Will Rising Gas Production Turn the Permian Basin into 'Marcellus West'?

Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Natural gas production in the Permian Basin has doubled over the last three years, and analysts expect continued strong growth in production. The Permian's gas production threatens to overwhelm local infrastructure, just as it has for oil--and just as the Marcellus Basin overwhelmed its gas infrastructure a few years ago. The situation caused one prominent energy analyst, Rusty Braziel, to coin a new term for the Permian's disconnect between production and takeaway capacity: TCD, or "takeaway capacity disorder."

The recent announcement of a $2 billion gas pipeline out of the Permian may help alleviate future imbalance between production and outbound transportation. But that project, assuming it gets built, won't be operating until the end of 2020 at the earliest. The Permian Highway Pipeline, developed by Kinder Morgan (NYSE:KMI) (Houston, Texas) and EagleClaw Midstream Ventures LLC, a unit of Blackstone (NYSE:BX) (New York, New York), is slated to bring as much as much as 2 billion cubic feet per day (Bcf/d) from the Waha Hub in the Permian to the Texas Gulf Coast and, potentially, Mexico. In its September announcement that a final investment decision had been made, the developers said nearly all capacity available on the system was subscribed and committed under long-term, binding transportation agreements.

A second major gas pipeline, the $1.7 billion Gulf Coast Express, also being developed by Kinder Morgan, plans to begin construction early next year. That project, capable of transporting up to 2 Bcf/d of gas from the Permian to the Gulf Coast, recently pushed back the start of construction by a few months. KMI expects the project to be operating by early 2020.

Over the summer, developers of a third mega-pipeline project out of the Permian, the Permian to Gulf Coast Pecos Trail Pipeline, pushed back the start of construction by one year, to late 2019. The in-service date for that project slipped to late 2020. That $750 million project, which is being developed by NAmerico Energy Holdings LLC (Dallas, Texas), would transport up to about 1.85 Bcf/d from Pecos, Texas, to the Texas Gulf Coast, near Corpus Christi.

Energy executives in October reportedly told the Dallas Federal Reserve Bank they expect the imbalance between gas production in the Permian and outbound transportation capacity to last until at least late 2019. That projection may prove to be optimistic, particularly as gas production there continues to grow.

IHS Markit (NASDAQ:INFO) (London, England) this past summer predicted gas production in the Permian will grow another 3 Bcf/d, to about 15 Bcf/d, by 2023. That basin has experienced dramatic growth in oil production in recent years, but surging gas production there mirrors the logistical and transportation challenges facing that basin's oil producers. According to the U.S. Energy Information Administration (EIA) (Washington, D.C.), gas production in the Permian is expected to average about 12 Bcf/d in November, roughly double the level of production of 2015.

Click on the image at right to see gas production in the Permian Basin since 2009.

Some firms are even more bullish on Permian gas production than IHS Markit. Bernstein analyst Jean Ann Salisbury expects Permian gas production to exceed 25 Bcf/d by 2025. If that happens, several additional pipelines, beyond the Gulf Coast Express, Permian Highway and Permian-to-Gulf Coast Pecos Trail, would be needed to move gas out of the Permian. Each of those incremental pipelines would be sized at about 2 Bcf/d, and each would have a price tag of about $2 billion.

A lot of the anxiety over Permian gas takeaway capacity stems from expected strong growth in pipeline exports to Mexico, as well as liquefied natural gas (LNG) exports along the Gulf Coast.

Click on the image at right to see a projection of gas pipeline exports to Mexico.

There are numerous challenges--ranging from labor to equipment to transportation--to building infrastructure and pipeline capacity in West Texas and southeastern New Mexico. Speaking at an industry conference in October, two energy executives likened operating in the Permian to playing the arcade game Whack-A-Mole--as soon as one problem is fixed, another pops up to take its place.

At the inaugural PermiCon conference, held in October by RBN Energy (Houston, Texas) in Houston, Dan Westcott, president of Legacy Reserves Incorporated, said, "You can't grow an industry this quickly without having constraints," according to a report in the Natural Gas Intelligence news service. "I think our operations in the Permian have been what I would argue is a bit of an arcade game of Whack-A-Mole. You smash it and another problem comes up..."

Parsley Energy Inc. SVP Stephani Reed echoed Westcott: challenges in the Permian have become "a little bit of Whack-A-Mole. A couple of years ago we were concerned about crews, not equipment," the NGI report continued. Now the company is having trouble attracting enough skilled labor.

Attracting skilled craft labor to the Permian Basin remains a major challenge for operators. Reed said his company is working with agencies in West Texas to find solutions to the area's acute labor shortage. The executive told attendees that infrastructure construction is being slowed by the estimated 10,000 unfilled jobs in the region. By 2030, there may be as many as 50,000 unfilled positions in West Texas, raising questions about planned pipeline and processing projects, he added.

Across the nation, natural gas production continues to surge. In its most recent Short-Term Energy Outlook (STEO), the EIA projected gas production will increase more than 10% in 2018, to a record 83.2 Bcf/d. Next year, production is expected to rise another 6.4 Bcf/d, to a new record of 89.6 Bcf/d. The Appalachian Region, which includes the Marcellus Shale, continues to be the nation's largest source of gas, with production estimated at 30.4 Bcf/d. The Permian Basin is the nation's second-largest gas-producing region, at slightly more than 12 Bcf/d today.

High levels of production are expected to keep average prices at Henry Hub hovering close to $3 per million British thermal units (Btu) in 2018 and 2019, EIA said in its November STEO. But if producers can't get their gas out of the Permian, they likely will face deep discounts, as their oil counterparts there are facing and as their Marcellus brethren did for years.

At the October PermiCon conference organized by his company, Braziel, president of RBN Energy LLC (Houston, Texas), explained his quip about takeaway capacity disorder: "For those of you not familiar with this affliction, it's caused by too much of a good thing--more production volume than pipeline capacity to get those barrels, or those cubic feet to market. The symptom of the disease is always the same: wide price discounts compared to major hub locations like Cushing and Henry."

According to a report in Natural Gas Intelligence, Braziel told his audience that the cure for TCD is always the same: build more infrastructure. "The good news is that the recovery rate is almost 100%," Braziel said. "Build the infrastructure and the market corrects itself." Unfortunately, he added, "we have not seen the worst of the capacity constraints."

It looks like curing TCD is getting more expensive. The Trump administration's 25% tariff on imported steel and 10% levy on imported aluminum will drive up pipeline and midstream processing project costs, regardless of whether domestic or imported materials are used. Following enactment of the tariffs, domestic steelmakers raised their prices significantly.

Plains All American Pipeline LP (NYSE:PAA) (Houston, Texas) recently decided to pay an extra $40 million for imported steel pipe for its Cactus II crude oil pipeline project rather than go through a process to secure an exemption from tariffs on the imported pipe, according to an article in Oil & Gas Journal (OGJ). The exemption process can run as long as 90 days, and the U.S. Department of Commerce (Washington, D.C.) has received thousands of requests for exemptions from import tariffs.

"Companies import 77% of the steel used in U.S.-sited pipelines and benchmark hot-rolled U.S. steel-coil prices are up more than 50% from last year," observed the OGJ article. "Domestic steel manufacturers often are not a viable alternative to imported steel because they either do not offer key metal grades or diameters, or because of long production lead times that would impede construction schedules. In many cases, it would cost tens of millions of dollars for steel manufacturers to upgrade their U.S. mills--a price most are unwilling to bear, considering already low margins."

All the ingredients seem to be in place for Permian gas producers and their downstream customers to experience a lengthy bout of TCD, to use Braziel's diagnosis.

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