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| Friday, August 1, 2014 | Issue #2345 | |
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Major Problem at America's Biggest Oil Find David Fessler, Energy and Infrastructure Strategist, The Oxford Club
 The Permian Basin in West Texas is the second-largest oil field in the world, responsible for 18% of America's oil production. And production from the Permian is growing so quickly that it could eventually become the largest.
Since August 2009, Permian oil production has increased 91%. It's currently at 1.63 million barrels per day (bpd), according to the Energy Information Administration (EIA). And the EIA expects it could reach 3.5 million bpd by 2025.
That's because most of the recoverable resource estimates come from only two of the formation's 11 layers. The other nine are still virtually untapped.
But there's a problem. A big one.
There are no refineries near the Permian Basin. The oil has to ship to the Gulf and West coasts to be refined into petroleum products.
That means exploration and production (E&P) companies have to sell their oil at a large and growing discount. West Texas Intermediate (WTI) crude priced in Midland, Texas (the heart of the Permian), has averaged $7.15 per barrel less than similar crude priced in Cushing, Oklahoma.
In July, the discount had reached $9.
Those discounts come right off the bottom-line profit of all Permian Basin producers.
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Permian production increased so fast, it quickly overwhelmed the region's pipeline capacity. According to Pioneer Natural Resources (NYSE: PXD), the current capacity out of the Permian is 1.27 million bpd.
Several new critical pipelines are under construction to relieve the problem. However, until Plains All American Pipeline L.P. (NYSE: PAA) completes an 80-mile long pipeline from Midland to Colorado City, Texas, the glut is going to continue.
In the interim, producers have no choice but to sell their oil at a discount. It has to be cheap enough to make it economical for buyers to ship it via trains and trucks.
How long could the Permian glut last?
A long time, according to Andy Lipow, president of Lipow Oil Associates in Houston. "The discounts could last longer than many in the market have anticipated given the significant production increases that are occurring in the Permian Basin."
The lack of pipeline capacity out of the region isn't going to stop E&P companies from drilling, of course.
But pipeline takeaway capacity from the Permian will continue to lag production. That means Permian crude will continue to sell at a discount.
Profit From the Problem
What does all of this mean for investors?
The big winners in the Permian - and frankly, most other unconventional oil fields, for that matter - are the pipeline companies. (Nearly all of them are set up as master limited partnerships, or MLPs.)
Of course, the granddaddy of all MLPs is Kinder Morgan Energy Partners L.P. (NYSE: KMP). Its pipeline network stretches coast-to-coast and includes parts of Canada, too. Kinder Morgan's network reaches every major shale play and most refineries.
But there are nearly 100 energy MLPs in the U.S. The tax advantages and the income they produce make them one of the best investment vehicles in today's wobbly markets.
Pipeline MLPs operate just like toll roads. They don't care about the price of what's moving through their pipes. They get paid via long-term contracts based on volume.
Right now, I can't think of a better sector than energy.
Good investing,
David Fessler
Editor's Note: Speaking of discounts, Sean Brodrick recently discovered an energy company that's doing what should be impossible. It's creating gasoline... without using a drop of oil. The implications for this company, and its lucky investors, are staggering. To learn more, click here. | |
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In today's edition of Investment U Plus, subscribers discover one of the companies that operates the oil industry's "toll roads," and owns the toll booths. To learn how to access the premium version of Investment U, click here. | |
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