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Growing pains for the Permian

The Permian is primed for years of booming production—if a range of infrastructure problems can be solved

Vast tight oil reserves, improving fracking techniques and attractive economics are pulling in tens of billions of dollars of new investment. Output just passed 3m barrels a day, up 1m b/d in just 18 months, and much more is in the pipeline. The top four investors—ExxonMobil, Chevron, Pioneer Natural Resources and Concho Resources, which is trying to takeover RSP Permian in a $9.5bn deal—alone have mapped out production growth of more than 2m b/d of oil by the mid-2020s. The dozens of smaller companies operating in the basin have their own ambitious plans.

"It's easy to plot a path to 7m b/d," Pioneer's chief executive Tim Dove told a gathering of investors at an event hosted by the Independent Petroleum Association of America in New York in April. But, as Dove pointed out, it's much easier to plot that path on a spreadsheet and in PowerPoint presentations than it will be to turn it into reality in Midland, Odessa and the other small West Texas and New Mexico towns that sit atop the vast Permian basin.

"How do you execute a plan that is basically in an occupation area?" Dove said of the herculean task ahead. This involves bringing all the manpower and equipment needed to facilitate the planned growth into the relatively remote and oil-dependent region.

Some of the growing pains are already visible. The pace of output growth has accelerated faster than pipeline builders have been able to lay down new pipe, leading to a glut of oil and gas supply.

Output constraints

Gas, most of which is produced alongside oil, is already oversupplied in the basin and the Waha benchmark, the nearest pricing point, has been trading at a steep discount to Henry Hub, Nymex and other benchmarks throughout the year. Permian crude looks increasingly likely to face a similar price blowout later this year as rapid output growth quickly catches up with pipeline and local refining capacity. Some companies could even be forced to curtail production, or find other ways to get to the market, by either truck or rail. While virtually no Permian operations rely on making money from gas, a large discount in Permian crude prices would hit producers' bottom lines and could force a slowdown in growth.

A slew of new pipeline capacity is arriving in the summer of 2019, which will ease the glut. But at its current growth rate the Permian will need about 1m b/d of new oil pipeline capacity a year for the foreseeable future, a huge challenge for both the midstream industry and producers.

Troubled waters

It isn't just moving oil and gas around the basin that's a challenge. Less talked about, but just as important, is the difficulty of expanding the capacity of water needed for fracking jobs in and around the basin. Companies need to both source fresh water—no easy task in the West Texas desert—and be able to dispose of the salty brine that's produced along with oil and gas.

The water challenge is growing as companies move towards larger and more intense frack jobs, which improve well economics but require vastly more water. Wells that needed fewer than 2m gallons of water a few years ago now look for as much as 20m gallons. Much of the water has been trucked around the Permian, which is inefficient and costly. Some, like Pioneer, have instead invested in major new water pipelines crisscrossing the Permian. "We have something akin to the Roman Canals out there," Pioneer's Dove said. Although expensive upfront, Dove says the investment will easily pay itself back over time, thanks to the trucking savings.

There's also a major buildout underway of wastewater disposal capacity. Matador Resources, a Permian producer that also has a sizable midstream business, has expanded its salt-water disposal capacity from just 25,000 b/d in late 2015 to 220,000 b/d this year. It uses this water for its own operations and then sells it off to other producers. Although often overlooked by investors, Matador's chief executive Joe Foran points out that the water issue is in some ways more of a challenge than that of gas pipelines. "You can flare gas, you can't flare water," said Foran.

Ultimately, companies will move towards recycling more wastewater in their fracking operation, which will become increasingly attractive as fresh water gets costlier and scarcer. Matador says that moving to recycled water alone could save it up to 5% on its completion costs.

Traffic jams

Then there are the region's notoriously clogged and dangerous roads, which have been overwhelmed by trucks moving oil and gas equipment around the area. Trucks ferrying frack sand from nearby mines, for instance, spend hours stuck in traffic on two-lane highways not built to handle the influx of vehicles, leading to drilling delays and logistical bottlenecks. The state is working to expand the road network around the basin, but funding is a major challenge.

1m b/d—New pipeline capacity needed per year in the Permian

The Permian will also need a whole lot more workers. "There's already a shortage of people," Dove said. Many of those that were laid off in the downturn haven't come back to the industry, and labour costs are rising sharply as a result of the shortage. Operators and service companies are raising wages and some are even treating the Permian like an offshore operation-flying workers into West Texas for a few intense weeks and flying them out for few weeks off.

The solution, Dove argues, is making Midland and Odessa, the region's two biggest cities, a more desirable place for the oil workforce to settle down. For decades, the region has seen its population swell when the oil industry was riding high only to see people flee during industry downturns. That has made urban planning difficult, with the cities and state not wanting to invest in services and infrastructure that wouldn't be needed when the next oil bust came.

Regional consolidation

Today's sustained boom, as a result, is putting pressure on the region. Housing shortages mean rents in this part of West Texas's wide open plains rival those in coastal Southern California and major cities across the country. Moreover, there aren't enough doctors, schools and other facilities to support the scale of workforce the Permian will need to reach the heights envisioned by its oil producers. If the region can't attract workers, labour costs will continue to rise sharply.

None of these problems on their own will derail the Permian's growth. But cumulatively they could start to undermine the basin's attractive economics and act as a drag on growth.

The mounting challenges will also reward bigger companies with the cash to invest in their own infrastructure. They can throw their weight around in negotiations for everything from securing frack crews to ensuring space for pipelines.

Pioneer says the water system it built, for instance, will deliver billions of dollars in savings in the coming years, thanks to improved efficiency and better pricing. A smaller operator running a rig or two, and drilling just a handful of wells a year, wouldn't be able to make such an investment, and as a result will have higher costs, making it less competitive. That's likely to add to the pressure, already building across the Permian.

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