Drilling surge in Permian Basin could add to natural gas glut

Permian drillers have added 45 rigs in West Texas over the past three months.
Permian drillers have added 45 rigs in West Texas over the past three months. TNS

One of the biggest threats to an extended rally in U.S. natural gas prices is lurking in the oil patch.

Gas production in most of the country has dropped amid cost-cutting. Not so in the Permian Basin, the nation’s biggest crude reservoir and one of the few places where drilling has remained profitable.

Permian drillers led by Occidental Petroleum and Irving-based Pioneer Natural Resources are pumping more oil as prices rise, pushing natural gas extracted as a byproduct from the West Texas play to almost 7 billion cubic feet a day, Bloomberg Intelligence data show. That’s about 8 percent of U.S. supply.

The Permian’s resilience may blindside gas bulls who nudged prices above $3 per million British thermal units for the first time in 16 months, following record demand during a hot summer and rising exports. At the same time, Permian drillers have added 45 rigs in three months, and a new discovery by Apache Corp. in the area promises to chase higher demand with a production surge starting in mid-2017.

“We’re drilling for oil in the Permian, but the dirty little secret is that there are also massive gas fields,” said Scott Hanold, an analyst at Royal Bank of Canada in Minneapolis. “The Permian is going to continue to grow, and it’s going to be the 900-pound gorilla.”

The Permian is making a swift recovery from a rout in oil prices that battered the energy industry earlier this year, forcing producers to cut output. The 45 rigs added over the past three months compare with just two in the neighboring Eagle Ford shale play during the same period, according to data from Baker Hughes.

That’s because the Permian’s unique geology allows explorers to extract more crude at lower cost, compared with other shale formations. Some wells in the region can break even with crude at $30 a barrel, among the lowest in the U.S, according to Will Foiles, an analyst at Bloomberg Intelligence in New York.

Since wells in some areas of the reservoir can produce more than 50 percent natural gas, oil’s rally to a 15-month high will also unleash more of the heating and power-plant fuel on the U.S. market.

In the Permian, “the gas economics are totally tied to oil prices, and the higher the oil prices go, the higher the gas production will be,” said Randall Collum, an analyst for Genscape Inc. in Sugar Land.

Gas prices have gained as production from gas-focused shale basins, including Appalachia’s Marcellus formation, dwindles and demand picks up. Power plants are burning more of the fuel as coal-fired generators shut, and gas exports to Mexico via pipeline have climbed to a record.

At the same time, Cheniere Energy’s Sabine Pass terminal in Louisiana is shipping cargoes of liquefied natural gas across the globe.

The boost in gas exports, combined with increased demand for the fuel from U.S. petrochemical manufacturers as that industry expands, has sparked concern that prices for domestic users will jump.