Pipeline Plays in the Permian

In the previous issue of The Energy Strategist, we discussed some of the oil producers in the Permian Basin. A brand new report from the Energy Information Administration (EIA) — Highlights of new Drilling Productivity Report — mapped the key tight shale oil and shale gas producing regions in the US:

Shale basins map

Source: U.S. Energy Information Administration

The EIA report noted: “The Permian region, which remains the biggest absolute oil producer, grew by about 93,000 barrels per day from last year’s production level.”

A single horizontal shale play within the Permian is called Wolfcamp, and it alone is estimated to contain 2-4 times the estimated oil reserves of the Eagle Ford or Bakken. And there are multiple commercially viable layers of oil and gas both above and below Wolfcamp.

But as I explained in the previous issue, the Permian isn’t just a tight oil play. The Permian has been producing oil for nearly 100 years, and had already produced nearly 30 billion barrels of oil and 75 trillion cubic feet of natural gas by the time the fracking revolution really took off. The Permian currently produces some 900,000 bpd of crude. This accounts for about 12 percent of US oil production, with projections that Permian production may reach 2 million bpd by 2018.

Longer-term and more aggressive investors may be content to invest in one or more of the Permian Basin’s many oil producers. An example is recently added Growth Portfolio holding Devon Energy Corp (NYSE: DVN). The company is very active in the Permian, and still attractively priced despite recently moving higher.

However, more conservative investors who would rather avoid too much commodity exposure might consider the midstream operators that are working to bring Permian Basin oil to distant markets.

A number of pipeline expansions are underway and new rail terminals are being built, but the present takeaway capacity in the Permian Basin is pretty tight given the growing crude supply. There are four major pipeline operators transporting Permian Basin production to the Midwest and Gulf Coast, and all of them are expanding.

Plains All American Pipeline

Plains All American Pipeline (NYSE: PAA) has a diversified portfolio of assets that covers most of the important energy producing areas of the US and Canada. The company has 18,000 miles of crude oil, NGL and refined products pipelines and moves approximately 3.5 million barrels of liquid product per day. PAA moves 450,000 bpd of crude oil on its Basin pipeline from Colorado City, Texas, to Cushing, Oklahoma.

PAA is also building the Cactus pipeline, which will transport both sweet and sour crude from the Permian Basin to the Three Rivers and Corpus Christi areas in South Texas. The 310-mile, 200,000 barrel per day pipeline is expected to start up in the first quarter of 2015, and will substantially improve the partnership’s Permian presence. At present, the only major outlet for crude through PAA’s pipelines is the bottlenecked terminal at Cushing. Access to the Gulf Coast will be very appealing to operators that have had to sell their crudes at a discount due to the backlog at Cushing.

Sunoco Logistics Partners

Sunoco Logistics Partners (NYSE: SXL) has a 60 percent interest in, and operates the West Texas Gulf (WTG) pipeline. The pipeline originates in Colorado City, Texas, northeast of Midland. The WTG has the capacity to transport 300,000 bpd of Permian Basin crude to Longview in East Texas, where it connects to the partnership’s Mid Valley Pipeline carrying crude oil to Michigan. The WTG pipeline also carries crude to Sunoco’s Nederland, Texas terminal on the Gulf Coast.

SXL also operates the Permian Express pipeline that will ramp up to 150,000 bpd of crude capacity destined for Nederland in the first quarter of 2014. SXL is also developing Permian Express Phase II, which would bring an additional 200,000 bpd of capacity connecting Colorado City to Nederland and to refineries in Louisiana.

SXL is a Buy in the Conservative Portfolio, with a current yield of 3.5 percent. At Tuesday’s close it was just above our buy target of $67.

Occidental and Magellan

The Centurion pipeline is a wholly-owned subsidiary of Occidental Petroleum (NYSE: OXY), which is presently a Best Buy in the Growth Portfolio. The Centurion has a capacity of of 175,000 bpd, and like PAA’s Basin pipeline it terminates at Cushing.

Occidental is partnering with Magellan Midstream Partners (NYSE: MMP), a master limited partnership currently recommended in our sister publication MLP Profits, to build the BridgeTex pipeline. This pipeline will give Occidental, the Permian’s largest oil producer, an outlet to Gulf Coast refineries. The BridgeTex will have an initial capacity of 278,000 bpd of crude oil, and will connect Colorado City, Texas to Magellan’s East Houston Terminal in Houston. The BridgeTex pipeline is projected to be complete by mid-2014.

Magellan also operates the Longhorn pipeline, which was originally a refined petroleum pipeline moving refined products from Houston refineries to El Paso. Magellan bought the pipeline for $250 million and then reversed its flow from Crane, Texas, southwest of Midland. The Longhorn now carries crude oil from the Permian Basin to Houston. The current capacity of the Longhorn is 225,000 bpd, but Magellan is expanding capacity by another 50,000 bpd by mid-2014.

Kinder Morgan

One project that failed to garner enough interest was Kinder Morgan Energy Partners’ (NYSE: KMP) Freedom pipeline proposal. This pipeline would have transported nearly 300,000 bpd of Permian crude to markets in California. Two factors essentially killed the project. The first is that California’s refineries are geared more toward heavy, sour crudes. While some of the crudes from the Permian are sour, they are all light. A refiner that has invested in equipment to handle heavy crudes will generally find the economics of heavy crudes preferable to light crudes.

The second obstacle is that rail is already bringing mid-continent crudes from the Bakken into California. So California refineries that do prefer light crudes already have some access, and hence weren’t willing to commit to long-term contracts with Kinder Morgan. This led Kinder Morgan to cancel the $2 billion project.

Pipeline capacity coming out of the Permian remains tight, but if all of the proposed projects are completed there will be plenty of new capacity to handle the expected production increases. Further, there will be more outlets to the more lucrative markets of the Gulf Coast.


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