Burn, Pay, Or Shut It Down: Three Evils For Permian Drillers

Authored by Julianne Geiger via OilPrice.com,

There was a time when natural gas was a welcomed byproduct of crude oil drilling, and drillers in the prolific Permian basin enjoyed this consolation prize--at least when natural gas prices were on the rise. All good things come to an end, though, and the amount of natural gas now exceeds the capacity to get rid of it.

With pipeline capacity fully exploited and natural gas prices squarely in the red, Permian drillers today are faced with three lousy choices: burn off the natural gas, pay to have the gas removed, or slow oil drilling activities to staunch the flow of natural gas.

Crude oil and natural gas are like two peas in a pod: when you find oil, you often find gas. 

Crude oil is pumped out of the well, and a small amount of natural gas comes almost inevitably comes with it. 

But over time, this ratio changes: less oil, more natural gas. 

Now, there is simply too much natural gas, and drillers in the American shale patch must face the not-so-pleasant music, with only one question remaining: which shale drillers can hold on until more pipeline capacity comes online?

Burn, Baby, Burn

The first option for drillers trying to weather the natural gas storm is to burn it off. 

This is flaring--and it’s a rather unpopular method, publicly speaking, due to the negative impact on the environment. For drillers, though, it’s a cost-effective way of dealing with the glut, and since they all must answer to shareholders and lenders, flaring is the first choice when it comes to watching the bottom line. 

Flaring has increased exponentially in recent years as the discrepancy between natural gas and pipeline capacity increased, creating unfavorable market conditions and leaving drillers holding a bag of unwanted natural gas. 

In fact, we’ve seen an increase from 123 billion cubic feet annual of vented and flared gas in Texas in 2017, to 238 billion cubic feet annually in 2018, according to the EIA

North Dakota, which has tighter flaring regulations, saw an increase from 88 billion cubic feet annually in 2017 to 147 billion cubic feet in 2018. 

Overall, the U.S. saw an increase in flaring and venting from 282 billion cubic feet in 2017 to 468 billion cubic feet in 2018--and oil production has increased by 1 million bpd since 2018.

According to Rystad Energy, flaring and venting in the Permian basin reached an all-time high from July to September 2019--at 750 million cubic feet per day. 

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Venting and flaring may be the cheapest option for oil and gas companies, but it’s also the most harmful to the environment, with flared and vented gas contributing to greenhouse gas emissions. Venting releases methane into the atmosphere, while flaring--which gets rid of the methane--still releases carbon dioxide into the air.

Pay to Take Away

Another method open to oil and gas companies in the Permian is to have their natural gas taken away. Oil drillers who come up with natural gas as a byproduct can--and do--pay to have it removed. 

Typically, as producers pay pipeline companies for use of the pipeline. They recoup their cost through natural gas profits, and those will longer term deals are essentially immune. For those companies who don’t have long-term contracted rates and contracted shipments, they are now paying others who have allotted space to take it--and at a huge loss, which has recently been considered a rather unpleasant cost of doing business in the oil industry.Related: Oil Prices Head Higher Despite OPEC+ Skepticism

This is cringeworthy for companies who are fastidiously watching their bottom line, all while their competitors are getting permits to flare it into the atmosphere largely for free.

Shut it Down

Finishing off our list of terrible options for oil drillers is to slow production until more pipeline capacity can be brought online. Oil production in the United States has increased by 1 million barrels per day from the beginning of the year.

In the Permian specifically, oil production has increased from less than 2 million barrels per day just three years ago to nearly 5 million bpd today. And according to the EIA’s Monthly Drilling Productivity Report, January is expected to increase by 48,000 bpd over December. 

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And with it, of course, natural gas production in the region is rising as well, with a projected 213 million cubic feet per day increase from December 2019 to January 2020. 

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With every month, the natural gas problem grows. And as oil prices climb, the thought of shutting wells in looks less and less attractive.

The Pipeline Resolution

All is not lost for Permian drillers. 

There are pipelines in the works set to increase the natural gas takeaway capacity in the region, which will alleviate the current burden on oil drillers. 

On the pipeline horizon is Kinder Morgan’s Permian Highway, which should increase takeaway capacity in the region by 2.1 Bcf/d by late 2020, Stonepeak’s Whistler (2.0 Bcf/d) by summer 2021, Permian 2 Katy (1.7 Bcf/d to 2.3 Bcf/d), Pecos Trail (1.9 Bcf/d), Permian Global Access (2.0 Bcf/d), Bluebonnet Market Express (2.0 Bcf/d), and the Permian Pass (2.0 Bcf/d). 

Until such time as these pipelines come into service, venting and flaring in the Permian is here to stay.