Beware The Neglected Secret That Lies In The Permian Basin

| About: The United (USO)

Summary

Oil isn't the only thing laying in the Permian Basin.

The threat posed to some energy investors from ramping up Permian shale production.

Permian could frustrate more than the proposed OPEC production cut in the months ahead.

Nothing can stop gas and oil supply from soaring in the Permian.

Click to enlarge

source: Stock Photo

For obvious reasons oil gets the majority of the press coverage in the U.S. shale play, but neglecting its weaker cousin natural gas could end up being a big mistake as producers add rigs and wells in the Permian Basin.

The price of natural gas has recently jumped past the $3 per million British thermal units for the first time in about 16 months, as exports climbed and demand from hot summer weather increased. This has produced a more bullish outlook for natural gas, which in the minds of a lot of investors has reached sustainable levels.

Just like the market underestimating the effect U.S. shale oil production could have on the price of oil in response to the proposed production cut from OPEC, for the most part it isn't even considering the impact the increase in drilling will have on natural gas supply in the months ahead.

While a lot of gas production has been cut back on in most locations in the U.S., it's alive and well in the Permian, which could catch a lot of investors off guard if it isn't included in analyzing the gas market.

Natural gas in the Permian

Over the last several months producers have added 45 rigs, with expectations that is going to continue to grow into and through 2017.

According to Bloomberg Intelligence data, the boost in production from the new rigs has increased the amount of natural gas as a byproduct in the Permian to just under 7 billion cubic feet a day. This is going to increase for many months as more wells are completed and rigs added, which at about 7 billion cubic feet a day is already representative of approximately 8 percent of U.S. supply.

It's not hard to see how that could probably jump to more than double that as Permian producers increase output. Under that assumption, natural gas supply from the Permian could increase to 16 percent to 20 percent of U.S. supply. That could definitely surprise a lot of natural gas investors if that is how it plays out. This could even surprise more to the upside of supply if the price of oil is able to continue to find support over the next 16 months. That would trigger even more well completions and added rigs to the region, which would increase the amount of natural gas byproduct.

How it breaks down in the Midland and Delaware

Based upon the top 20 wells in the Delaware Basin and Midland Basin, Midland has a higher percentage of oil per well. The Midland Basin has an average of about 85 percent oil in the top wells, while the Delaware has closer to about 70 percent.

Leading in the Midland Basin is Pioneer Natural Resources (NYSE:PXD), which as 14 of the top 20 wells. Only energy major Exxon Mobil (NYSE:XOM) has more than 1 well in the top 20.

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source: oilgas360

Cimarex Energy (NYSE:XEC) leads in the Delaware, with 7 of the top 20 wells. All of those have oil accounting for under 70 percent of the total. Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) and Anadarko (NYSE:APO) each have two in the top 20. It's interesting to note that of the two majors - Exxon Mobil and Royal Dutch Shell, they're both near the bottom of the top wells in both Basins.

In the case of Shell it does have more oil as a percentage of the well than most other producers in the Delaware.

If the top wells are indicative of the overall mix of oil and gas in the Permian, output from the Delaware will have a stronger impact on natural gas than production coming from the Midland.

source: oilgas360

Importance of the Permian as a probable disruptor

If there is anything that will disrupt the bullish sentiment permeating the oil and gas markets, it is the quantity of supply that is likely to come from the Permian. What isn't known at this time is how much oil will be added as rigs are increased and wells are completed. That is because of the enormous improvements in productivity, of which the full impact is yet unknown as to how much supply will be added to the market.

Natural gas is clearer at this time, but the quick increase in rigs and wells is going to continue to change how much resource is being brought to the market.

In my view, how goes the Permian will be how goes the price of oil and gas over the next 14 months or so. I believe both are going to surprise to the upside, and no artificial drop in production will be able to offset the coming boost in supply that will once again test the price of oil going forward.

Natural gas in and of itself isn't even on the radar of most investors in regard to Permian output, and oil is vastly underrated as a potential disruptor of the current narrative the oil has found support and OPEC is back in the driver's seat.

Oil has temporarily found support, but OPEC is definitely not in the driver's seat. U.S. shale producers are, which the market will find out in the months ahead.

Conclusion

No matter what OPEC or Russia announce in November, the Permian is going to continue to increase the amount of oil and gas supplied to the market, and in the case of natural gas in particular, it could catch a lot of investors by surprise if it isn't being included in their analysis.

Accounting for 8 percent of U.S. natural gas supply at this time, I do see the increase in Permian output easily doubling over the next year, and it could even go higher than that if oil prices remain at profitable levels to those working the Permian.

Interestingly, the better oil looks in the months ahead, as far as it relates to its effect on the Permian Basin, the worse it'll be for natural gas. For that reason those with less exposure to natural gas, meaning those working the Midland, should do better than those with more exposure to the Delaware.

Either way, we need to closely watch natural gas supply and how it'll be affected by the rapid deployment of rigs and completion of wells in the Permian. It's going to have a stronger effect than the market is seeing at this time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.