Lack of pipeline capacity from Permian Basin to Midwest refineries and export terminals on the Gulf Coast is constraining US oil production. This, in turn, is causing the oil market to tighten at a time when the Trump administration sanctions against Iran are soon to be re-imposed.  Drones of Texas photo via YouTube.

US oil production constrained by pipeline capacity, labour shortages, higher costs

By John Kemp

LONDON, Sept 12 – US oil production is running into capacity constraints, which are starting to have a material impact on the global availability of crude, causing the market to tighten and putting upward pressure on prices.

The biggest problem is the lack of sufficient pipeline capacity to move oil from shale wells in western Texas and eastern New Mexico to refineries in the Midwest and export terminals on the Gulf Coast.

But production in the Permian Basin has also been constrained by shortages of labour, equipment and materials, which have pushed drilling, pressure pumping and completion costs sharply higher.

The most obvious impact has been a sharp drop in the price that Permian producers receive for their oil compared with other benchmarks, especially Brent.

West Texas producers are currently receiving just $55 per barrel for oil delivered to Midland, in the heart of the Permian, compared with $79 for North Sea Brent.

The massive discount reflects the twin difficulties of moving the crude out of the Permian to the main inland trading hub at Cushing in Oklahoma or down to the refineries and export terminals on the coast.

Midland crude is currently trading at discount of $14 per barrel compared with Cushing, while Cushing is itself priced at a further discount of $10 to Brent.

Midland has traded at an average discount to Brent of more than $12 per barrel this year, up from $4 in 2017 and less than $1 in 2016, and the price differential is steadily worsening.

Midland prices have mostly been falling this year while Brent has climbed, leaving Midland up by just $10 per barrel (22 per cent) since the end of June 2017 while Brent has risen by $32 (68 per cent).

Easing off the accelorator

Softening Midland prices have already eased the region’s drilling frenzy, with the number of rigs drilling in the Permian flat over the last three months, after rising by more than 110 in the previous year.

Well completions, which are more relevant for production, also show signs of stabilising in recent months, after increasing fairly consistently over the two previous years (“Drilling productivity report”, EIA, August 2018).

Since the Permian Basin has been the biggest contributor to US oil output growth in the last two years, the slowdown is starting to temper expectations for further increases in the rest of 2018 and through 2019.

The US Energy Information Administration now expects US crude production in 2018 to average 10.66 million barrels per day (b/d), down from 10.79 million b/d at the time of its July forecast.

The agency has cut its prediction for 2019 even more sharply to 11.50 million b/d, down from 11.86 million b/d at the time of its May forecast (“Short-Term Energy Outlook”, EIA, September 2018).

Slower growth in US production, when combined with strong demand, production problems in Venezuela and other countries, and the re-imposition of sanctions on Iran, is enough to tighten the global market in late 2019.

John Kemp is a Reuters market analyst. The views expressed are his own.

(Editing by Mark Potter)