It’s an odd time to be a shale oil producer. On the surface, it appears the stage should be set for production in the Permian and other U.S. basins to surge into a premier market position. After a period of massive global oversupply that sent crude prices tumbling and left the industry in a troubling spot, the oil supply has corrected itself and increasingly tightened. Demand has soared as well, and now turmoil in several oil-producing regions threatens to cut production even further. Instead of racing to seize this opportunity, however, shale oil producers are left scrambling to answer a question that could undermine the entire enterprise: what happens when the pipelines are full?
Setting the Stage for Opportunity
Following a period of surplus supplies and flagging markets that kept oil prices down for more than two years, crude is once again surging around the world. As strong demand coincides with increasingly troubled production outlooks, prices have increased in recent months and could potentially continue to accelerate. OPEC has recently pledged an increase of one million barrels per day, but there is clear cause to wonder whether some of the member countries can hold up their ends of the bargain.
In particular, political turmoil in places like Libya, Nigeria and Venezuela has raised concerns about whether those countries can continue to keep pace in their production. Sanction disputes with Iran have only complicated the picture, causing some analysts to speculate that a massive increase in crude prices could be on the horizon. The fact that spare production capacity is tight has also amplified anxieties. With less margin for error, unforeseen developments like an Atlantic hurricane or unrest in another oil-producing country could have an outsized impact on the markets.
The Capacity Conundrum
All of this should be a golden opportunity for Permian oilfield producers and others in the shale oil industry to swoop in and stake an even larger claim of the market. Despite booming production and a general sense of optimism, however, the shale oil industry finds itself staring down a crisis. There simply isn’t enough capacity to transport all of the oil being produced, and with production showing no signs of slowing, the capacity crunch is growing worse with each passing day.
Current takeaway capacity in the Permian stands at about 2.8 million barrels per day. This already falls short of the production capacity of 3.2 to 3.3 million barrels, and production is expected to grow by around 800,000 barrels per day annually. Producers in the region are increasingly turning to trucks, trains and other transport methods to alleviate the bottleneck, but even accounting for other takeaway methods, it’s clear that time is about to run out on the Permian’s ability to handle all of the oil it produces. Analysts and industry personnel have sounded the alarm that production shutdowns are just around the corner, and some companies are already exploring the possibility of moving some rigs to other U.S. basins that aren’t yet dealing with capacity problems.
An Uncertain Future
Ultimately, the capacity bottleneck facing the Permian oilfield and other shale producers could prove to be little more than a temporary speed bump. The industry has a number of pipeline construction projects in the works that could more than double the Permian’s current capacity by 2020, growing the total rate to 5.8 million barrels per day or more once completed. Industry heavyweights are also actively searching for new ventures to expand the capacity further. However, even these solutions are not without problems.
It remains to be seen how many of these large-scale projects will be able to move forward given the uncertainty of tariffs, looming trade wars and shortages in both materials and manpower. Some projects rely on pipes that can only be sourced from a select few mills around the world, putting them at great risk of delays, budget overruns and other problems should trade disputes get in the way. To make matters worse, the takeaway bottleneck expands beyond just pipelines. There’s currently only one port terminal in the country that can accommodate the massive supertankers that are the preferred way to ship American oil to Europe and Asia. Projects are in the works to expand to other ports, but these are also unlikely to come online before 2020.
In the meantime, the net result of all this turmoil is that U.S. oil is trading at its sharpest discount to global benchmarks since at least 2015. Since even small pipeline projects are unlikely to become operational until late 2018 or early 2019, the discount is only likely to deepen in the short term. That means suppressed stock values for Permian producers and a major roadblock to growth for a shale industry capable of so much more. Indeed, it’s perhaps not a stretch to say that the future of the U.S. shale oil industry will be defined largely by how oil producers are able to resolve the current bottleneck crisis.
