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All Dressed Up With Nowhere to Go, Part 5 - Economic Justification for New Permian Crude Pipelines

Even with crude oil prices down $1.67/bbl yesterday, the wide differential between Permian prices and those in destination markets held up, with WTI Midland trading at $15.60/bbl below the same quality of oil on the Gulf Coast. This has become a red-hot topic for all Permian-watchers. For example, in first quarter earnings calls, a number of producers not only reported their Permian well productivity and drilling plans, they also reviewed how much firm pipeline space they have signed up for in the Permian and how they plan (or hope) to avoid negative financial consequences from the differential blowout. With so much demand for new pipeline space, shouldn’t it be easy to get a bunch of shippers signed up for long-term commitments to fund a new project? Today, we’ll look at what it takes for commitments to pay off massive pipeline projects, the hurdles midstream companies go through to achieve it, and the possibility of new pipeline projects getting added to the development schedule.

In Part 1 of this series, we examined how rising crude oil production in the Permian is surpassing pipeline takeaway capacity and its impact on differentials between Midland and markets at Cushing and the Gulf Coast. In Part 2, we considered how smaller “Tier 2” exploration and production companies (E&Ps) are taking a more developmental drilling approach to their acreage, rather than just acquiring drilling rights and flipping them. These new actors have increased production in the Permian well above what much of the market was expecting. In Part 3, we discussed why these smaller producers would decide not to build out gathering systems and sign up for firm pipeline space. In Part 4, we dug into the severe lack of trucking capacity in the Permian and what it means for those producers who have not planned ahead. Today, we’re circling back to the initial question that started off this series: What will it take for the next pipeline out of the Permian to get built?

As usual, we’ll kick off with an update on the most recent news in the basin. As shown in Figure 1, the differentials between West Texas Intermediate (WTI) at Midland and Cushing (blue line) and between WTI-Midland and Magellan East Houston (MEH) crude (orange line) at the Gulf Coast widened again over the past few days after a short uptick following the restart of the Borger refinery and capacity additions on the Midland-to-Sealy Pipeline that we noted in Part 3. Yesterday (May 8, 2018) the Midland-Cush spread was traded at $12.75/bbl and the Midland-MEH spread hit $15.60/bbl. 

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