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Moody's: Some E&P firms' credit ratings in limbo until Permian bottleneck eases

Oil and gas pipeline constraints in West Texas could put credit ratings upgrades out of reach for Permian Basin-focused drillers with limited transportation contracts, according to a new report from Moody's Investors Service.

Booming production in the Permian Basin in recent years has not been matched with equally prolific takeaway capacity development, but the bottleneck's credit ratings implications for producers are not uniform, Moody's energy industry analysts said.

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Independent drillers such as Noble Energy Inc. and Carrizo Oil & Gas Inc. are responding to the Permian supply glut by heading north to the Powder River Basin and east to the Eagle Ford shale, and large Permian-focused producers like Pioneer Natural Resources Co. and Concho Resources Inc. have contracted what Moody's analysts quantified as "all or most" of their projected output for 2019. Smaller firms like Laredo Petroleum Inc., Jagged Peak Energy Inc. and Endeavor Energy Resources LP, however, do not have sufficient firm transportation reservations, Moody's analysts said.

These companies can use hedging and spot market sales to make up the difference, but neither avenue guarantees that drillers will be able to increase production. That lack of flexibility means those companies could remain in credit ratings limbo for the foreseeable future.

"For the pure-play Permian producers, particularly those of modest scale, any limitations on their ability to increase their production volumes would likely slow an improvement in their credit quality — and by extension, their ratings," the Oct. 10 report said. "Credit quality for such companies will not easily improve without adequate midstream access, compared to most bigger or more diversified Permian producers."

Since crude oil prices stabilized in 2016, drillers have poured money into the Permian. But while the large shale basin delivered record daily oil production of 3.38 million barrels per day in August, a pipeline capacity bottleneck has prompted some firms to direct their capital elsewhere and forced others to rely on more expensive types of transportation. That constraint is not expected to ease up until the second half of 2019 when a slew of new takeaway projects are scheduled to come online. Permian natural gas supplies, too, face a similar issue as production continues at a breakneck pace.

Still, most drillers operating in the Permian will not see "significant negative credit implications" despite the widening basis differentials between West Texas Intermediate crude prices at the Midland and Cushing hubs and U.S. Gulf Coast prices that have reduced exploration and production revenues, the analysts wrote.

"Lower realized prices ... lowers [drillers'] cash flow and weakens their ability to make future capital investments and grow production. But the impact from midstream constraints is temporary, and new pipeline capacity will alleviate the strain as it comes into service," Moody's analysts concluded.