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Area Oil Business Rapidly Changing

Posted on October 15, 2019

Hastings Equity Partners in Houston and the University of Houston have combined to research new pipelines coming into the Permian Basin, figuring out where all the oil would be going, who would be using the oil on the other side and what bottlenecks would occur when the lines were in place.

“We wanted to understand where those new pipelines were going to take the incremental oil so we could understand how the dominoes would be affected down the road,” said Ted Patton, founder of Hastings Equity Partners in Houston.

Patton said in a phone interview that most of the oil is heading toward Corpus Christi.

“There’re probably 2.5 million barrels a day for new pipelines that have been or are being constructed, running essentially from Midland straight to Corpus, and ultimately the oil coming out of those pipelines will be going to the rest of the world from the Port of Corpus Christi.

“What’s fascinating is that the fates of Corpus and Midland-Odessa are now fairly intertwined,” Patton said. “It’s good in the long run. Corpus will have some of the same challenges you have with the growth. It’s never easy to plan for all this stuff. There are a lot of things that need to get done in a short period of time to handle all the volume coming out of Midland and Odessa.”

He added that Corpus Christi has a lot to learn from the Basin because of the rapid growth it have experienced over the last decade. Patton said probably “somewhere north of $20 billion is going to be invested in Corpus over the next decade and it’s all because of the volume out of Midland-Odessa.”

Patton’s firm invests in oilfield service companies (downstream services companies) around the Basin and Gulf Coast. He said it has invested in businesses that help to maintain refineries and well sites on the Gulf Coast, an Odessa chemical firm that treats wells and a welding business in Gonzales, La., that welds and fixes the pipes you see all over refineries.

Until a couple of years ago, Patton said, oil coming out of the Permian Basin had mainly gone to U.S. refineries where it was turned into gasoline, diesel fuel for trucks and airplane fuel. He said that two years ago there wasn’t enough capacity to take away all the oil being produced, so a number of new pipelines were proposed and some of them funded.

And the heightened production has decreased the nation’s dependence on foreign imports.

Patton explained that the Basin’s oil in the past 10 years has been going to American refineries, thus displacing the need for imports. With 4 million barrels a day from the Permian, Patton said, there has been no need to import on the sweet crude side.

Economist Ray Perryman said the 4 million barrels doubles the level of about three years ago (which equaled the prior record in 1973).

Perryman added that production levels are projected to continue to expand over the next several years.

Now, Patton said, the biggest customer for Permian Basin oil is the rest of the world.

He said Europe is the Basin’s biggest trading partner, “but tomorrow it’s going to be Asia because there’re not that many incremental barrels, probably 600,000. It’s predicted that the Permian will add a million barrels a day every year to their total production. Where it’s 4 million today, it’s going to be 5 million next year,” Patton said.

He said the major oil companies moved to an international focus decades ago because they were looking for massive projects that required huge investments

“Those just didn’t exist in the Permian Basin, nor was there the amount of volume that they were looking for in the Basin when you had your traditional vertical wells,” Patton said. “When fracking came out and all of a sudden it became attractive to drill in the Permian Basin again, the independents were the ones that were flexible and could move quickly. They took advantage. The majors took a lot longer to make their move.”

Independents were here first, he said, and companies like Pioneer, Diamondback and Concho were “able to grab lots of acreage and start drilling and proving out their reserves, but there were two majors Chevron and Exxon, who bought XTO, then bought bunch of acreage from Bass family in Dallas, so they made a lot of acquisitions and acquired a bunch of acreage and have set targets of 1 million barrels a day by 2024,” Patton said.

“That’s a lot of oil. A million barrels for Chevron, a million, for Exxon, then have BP (British Petroleum) and now really Oxy and Anadarko will probably do another million barrels combined,” he added.

So, Patton said, if he used the example of 4 million barrels a day as satisfying U.S. refinery needs, that would leave 1 million barrels a day for the independents and put them at a disadvantage going forward because the majors have downstream assets.

“There’s a bit of a battle going on,” he said. “Independents will slowly get pushed into selling overseas and the majors are going to corner them so that they have to find international customers.

“The likely outcome is consolidation. They’re going to have merge. It’s not necessarily a bad thing, but there are a lot of egos involved and everyone wants to be top dog. So they have figure out how to navigate that. The real competition is Chevron, Exxon and BP, not independents, so they have to overcome that side of things and learn how to work together.”

Perryman said consolidation can bring economies of scale, and can be a powerful motivator.

“Historically, we have tended to see waves of consolidation when prices are low and companies don’t have enough work. At present, however, the key factor driving the future drilling patterns is a push to continue to significantly reduce cost. This is likely to lead to continued consolidation, although some innovative smaller firms that are nimble will also do quite well,” Perryman said in an email.

“Similarly, the drive to reduce costs and the scale that the major firms can provide is likely to drive some additional consolidation and concentration. Having said that, a number of independents have been and continue to be successful in the Permian, and I think there will continue to be a role for such operators (likely on a grander scale). As lease prices are bid up and the majors make large investments in acreage and long-term drilling programs, there may well be additional challenges in the future,” he added.

“The bottom line is that service firms, majors, and independents will also be laser-focused on costs, and those who can excel in this environment will prosper,” he said.

Patton said another challenge for independents is that they need a marketing organization and a relationship with refiners in China. To build those organizations, Patton said, the independents have to get larger by merging.

“The other solution they might have is to build a refinery themselves, or buy one so they can be like the majors, who are effectively selling to themselves,” he said, adding that the last refineries were built in the 1970s.

“In the oil industry, size is your friend because the larger you are the more options you have for what you can do with the oil and ultimately there are benefits of scale that will likely be seen in the Permian just like other side of the world.

“The reason why this is important for us is that the companies we were investing in in and around Odessa don’t benefit from consolidation. They actually lose when there’s consolidation because, if you can imagine, you have more pricing power if you’re selling to 10 customers than if you’re selling to one. Consolidation is to the detriment of the service guys,” Patton said.

He said some people might lose their jobs, but more likely consolidation will combine the entities so they can produce more together. He said consolidation is bad for Odessa but good for Midland.

“There will be some lost jobs, but I think the volume will increase as a result of consolidation. So I think there will be some gain in jobs as well. I don’t see it as a bad thing for the economy of Midland and Odessa.

“What will likely happen is that there will be consolidation on the service side as well,” Patton said. “In the end, there are going to be fewer companies left on both sides and the companies that are left will be much larger,” he added.

Though Patton expects the energy industry to change “dramatically” for Odessa and Midland in the next five years, he said it won’t be worse or better, just different.

“Fewer companies but bigger companies; activity levels will increase — all good for the region in general. The days of the oil entrepreneur in Midland-Odessa are kind of going away and it’s moving toward manufacturing and a more corporate type of companies,” he said.

By “manufacturing,” Patton said, he meant that it’s no longer prospecting or wildcatting, it’s more professional and predictable.