Oil and natural gas pipeline constraints in the Permian Basin may be the headline story, but operators are playing “whack-a-mole” in the giant play, where once one issue is resolved, another immediately pops up, executives said Wednesday.
Devon Energy Corp.’s Kevin Lafferty, senior vice president (SVP), Legacy Reserves Inc. President Dan Wescott and Parsley Energy Inc. SVP Stephani Reed shared a panel to discuss the opportunities and challenges facing operators in the Permian at the inaugural PermiCon event in Houston, sponsored by RBN Energy LLC.
The Permian has grown production faster than infrastructure — and demand — can handle, the executives said.
“You can’t grow an industry this quickly without having constraints,” Wescott said. “I think our operations in the Permian have been what I would argue is a bit of an arcade game of whack-a-mole. You smash it and another problem comes up…”
Reed, whose company is a Permian pure-play, said the challenges have become “ a little bit of whack-a-mole. A couple of years ago we were concerned about crews, not equipment.” Finding enough people is still a top issue.
Parsley is working with Midland-Odessa officials in West Texas to find solutions to an acute labor shortage in what has forever been a sparsely populated area. Reed estimated that 10,000 jobs remain unfulfilled. By 2030, there may be an “estimated 50,000 additional jobs in the Permian that we don’t have employees for…”
Parsley is looking at “all options” to solve the people shortage, but it’s not easy. The company is working hand-in-hand with regional officials to expand educational opportunities and ensure there is enough healthcare, which are at the top of the to-do list.
That type of job growth might not be as big a concern for Houston, which has more than 2.3 million people, Reed said. Together, the Midland-Odessa area has around 250,000.
Another issue is convincing talented people to live in West Texas, which is more than four hours from Dallas-Fort Worth and nearly eight hours from Houston. In fact, Parsley four years ago moved its headquarters from Midland to the Texas capital in Austin, a mecca for the young and young-at-heart, but it’s also a long commute at around five hours.
“It’s interesting because we have 250 employees and families in the Permian Basin, and we think about the quality of life with employees,” Reed said. “What does education look like? Midland lost 500 teachers last year. In Houston, that’s not a big number but in Midland, that’s huge.”
As much as the energy industry has moved to “control rooms and automation,” it’s still a “labor- and people-intensive business,” Lafferty said.
Still, the No. 1 issue for producers is takeaway, which is “on everybody’s mind today,” he said. “It’s not one thing tripping everybody up. It’s producer specific, it’s midstream specific…It has to do with contracts, capacity, hedging programs. It’s not one thing that impacts everybody.”
Some producers are building their inventories of drilled but uncompleted wells, or DUCs. “Some are choosing to drill,” Lafferty said. If a company lacks hedges and takeaway, they may wait to complete wells. Some are flaring gas to produce oil. And some are shifting capital out of the Permian to other parts of their portfolios, he said.
Devon is sitting in a sweet spot. Between hedging and firm contracts, it is protected this year for about 90% of its output. “For us, we’re not impacted by differentials blowing out” because the company has space and capacity. It has natural gas liquids arrangements in place and fractionation capacity at Mont Belvieu near Houston.
Devon also is a long-time Permian player, having operated in the basin for more than 20 years. Established relationships help when there are issues. “We know the key players,” Lafferty said.
The Oklahoma City-based independent also doesn’t have issues with water, as 95% of the water to wells is on pipe, with 80% of it recycled back to the wells.
On the supply chain side, Devon came out of the 2014-2016 downturn by locking in contracts for rigs and spreads, as well as moving to regional sand.
Some operators are facing increased costs, lower margins and price blowouts, but not Devon, said Lafferty.
“When others are having to make other choices in their portfolio, we’ll lean into the Permian,” he said. “We’ve put ourselves in a a great spot.”
Parsley doesn’t have the luxury to move rigs to other plays as the Permian is it, Reed noted. What the company does to thrive is balance the need for production versus takeaway, she said. In the Midland sub-basin, Parsley has about 164,000 net acres, with acreage consolidation efforts ongoing to avoid “checkerboard” leases. That gives the company the option to drill longer laterals, which are averaging around 9,500 feet.
To keep production growth and takeaway capacity balanced, Parsley is “very fortunate to lean on existing agreements we entered into in 2017,” she said. Because it cannot move outside the Permian, “we have to solve the problem.” This year, the company was “locked and loaded” to avoid pipeline constraints.
In 2019, it plans to move into a more “moderate growth mode,” with 40-60% of its output hedged now.
The panel was asked whether it was better to complete wells or build a DUC inventory.
“Parsley is probably not in the camp of building any kind of DUC bank,” Reed said. Because cash flow from the well is over the life of that well, “you won’t see us artificially build a DUC bank. That said, from a business perspective, if it makes sense, we may slightly defer completions a month or so but not artificially build a bank.”
Legacy is not a Permian pure-play, but it’s also not a company with “sufficient size” to take out firm transportation contracts, Westcott said. However, the company has two-thirds of its oil hedged, and for 2019, about one-half of output already is hedged.
“As it relates to existing production, we’re not…in the camp of speculating when to bring on wells,” Westcott said. “We do build DUCs. Our DUC build is almost a function of our working capital — I would argue, a good chunk of it…
“You can’t grow the Permian rig count to nearly 500 rigs and not have an increase in DUCs. The pads are getting bigger. The wells per pad are getting bigger. It’s the same argument for storage. You can’t increase basin-wide production without an increase in working capital…” Low price may influence Legacy’s decisions on whether to do a workover to bring a well back or to rework a well.”
In every case, Westcott said, “you have to have contingency plans. As I am often reminded by our COO, it doesn’t always work out like a spreadsheet.”
Devon has capacity on long-haul pipelines to the Houston market, with oil pricing “tracking along with more Brent-type markers,” Lafferty said. “We want to have a long-term view to smooth out cash flows.”
Exploration and production companies, Lafferty said, “don’t make money. The return on capital employed literally showed nothing worked,” so about a year ago, the company launched a different strategy to become more “value oriented.” By hedging, production has become more of a “long-term type investment, making money over time.”
Not only is Permian output hedged but the barrels sold in Houston also are hedged. Devon also has contracts with refineries and an ongoing strategy to export more of its output. The strategy was formed as more output was moving south from the Rocky Mountains and Appalachia.
Almost everything between the Rockies and Appalachia “has to get exported,” he said. “We are moving constraints further in the value chain.”
Asked when the Permian’s takeaway issues would be solved, Lafferty said he was unsure what could happen next week, let alone in five or 10 years. “The incremental oil, gas, NGLs are causing displacement” everywhere. The United States still is importing oil to the Gulf Coast, but barrels in the middle of the country also need to “hit the water.”
U.S. oil produced in the Lower 48 is mostly light and sweet, but domestic refineries mostly process heavy sour crude. That means a lot of Lower 48 production has to move overseas, Lafferty said.
Another big issue to be solved in the Permian has to do with safety, Westcott said. “With Permian growth, we’ve seen quite an increase in vehicle-related deaths. Midland Count is up 100% year/year on traffic accidents. That’s really sad.
It’s going to take a more proactive approach. Midland has a concerted effort to gather resources, and we’re well connected in the community to address issues. That’s really tough.”
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