The oil gushers in Texas' Permian Basin should be a good thing.
For the first time in decades, U.S. oil production is on its way up again. We have multiple increasing sources of domestic oil. And our imports, particularly from OPEC, are declining.
But all it takes is a lack of infrastructure to turn a good thing into a burden.
For Texas, the absence of pipelines is significant, and lately it's causing production issues for major producers like Concho Resources Inc. (NYSE: CXO), Occidental Petroleum Corp. (NYSE: OXY), and Devon Energy Corp. (NYSE: DVN).
Both pipeline and refinery capacity are limited in Texas. As the wells pump more and production grows, the excess oil is backed up in Texas, and as a result, prices have plummeted.
Permian crude, which is priced in Midland, Texas, has been selling at a $9.82-per-barrel discount to oil from Cushing, Oklahoma for the last month. In late November, the spread grew as wide as $20 a barrel. And according to analysts, this spread doesn't reflect quality.
“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.”
Permian output has almost doubled since the shale boom took off. The 1.29 million barrel-per-day output the region is now experiencing is 49 percent higher than levels in 2007. By 2022, Bentek Energy LLC expects it to hit 2.3 million barrels.
That's if companies don't begin to slow down their production. The backup in oil that's occurring because transportation is lacking is causing companies to push prices lower and lower. As profitability drops, so will production.
A report by Barclays analyst James West estimates that capital spending in shale deposits will only increase 1 percent next year, compared to 9 percent this year, 31 percent in 2011, and 20 percent in 2010.
North Dakota's Bakken shale has been having similar problems, though those are lessened by railway access.
Texas, meanwhile, does not have sufficient rail access, either. Besides, Andy Lipow of Lipow Oil Associates LLC told Bloomberg, “most of the rail cars are being used in North Dakota.”
Pipeline expansions through the region are occurring. Occidental is partnering with Magellan Midstream Partners LP (NYSE: MMP) to complete a 300,000 barrel-a-day pipeline in West Texas by 2014.
Magellan is also working with Sunoco Logistics Partners (NYSE: SXL) to complete a Permian pipeline by 2013 and expand capacity to 485,000 barrels-a-day by 2014.
But they require permits and construction – both of which take time. And oil production is expanding too quickly to allow them to catch up.
Producers are already struggling. Devon Energy, for example, has lost more than 15 percent so far this year. Concho Resources, which was up a slight 1 percent today, has dropped 11 percent this year. And Occidental has fallen more than 19 percent.
The pipeline companies, meanwhile, are the ones receiving a boost. Both Magellan and Sunoco have gained nearly 25 percent in 2012.
Permian oil producers are waiting on those pipelines, and those companies are going to profit as others bank on their success for the future of domestic oil production. 2014 is still some time away, and the spread will likely remain sizable for the near future.
“Producers and refiners are impatient,” [Wood Mackenzie analyst Harold] 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.”
And in the few years that it takes, we may see a number of companies slim down their resources in the region or move out altogether. Those who remain will profit once prices move back up, but many may not be able to hold out that long.
That's all for now,
Energy & Capital's modern energy guru, Brianna digs deep into the industry with accurate and insightful updates into the biggest energy companies and events. She stays up to date with the latest market moves and industry finds, bringing readers a unique view of current energy trends. For more on Brianna, see her editor's page.