While Permian oil and gas production was soaring in 2018, U.S. midstream operators were planning and building pipeline takeaway capacity, expecting that the largest U.S. shale play would increase output for years to come, even if at a slower pace than before.
Pipeline companies rushed to invest in and complete new oil pipelines in the region to stay ahead of the booming Permian production. But they got ahead of themselves in boosting pipeline takeaway capacity.
The black swan year of 2020 exposed the stark reality of the shale and pipeline construction boom. Current pipeline capacity in the Permian is exceeding production so much that in a year or two, when pipelines currently under construction are completed, Permian producers could find themselves using just half of the available takeaway infrastructure, according to analysts.
Granted, oil pipeline infrastructure was already running ahead of Permian production at the end of last year, when output growth slowed down with many producers prioritizing profits over production as the capital markets and investors soured on footing the bill for explosive output growth without meaningful returns.
Then came the pandemic and the price crash in March 2020, forcing Permian exploration and production companies to curtail production, which has dropped from nearly 5 million barrels per day (bpd) as of March to an estimated 4.150 million bpd in September—a drop of around 700,000 bpd over the six months since oil prices collapsed.
After the crash, pipeline infrastructure companies started to announce deferrals of final investment decisions and start-up dates for planned oil and gas pipelines, especially in the Permian, which suddenly found itself with additional overbuild of capacity as production and consumption of oil struggled to recover from the pandemic-driven crisis.
The latest announcement of a canceled oil pipeline came from Enterprise Products Partners, which said earlier this month that it was scrapping the 450,000 barrels per day Midland-to-ECHO 4 crude oil pipeline project.
But many of the pipelines planned back in 2018 are already in service and capacity was already exceeding production even if project deferrals and cancellations are taken into account. “Permian oil infrastructure is already overbuilt. We anticipate that Permian oil output will recover to pre-COVID records of 4.9 million B/D by the end of the next year, but, even then, we will have 2 million B/D of unutilized outbound capacity,” Rystad Energy’s head of shale research Artem Abramov told the Journal of Petroleum Technology earlier this month.
Permian Crude Pipelines Face Years Of Low Utilization
According to midstream sector analytics company East Daley Capital, while the cancellation of Midland-to-ECHO 4 removes 450,000 bpd of future takeaway capacity from the Permian, this is just a small step in addressing a looming oversupply of the basin’s egress capacity. Currently, Permian crude oil supply is just over 4 million bpd, while the takeaway capacity exceeds 7 million bpd.
By early 2021, crude oil pipeline capacity is set to jump to 8.3 million bpd, which would be double the production in the Permian, East Daley’s estimates reported by The Wall Street Journal show.
According to Wood Mackenzie, long-haul crude oil pipelines between the Permian and the U.S. Gulf Coast were overbuilt even before this year’s price crash. Pipeline utilization in the biggest American shale basin is set to fall to 60 percent by October 2020, and stay at around that level until at least December 2021, Alex Beeker, WoodMac’s Principal Analyst, Corporate Research, said in June.
Oil Crisis Spills To All Sectors
The crash in oil prices and shale production spilled over to the midstream sector, which is now caught between falling oil production and pipeline utilization from the upstream and crumbling demand for fuels in the downstream. The midstream sector is reducing capex and deferring some pipeline projects, while analysts and industry executives say that the industry is set for a wave of consolidation with increased competition and weakened financial profiles of some operators.
Oil producers and oil infrastructure developers in the Permian – as well as everyone in the world – were taken by surprise in a “global pandemic that would substantially slow economic activity in much of the industrialized world, especially the U.S.; annihilate demand for jet fuel, motor gasoline, and (to a lesser degree) diesel; and spur the U.S. refinery sector to reduce their utilization rates to less than 70%,” RBN Energy said this month.
New pipelines, production curtailments, changed forecasts, and reduced capex by producers have “significantly altered crude oil and natural gas market fundamentals,” in the Permian, RBN Energy added.
The excess Permian pipeline capacity has helped raise the price of oil in Midland, Texas, to the levels of the WTI traded in Cushing, closing the double-digit dollar discount of Midland oil from early 2018 when crude takeaway capacity in the Permian was severely constrained. These days, producers who don’t have contracts to ship their crude at fixed prices could sell their Permian crude at prices similar to the U.S. benchmark. This could be some, but not enough, consolation for producers, considering that WTI Crude is struggling to hold onto the $40 a barrel handle these days.
For refiners along the Gulf Coast, gone are the days of Permian oil significantly cheaper than WTI Crude. The more expensive Permian crude for processing only adds to refiners’ biggest distress these days—the crash in fuel demand.