North American Oil & Gas Pipelines

SEP 2018

North American Oil & Gas Pipelines covers the news shaping the business of oil and gas pipeline construction and maintenance in North America, including pipeline installation methods, integrity management innovations and managerial strategies.

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26 North American Oil & Gas Pipelines | SEPTEMBER 2 018 By Jamie Brick T he Permian Basin is experiencing its first natural gas problem. Gas production is starting to exceed pipeline capacity exiting the production region, and in-basin prices are falling as a result. Paradoxically, the second prob- lem is a potential overreaction to the first: market fundamentals could attract too many pipelines, running the risk of having underused pipelines. Permian gas prices will remain weak for the next few years despite nearly 2 billion cubic feet per day (Bcf/d) of addi- tional pipeline capacity coming online by 2020. This is because the Permian, predominantly a shale oil play, has large quantities of associated gas produc- tion. McKinsey Energy Insights expects Permian crude and natural gas liquids (NGL) production to grow from 3.3 mil- lion barrels per day (bpd) in 2017 to 8.8 million bpd by 2025 — which in turn is expected to cause natural gas produc- tion to rise from 7.1 to 16 Bcf/d over the same time frame. The Texas Gulf Coast and, to a lesser extent, Mexico are the most likely desti- nations for incremental Permian gas vol- umes. While the fundamentals support additional pipelines (i.e., large quantities of new gas being produced), there is a real risk that the Permian will become over-piped in the medium to long-term. As private equity looks to fund the next major pipeline project, they will be in- creasingly drawn to projects linking the Permian to demand centers in the Gulf Coast. This is because pipelines typically offer stable revenue, and the regulatory risk is minimal in an oil and gas friendly state like Texas. Combining favorable fundamentals, minimal regulatory risk and private equity, it's possible that too much capacity will be developed in the long term. Conventional Economics Don't Apply For all the excitement the Permian basin enjoys, it poses a major problem to gas markets. Depending on the year, an increase in oil production due to oil prices rising USD 10/bbl would also cause associated gas production from the Permian to increase by 1-2.5 Bcf/d. With sufficient gas pipeline capacity, this inexpensive associated gas would displace gas from other basins, causing U.S. gas prices to drop by about USD 0.10/mmbtu. If pipeline usage exiting the Perm- ian remains below 80 percent, in-basin gas prices are expected to be about USD 0.10/mmbtu cheaper than on the Texas Gulf Coast, because of the variable cost of transporting the gas (see Exhibit 1, D). Once pipeline usage exceeds 80 per- cent, in-basin prices start to decrease as Permian gas competes with other gas for access to limited pipeline capacity, caus- ing in-basin prices to fall further. The Permian has already crossed that 80 per- cent threshold, and prices are starting to show the effects. This scenario would usually result in operators reducing gas drilling, but only approximately a quarter of Permian gas production is not associated with oil and is sensitive to in-basin gas prices. If in-basin gas prices fall, the first to be affected will be the less than 5 percent of production that comes from new gas wells, which have a breakeven of be- tween about USD 2-3/mmbtu (see Ex- hibit 2, C). Next would be the estimated 25 percent of Permian production from gas wells that have already been drilled, which break even at about USD 0.80- 1.00/mmbtu (see Exhibit 2, B). The re- maining 75 percent of gas production is associated with oil, and can even have a negative value, as oil revenue is what drives investment decisions for those wells (Exhibit 1, A). Since this associated gas is largely unaffected by in-basin gas prices, we can expect to see Permian gas production continue to increase even as the takeaway capacity approaches 100 percent. Where Will Incremental Permian Gas Production Go? There are two primary destinations for incremental Permian gas: Mexico and the Gulf Coast. Once bottlenecks are resolved, new pipelines to Mexico should add an effective export capacity of about 2.9 Bcf/d, a much-needed out- let until new pipelines to the Gulf Coast come online in 2020. The other desti- nations for Permian gas are to the west and north. However, both routes face problems. Building additional pipelines to the west is difficult, especially in Cali- fornia, while western gas demand is un- certain due to higher solar generation. Meanwhile, competing volumes from A N A L Y S I S Permian, We Have a Gas Problem Pipeline Capacity Can't Keep Up with Production

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