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Mixed messages from the Permian: As pipeline pinch sets in, drillers stay active

The first signs of a long-awaited pipeline capacity pinch in the Permian Basin are taking hold, but the full effects have not yet trickled upstream as production keeps setting records despite steep regional price discounts.

Producers of oil and natural gas in the shale play in West Texas and New Mexico are dealing with the reality that a pipeline shortfall will exist well into 2019, which could cause problems for those without firm shipping contracts. Some companies have already diverted capital elsewhere for the time being, and the number of drilled but uncompleted wells has reached record levels.

On the other hand, permitting numbers continue to rise along with production results that are still smashing records.

Westwood Global Energy Group predicted in a new report that at least 345 wells in the Permian that were expected to be completed by the end of 2019 will not be because of the pipeline shortfall. As a result, the capital and supplies that would have been used for those completions will be either diverted elsewhere or put on ice.

"Westwood expects 2.5 million tons of sand and 5 billion gallons of water will be directly impacted by the deferred completions," the research and consulting firm said. "Demand for 1.6 million horsepower for pressure pumping will evaporate in the second half of 2018 and $1.4 billion of CAPEX for completion operations will also be delayed or reallocated on other basins such as Eagle Ford, DJ Niobrara, Bakken, and MidCon."

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Data from the U.S. Energy Information Administration's monthly Drilling Productivity Report may provide other signs that a capacity-related slowdown is starting to occur. According to the EIA, the Permian's drilled but uncompleted, or DUC, well count increased by more than 800 from January to July, from 2,621 to 3,470.

"They've been increasing at a time that you'd think they'd be decreasing, with prices going up," energy economist Karr Ingham said. "The number of DUCs has been pretty high out there anyway, but the increase in DUCs is happening at a greater pace."

Ingham, who created the Texas Petro Index to gauge the health of the industry for the Texas Alliance of Energy Producers, does a similar numeric analysis of activity in just the Permian. He said the latest batch of data from the Railroad Commission of Texas that could be taken several ways.

"The number of completions did drop from June to July, but this is also a number that has some volatility to it. The same thing happened last year," he said. "Also, the number of completions was still 30% higher than July of last year. We can suggest that the lack of capacity is at the heart of the drop in these three Railroad Commission districts [which cover the Permian], and it would make sense. But I'd want to watch it for two or three months before I decided."

Similarly, new permits for drilling in the Permian fell from June to July but remained 19% higher than the numbers from last July. The rig count in the region, which dropped slightly in July, bounced back in August.

Even as production remains strong, producers are facing pressure from the price differential in the basin. Ingham said West Texas Intermediate crude in the Permian is selling at a discount of $10 to $15 per barrel versus posted prices in order to gain pipeline access. Natural gas discounts are even more severe, reaching as much as $1/Mcf at the Waha Hub in comparison to the Henry Hub or the Houston Ship Channel.

"The economics remain pretty good out there, even with these discounts. They're still drilling and completing these wells even at these discounted prices," Ingham said. "Eventually, [the shortfall] will cut into activity levels, but I wonder if we're there yet."