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Analysts expect Permian growth in 2019 despite low prices, pipeline issues

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Analysts expect Permian growth in 2019 despite low prices, pipeline issues

The Permian Basin may be one of the world's most prolific hydrocarbon plays, but the independent producers drilling in West Texas will face some tough decisions in 2019.

With the lessons of the oil and gas price collapse still fresh and prices again dropping below $50 per barrel for U.S. crude, the conservative approach taken by many operators when assembling their year-ahead budgets seems prudent. But if prices fall much further, some may be reluctant to dial back spending.

"The key variable is what's happening with oil prices the last couple of months. There's been a big correction," Morningstar Analyst David Meats said in an interview. "You've got a lot of [exploration and productions] taking a wait and see approach."

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Analysts believe growth in the Permian Basin will continue in 2019, even with potential major obstacles.
Source: Associated Press

Shareholder reactions to outspending cash flow in recent years has pushed producers to maintain caution as prices rose. Investors have slammed the stocks of independents who have emphasized expansion over shareholder benefits. After a year of focusing on shareholder returns and share buybacks, however, some independents may risk the wrath of their stockholders by holding to their budgets even if low prices become a longer-term reality.

"Should current strip prices materialize, we believe many companies will operate with outspends rather than reign in activity to operate within cash flow, given financial leverage remains in check and a loss of momentum would be detrimental to 2020 production and cash flow trajectories," Williams Capital Group LP upstream analyst Gabriele Sorbara said. Such prospects, Sorbara said in an email, will keep investors exercising "selectivity" when it comes to buying a stake in a producer.

Even with low prices, analysts expect production in the Permian to continue to surge. In its latest Drilling Productivity Report, the Energy Information Administration said it projects production to reach 3.8 million barrels of oil per day in January, and observers believe the play could push the 5 million bbl/d plateau by the end of the year.

"Production in the Permian will continue to increase in 2019, potentially by a million barrels per day or even more," Raymond James Analyst Muhammed Ghulam said in an interview.

That growth continues to face a major pipeline shortfall in the region for both oil and gas. A significant amount of new projects are in the construction process, but major increases in capacity will not come until later in the year. While some producers have reserved enough pipeline space and others are trucking oil out of the Permian, the shortfall will still serve as a weight on growth through the first half of 2019.

"The pipeline capacity shortfall is the check on growth the first six months. As pipelines come on, they will be filled," Morningstar's Meats said. "I think you're going to see solid growth going into the second half. Growth will be muted in the first half by constraints, but once they're lifted, you'll see some robust growth if prices aren't disappointing."

The three analysts agreed that merger and acquisition activity in the Permian is a near-certainty in 2019, given the uptick in M&A late in 2018 and the lack of available acreage in the play. In order to expand operations, producers now have to buy out competitors to take their stakes.

"We are likely to continue to see significant M&A activity in the basin in 2019, although the volatility in oil prices over the past few weeks may slow the pace of deals over the near term," Ghulam said. Sorbara echoed those sentiments, saying Callon Petroleum Co., QEP Resources Inc. and SM Energy Co. were top "takeout candidates" for the coming year.