The oil price crash has hit the US Lower 48 hard. But as exploration and production companies work to mitigate the impact of the crash on their businesses, their strategies are affecting the region’s midstream players, as reported by Wood Mackenzie.
Alex Beeker, from Wood Mackenzie’s upstream corporate research team, said: “Lower 48 E&Ps have slashed capital expenditure by anywhere from 30-50% and cutting the rig count in half since March this year. The response has been rapid.
“Shale is finally behaving the way shale was intended to behave – flexibly and with an eye to short-cycle investment opportunities. They are doing whatever it takes to survive. Cuts of this magnitude were absolutely the right move, but balance sheets will still be tested this year.”
He added: “Many are electing to defer drilling and completion activity, in violation of their minimum volume commitment contracts with midstream companies. They’d rather pay a few million dollars in penalties than drill at current prices.
“Very little new drilling makes sense at $35 a barrel (/bbl). On a basin-wide average, the Permian is the only region that can make money at that price level. In order to see a meaningful recovery in drilling and completion activity, we need to see prices north of $45/bbl.”
As a result of the Lower 48’s response to the macro environment, oil production is expected to decline by 1.4 million barrels per day (b/d) from March to June 2020. Around 1 million b/d of this comes from shut-in or curtailed production.
As things stand today, Wood Mackenzie assumes that some of that production will come back online in July, with a return to normal levels by August. Whether June is the production low depends on price.
Robert Polk, who is also part of the upstream corporate research team, said: “On the whole, companies face more difficult circumstances than they did in 2016, at the depth of the last price cycle. While low prices play a role in this, price isn’t the whole story. Other factors also have an impact: credit ratings, near-term debt maturities, liquidity.
“Even with oil prices at around US$30/bbl, a lot of US shale acreage simply doesn’t work. And so liquidity, cash-on-hand, cash-flow generation, and available credit takes on more significance in a challenged environment like this.”
Polk added that there are fewer options available to E&Ps at present, particularly if the price environment remains depressed for a prolonged period of time.
“One of the things we’ve seen over the first quarter of this year, which doesn't include the full brunt of the demand destruction brought about by the Covid-19 pandemic, is that total liquidity has deteriorated significantly for a lot of Lower 48 companies,” he said.
Oil demand should recover progressively in the coming months as lockdowns ease, and Wood Mackenzie expects Brent to reach US$40/bbl through the fourth quarter of the year. That would be enough to lift some shut-ins back above short-run marginal cost; and re-opening wells could push US Lower 48 production back up to 9.3 million b/d during the third quarter. But a sustained price recovery is necessary to spur drilling.
Several years of significant production growth in the Lower 48 prompted an expansion of midstream infrastructure, including gathering and processing lines, as well as long-haul pipelines. For midstream companies that made major investments based on pre-Covid-19 production forecasts, the situation is challenging. The wave of shut-ins across the Lower 48 means low pipeline utilisation.
Polk said: “Midstream infrastructure projects, many of which were financed with high levels of debt, will struggle to deliver projected returns. And cashflow is falling in tandem with utilisation, limiting the ability of the midstream to increase or even maintain distribution.
“The Permian basin was viewed as the Lower 48’s growth engine, driving infrastructure investment. As a result, pipeline capacity from the basin was overbuilt even before the price downturn.”
Wood Mackenzie forecasts utilisation in the Permian will fall to 60% by October this year - further and faster than in the Bakken, Wyoming and Colorado - and stay at around that level until at least December 2021.
In contrast, Colorado and Wyoming midstream infrastructure utilisation rates show a V-shaped recovery, returning to normal levels by early 2021. The Bakken stabilises at about 80% utilisation by October this year.
As oil prices improve, E&Ps in the Permian will place greater emphasis on cash flow generation as opposed to production growth. Long-haul capacity is expected to exceed supply by July 2020, reaching an excess of 2 million b/d by July 2025.
Polk said: “What does this mean for midstream companies? It’s not a good environment. The components of the broader industry are intermingled and intertwined, so the relative success or failure or financial health of one has an impact on others. Midstream is by no means immune.”
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