During the past year, we have endured the ubiquitous Permian crude production versus pipeline takeaway charts, showing forecast crude output running well above anticipated pipeline capacity.  These charts may highlight the obvious shortfall in takeaway capacity, but the physics is dubious.  Although pipeline operators can take actions to boost pipeline throughput above the stated capacity, and are certainly scrambling to add any capacity to their Permian systems, crude outflows from the region are still limited to something near these capacity figures.  Regional pricing differentials are now signalling full pipelines, with the negative spread between WTI Midland and WTI Houston sliding towards the US$21/bbl record lows seen in August 2014.  With meaningful pipeline capacity unavailable until mid-2019, Permian production will need to flatten over the next 12 months.

Estimates for rail and trucking takeaway capacity from the Permian Basin vary, but the consensus is that these transportation modes are limited to only 100-150 kbpd.  The following chart shows our Base Case assumptions for rail and truck movements, versus the required volumes, based upon production and pipeline capacity forecasts.  The need for these outlets is short-lived, and disappears once the new pipelines come on line.  This timeframe is too short for producers to commit to the longer take-or-pay contracts that railroads would demand for the same reason, so this approach would remain limited.

This places significant pressure on Permian producers to limit production without an outlet.  One approach is to stop adding oil rigs to the basin.  The pace has certainly slowed during the past few weeks, averaging a little more than one a week since June, but the rig count needs to decline soon.  The following chart provides our Base Case forecast for oil rigs in the five major LTO basins, and suggests that Permian rigs need to move towards 430 by mid-2019, from the current 486 count.  Oil service companies are suggesting that the Eagle Ford and other LTO basins may benefit from rig redirection from the Permian.  Rig counts rebound in the Permian once the new pipeline capacity comes on line, but drilling activity jumps in all basins during 2h19 and 2020, on higher oil prices from global tightness and IMO 2020.  Typical cyclicality returns in 2022-23, as another LTO supply surge hits slipping demand from the 2020 price shock.

The other approach to stifling Permian production is to not complete wells.  This would further swell the inventory of drilled-but-uncompleted (DUC) wells in the basin, but this is probably the most effective approach.  As shown in the following chart, as of July 2018, EIA data indicates that Permian DUCs have surged by 80% yoy, to 3,468, which represents an inventory of 8.0 DUCs per well completion.  Producers will always have some inventory of DUCs awaiting completion crews, but this measure provides some indication of the backlog relative to completion activity, and hence, crews available.  Given the anticipated rigs, rig productivity, initial production (IP) rates and decline rates, Permian DUCs would need to rise to almost 5,000 by mid-2019, with DUCs per completion jumping to 14.8 in 1q19.  This would keep well completions near 400 per month and production limited to 3.6 mbpd, consistent with pipeline capacity until mid-2019.

The arrival of new pipeline capacity would prompt a release of the DUCs accumulated during the constrained output, but the anticipated rise in oil prices would also support a decline in DUC inventory.  The DUC cycle reverses once prices decline in 2022-23.

Although the EIA does forecast some flattening in the growth of US crude oil production in its Short-term Energy Outlook (STEO), our Base Case forecast is 200 kbpd lower during the last nine months of 2019, as shown in the chart below.

Our forecast then exceeds the EIA outlook by 900 kbpd during 2021, from higher oil price and resulting rig count assumptions.  For example, the latest STEO expects WTI prices of US$64.33/bbl during 2019, a 2.8% decline from their 2018 expectations of US$66.18/bbl.  One hint that the EIA price outlook may be too low — hardly any widening in the diesel-fuel oil spread in late-2019, as if IMO 2020 does not exist.