Permian gas producers eye price volatility in 2023 before midstream expansion

The Permian Basin natural gas market is likely to have another midstream capacity crunch in 2023 as growing output puts production takeaway pipelines to the test and keeps hub prices in West Texas under pressure.

Gas production from the Permian continued its upward march in 2022, rising about 1 Bcf/d over 12 months, raising alarm among market participants over the basin's capacity to handle additional growth in 2023.

As of December 2022, production was trending around 15.8 Bcf/d, with daily output continuing to test new record highs at over 16 Bcf/d not far from the basin's theoretical maximum of around 17 Bcf/d-18 Bcf/d, data from S&P Global Commodity Insights showed.

Production growth in West Texas slowed in 2022 thanks to service-cost inflation, supply chain constraints and many producers' commitment to capital spending restraint. But some of the basin's largest producers still managed to capitalize on high crude prices in 2022 by dialing up output. Among them are Chevron Corp. and Exxon Mobil Corp., both of which achieved double-digit percentage growth in their respective Permian production volumes compared to 2021.

For 2023, rising concerns over cost inflation, along with shortages in drilling equipment, rigs and completion crews, have made many Permian producers pause in decisions of whether to grow output.

"We are seeing operators continue to emphasize on maximizing free cash flow and returning capital," said Narmadha Navaneethan, associate director of research and analysis at Commodity Insights.

"It's all limiting operators from growing volumes, especially for gas-focused operators who have hedged almost two-thirds of the production [in 2022] and already about one-third of production for [2023] at less than $4," Navaneethan said.

Still, most analysts believed that gas production from West Texas will continue climbing, albeit at a slower pace. According to Commodity Insights, Permian output could top 16.5 Bcf/d by late 2023.

Forwards prices

Production growth from the Permian has already triggered market volatility in the West Texas gas market. In fall 2022, the basin's benchmark location, Waha Hub, was hit hard by low shoulder-season demand, limited production takeaway capacity and midstream maintenance, the combination of which pushed gas prices into negative territory in October. For many, the all-too-familiar reality came much sooner than previously anticipated.

Over the past several years, many market analysts and observers anticipated a longer growth runway for Permian production as gas transportation capacity was added on Kinder Morgan Inc.'s Gulf Coast Express Pipeline LLC and Permian Highway Pipeline LLC systems and on the Whistler Pipeline LLC line. The 6 Bcf/d in new capacity, though, has been quickly consumed by rapid production growth.

Looking to 2023, many traders anticipated relatively wide basis-price spreads at Waha, especially heading into the second quarter as winter demand begins to fade. At Waha, the forward market is pricing January and February gas contracts at around a 50-60 cent surplus to Henry Hub per MMBtu. By March, though, the market is pricing in a discount of around $2.50-$3/MMBtu, with second-quarter prices now averaging more than $3 below the U.S. benchmark. Over the balance of the year, the market will likely not get much relief until November, when seasonal demand will begin to pick up.

Midstream expansions

RBC Capital Markets analyst Scott Hanold said in a Dec. 29, 2022, note that "[existing] Permian gas infrastructure capacity could cause constraints by late 2023. De-bottlenecking and compression expansions could provide more capacity prior to new major infrastructure additions."

By winter 2023-2024, just as demand will start to rise, previously announced pipeline expansions are also expected to begin entering service, offering more capacity to move gas east to the Texas Gulf Coast.

In 2022, Kinder Morgan and a consortium of other midstream project developers announced plans to proceed with several brownfield pipeline expansions and a single greenfield project that promised to expand production takeaway capacity by a combined 4.2 Bcf/d. Kinder Morgan's 650-MMcf/d capacity expansion of the Permian Highway pipeline was among the latest projects to move forward with construction. The company's 570-MMcf/d expansion of the Gulf Coast Express pipeline still awaits a final investment decision, or FID.

A similar-sized, 500-MMcf/d brownfield expansion of the Whistler pipeline was announced in spring 2022 by a consortium including MPLX LP, WhiteWater Midstream LLC, and a joint venture of Stonepeak and West Texas Gas Inc. That announcement was followed up just two weeks later by notice of an FID on the greenfield Matterhorn Express, a 2.5-Bcf/d, Permian-to-Gulf Coast pipeline to be developed by WhiteWater, EnLink Midstream LLC, Devon Energy Corp. and MPLX.

More recently, Oneok Inc. announced plans to advance its proposed Saguaro Connector project a greenfield pipeline that would deliver up to 2.8 Bcf/d of Permian Basin gas to the Mexico border. An FID on the project is expected by mid-2023.

Processing plants

While the planned pipeline expansions could offer a runway for Permian production growth into the late 2020s, newly announced gas processing capacity could push supply into the West Texas gas market earlier than expected, potentially shortening the timeline. Over the past six months, U.S. midstream players, including Targa Resources Corp., Energy Transfer LP, Enterprise Products Partners LP and MPLX, have announced plans to add at least 700 MMcf/d of processing capacity to the Permian Basin by 2024.

Including projects that are already under construction, planned or proposed, the Permian Basin could see upwards of 3.9 Bcf/d in new processing capacity by mid-2024. But with planned pipeline expansion projects adding just 4.2 Bcf/d in takeaway capacity over the same period, Permian Basin producers could quickly find themselves under threat from new capacity constraints.