Higher Than Expected GORs In the Permian Mean MLP Infrastructure Opportunities

Where is all the Permian gas going?

When my brother-in-law married my sister, both she and her cat, Boots, moved into his home. He married my sister, but the cat came along as part of the package. In a similar (kind of) way, when producers drill for oil they also get gas as part of the package. The gas-to-oil ratio (GOR) is exactly what it sounds like: a way to measure how much gas there is per barrel of oil.

We’ve talked a lot about the Permian this year. Oil production in the area has tripled since 2008 and it’s been hailed as the darling of drilling in 2017. When people think of the Permian, they think of oil; however, given announcements from companies like Pioneer Natural Resources (PXD) saying that recent GOR recovery rates are higher than expected, natural gas has entered the conversation. In a recent PXD investor presentation, the company presented data indicating that its GORs in the Permian region ranged from about 2,100 scf/bbl to just over 5,000 scf/bbl. The presentation highlighted that GORs typically increase over time and that things like well spacing and type of well (horizontal versus vertical) can affect the ratio. GORs on horizontal wells increase faster than vertical because of surface area covered and a quicker draw down of pressure. The prevalence of horizontal wells could explain some of the higher-than-anticipated GORs in the region.

In order to move gas out of the Permian, the first step is to have gathering and processing systems in place. Gathering pipelines are the small lines that connect to processing facilities that then send the gas on the big pipelines. Companies like DCP Midstream (DCP), Energy Transfer Partners (ETP), and Targa Resources Corp (TRGP) all have these systems in the area.

Once processed, there are several existing gas pipelines that take gas production out of the Permian. For example, the El Paso Pipeline (operated by Kinder Morgan (KMI)) and the Transwestern Pipeline (operated by Energy Transfer Partners (ETP)) take gas westward. There are also a handful of pipelines that take gas to the Mexican border. These include ONEOK’s (OKE) Roadrunner Pipeline, along with ETP’s Trans-Pecos Pipeline and Comanche Trail Pipeline. However, even with these outlets as well as gathering pipeline systems, reports of the need to flare off excess gas remain.

For anyone who is unfamiliar with the science of flaring, it’s basically a way for producers to turn methane (a nasty greenhouse gas) into carbon dioxide (also a greenhouse gas but not as bad as ethane) by setting the gas on fire. The Texas Railroad Commission (RRC) regulates flaring in the state. Evidently, the general rule is that the RRC allows flaring for up to 10 days after a well’s completion for well potential testing and there are “rare exceptions” made for extending this term. The RRC supposedly tracks how much gas is being flared, but the latest chart I could find only ran through 2014 where it was reported that around 0.8% of total gas reported to the RRC is flared. I would imagine this number has increased significantly given the Permian boom, but this is speculative.

With word of flaring activity comes the question of how much more midstream infrastructure is needed in order to not “waste” gas produced in the region. As a reminder, KMI and DCP proposed a project to take natural gas out of the Permian. The Gulf Coast Express Pipeline Project would carry 1.7 million Dth/d out of the basin running from Waha, Texas to Agua Dulce, Texas. Further, TRGP announced that it would be building two additional natural gas processing plants in the Midland and Delaware Basins representing an additional 450 MMcf/d of capacity. ETP also announced plans for a 200 MMcf/d processing plant.

Exactly how much opportunity for gas infrastructure is there in the Permian? Here’s some very simple back-of-the-envelope math. Currently, 8.6 Bcf/d of natural gas is being produced in the region, or 15% of total onshore US gas production. Oil production is roughly 2.56 million barrels per day right now. If you’re overly optimistic like the CEO of RSP Permian (RSPP), Steve Gray, and think the Permian will be cranking out 5 million barrels per day in the next few years, and assume a GOR between 2,000-5,000 scf/bbl (the range of PXD’s 26 early horizontal wells), that’s a potential need for an incremental 4.9 Bcf/d – 12.2 Bcf/d of natural gas takeaway. If you’re not as gung ho as Steve, a more conservative (and realistic) data point would be from the EIA. Last week’s EIA short-term energy outlook expects oil production to increase roughly 500,000 barrels per day from 2017 to 2018. If you were to assume that ALL those barrels came from the Permian, that would be the equivalent of 1.0 Bcf/d-2.5 Bcf/d of incremental natural gas takeaway needed.

Clearly, there is a wide range of ideas out there about exactly how much gas infrastructure is needed in the Permian. However, no matter how things shake out, you can bet your Boots we’ll be seeing more gas related midstream project announcements.