Read comments from any producer, pipeline, or oil services company these days and you will come across the same thing: North American production is overwhelming infrastructure capabilities. It is allowing some companies to generate outsized profits, while others have warned that this could drastically impact the bottom line over the next several months.
One company that seems to be unperturbed by these issues is oil giant Chevron (NYSE: CVX). Even though the company is one of the top producers in the Permian Basin and is growing its shale production by leaps and bounds there, management seems to think that pipeline capacity won't be an issue.
Image source: Getty Images.
An ounce of planning is worth a pound of production
It's getting harder and harder to overstate the size and production potential in the Permian Basin every day. Pure-play shale producer Pioneer Natural Resources estimates that the Permian is about the same size as Saudi Arabia's supergiant Ghawar field, and that breakeven prices across the basin are less than $30 per barrel. With stats like that, companies with sizable acreage there could make a killing.
That is all well and good, but it won't matter if companies can't get the product to market. Today, that is the largest challenge to Permian players: finding enough capacity to move product out of the basin. Capacity to move crude oil to the Gulf Coast for export is practically worth its weight in gold these days, and companies that don't have adequate takeaway capacity are realizing much lower prices. The Midland-WTI Differential, which is the price difference between oil in the Permian Basin and the U.S. domestic benchmark price, for crude delivered this month is $12.80 per barrel.
Chevron is one of the biggest players in the Permian, as it produced more than 270,000 barrels per day from its shale assets on top of its conventional and legacy production there. Moving that much production requires a lot of pipeline capacity, but according to upstream executive vice president Jay Johnson, getting its production out of the basin isn't an issue.
Chevron has secured from transport capacity at competitive rates to move the equivalent of nearly all of our forecasted 2018 and 2019 operated and NOJV [non-operated joint ventures] taken in-kind oil production to multiple markets, including the U.S. Gulf Coast. As a result of these contractual arrangements and long-term planning, this equivalent production is not materially exposed to the Midland basis differential.
The reason that Chevron isn't scrambling to find takeaway capacity or changing its investment plans, according to Johnson, is that it had the foresight to buy pipeline capacity well in advance of needing it. So much so, in fact, that it has been able to take advantage of those companies that didn't have the same amount of foresight.
We previously mentioned that the pipeline takeaway capacity and production don't always move in perfect lockstep, there'll be periods of tightness and length. As an example, in June, we had more than 50,000 barrels a day of excess takeaway capacity out of the Midland basin, which we monetize through purchases of third-party volumes. We expect that excess capacity to attenuate through the rest of the year as our production continues to grow. Agreements are in place to access additional pipeline capacity in early 2019 in line with our production growth forecast. In July, we utilized firm dock capacity in the Houston ship channel to gain access to world markets for Permian sourced crudes. We have firm contractual arrangements in place to further increase that dock capacity in 2019.
Overall, we've exported more than 8 million barrels of liquids from the Gulf Coast in 2018, further demonstrating our midstream's ability to batch, blend, trade and export to secure the highest value for our products.
Image source: Getty Images.
Remember, the Midland-WTI differential is more than $12 a barrel, and the difference between WTI and the international benchmark, Brent, is close to $10 a barrel as well. With that 50,000 barrels per day of excess pipeline capacity, it can buy crude from others in the basin at Midland prices and then export it at Brent prices, a significant gain just for having the wherewithal to lock in transportation capability early.
Chevron being able to take advantage of a few producers jonesing for pipeline capacity is by no means a reason to go out and buy this stock. This is a company that produced 2.8 million barrels of oil equivalent per day and has substantial investments in refining and chemical manufacturing. Swindling a few producers to net a gain on crude differentials is a drop in the bucket for a company that earned $3.4 billion in the prior quarter.
The more important takeaway here is that not all shale producers in North America are equal, and it should be an important factor for investors when looking at this industry. Those like Chevron that can anticipate issues like pipeline capacity and allocate capital accordingly are going to be the ones that are successful, while others that think the solution to all their problems is to drill for more oil and gas will be the ones that miss out on millions in revenue and generate marginal returns. As an investor, take your time to discern which companies are the ones that are putting some thought to their development plans because it will play a large part in your portfolio gains.
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