U.S. Producers confront Permian slowdown

America’s hottest oil and gas play is cooling off. In the past three years, oil production from West Texas’ Permian Basin has doubled amid a flurry of drilling from companies large and small.

In six separate months last year, activity increased by more than 2 percent. This year, growth exceeded that rate only once, and it’s expected to rise just 1 percent in August compared with July, according to the U.S. Energy Information Administration.

Some of the reasons for the slowdown have been building for years. Pipeline construction has consistently lagged production in the region. Companies are drilling wells closer together, which has reduced production per well, as they attempt to extract more oil and gas per acre because the costs of acquiring new leases have skyrocketed. Moderating oil prices have also contributed to the slowdown, as many producers are getting less money for each barrel of oil they pull from the ground.

Rising U.S. production has swamped the global market, even as OPEC has attempted to shore up prices by curtailing supplies from its member countries. The International Energy Agency has predicted “the potential for oversupply next year” largely because of rising U.S. output.

In addition to prices and infrastructure issues, producers are wrestling with the nature of the wells themselves. Shale wells typically produce as much as 40 percent of their expected lifetime production in the first three years after they were drilled.

Unconventional wells are known for rapid decline rates, but the declines in the Permian appear, on average, greater than those of other shale formations. While the output of most unconventional wells falls by between 5 percent and 10 percent a year, shale wells in the Permian can show decline rates as high as 14 percent, according to a study last year by Wood Mackenzie. Many companies drilling in the region, however, have been basing estimated recoveries on the 5 percent to 10 percent assumption, Wood Mackenzie found. That miscalculation may be catching up with some of the Permian’s biggest producers.

In July, Parsley Energy, one of the more venerable drillers in the Permian, said it would slash 2019 growth rates by as much as 40 percent from last year. On Aug. 1, Apache Corp., which is developing the Alpine High prospect in the Permian, posted a $360 million quarterly loss on a 17 percent decline in revenue after announcing this spring that it would curtail production because of pipeline shortages.

Other top Permian producers, including Diamondback Energy, EOG Resources and Pioneer Natural Resources, have said they plan to lower capital spending and increase production.  Diamondback also has announced plans to spin off its pipeline operations as well as its more mature properties in the region.

Other companies have considered asset sales as well. Pioneer recently sold its holdings in the Eagle Ford Shale of South Texas to focus on the Permian.

For the past decade, many oil producers in West Texas and eastern New Mexico have spent beyond their cash flows to expand their output. Investors, however, didn’t see the benefits of the expansion, as share prices lagged. Now, Wall Street is demanding more financial discipline, which means less spending and a stronger focus on producing the resources the companies have accumulated.

Overall, rig counts have fallen 10 percent from their November peak to 437, their lowest since March 2018, according to Baker Hughes, which tracks rig data.

To be sure, the Permian remains the world’s most productive energy basin, churning out about 4.2 million barrels of crude daily and accounting for more than one-third of the total U.S. daily production of 12 million barrels.

While the smaller independents are pulling back, majors like Exxon Mobil and Chevron are beefing up their operations. European majors such as Royal Dutch Shell and BP have stepped up their investments in the region as well.

The majors were slow to join the Permian party, waiting until smaller producers had established the resource base in shale formations through hydraulic fracturing and horizontal drilling.

In addition to having greater financial resources that they can tap to continue investing in Permian projects, even at lower commodity prices, many of the majors also have petrochemical interests on the Gulf Coast that benefit from cheap natural gas being extracted in West Texas. This creates a natural market for at least some of their production.

At the same time, the nature of Permian activity is changing, part of a natural transition that occurs as a basin evolves. The region is less of a prospector’s paradise these days as producers move into what many call “manufacturing mode,” which requires less exploratory drilling and more investment in production wells that can tap the vast resources already identified.

Not all the investment is coming from the majors, however. In early August, Occidental Petroleum completed its $38 billion takeover of Anadarko Petroleum, which is designed to strengthen its Permian stronghold and will make it the most active player in the region. The company recently issued $13 billion in bonds to help finance the deal, which also includes a $10 billion infusion from billionaire investor Warren Buffett.

This Permian’s transition isn’t really a surprise. Many analysts and oilfield service companies have been predicting it since the spring. And it doesn’t mean Permian’s glory days are over. Far from it. Smaller producers will continue to conserve cash while they wait for pipeline bottlenecks to ease, which could come as early as next year, even as the major ramp up.

The Permian may be slowing down, the basin is far from playing out, and it is likely to remain a key driver of America’s newfound dominance in global oil markets for years to come.