Petroleum index continues to climb Price fallout from pipeline constraints beginning to undercut growth

Pumpjacks operate on oil wells in the Permian Basin near Crane, Texas on March 2, 2018. MUST CREDIT: Bloomberg photo by Daniel Acker Pumpjacks operate on oil wells in the Permian Basin near Crane, Texas on March 2, 2018. MUST CREDIT: Bloomberg photo by Daniel Acker Photo: Daniel Acker/Bloomberg Photo: Daniel Acker/Bloomberg Image 1 of / 1 Caption Close Petroleum index continues to climb 1 / 1 Back to Gallery

The three main legs of the Permian Basin regional oil and gas economy -- crude prices, rig count and drilling permits -- remain well below their highs reached in 2014-2015. But they remain strong enough to propel the Texas Permian Basin Petroleum Index sharply higher.

Karr Ingham, the Amarillo economist who prepares the index, says it jumped 5 percentage points from May to June and is 27 percent higher than the June 2017 index. Still, he said that the index remains about 60 points below its peak set in November 2014 as crude prices were beginning to fall.

Even with the index and its three primary drivers well below their highs, crude production volumes soared 23.1 percent in June above June 2017 levels, and volumes in the first half of the year climbed 24 percent over the first half of 2017.

Natural gas production volumes, often associated with crude production in the Permian Basin, followed a similar trend, up 21.8 percent in June over last June and up 21.7 percent to date this year over a year earlier.

Crude prices were up sharply over 2017 levels, with the June average of $63.75 a 52.8 percent gain over the $41.71 averaged in June 2017. Prices in the first half of 2018 are averaging $61.86, up 33.3 percent from $46.42 in the same period last year.

The rig count averaged 384 in June, up 24.3 percent from 309 last June and is averaging 358 so far in 2018, up 30.6 percent from 274 a year ago.

There was a slight dip in the number of drilling permits issued in June, with the 747 issued by the Railroad Commission down three from the 750 the commission issued in June 2017. The commission has issued 4,248 so far in 2018, up 15.3 percent from the 3,685 issued last year.

Oil and gas employment continued to rise, with June employment averaging 39,640, up 28.1 percent from 30,955 last June and averaging 37,714 so far in 2018, up 28.6 percent from 29,335 a year ago.

Even so, Ingham said he sees cracks beginning to appear in the Permian Basin's armor, and pipeline constraints are serving as the chisel. He said the regional rig count, primarily in Railroad Commission District 8, was peaking and beginning to decline in June, a trend he said continued into July.

"That's almost certainly tied to growing production relative to takeaway capacity, and the resulting discounts for Permian-produced crude oil and natural gas," Ingham said. "The first casualty of lower prices is the rig count."

He said that crude oil discounts remain at $15 a barrel or higher in some locations. Natural gas prices are off by as much as a third, or more than $1, compared to other pricing locations, he said. June natural gas prices averaged $1.97 per Mcf, down 25.9 percent from $2.66 last June. Prices are averaging $2.29 so far this year, a drop of 17.6 percent from $2.77 last year.

"Rising natural gas production is something producers can't do anything with: They can't market it, they can't get it on the pipeline, they've reached flaring limits. (Their option is) shutting in crude wells," he said.

Ingham said the pipeline constraints and widening price differentials are signals from the markets to producers "to bring us less of that." But there is little evidence so far activity levels have been affected, he said.

Indeed, producers reported 521 oil completions in June, up 71.9 percent from 303 the previous June, and have completed 2,905 oil wells so far in 2018, up 63.3 percent from 1,779 last year. Producers completed 31 natural gas wells in June, up 106.7 percent from 15 last June and have completed 236 gas wells so far this year, up 174.4 percent from 86 in the first half of 2017.

"However, lower prices were almost certain to bring out some observable decline in activity, and it appears as though June is the time in which that became noticeable," Ingham said.

The good news is that the constraints have prompted additional pipeline development that is expected to come online beginning in 2019, Ingham said.

But there are still concerns as pipeline companies rush to expand takeaway capacity, and those are based on the impact of steel tariffs, he said.

"Our concern is on steel tariffs dramatically raising the price of the projects. It may very well change the economics of the pipelines once they're in place. What the pipeline companies would have to recover from producers goes way up. That's the No. 1 leg of concern: the cost to producers. The second leg is retaliation and the potential impact on exports of crude and natural gas. And third, the potential impact on midstream development and development budgets," he said.

Mella McEwen is the Oil Editor and covers the latest business and energy news. You can read more from her here. |mmcewen@mrt.com|