Permian Gushers Squeeze Texas Profit as Pipes Lag Output

Source: Occidental Petroleum Corp. via Bloomberg

In West Texas, Occidental announced plans to build a 300,000 barrel-a-day pipeline with Magellan Midstream Partners LP that will be in service by 2014. Close

In West Texas, Occidental announced plans to build a 300,000 barrel-a-day pipeline with... Read More

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Source: Occidental Petroleum Corp. via Bloomberg

In West Texas, Occidental announced plans to build a 300,000 barrel-a-day pipeline with Magellan Midstream Partners LP that will be in service by 2014.

The glut of U.S. shale oil caused by too few pipelines has spread to West Texas, cutting prices and draining $1.2 billion in potential profit from producers including Concho Resources Inc. (CXO) and Occidental Petroleum Corp. (OXY)

Surging output in the Permian basin in West Texas and New Mexico -- the largest onshore oil producing region in the U.S. - - has exceeded pipeline and refining capacity, reducing crude prices by an average of $9.82 a barrel in the past month.

The market disparity echoes similar surpluses seen in North Dakota’s Bakken Shale and Oklahoma’s Midwestern pipeline hub as growing supplies from shale rock and Canada’s oil sands created transportation bottlenecks. That’s forcing producers to lower prices, and it may restrain investment in wells.

“It’s all logistics,” said Michael McMahon, managing director of the energy investment team at Pine Brook, a New York-based private equity firm, explaining why Permian crude is discounted to the U.S. benchmark. “Permian oil is actually very high-quality and should be selling at a premium, if it weren’t for the logistical challenges.”

The glut has its roots in surging crude output in the 75,000-square-mile Permian basin, home to gushers since the 1920s. Production has jumped 49 percent to 1.29 million barrels a day since 2007, U.S. Energy Information Administration data show. It may reach 2.3 million barrels a day by 2022, according to Bentek Energy LLC, an Evergreen, Colorado-based energy research firm.

Photographer: Shane Bevel/Bloomberg

Oil pipelines run near storage tanks at the Enbridge Inc. Cushing Terminal in Cushing, Oklahoma. Close

Oil pipelines run near storage tanks at the Enbridge Inc. Cushing Terminal in Cushing, Oklahoma.

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Photographer: Shane Bevel/Bloomberg

Oil pipelines run near storage tanks at the Enbridge Inc. Cushing Terminal in Cushing, Oklahoma.

The number of rigs operating in the Permian the week of June 29 reached 504, the highest this year and nearly double the total from the same period in 2010.

Choking Growth

Across North America, a lack of options to deliver oil to market will choke back crude production growth in 2013, James West, an analyst with Barclays Plc said in a Dec. 4 report.

Capital spending should flatten, with companies spending about $140 billion in the U.S., an increase of less than 1 percent over this year, he said. That compares to growth rates of 9 percent, 31 percent and 20 percent in 2012, 2011 and 2010, respectively, according to the report.

“This is putting a pause on what should be continued spending growth in North America,” West said in a telephone interview.

New drilling techniques that allow producers to tap into previously inaccessible reservoirs may allow the U.S. to overtake Saudi Arabia as the world’s largest oil producer by 2017, according to the International Energy Agency. The slowdown in Texas “puts the thesis of the U.S. becoming the next Saudi Arabia at risk,” West said. Companies have turned to rail cars and trucks to transport their oil in the meantime.

Record Discount

The inability to get all the new oil to market has deflated prices in the Permian’s Midland, Texas, where crude on the spot market sold in the past month for an average $9.82 a barrel lower than spot prices in Cushing, Oklahoma, where the U.S. benchmark crude is delivered -- a record discount. Since 1991, the average annual discount in Midland had never been greater than 52 cents.

The Permian glut widened in November as maintenance at Phillips 66 (PSX)’s Borger, Texas, refinery extended longer than expected, reducing demand for crude. Production units at the plant were taken down on Sept. 22 and work may be extended through Dec. 14. Western Refining Inc. plans maintenance on its El Paso, Texas, plant in February.

Lasting Gap

Since the beginning of October, Midland crude has traded for an average $6.13 a barrel lower than in Cushing, and the spread reached $20 on Nov. 20. That will compound the squeeze felt by producers in the fourth quarter this year, which has seen U.S. benchmark crude prices fall 5.3 percent to an average $88.61, according to data compiled by Bloomberg.

A Midland price gap of as much as $5 a barrel is expected to hold at least through the first three months of 2013, when new pipelines will expand producers’ capacity to ship oil to Gulf Coast refineries, Tim Rezvan, an analyst at Sterne Agee & Leach Inc., said in a November 29 research note.

In North Dakota, where in February oil prices were discounted as much as $27.50 a barrel compared to the U.S. benchmark as new supplies overwhelmed pipeline capacity, rail transportation has moved in to help ease the backlog. That’s less likely to happen in the Permian, where there are limited facilities to handle offloading oil into rail cars, said Andy Lipow, president of Lipow Oil Associates LLC in Houston. And anyway, “most of the rail cars are being used in North Dakota.”

Pipeline Expansions

The ability to capture higher prices for their oil is just one of the motivations for companies to build and expand pipeline networks, said Pine Brook’s McMahon, whose firm owns stakes in two closely-held Permian oil explorers. The other is predictability: pipeline shipments aren’t subject to the vagaries of weather and accidents that can interrupt truck and rail traffic, he said.

Enbridge Inc. is proceeding with a $6.26 billion expansion of its pipeline network to carry Bakken crude to eastern and Midwestern markets, the company said last week. Production still is growing so fast that “in North Dakota they will be railing crude for at least the next three to five years,” Lipow said.

In West Texas, Occidental announced plans last month to build a 300,000 barrel-a-day pipeline with Magellan Midstream Partners LP (MMP) that will be in service by 2014. Magellan and Sunoco Logistics Partners (SXL) expect to finish separate projects adding 185,000 barrels a day of pipeline capacity out of the Permian by the end of the first quarter of 2013, expanding that to 425,000 by the middle of the year and 485,000 by early 2014.

Profits Trimmed

Based on October-to-March U.S. Energy Department Permian production estimates and an average $5 discount in that period, lost profits for producers there may climb to $1.18 billion in the two quarters, according to data compiled by Bloomberg.

Drilling in the Permian basin is still profitable, with margins ranging from $40 to $45 a barrel, said Harold York, principal oils analyst at consulting group Wood Mackenzie Ltd. in Houston.

Devon Energy Corp. (DVN), which produced the equivalent of 65,100 barrels of crude a day in the Permian in the third quarter, may see profits trimmed by as much as 3 cents a share in the final three months of the year, or about $12 million, Jeff Dietert, an analyst at Simmons & Co. International, said in a Nov. 26 note to clients. Chip Minty, a Devon spokesman, declined to comment on the estimate.

Devon shares have lost 15 percent this year, compared with a 13 percent decline by Concho and Occidental’s 20 percent drop.

Concho, Occidental

Concho, based in Midland, produced about 50,000 barrels a day from the region in the third quarter, according to a Dec. 4 investor presentation. A price gap of $5 a barrel from October to December would represent $23 million, or about 21 percent of the average fourth-quarter net income estimate of 15 analysts compiled by Bloomberg. Toffee McAlister, a spokeswoman for Concho, did not return a call or e-mail seeking comment.

Occidental produced 144,000 barrels a day in the Permian in the third quarter of this year, according to the Los Angeles- based company. A discount of $5 a barrel in this quarter and the first quarter of 2013 on that amount of production would represent $131 million. Melissa School, an Occidental spokeswoman, declined to comment.

In 2011, Occidental produced the most oil in the Permian basin, followed by a unit now controlled by Kinder Morgan Inc., Apache Corp., Pioneer Natural Resources Inc. and Chevron Corp. (CVX), according to the Texas Railroad Commission, which tracks drilling data in the state.

Since producers reinvest much of their cash into drilling, lower oil prices are likely to force some companies to curtail their programs or rely more on debt, said Wood Mackenzie’s York.

“Producers and refiners are impatient,” York said. “This isn’t something they’ve had to deal with in the past, but they’re going to have to deal with it. It’s going to take a few years for these spreads to clear up.”

To contact the reporters on this story: Bradley Olson in Houston at bradleyolson@bloomberg.net; Dan Murtaugh in Houston at dmurtaugh@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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