has routinely traded in excess of $10 per barrel for much of this year. That means that while WTI trades at around $70, Permian drillers that have not hedged their production or secured pipeline space are selling their oil in the mid-$50s. “We expect that smaller producers are more likely to throttle back activity as bottlenecks worsen since they usually have less firm takeaway capacity or are less well hedged,” Bank of America Merrill Lynch said in a note.
A variety of other constraints have also materialized, including for labor, completion services and water disposal. The result has been cost inflation, although there is quite a bit of disagreement from within the industry over how serious these problems really are.
A variety of other constraints have also materialized, including for labor, completion services and water disposal.
“The egress situation in the Permian is casting a pall on investor interest in Permian-focused E&Ps and is leading to a decline in completion activity,” Barclays wrote in a note, summarizing the results of their CEO Energy-Power Conference in New York from earlier this month. “Though some equities investors we spoke with seem to be confident they can see through the pain, others are wondering whether the problem is more structural than temporary.”
Shale companies look elsewhere
Attention and capital has already begun to decamp to other shale basins, and not just because of pipeline problems in the Permian. Shale companies have been attracted to lower land prices, lower costs of production, undeveloped acreage and fewer constraints on an array of services when compared to the crowded Permian basin.
“As a result of the strain that Permian producers are likely to face for the next 6-12 months, production from other basins, including the PRB, Niobrara, SCOOP/STACK, and Bakken, may see increased activity in the coming months,” Barclays said.
Harold Hamm, CEO of Continental Resources, said at the Barclays conference that the Bakken is set for a “renaissance.” That conclusion was backed up by several other shale E&Ps. WPX, Marathon Petroleum, Whiting Petroleum and Hess Corp., which collectively account for nearly half of crude oil and condensate production in the Bakken, all reported optimistic results from the region over the past year. Continental Resources is seeing a “step change in well performance rapidly expanding across the Bakken,” leading to a significant increase in its rate of return compared to 2017.
While Permian producers might be fetching somewhere around $55 per barrel for their oil due to pipeline-related discounts, Bakken producers do not have that problem.
Not only are companies returning to the Bakken to deploy improved drilling techniques, but prices in the Bakken are also faring better than in the past. While Permian producers might be fetching somewhere around $55 per barrel for their oil due to pipeline-related discounts, Bakken producers do not have that problem. In fact, Bakken oil has occasionally traded at a premium to WTI, and the inauguration of the Dakota Access Pipeline last year resulted in new midstream capacity, which lifted regional prices. This past summer the Bakken overtook the Permian as the most profitable shale play in the country, according to S&P Global Platts. “We see Bakken production increasing by almost 100 kb/d in 2019, yet we see upside risk to this forecast given the lack of takeaway constraints compared to other basins,” Barclays concluded.
The investment bank also said that it thinks the Austin Chalk is a “sleeper play,” a shale formation that stretches from South Texas into Louisiana is suddenly garnering more interest as companies begin to pivot away from the Permian. “There was increased talk about south Texas’s Austin Chalk play amongst a number of E&Ps,” Barclays noted. “EOG and Magnolia both pointed out that their Austin Chalk acreage is seeing better returns than parts of their Eagle Ford position.” Meanwhile, a growing number of notable shale companies, such as Anadarko Petroleum, EOG Energy, Devon Energy and Chesapeake Energy are trumpeting their positions in Wyoming’s Powder River Basin, where acreage can sell for a tenth of what it might cost in the Permian.
Permian problems likely temporary
The lack of midstream capacity could force a slowdown in production over the next year, but with a series of pipelines on the way, the bottleneck – and the associated pricing discounts – will likely be temporary.
“Over the near-term, spot Midland prices could drop into the mid or low $40s, limiting cash available to some E&Ps and hampering their ability to keep pace with previously planned completion schedules,” Bank of America Merrill Lynch said in a note. “But as Permian constraints ease during 2019, new oil bottlenecks are likely to arise in the Bakken and Niobrara caused by strong production growth in those basins, depressing oil prices at their respective hubs.” Just as the Permian is suffering from pipeline woes, so too could the Bakken and others if production starts to climb rapidly.
Drilling activity in the Bakken is up 20 percent compared to the same period in 2017.
Year-to-date, drilling activity in the Bakken is up 20 percent compared to the same period in 2017, according to Bank of America Merrill Lynch. While the region currently has ample pipeline space, higher production will eventually max out capacity. “During 2019, we expect Bakken production to exceed takeaway capacity again, which should cause oil there to trade at a more persistent discount to WTI until new pipeline capacity arrives,” Bank of America Merrill Lynch wrote. “Oil pipelines aren’t the only limitation for Bakken growth, gas processing, and gas and NGL pipeline expansions will likely be needed to accommodate growth.”
The Niobrara could also face constraints because of the inability to handle the surge in associated natural gas. “Output in the Niobrara has surged in recent months but gas processing bottlenecks have been a limiting factor for growth in the basin,” Bank of America Merrill Lynch concluded. “During this time, we expect takeaway capacity constraints to re-emerge, particularly as rising Canadian and Bakken volumes compete for takeaway capacity in the region.”
Midstream constraints could start impacting upstream operations in some of these shale plays in late 2019, just as the bottlenecks in the Permian are resolved. The industry could very well then turn back to what made the Permian attractive in the first place: vast oil reserves layered in stacked shale formations that allow companies to produce high volumes of oil at relatively low cost. In other words, it isn’t clear that newfound interest in a variety of shale plays outside of West Texas will prove durable.