By Robert Auers and John Auers
We last covered the issue of Permian takeaway capacity in November 2017 here. At that time we predicted that Permian production wouldn’t hit 3.3 MMBPD until the end of 2018, and as a result, that we wouldn’t see significant pipeline capacity bottlenecks out of the region until late this year. However, Permian production growth has significantly outpaced our (and most everybody else’s) forecast, reaching 3.2 MMBPD in May and closing in on 3.3 MMBPD already. As a result, we are already encountering severe takeaway constraints out of the basin, with Permian barrels becoming, to paraphrase Stealers Wheel, “Stuck in the Midland With You”. This is causing the regional WTI differential from Houston to Midland to reach nearly $20/barrel and will certainly impact production momentum, at least in the short term. Help is on the way, however, with several pipelines currently under construction and new potential projects being announced on what seems a weekly basis. When will Midland see relief and what does the long term landscape look like? In todays’ blog we review the factors that go into answering these questions, including the prospects for the pipeline projects, our views on Permian production levels, other potential regional constraints and our overall forecast of the Supply vs. Takeaway situation for the Permian over the coming years.
It’s So Hard to Keep This Smile From My Face” – Permian Headed Higher Despite Bottlenecks
The current constraints and ballooning Midland discount will certainly impact short term Permian production growth. Last week’s drop in the Permian rig count by 4 might very well be an early indicator of this slowing activity (although its not wise to read too much into one data point). Unlike in the Bakken or Canada, there is limited ability to ship crude by unit train to the Gulf Coast and manifest rail and truck options are not only expensive but have physical capacity limits as well. This has resulted in record setting discounts for Midland barrels, which have only gotten wider in recent weeks, as shown in the graph below. 
While this will certainly cause the recent levels of rapid production growth in the Permian to slow (reaching only about 3.5 MMBPD by year end in our opinion), long term prospects for the region are as rosy as ever. Recoverable reserves continue to rise (exceeding 70 billion barrels by some estimates), production efficiencies continue to improve, and breakeven prices move ever lower. These dynamics are resulting in ever rising forecasts of long term production volumes. We currently forecast that Permian production will exceed 6 MMBPD by year end (YE) 2023 while others are even more bullish. One notable example of this is pipeline operator Plains All American, which released a forecast in its recent 2018 Investor Day presentation for Permian production to reach 6.4 MMBPD by YE 2023.
“Trying to Make Some Sense of it All” – The Outlook for Expanded Takeaway Capacity
Of course, for this new production to materialize, we will need to see significant increases in pipeline takeaway capacity to get all these barrels to market. Fortunately, the regulatory environment in Texas has and, more than likely, will continue to be favorable not only for pipeline construction, but also for the oil and gas industry as whole. This contrasts markedly with the situation in other regions, including that which we discussed for Western Canada last week. While this obviously doesn’t prevent short term takeaway capacity constraints from arising (as is being demonstrated right now), long term, sustainable limits to growth due to logistical limitations are much less likely. We anticipate the current bottleneck to be resolved next year when several projects currently under construction are expected to come on line.
Very little relief is expected during the first half of 2019, with only a rather modest 120 MBPD expansion in the Plains Basin system (to Cushing) coming online (2Q 2019). However, there are a slew of projects starting up in the second half of the year (all of them to Corpus Christi), including the 440 MBPD EPIC pipeline, 670 MBPD Cactus II pipeline, and the 700 MBPD (expandable to 1 MMBPD) Gray Oak pipeline. While nearly 2 MMBPD certainly seems like a lot of additional pipeline capacity (and it is), we expect that production will rapidly grow to fill these new lines and that more new pipeline capacity will be needed again by 2021 or 2022.
The industry sees the longer term need for more pipeline capacity as well and projects are already being proposed and developed to meet that need. This next wave looks to be led by Energy Transfer Partners (ETP) 1 MMBPD Midland-Nederland line, which is currently slated for start up by year end 2020. Supplementing this project could be the recently-announced 1 MMBPD Plains / Exxon JV line from the Permian to Baytown and Nederland. Very few details regarding this latter project have been released as of yet, but we forecast completion sometime in 2022 or 2023 if all goes as expected.
Other projects are also being discussed, including the Enterprise NGL-to-crude oil pipeline conversion running from the Permian to the Houston area (~200 MBPD) and the more prospective Jupiter project – a 500 MBPD pipeline which is planned to service a proposed new crude export dock in Brownsville, TX. While completion for this last project is certainly possible, we currently don’t forecast that it will be needed, and the lack of a strong sponsor coupled with the additional investment needed to construct a large scale export dock at Brownsville, lead us to conclude that this project has a very uphill climb. Overall, our current forecast shows adequate takeaway capacity from the Permian after the slew of projects start up at the end of next year through at least the end of 2025. However, it is certainly very possible that project delays or Permian production that exceeds expectations could change this situation, resulting in takeaway capacity constraints and periods where crude gets “Stuck in the Midland” again.
“Clowns to the Left of Me, Jokers to the Right” – Permian Gas Takeaway Constraints
Besides crude pipeline takeaway issues, other bottlenecks could also impact Permian production prospects. One of these is the situation with natural gas takeaway capacity. With growing crude production comes growing production of associated gas. Moreover, gas-oil ratios in the Permian (especially the emerging Delaware Basin) have been higher than initially expected. As we understand, this issue has not been caused by lower-than-expected oil production per well, but by higher-than-expected gas production per well. This resulted from engineers assuming conservative low gas rates per well, as high gas production rates have not been needed to justify increased drilling activity.
Furthermore, the exact current limits of allowable flaring in the Permian are not well understood. Each producing well is allowed to apply for a 45 day permit during which associated gas can be flared. After this, a producer can apply for an extension, but an extension being granted is far from a sure thing. Therefore, a bottleneck in Permian gas takeaway capacity has the ability to limit oil production growth if oil wells are forced to be shut-in due to flaring restrictions. The completion of ETP’s Trans-Pecos (1.4 BCFD) and Comanche Trail (1.1 BCFD) Pipelines in 1H 2017, however, increased total WAHA gas takeaway capacity to approximately 10.5 BCFD, which remains in excess of current pipeline utilization of 8-9 BCFD from the West Texas storage hub. Nonetheless, we do note that the two new ETP pipes to Mexico are not able to truly operate at full capacity due to lack of demand for that amount of gas on the Mexican side (an issue that will likely persist until at least 2021). As a result, if Permian gas production continues to grow at its current rate of 200+ MMCFD/Month, a takeaway capacity bottleneck could be encountered later this year or early next, and gas prices at the Waha hub are already ~$1 below those at Henry Hub. Flaring permits in the Permian have not, however, picked up significantly thus far in 2018.
The completion of Kinder-Morgan and Targa Resources’ Gulf Coast Express 1.92 BCFD natural gas pipeline, expected in 4Q 2019, should relieve any potential takeaway constraints, at least temporarily, but capacity will likely still be tight, given that the Permian appears to be adding nearly 1-1.5 BCFD/year of gas production (though this should slow somewhat as the crude production growth rate slows going forward). Still, three additional projects (which have not yet received final approval) provide visibility for another 6 BCFD of Permian gas takeaway capacity by YE 2022. These projects include Namerico Holdings’ Pecos Trail pipeline to Corpus (we have noticed particularly little news regarding this project as of late), Sempra and Boardwalk’s Permian-Katy pipeline, and Tellurian’s Permian Global Access Pipeline to its proposed Driftwood LNG export terminal in Louisiana. Despite these projects, Permian gas takeaway capacity appears to be tight for the foreseeable future. Fortunately, as is the situation with crude oil pipelines from West Texas, there appears to be plenty of capital chasing natural gas pipeline opportunities in the region, and this, coupled with a generally industry-friendly regulatory environment in Texas, should prevent a true long-term shortage of Permian gas takeaway capacity. Nonetheless, the potential for short-term bottlenecks remains, and this could potentially limit the rate of crude production growth in the region as well.
We will continue to watch the developments in the Permian, both on the production and logistical buildout sides and analyze impacts on prices and supply/demand balances. We will be focusing especially on these types of issues in our upcoming 2018 Mid-Year Update of our Crude and Refined Products Outlook (C&RPO). Included in our C&RPO will be a detailed forecast of both crude and product prices for all the key regions worldwide. Pricing is based on a variety of factors, including pipeline availability, but also are impacted by other dynamics not discussed in this blog. Supply of refined products is also a key part of the equation, and we include an analysis and forecast of the impact of new refinery projects on the supply of gasoline and other products in the C&RPO. For more information on this report or on any of our other analyses or consulting capabilities, please send us an email or give us a call.