Crude differentials in the Permian are getting squeezed. The spread between Midland and WTI at Cushing widened out to near $18/bbl at one point in 2018, when pipeline capacity was scarce. But that same spread averaged a discount of only $0.25/bbl in March 2019. Differentials between Midland and the more desired sales destination at the Gulf Coast are also in a vise. What gives? Production in the Permian continues to climb, but the rapid pace of growth we saw in 2018 has slowed down a bit lately, with fewer rigs in service and fewer new wells being brought on each month. More importantly, we’ve seen several new pipeline expansions and pipeline conversions come online in bits and bursts — in some cases, ahead of schedule — and this new chunk of pipeline space has compressed Midland pricing. In today’s blog, we begin a series on Permian crude takeaway capacity and differentials, with a look at the handful of new projects that have come online in the past few months and what has happened to Permian prices as a result.
It was only a matter of time before the crude oil market found a way to kill the price spread. It’s happened again and again. A few years back, pipeline takeaway capacity in both the Bakken and the Powder River Basin was limited, crude-by-rail was getting built out at an impressive clip, and traders were taking advantage of unique pipeline, rail, and trucking options to capture arbitrage opportunities on double-digit spreads. While producers were seeing low netbacks and weren’t happy, traders and end-market users were living the good life. Over time though, more than enough pipeline capacity got built out in those areas, spreads tightened, and most of the crude-by-rail and niche trucking opportunities were mothballed. Midstream companies saw wide price differentials, recognized the opportunity, built projects like the Dakota Access Pipeline, and the spread was dead.
That’s similar to what we’ve seen materializing in the Permian Basin over the past six months or so. In September 2018, with production quickly rising and pipeline capacity scarce, the Midland-Cushing spread widened out to minus-$18/bbl (blue line and dashed red oval in Figure 1) and the Midland-Magellan East Houston (Midland-MEH) spread widened out to minus-$24/bbl (orange line and dashed red oval). Spreads at those levels supported all kinds of movements, from Permian pipeline transportation to Cushing and the Gulf, long-haul trucking barrels to Eagle Ford pipelines — even a few crude-by-rail projects in West Texas had legs for a couple of months. Since then, however, those spreads have diminished substantially. At the end of January, we discussed how the Permian had become a tighter market; production disruptions in the area had slowed the growth and forced traders to scramble to find barrels. At that time, we saw West Texas barrels actually trade at a premium to WTI at Cushing, something that had seemed impossible only a few months earlier. Since the end of January, the Midland-Cushing differential has remained within a narrow band, with Midland trading at times just above or just below WTI at Cushing and averaging a discount of minus-$0.15/bbl over the course of February and March.