The Permian Takeaway Bottleneck: How Bad Is It?

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Includes: ANDV, APA, ARES, BPL, DCP, ENB, EPD, KMI, LNG, MMP, PAA, PSXP, PXD, SEP, TELL, TRGP, XOM
by: Laurentian Research

Summary

As of May 2018, the Permian oil production stands at 3.199 MMbo/d, up from 2.8 MMbo/d as of end-2017 and expected to rise by another 78 Mbo/d in June 2018.

According to industry forecast, crude output in the basin is expected to be 3.4-3.5 MMbo/d by end-2018 and may reach 4.8 MMbo/d by 2022.

From the actual and expected pipeline capacity profile, the oil production in the basin will outstrip the takeaway capacity from 2Q2018 through 2Q2019.

Such a takeaway capacity tightness will not be relieved until mid-2019 when a series of major pipeline projects come on stream.

Houston, we've got a problem

Surging production has begun to outstrip the pipeline takeaway capacity out of the Permian Basin, dampening production growth prospect in the future until new pipelines come onstream. Different companies have varying exposure to this transportation tightness, depending on their 2018 drilling program, well economics and hedging profiles. In this article, let's look at what all of this means to the investors.

Permian production

The oil production from the Permian Basin has been in a rapid rise since 2016, after a short-lived hiatus during the previous year (Fig. 1). As of May 2018, the oil production there stands at 3.199 MMbo/d, which is up from around 2.8 MMbo/d as of end-2017 and expected to rise by 78 Mbo/d to 3.277 MMbo/d in June 2018, according to EIA (see here).

Fig. 1. The historical and forecast front month production from the Permian Basin. Source.

Other sources forecast an even higher crude output by the end of 2018, e.g., 3.4-3.5 MMbo/d according to Plains All American Pipeline (PAA), on the way to 4.8 MMbo/d by end-2022 (see here) (Fig. 2).

Fig. 2. Permian Basin crude oil production, excluding NGLs. Source.

Crude takeaway capacity outstripped

The midstream companies have been busy in expanding the oil transportation capacity out of the Permian Basin (Fig. 3). The total oil takeaway capacity from the Permian Basin increased to approximately 2.8 MMbo/d in early December 2017, after the 330 Mbo/d Midland-Sealy pipeline of Enterprise Products Partners (EPD) came on stream (see here), which rose further to 540 Mbo/d by April 16, 2018 (see here) (Fig. 4).

Fig. 3. The crude oil pipeline and refining infrastructure out of the Permian Basin. Source.
Fig. 4. Permian production vs. operable pipeline takeaway capacity, with the green circle signifying actual production in December 2017 and May 2018 and expected production in June 2018. The Gray Oak Pipeline is not shown due to its still being in the open season. Modified after source.

The rig count in the Permian Basin has risen by 40 since the beginning of 2018 (see here). Typically, depending on the annual capital budget, the E&P operators ramp up (or slow down) drilling the most in the first quarter and slightly in the second quarter, and adjust their drilling programs in the remainder of the year according to the commodity price outlook.

Given that the oil price as represented by WTI has appreciated considerably from 1Q to 2Q2018 (Fig. 5), one would expect the producers to mobilize more drilling rigs. However, the rig count in the Midland Basin (the eastern sub-basin of the Permian Basin) has been flat for three weeks in a row, while that in the Delaware basin (the western sub-basin of the Permian Basin) has been flat over the last two weeks as of May 18, 2018 (see here). Such a taper-off of drilling activity in the Permian Basin may confirm that the rising production there has probably equalized the pipeline capacity entering May 2018 (Fig. 4).

Fig. 5. The price of WTI in 2018. Source.

New oil pipelines under construction

EPIC

The EPIC Crude Oil Pipeline will extend 700 miles from Orla, TX to the Port of Corpus Christi, TX. The project includes originating terminals in Orla, Pecos, Saragosa, Crane, Wink, Midland, Helena, and Gardendale, with Port of Corpus Christi connectivity and export access. It is financially backed by Ares Management (ARES).

With a capacity of 550 Mbo/d from the Delaware and Midland basins and the Eagle Ford trend, the oil pipeline will be laid alongside a 350 Mb/d NGL pipeline, which was reportedly proceeding on schedule as of April 2018 (see here).

The right of way is 100% secured for the first two phases of the oil pipeline system, and construction is expected to commence in 4Q2018, with the crude system expected to be in service in 2H2019 (see here).

Fig. 5. The EPIC crude oil pipeline. Source.

Cactus II and Sunrise of Plains All American

Plains All American (PAA), the major oil and gas transportation company in the Permian Basin with 1 MMbo/d of long-haul capacity, is undertaking an all-out campaign to overhaul its infrastructure in 2018 (Fig. 6):

  • The company is working on the 120 Mbo/d Sunrise expansion from the Permian Basin to Cushing, OK, in two phases; in Phase I, the company is building the Sunrise Extension from Colorado City to Wichita Falls, TX, and in Phase II, it will install the Sunrise Loop from Midland to Colorado City. The Sunrise expansion is scheduled to come onstream in early to middle 2019 (see here).
  • The company is also working on the Cactus II Project, which consists of the Wink to McCamey and McCamey to Corpse Christi segments, thus linking up the various origination points at Orla, Wink, Midland, Crane, and McCamey in the Permian Basin to multiple docks in the Corpus Christi-Ingleside area on Gulf Coast. The company has already secured 525 Mbo/d of third-party commitments (including 425 Mbo/d of minimum volume commitments, aka, MVCs, and 100 Mbo/d of acreage dedications), with 60 Mbo/d reserved for walk-up shippers, for a total capacity of 585 Mbo/d. Permitting, right of way, and procurement activities are currently underway, with the pipeline targeting a 3Q2019 start-up (see here).

Fig. 6. The oil takeaway projects of Plains All American from the Permian Basin. Source.

Midland-to-Sealy of Enterprise Products Partners

Enterprise Products Partners L.P. said it expected to raise the capacity of the Midland-to-Sealy pipeline, which is fully subscribed under long-term contracts, to 575 Mbo/d by May 2018, after having reached 540 Mbo/d as of April 16, 2018 (see here).

  • At Sealy, TX, the pipeline links to the 36" Rancho II pipeline which leads to the 7.4 MMbo ECHO crude terminal in southeast Houston, which already has access to Gulf Coast refineries and deepwater docks (Fig. 3). At the western end of the pipeline, the company looks to complete a 143-mile, 300 Mbo/d pipeline system from the Delaware Basin to its Midland terminal by July 2018.

Gray Oak Pipeline

On April 24, 2018, Phillips 66 Partners (PSXP) and partner Andeavor (ANDV) announced that they had received sufficient binding commitments on an initial open season to proceed with construction of the Gray Oak Pipeline system from the origination stations in Reeves, Loving, Winkler, and Crane counties in West Texas, as well as from locations in the Eagle Ford production area in South Texas, to destinations in the Corpus Christi and Sweeny/Freeport markets, where it will connect to a new 3.4 MMbo marine terminal under development by 50% stakeholding, operating Buckeye Partners, L.P. (BPL) and partners Phillips 66 Partners and Andeavor, each holding a 25% interest (Fig. 7).

The tentatively 700 Mbo/d (expandable to 1,000 Mbo/d) pipeline is expected to be placed in service by end-2019. Phillips 66 owned 75% and Andeavor (ANDV) 25% in the pipeline joint venture, with other third parties, including Enbridge Inc. (ENB), having an option to acquire up to 32.75% interest from the former (see here).

Fig. 7. The Gray Oak Pipeline system. Source.

Magellan Midstream Partners (MMP) announced in December 2017 a plan to build a long-haul, 24" crude oil and condensate pipeline from Crane, TX, in the Permian Basin to Corpus Christi by late 2019, however, the company failed to receive adequate commitments to proceed with the project in the open season (see here).

The natural gas bottleneck

The Permian Basin produces natural gas, mostly associated with the unconventional oil, at 10.273 Bcf/d as of May 2018. The gas production is expected to reach 10.498 Bcf/d the next month (Fig. 8). Natural gas production from the Permian region as a whole is expected by IEA to exceed 12 Bcf/d, at a minimum, by 2023 (see here). NAmerico reckons that the associated gas production from the Permian Basin may reach as high as 20 Bcf/d by 2025 (see here).

Fig. 8. The actual and expected natural gas production in the Permian Basin. Source.

Currently, there are at least three gas pipelines are in various stage of construction.

Permian Global Access Pipeline

Permian Global Access Pipeline LLC, a wholly-owned subsidiary of Tellurian Inc. (TELL), announced a non-binding open season for transportation services on the Permian Global Access Pipeline, a proposed interstate natural gas pipeline that measures approximately 625-miles and 42" in diameter, originating at the Waha Hub, the gateway for Permian gas heading to market, and terminating near Lake Charles, LA. The pipeline will aggregate natural gas production from supply points throughout the entire Permian Basin and feed to the Driftwood LNG export facility near Lake Charles (see here) (Fig. 9).

Fig. 9. The various natural gas pipeline projects from the Permian Basin. Source.

Gulf Coast Express Pipeline Project

On December 21, 2017, Kinder Morgan (KMI) Texas Pipeline, DCP Midstream (DCP) and an affiliate of Targa Resources Corp. (TRGP) announced a final investment decision to proceed with the Gulf Coast Express Pipeline Project, aka, GCX, after having secured sufficient firm transportation agreements with shippers. Approximately 85% of the project capacity is subscribed and committed under long term, binding transportation agreements with Apache Corporation (APA), Pioneer Natural Resources (PXD) and XTO Energy (XOM) etc.

The 1.98 Bcf/d GCX Project Mainline portion consists of 447.5 miles 42" pipeline originating at the Waha Hub near Coyanosa, TX in the Permian Basin and terminating near Agua Dulce, TX. The Midland Lateral portion consists of 50 miles of 36" pipeline and associated compression, connecting with the GCX Project Mainline (see here)(Fig. 10).

The project will start construction on the Midland Lateral in May 2018 and on the GCX Mainline in October 2018, looking to be in service by October 1, 2019 (see here).

Fig. 10. The Gulf Coast Express gas pipeline. Source.

Pecos Trail Pipeline

Financially backed by Dallas-based private-equity firm Cresta Energy Fund I LP, NAmerico is building the 468-mile, 42", 1.85 Bcf/d Pecos Trail Pipeline, slated to be operational in 3Q2019 (see here and here). Construction is scheduled to start in mid-2018 (see here).

Pecos Trail will deliver to numerous intrastate pipelines in Texas, the Valley Crossing Pipeline of Spectra Energy (SEP), the NET Mexico Header, and the Cheniere Energy (LNG) Corpus Christi LNG Header system, subject to shipper commitments.

Therefore, by 3Q2019, a total of 3.83 Bcf/d of natural gas transportation will be added.

Investor takeaways

Surging production has begun to outstrip the pipeline takeaway capacity out of the Permian Basin, dampening production growth prospect in the future until new pipelines come onstream.

However, the pipeline bottleneck is expected to be much relieved by mid-2019, with a slew of major pipelines to be brought on stream by then. This is, therefore, a crisis with a positive outcome for the better run E&P concerns.

What does this mean for the specific E&P operators in the prolific Permian Basin? Each company requires an in-depth examination of its production profile, cost structure, hedging positioning, and liquidity outlook. A general bearish attitude toward any operators in that basin is not advised. This is because this crisis may actually present an opportunity for investors with an investment horizon longer than one year to make an entry into select E&P names, although some operators undoubtedly will suffer.

Disclosure: I am/we are long THE TNRH MODEL PORTFOLIO.

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.

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