Commodities 2023: US Permian gas producers eye more volatility before midstream expansion

The Permian Basin natural gas market is likely to see another midstream capacity crunch in 2023 as growing output there would put existing production takeaway pipelines to the test and keep hub prices in West Texas under pressure.

Gas production from the Permian has continued its upward march in 2022, rising about 1 Bcf/d over the past 12 months, raising alarm among market participants over the basin's capacity to handle additional growth in the year ahead. As of December, production is trending around 15.8 Bcf/d, with daily output continuing to test new record highs at over 16 Bcf/d -- not far from the basin's theoretical maximum of around 17-18 Bcf/d, data from S&P Global Commodity Insights shows.

While production growth in West Texas has slowed in 2022 -- thanks to service-cost inflation, supply chain constraints and many producers' commitment to capital spending restraint -- some of the basin's largest producers have still managed to capitalize on high crude prices in 2022 by dialing up output. Among them are Chevron and ExxonMobil, both of which have already achieved double-digit percentage growth in their respective Permian production volumes compared to 2021.

For 2023, rising concerns over cost inflation, shortages in drilling equipment, rigs and completion crews have given many Permian producers pause over the question of whether to grow output.

"We are seeing operators continue to emphasize on maximizing free cash flow and returning capital," said Narmadha Navaneethan, associate director of research and analysis at S&P Global.

According to Navaneethan, supply constraints and cost inflation are also impacting producer behavior.

"It's all limiting operators from growing volumes, especially for gas-focused operators who have hedged almost two-thirds of the production this year and already about one-third of production for next year at less than $4," she said.

Still, most analysts believe gas production from West Texas will continue climbing, albeit at a slower pace. According to S&P Global, Permian output could top 16.5 Bcf/d by late 2023.

Forwards prices

Production growth from the Permian has already triggered market volatility in the West Texas gas market this year. This past fall, the basin's benchmark location, Waha Hub, was hit hard by low shoulder-season demand, limited production takeaway capacity and midstream maintenance, the combination of which pushed gas prices into negative territory in October. For many, the all-too-familiar reality came much sooner than previously anticipated.

Over the past several years, the addition of capacity on Kinder Morgan's Gulf Coast Express and Permian Highway pipelines, along with Whistler Pipeline had many market analysts and observers anticipating a longer growth runway for production there. The additional 6 Bcf/d in midstream capacity added by the three expansions, though, has been quickly consumed by rapid production growth.

Looking to 2023, many traders are anticipating relatively wide basis-price spreads at Waha, especially heading into the second quarter as winter demand begins to fade.

At Waha, the forward market is pricing January and February gas contracts around a 50-60 cents surplus to Henry Hub. By March, though, the market is pricing in a discount of around $2.50-$3, with second-quarter prices now averaging more than $3 below the US benchmark. Over the balance of 2023, the market isn't anticipating much relief until November when seasonal demand begins picking up again.

Expansions

RBC Capital Markets analyst Scott Hanold said in a Dec. 29 note that "[existing] Permian gas infrastructure capacity could cause constraints by late 2023. De-bottlenecking and compression expansions could provide more capacity prior to new major infrastructure additions."

By winter 2023-24, just as demand begins picking up, previously announced pipeline expansions are also expected to begin entering service, offering more capacity to move gas east to the Texas Gulf Coast.

Earlier in 2022, Kinder Morgan and a consortium of other midstream project developers announced plans to proceed with several brownfield pipeline expansions and a single greenfield project that promised to expand production takeaway capacity by a combined 4.2 Bcf/d.

Kinder Morgan's 650 MMcf/d capacity expansion of Permian Highway Pipeline was among the latest projects to move forward with construction while the company's earlier announced 570 MMcf/d expansion of Gulf Coast Express Pipeline still awaits a final investment decision.

A similar-sized 500 MMcf/d brownfield expansion of the Whistler Pipeline was announced this spring by a consortium including MPLX, WhiteWater, and a joint venture of Stonepeak and West Texas Gas. The project was followed up just two weeks later by an FID announcement on the greenfield Matterhorn Express, a 2.5 Bcf/d Permian-to-Gulf Coast pipeline to be developed by WhiteWater, EnLink Midstream, Devon Energy and MPLX.

According to the MPLX consortium, the Whistler Pipeline could be the first to offer Permian producers some relief beginning in September 2023. Kinder Morgan, meanwhile, is banking on its Permian Highway and Gulf Coast Express expansions to enter service, potentially just weeks later, sometime in the fourth quarter. The WhiteWater group's greenfield Matterhorn Express Pipeline is expected to be longer-dated, reaching completion sometime in Q3 2024.

More recently, Oneok announced plans to advance its proposed Saguaro Connector project -- a greenfield pipeline that would deliver up to 2.8 Bcf/d of Permian Basin gas to the Mexico border. A final investment decision on the project is expected by mid 2023.

Processing

While the planned expansions could offer a runway for Permian production growth into the late 2020s, newly announced gas processing capacity could push new supply into the West Texas gas market earlier than expected, potentially shortening that timeline.

Over the past six months, US midstream players, including Targa Resources, Energy Transfer, Enterprise Products Partners and MPLX, have announced plans to add at least 700 MMcf/d of processing capacity to the Permian Basin by 2024.

Including previously announced projects that are already under construction, planned or proposed, the Permian Basin could see upwards of 3.9 Bcf/d in new processing capacity by mid-2024. But with planned midstream expansion projects promising to add just 4.2 Bcf/d in production takeaway capacity over the same period, Permian Basin producers could quickly find themselves under threat from new capacity constraints.