The Great Permian Capital Reallocation Begins

A new report from the U.S. Energy Information Administration (EIA) indicates that the growing shortage of pipeline takeaway capacity in the Permian Basin of West Texas and Southeast New Mexico is resulting in some companies reallocating capital initially earmarked for Permian drilling to other areas in which they produce. The report points out that “As a result of these constraints, some producers with a geographically diverse portfolio of upstream assets announced plans in their second-quarter earnings releases to redirect capital expenditures from the Permian Basin to other regions.”

As the Washington Examiner notes, the EIA “said it is tracking 45 publicly-traded oil companies’ investment strategies, and spotted a trend. ‘As a result of these constraints, some producers with a geographically diverse portfolio of upstream assets announced plans in their second-quarter earnings releases to redirect capital expenditures from the Permian Basin to other regions.'”

While this development may come as a surprise to some observers, it is really just the normal course of business. The high likelihood of this taking place was noted in my “Oil and Gas Situation” piece posted on May 14:

“While drilling budgets for most producers are set through the end of June, this increasingly constrained situation could result in companies that produce in multiple basins shifting some of their drilling capital to non-Permian regions during the second half of the year and into 2019. The Eagle Ford Shale, DJ Basin and Bakken Shale would be the most likely beneficiaries of such a re-directing of capital. The per-well economics in these other basins may not measure up to those in the Permian, all other factors being equal, but the differential blowout for some Permian producers means all other factors aren’t equal at this point. This situation is likely to persist into 2019, when a raft of new pipeline buildouts are scheduled to come online.”

There’s no magic there on my part: It’s just an understanding of how the big independent producers who drill the vast majority of shale wells go about developing capital budgets and adjusting them at mid-year. When 2018 dawned, the looming pipeline capacity constraints in the Permian weren’t really high on anyone’s radar, and it was natural for upstream independents to allocate their capital to the projects they believed would have the highest potential rate of return. Permian economics being superior to other basins, those producers would want to target as much capital as possible to drilling projects in that region.

But as these companies went about adjusting their budgets during April for the second half of the year, the situation with pipeline capacity coming out of the Permian had become clear, so it was only natural that they would reallocate some of that capital to projects in other basins where they have leasehold. Simple, really.

We should expect the flow of drilling capital out of the Permian to other U.S. shale basins to continue into 2019 , given projections that the major new pipeline projects currently under construction won’t begin coming online until around mid-year. We should also expect the flow of capital to begin reversing itself back into the Permian when these companies make their mid-year budget revisions next April, in anticipation of the additional capacity coming online.

This is almost certain to happen to some degree, because the per-well economics in the Permian remain superior to those in any other producing basin, and capital dollars will always flow to the highest anticipated rate-of-return, all other factors being equal. The problem in the Permian right now has nothing to do with the quality or quantity of the resource ; rather, it is that those other factors, though solvable over time, are not currently equal.

Forbes