"Famine Due to Feast"
Flatly stated, the estimates have failed the planners. The Permian powerhouse which has
become the most productive oil producing region in the world, continues to see upward revisions in estimated productivity. As pipeline addition projects were planned based on old, lower production numbers, the 2019 buildout will ultimately fail to keep up with the production capabilities of the Permian. The result - a depressed profit margin for producers.
The Backdrop It can get rather confusing, all the numbers involved in discussing production, take-away capacity, and pricing, but the easy to understand explanation is rather basic. The old economic standard example is the “used car salesman.” If dealer “A” has 1,000 cars for sale, and dealer “B” has 1,000 cars, and there are 3,000 people who want to buy those cars, that’s great news. Typically, more buyers than cars means those cars will sell at a premium price.
But if those dealers are located 750 miles away from those 3,000 people, then dealers have to get those cars to those 3,000 buyers. If there’s only a few transport trucks available that can at a maximum carry 1,500 cars, those dealers have to fight for space on those carriers. That “fight” is in the form of paying more than the other dealer for that transportation space. That in turn results in less profit per car as transportation costs cut into profit margin.
This is what is happening in the Permian.
Recent History They saw this coming. Estimated production just a few years ago for the future of the Permian was encouraging. Thus, in the past two years, E/P majors and Midstream companies have been frantically planning for a buildout that is now coming to fruition. The problem is that recent projected production numbers are beyond encouraging with solid data indicating the Permian will nearly double its output by 2023. That’s a problem as new capacity additions will soon prove to fall well short of need.
The standard benchmark quoted in the press for U.S. oil prices is the WTI-Cushing, OK benchmark (West Texas Intermediate). All other prices for oil around the U.S. are based on that benchmark and reflect a discount to it, meaning, if WTI is priced at $60, and it costs $8 a barrel average to ship oil from the Bakken, then the cost of a barrel of oil sold in Bakken would be $52. Such discount spreads expand when transportation capacity is limited, and thus, more expensive.
As Permian production hit 3.45 million barrels a day (bpd) in 2018 against a pipeline capacity of about 3.1 million barrels, the bottleneck created forced producers to fight for pipeline space by discounting their prices (WTI Midland) by as much as $18 a barrel compared to the Cushing standard WTI benchmark. The discount spread against transporting that oil to Houston was even greater at times.
(What is it? WTI Midland is the Domestic Crude Oil Grade Market benchmark for the Permian production region of western Texas and eastern New Mexico. The WTI Cushing and the Magellan East Houston pricing indicators represent crude oil prices at aggregation points in Cushing, Oklahoma and Houston, Texas, respectively.)
The planned pipeline buildout that finally started to come online this year with the 120,000 bpd extension to the Sunrise Pipeline heading to Cushing and the conversion of the Seminole-Red line from natural gas to crude, adding 200,000 bpd, have helped dropped the WTI Midland discount to single digits. But until capacity expansion to the Gulf Coast comes online later this year, the discount spread to the Magellan East Houston benchmark will remain in the double digits. Those additions are significant including the 670,000 bpd Cactus II line, the EPIC pipeline that will move 585,000 bpd from Midland to the Gulf Coast (both should be in service by the third quarter of this year) and the 700,000 bpd Grey Oak Pipeline assumed to be operation by the end of 2019.
However, as Permian production has already outpaced older forecasts for 2019 forecasts of 3.9 bpd, hitting 4.2 million bpd in early 2019, and new forecasts showing an echo boom of sorts into 2023 (of 8 million bpd), even those pipeline additions coupled with planned 2020 projects like the 600,000 Houston-Nederland line, will simply not suffice in the face of Permian expansion.
The Result? The average worker in the trenches of the Upstream workforce must realize that WTI price gains don’t mean much to their direct interests. It’s those pesky Crude Grade Market prices near the well head that matter. Thus, a global oil price boom will not necessarily result in a profit boom for producers who have to pay increasing premiums to get that oil to market. The result of this bottleneck, if unresolved, could lead to a “famine due to feast” scenario.