Permian Midstream Adjusting to Lower Growth Investment targets gathering systems

Transcription

1 ? Permian Midstream Adjusting to Lower Growth Investment targets gathering systems Morningstar Commodities Research Aug. 26, 2016 Sandy Fielden Director, Oil and Products Research Connecting the First Mile After doubling from 1 million to 2 million barrels/day between 2011 and 2015, crude production in the West Texas Permian Basin has leveled off recently in the face of lower oil prices. The slowdown in output has given takeaway infrastructure a chance to catch up, and the addition of over 700 thousand barrels/day of new mainline capacity has transformed congestion into overcapacity on long haul pipelines out of the region. While new drilling has slowed considerably, a recent uptick in deployed rigs reflects optimism among producers that the Permian offers the best rates of return. Midstream operators continue to build out transport networks to help secure current and future market share. These new projects confirm that active investment in midstream infrastructure continues in the Permian. The focus of development has moved away from big mainline pipes to get crude to refining markets because the slow down in production has left that sector overbuilt. Instead, midstream companies are now connecting the first mile by building out gathering systems and protecting their market share by tying in producers at the wellhead. The improved infrastructure will save transportation costs for hardhit producers as new rigs roll out into Permian hotspots in response to the partial crude price recovery since February Rolling Out the Drilling Rigs During the past three months over 40-mothballed drilling rigs have rolled out in the prolific Permian Basin as producers respond to a modest recovery in market prices from a low of $27/barrel in February 2016 to the $50/barrel range between June and August Exhibit 1 shows the history of drilling rigs deployed in the Permian according to the Energy Information Administration (blue line, left axis) increasing from 330 in January 2011 to a peak of 565 in November 2014 and then falling off a cliff to a low of 137 rigs in May 2016 after crude prices collapsed. Over the same period Permian crude production (red line, right axis) experienced rapid growth from 1 million to 2 million barrels/day between 2011 and 2016, peaking in March Since then production has hovered around 2 mmb/d and is not expected to increase significantly during the next year as new drilling will at best replace declines from existing wells. We believe a return to crude prices above $60/barrel by 2018 will prompt a stronger recovery in drilling activity and a return to production growth in the Permian. Although current output levels are static or rising slowly, the Permian is still the most attractive shale basin to producers because of its perceived potential to deliver better rates of return with oil prices at or below $50/barrel. Typical shale wells in current Delaware and Midland basin hot spots in the Permian provide the best new drilling opportunities in the U.S. shale patch today. Mergers and acquisitons

2 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 thousand barrels/day Rig Count Page 2 of 6 activity has increased as some hard-pressed producers give up valuable Permian assets to help pay down debt and others with deeper pockets buy up distressed acreage in pursuit of higher returns. Exhibit 1 Permian Drilling and Production 2500 Production Rig count Source: EIA, Morningstar Long Haul Pipelines Catch Up The slowdown in new production has given midstream infrastructure a chance to catch up with higher output. Before prices began to tumble in the fall of 2014, Permian crude output exceeded regional takeaway capacity leading to pipeline congestion getting out of the basin to Midwest and Gulf Coast refining markets. During 2015 that congestion was relieved by new outbound capacity coming online between regional crude gathering hubs and refining markets. Significant pipeline projects in this time frame included: The Magellan Midstream Partners and Plains All American joint venture 300,000 barrels/day (or mb/d) BridgeTex pipeline from Colorado City to Houston. The Plains 250 mb/d Cactus pipeline from McCamey to Gardendale in the South Texas Eagle Ford basin expanded in 2016 to 330 mb/d. At Gardendale the Cactus pipeline links to the Enterprise Products Partners Eagle Ford pipeline to Houston and the Plains/Enterprise JV pipeline to Corpus Christi. The Sunoco Logistics 200 mb/d Permian Express II pipeline from Garden City to Nederland/Port Arthur Sunoco Logistics/Vitol JV 200 mb/d Sunvit connector between Midland and Garden City. In addition to these mainline capacity expansions, the proposed Enterprise Midland to Sealy pipeline is expected to add an additional 450 mb/d of outbound capacity to Houston if it is completed as expected in mid These new projects not only relieve existing congestion but have also created significant overcapacity out of the region. Exhibit 2 shows the outbound capacity stack from 2014 through 2018 as well as EIA actual and forecast production. The addition of the BridgeTex and Cactus pipelines in 2015

3 1/1/14 4/1/14 7/1/14 10/1/14 1/1/15 4/1/15 7/1/15 10/1/15 1/1/16 4/1/16 7/1/16 10/1/16 1/1/17 4/1/17 7/1/17 10/1/17 1/1/18 4/1/18 7/1/18 10/1/18 thousand barrels/day Page 3 of 6 boosted capacity above production (black line). The addition of Enterprise Midland to Sealy in 2018 will further exaggerate the overcapacity. Exhibit 2 Permian Crude Takeaway Stack Local Refinery Consumption 3,500 Permian Express II Cactus Rail 3,000 Existing Pipelines Bridgetex Midland Sealy Production 2,500 2,000 1,500 1, Source: EIA, Morningstar Local Connections With outbound long haul capacity overbuilt, midstream infrastructure companies have turned to smaller projects linking the most active drilling and production plays in the Permian to regional takeaway hubs. These smaller in-fill projects make sense for a number of reasons. For producers they reduce costs to transport crude from the wellhead to mainline pipeline hubs by replacing costly trucking fees with lower pipeline tariffs. With crude prices and drilling rates of return now far lower than they were in 2014, these cost savings help producers stay afloat in a low price environment. For midstream companies, building connector pipes from newer drilling hotspots in the Western Permian Delaware basin to outbound pipeline hubs located to the south and east provide a feed-in system to access future volumes. For example, producers often dedicate all their output barrels from specific acreage to midstream gathering operators, providing a guarantee of future volume to justify building pipeline receipt stations. Building gathering system pipelines also protects midstream operator market share by ensuring the delivery of committed volumes to outbound mainline pipes that are now competing for business in a market with too much capacity. Within the Permian Basin the following major connector infrastructure projects pushing supplies to mainline takeaway hubs have recently come online or are underway and expected in service by the end of 2017: Navigator Big Spring Gateway: The 160 mb/d Big Spring Gateway (BSG) Pipeline commenced service in September 2015, gathering crude from Martin, Howard, Glasscock, Midland, and Mitchell counties in the North Midland basin to Colorado City. The system connects to the BridgeTex, Sunoco Permian

4 Page 4 of 6 Express II, and West Texas Gulf outbound long-haul pipes as well as to the 73 mb/d Alon Big Spring, Texas, refinery. Medallion Midstream Wolfcamp Connector: The 105 mb/d Wolfcamp Connector crude pipeline initially ran 60 miles from Garden City to Colorado City, Texas, and now has several gathering extensions, completed or under construction. The pipeline gathers production in Mitchell, Howard, Glasscock, Reagan, Upton, and Midland Counties, Texas, and connects with the BridgeTex and Permian Express II long-haul pipes to the Texas Gulf Coast. The Midkiff Lateral extends to Crane, providing a connection to the Magellan Longhorn pipeline to Houston. The recently proposed Martin/Midland extension would provide access to multiple long-haul pipes via Midland. Alpha Crude Connector (or ACC): A 400-mile crude oil gathering system now operating in southeast New Mexico and Texas with initial capacity of 100 mb/d (Exhibit 3). Frontier Energy Services and Concho Resources jointly own the ACC. The pipeline provides access to multiple downstream markets via interconnects with Plains, Enterprise, and Sunoco pipelines as well as to the local Western Refining and Holly Frontier refineries and a Genesis rail terminal at Wink. Exhibit 3 Alpha Crude Connector Source: Frontier Energy Services, RBN Energy The Rangeland Energy integrated oil (RIO): A gathering system with both rail and pipeline components serving the Delaware Basin. The 125 mb/d RIO pipeline runs from the Texas/New Mexico Stateline in Loving County, Texas, to Midland and is expected online during the second half of The pipeline is a joint venture two thirds owned by Rangeland and one third by Delek Logistics (part of refiner Delek U.S. Holdings, the anchor shipper on the pipeline). The RIO rail hub (connected to the BNSF railroad) handles inbound deliveries of sand proppant and drilling equipment. Oryx Midstream Services: The 160 mb/d Oryx Trans Permian (OTP) pipeline gathers oil from wells in Reeves, Ward, and Pecos counties in the Southern Delaware basin to regional pipeline hubs at Crane

5 Page 5 of 6 and Midland. At Crane the pipeline connects with Magellan s Longhorn pipeline to East Houston, and at Midland the OTP system connects with the Enterprise network. Energy Transfer/Sunoco Logistics: Sunoco Logistics (a subsidiary of Energy Transfer Equity) owns significant crude pipeline gathering and takeaway assets in the Permian including the mainline 375 mb/d West Texas Gulf system from Colorado City to Longview and Goodrich, Texas, and the recently online 200 mb/d Permian Express II from Garden City to Nederland, Texas. The 100 mb/d Delaware Basin Expansion pipeline from Lea County, NM to Midland, Texas, came online in August 2016, providing direct connectivity for Delaware Basin producers to takeaway hubs at Midland, Colorado City, and Garden City. Three Sunoco crude gathering systems in Lee County New Mexico and Loving County, Texas, feed into the Delaware Basin Expansion. Sunoco will soon offer producers access to Louisiana refineries via the Permian Longview and Louisiana Extension expected online by the end of Centurion Terminals: Privately owned Dallas based midstream operator Centurion, has recently launched a two-phase project known as the Delaware Basin Express to gather and deliver crude and condensate to the Texas/Mexico Gulf Coast border at Brownsville by rail. Phase 1 of the project expected online during the third quarter of 2016, involves connecting two crude gathering terminals at Orla and Pecos, Texas, via a 24-inch pipeline. The Pecos Terminal will ship up to 160 mb/d of crude and/or condensate to Brownsville on dedicated unit trains using the Union Pacific railroad. The Brownsville terminal (under construction since September 2015) will unload rail shipments from Pecos for export via a marine dock or for processing at an on-site 50 mb/d condensate splitter that Centurion is constructing. Crestwood Delta: A proposed 164-mile 200 mb/d Delaware Takeaway crude and condensate gathering system (known as Delta ) is currently being developed by Crestwood Equity Partners, running from Orla, Texas, to connect with multiple outbound mainline pipes delivering to El Paso, Midland, Cushing, Houston, and Corpus Christi. Delta is currently expected to be operational in third quarter of Refinery Demand Pull Midstream companies are also competing for business at the distribution end of the mainline pipes by building out new destination options in crowded refining markets like Houston. These options may be in the form of pipeline connections to refineries further east on the Gulf Coast in Louisiana or access to marine docks that can handle export cargoes. Pipeline operators are also increasingly offering batch service so that producers can segregate and deliver particular grades of crude that are desirable to processors or export markets, such as ultra light condensate or sour crude grades. With overall production volumes flat or expanding slowly, larger midstream players seek to wring every last transportation dollar from producers by providing service from the wellhead to the refinery. Regional Permian refiners such as Western Refining and Holly Frontier have also built out new pipeline connections to improve their access to local supply. K

6 Page 6 of 6 About Morningstar Commodities Research Morningstar Commodities Research provides independent, fundamental research differentiated by a consistent focus on the competitive dynamics in worldwide commodities markets. This joint effort between Morningstar's Research and Commodities & Energy groups leverages the expertise of Morningstar's 23 energy, utilities, basic materials, and commodities analysts as well as Morningstar's extensive data platform. Morningstar Commodities Research initially will focus on North American power and natural gas markets with plans to expand coverage of other markets worldwide. Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individuals, financial advisors, and institutions. Morningstar's Commodities & Energy group provides superior quality market data and analytical products for energy data management systems, financial and agricultural data management, historical analysis, trading, risk management, and forecasting. For More Information North America Europe commoditydata-sales@morningstar.com? 22 West Washington Street Chicago, IL USA 2016 Morningstar. All Rights Reserved. Morningstar's Credit Ratings & Research is produced and offered by Morningstar, Inc., which is not registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization ("NRSRO"). Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. To license the research, call