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Even Flow, Part 2 - Crude Oil Pipeline Rate Compression from the Permian and Cushing to the Coast

The battle for pipeline supremacy in the Permian is really heating up. From Cactus II, to EPIC, to Gray Oak, to a bevy of upcoming expansions and a couple of longer-term behemoth greenfield projects, there are multiple new takeaway options for Permian producers. But could it all be coming online at the wrong time? If there’s one thing we’ve learned from third-quarter earnings calls and recent conversations with producers, it’s that balance-sheet management and fiscal conservativism are top of mind right now. As a result, drilling plans and production growth expectations have been tamped down considerably for 2020 and beyond. Midstreamers and pipeline companies in the Permian are responding quickly. Tariffs are being slashed, margins are getting cut, and competition for West Texas barrels is fierce. Today, we look at recent developments and what they’ll mean for revenues and market differentials heading into the New Year.

Several Permian-focused exploration and production (E&P) companies’ stocks took a hit after third-quarter investor calls revealed their previous production targets had been missed, or that upcoming goals would be lowered. While Permian wells are still highly productive, producers there are being pressured by Wall Street to focus less on absolute productivity, and more on profitability and financial sustainability. As a result, in their earnings calls, many producers announced lower capital budgets for 2020 and scaled-back drilling plans. Further, productivity improvements are having less of an impact than they did a couple of years ago when the basin was ramping up, meaning that lower producer activity will not be offset as much by increasing well results. The cumulative effect of initial decline rates on all of the recently drilled wells in the Permian is huge, so you need to keep completing more and more wells to keep production numbers increasing. The production treadmill that E&Ps are on is getting faster as the proportion of new wells (experiencing typically much higher decline rates) to legacy wells (whose decline rates have leveled off) has increased, and producers are having a harder time staying on it while keeping their investors happy.

This producer paradigm shift is occurring right after a number of midstream companies made major investments in the Permian to build-out new pipeline takeaway capacity. Those pipes were lusted after by producers less than a year ago when supply growth was outpacing available takeaway capacity. But now, with ample space open and production rates getting tougher to maintain, midstreamers are locked in a tough competition for smaller and smaller subsets of incremental production. In Part 1 of this series, we discussed the potential overbuild facing Permian takeaway pipelines being developed to serve the Gulf Coast market. In our view, that scenario is a realistic one, even after assuming Permian production growth of almost 2 MMb/d between October 2019 and year-end 2021.

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