Thanks to the high returns drillers can earn on new wells, the Permian Basin has been a hotbed of activity in recent years. Oil production in the Texas basin is on pace to rise from under 2 million barrels per day (BPD) in early 2015 to an estimated 3.8 million BPD by the end of this year. That fast-paced growth has overwhelmed the region’s infrastructure, causing congestion in getting crude out of the area. The problem has gotten so bad that regional oil prices have plummeted versus other oil benchmarks, which is hitting the profitability of oil companies focused on the Permian.
While midstream companies are working to resolve this issue, it takes time to build new pipelines. Because of that, oil companies are anxiously awaiting their arrival, which should begin in the second half of next year. Once that happens, it could provide a boost to Permian producers.
Tapping the brakes until a new pipeline comes online
Halcon Resources (NYSE: HK) is one of the many Permian-focused producers caught in the region’s infrastructure issues. Shares of the company have shed nearly 50% of their value this year due in part to regional oil price issues, which have caused its “oil prices realizations [to] decline significantly” in recent weeks, according to CEO Floyd Wilson. Because of that, Wilson said his company has “decided to moderate our drilling pace to three operated rigs for the remainder of 2018,” which is down from the four it planned to run. As a result, production won’t grow as fast as the company expected later this year.
However, Halcon is taking steps to address its issues by working to secure 25,000 BPD of capacity on a pipeline to the Gulf Coast, which should start up in the second half of next year. That agreement will enable the company to sell the bulk of its forecasted oil output to higher-priced Gulf Coast markets, which will improve cash flow and its growth prospects.
Securing space all over the place
Diamondback Energy (NASDAQ: FANG) has also worked to firm up its oil takeaway strategy so that it can get better pricing for the oil it produces. The company noted that by the end of the third quarter, about 83,000 BPD of its production should realize Gulf Coast pricing — roughly 70% of total output — which will narrow the discount from what it currently realizes to $14 to $16 a barrel below prices along the Gulf. Meanwhile, the company has locked up firm capacity to ship about 105,000 BPD next year — also about 70% of anticipated output — which should narrow the discount to about $10 to $12 per barrel. That should rise to more than 200,000 BPD by 2020, exposing 100% of its oil to Gulf Coast pricing and narrowing the discount to less than $5 per barrel.
One of the drivers of that increase is the fact that Diamondback Energy has secured 50,000 BPD of capacity on the Gray Oak Pipeline, which is under development by Phillips 66 Partners (NYSE: PSXP) and Andeavor (NYSE: ANDV). Initially envisioned as a 385,000 BPD pipeline, Gray Oak will now be a 700,000 BPD pipeline that its developers could expand to 1 million BPD if they secure enough customers. Phillips 66 Partners, which is leading the development, expects the project to enter service by the end of 2019.
In addition to that pipeline, Phillips 66 Partners and Andeavor have also partnered with another company to build a marine terminal that will export some of the oil from Gray Oak to global markets, enabling companies like Diamondback Energy to realize even higher global prices for their oil.
Signing on to the solution for an epic problem
Both Apache (NYSE: APA) and Noble Energy (NYSE: NBL) have signed on to the private-equity-backed EPIC Pipeline, which will move 590,000 barrels of crude per day to the Texas coast when it starts operations in the second half of next year.
That will include shipping 440,000 BPD out of the Permian. Noble locked up 100,000 barrels of that capacity to “ensure long-term flow assurance” for its rapidly growing oil volumes in the Permian. Apache, meanwhile, signed up for 75,000 BPD of EPIC’s capacity, which gives it “long-term operational flexibility and market optionality” for its Alpine High play as well as other Permian assets. By improving the flow of oil, EPIC should also help improve the cash flow of both Noble and Apache later next year.
Help is on the way
Oil drillers have unleashed such a gusher of new production in the Permian that it has overwhelmed the area’s infrastructure, causing regional oil prices to slump. However, those problems should abate later next year as new oil pipelines enter service. As they do, producers will be able to fetch higher prices for their oil, which should boost their profitability and stock prices. That makes now a good time for investors with a long-term mindset to consider scooping up a Permian producer.
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