Quality Differentials and Permian Gas Forecasts

Associated Gas and Growth Forecasts

A key concern for future North American gas prices is associated gas, since this production wedge is less responsive to price. The main reason often cited is the Permian, where oil production appears to be economic enough to keep gas production from abating at multiple pricing scenarios. This theory has held true for the past year with 489 rigs, of the current 856 drilling rigs in the US, currently developing the Permian. However, as Permian production volumes have hit the market, Delaware crude volumes have been discounted as they trend lighter than desired by refiners. This trend may begin to lower Permian gas production forecasts as the lower prices reduce cash flow for reinvestment. It may also cause a shift to more development in the Midland Basin, which produces less gas.

The Size of the Impact

How can cash flows in a single basin in the Permian drive macro gas prices? Quantifying the impact on gas supply is key to understanding this. Permian gas production recently reached approx. 10.5 Bcf/d, and new pipelines are increasingly connecting this gas to demand centers and pricing hubs. Since the start of 2017, the Permian has contributed approximately 25% of the gas growth in the major basins. Much of the gas growth comes from the Delaware basin, where the majority of future drilling is expected. Almost two-thirds of oil growth in the Permian is expected to come from the Delaware Basin. Compounding this is the fact that Delaware wells are gassier. Core Delaware curves often average 25% gas or higher, while highly economic Midland curves average only 15% gas volumes. This compounds the dependency of gas production forecasts on Delaware basin development. All things considered, a switch by operators to more Midland drilling, or a straight reduction in Delaware drilling, will result in gas production forecasts that are below expectations.

Light Oil Pricing and Gas Forecasts

Many forecasts for Permian production have Delaware volumes receiving WTI pricing. For certain areas, this is potentially optimistic based on the qualities being produced. Midland basin production ranges between 38° and 44° API and can trade at a premium to WTI, while Delaware basin production is much lighter, ranging between 45° and 50° API. This lighter production in the Delaware typically qualifies as West Texas Light, receiving a discount of $1.50 or higher. Certain locations have come in even lighter and receive additional discounts. This pricing disconnect will likely compound in the near-term as more of the light production hits the market, further reducing the received prices. Eventually, industry projections will start to take this into account. The effect of reduced pricing should flow through to forecasts, and the associated gas Permian projections will likely decline. 

Overall, the Permian is a fantastic resource in both the Delaware and Midland. However, as the Delaware quality differentials get factored into forecasts, the gas production forecasts for the Permian and the US will likely come down. 

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Mark Le Dain