Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

It may not look like it, but the Permian Basin in West Texas is a magical place. At least, it is if you produce oil for a living.

The real magic, though, concerns natural gas. Permian production is surging despite the fact no one is actually drilling for it:

Look, No Rigs!
Permian Basin natural gas output has risen by 1 billion cubic feet a day since May 2016, when the gas-rig count dropped to zero
Source: Energy Information Administration, Baker Hughes
Note: Indexed to 100 as of January 2012.

While the Permian is ground zero for the recovery in U.S. oil production, the 25 percent increase in its gas output since the end of 2015 is actually slightly higher. Of course, the magic, such as it is, comes courtesy of that recovery in oil production. The number of oil-directed rigs drilling in the basin has more than doubled since last May, adding roughly 300,000 barrels a day of output. The extra gas is just a byproduct.

When something is a byproduct, it creates interesting economics. And by "interesting" I mean "deflationary."

Although natural gas prices have risen as winter got a second wind in March, the extra demand this month has merely helped to alleviate some of the glut added during an exceptionally mild February (see this). Near-term futures have popped by about 10 percent, but medium-term prices remain anchored below $3 per million BTUs:

Rule of $3
The rally in natural gas futures on cold weather is relatively muted
Source: Bloomberg

Permian producers are price takers for their oil, but maybe even more so for their gas. The discount at which natural gas trades in the spot market in West Texas compared with the national benchmark has been widening:

Priced to Move
The discount for gas in West Texas has widened since the middle of last year
Source: Bloomberg
Note: Waha, Texas gas hub price less Henry Hub spot price.

Pipeline constraints mean Permian gas can't easily access networks on the Gulf Coast, says Jacob Fericy, analyst at Bloomberg New Energy Finance. So even as the start-up of exports of liquefied natural gas from the coast offers some support to gas prices in general, pricing at Waha in West Texas gets less of the benefit. The problem is compounded by the damage being inflicted on local gas demand by rising wind-power output in Texas.

When a commodity is this cheap and constrained, value migrates to those who can use it or help get it to market. That makes Permian gas an opportunity for pipeline operators.

Both Kinder Morgan Inc. and Enterprise Products Partners LP have recently proposed new pipelines to bring Permian gas south toward the coast and Mexico, with the latter an important and growing export market for U.S. gas in general. Besides these, Targa Resources Corp. is one of the largest operators of gas gathering and processing pipes and equipment in the Permian basin.

As the volume of gas coming out of the ground keeps rising, almost without trying, such companies should benefit. For U.S. gas bulls also facing a coming wave of supply from Appalachia, though, the Permian looks anything but magical.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net