There has been much news in the energy industry about the deficit in capacity from pipelines shipping crude oil out of the Permian Basin in West Texas. That has made crude oil price differentials widen between Midland, Texas and the Gulf Coast exporting region.
Major midstream and downstream companies like Plains All American ( PAA) , Enterprise Products Partners ( EPD) , Phillips 66 ( PSX) and Magellan Midstream ( MMP) have raced to build a series of pipelines connecting West Texas to the Gulf Coast. Several of those projects are scheduled to be completed next year. But what would happen to crude oil prices if some or all of those projects are delayed?
The answer -- there's nothing producers can do as they are land-locked in this part of the country, which is lacking not only in infrastructure but also in trained workers. Today there's a shortage of truckers and trucks available to haul crude, and Crude-by-Rail has also become a limited option.
As I've mentioned in prior columns, crude oil for delivery to Midland, Texas, where the local price of crude is set, has recently sold for $12 to $15 below the price of crude for delivery in Cushing, Okla., which is a major crude oil trading hub in North America. This discount reflects the added cost getting oil to refineries and export facilities out of the region using trucks and trains.
A report this week by energy consultancy Wood McKenzie has brought to light what Permian producers are doing to mitigate this possibility, protecting themselves against a further drop in price differentials. According to Wood McKenzie, hedges have increased more than four-fold for some producers.
Companies like Concho Resources ( CXO) , Energen ( EGN) , and SM Energy ( SM) have substantially increased their 2020 Midland-Cushing differential hedging exposure since the beginning of the year, with EGN and SM hedging almost twice the volumes. What Wood McKenzie concluded is that Permian producers are worried that key pipeline projects won't be completed on schedule.
With oil production in the Permian Basin predicted to grow at a pace of 400,000 barrels a day per year until 2022, producers fear that they will not be able to get their crude out of the basin. Options include keeping it on the ground or entering into a hedging agreement with the banks.
While midstream operators like EPD, PAA, and MMP are racing to complete pipeline projects and expansions to help ease this congestion, more than 2 million barrels per day of capacity is slated to come online beginning in late 2019 and early 2020. As a result, the basin could be in a temporary medium-term, over-build.
Wood McKenzie predicts it could take more than a year before West Texas producers see sustained pricing relief.
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