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The Permian Basin’s Pipeline Woes Are About to Ease

By Matthew DiLallo – Sep 24, 2018 at 4:15PM

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Oil pipeline giant Plains All American Pipeline is about to start up one of its expansion projects.

A gusher of new oil production in the Permian Basin has stretched the region's pipeline capacity to the max. Output in the area has doubled in the last three years to 3.4 million barrels per day (BPD), which is bumping right up against the region's current pipeline space of 3.5 million BPD. That bottleneck has caused oil prices in the Permian to sell at as much as an $18 a barrel discount to the U.S. oil benchmark WTI.

However, thanks to the efforts of Plains All American Pipeline (PAA -0.09%), that problem will start easing up a bit at the beginning of November, when the company expects to start up its expanded Sunrise pipeline. It's one of several initiatives by the industry to prevent its main growth engine from stalling out.

A burst of sunlight shining on a pipeline.

Image source: Getty Images.

Building as quickly as it can

Plains All American is building oil pipelines in the Permian as fast as it can. The company currently has two large projects underway, Sunrise, which it initially expected to finish in January of 2019, and Cactus II, which it hoped would start partial service by the end of 2019.

However, given the crucial need for more pipeline space, Plains is "trying to accelerate both of these projects as much as reasonably practical," according to Chief Operating Officer Willie Chiang. To do so, Plains is "incurring additional costs to expedite material deliveries and vendor services and even installing temporary generators for our pumps until permanent utility power is available." Those efforts are paying off, as the company now expects to begin commercial operations on Sunrise on the first of November.

The pipeline will move oil from the Permian up to a hub in Texas, where it can catch a ride on other systems to America's main oil storage hub in Cushing, Oklahoma. Sunrise should be able to transport 360,000 BPD by the first quarter of next year, with full capacity slated to be as much as 500,000 BPD. That near-term in-service date has helped ease the pressure on oil prices in the Permian, causing the discount with WTI to narrow to $11 per barrel.

Pipes laid out for construction.

Image source: Getty Images.

More help is on the way

In addition to the capacity from that pipeline, railroads are looking for ways to help ease the bottleneck in the near term by shipping some crude by rail. "The [Permian] is an interesting place, and we're definitely seeing some reduction in crude production due to the lack of pipelines," said Beth Whited, the chief marketing officer of Union Pacific (UNP 1.24%) on the company's second-quarter call. Union Pacific has "some capacity in our network and expects to see some results in the third and fourth quarter." Since that time, Union Pacific struck a deal with a logistics company to ship about 400,000 barrels per month of crude on its system through next year, with the potential for it to last into 2020.

However, the big capacity boost will come toward the end of next year, when as many as three large-scale pipelines could enter service. Plains All American Pipeline's Cactus II should begin partial service by the third quarter of next year before starting full service of 670,000 BPD by April of 2020. Meanwhile, Phillips 66 Partners (PSXP) and Andeavor (ANDV) are building the Grey Oak Pipeline, which could move as much as 800,000 BPD to the Gulf Coast. Phillips 66 Partners and Andeavor plan to spend $2 billion to build the pipeline, which should start up by the end of 2019. That line would not only bring oil to refineries in the region but also to a new export dock under construction by Phillips 66 Partners, Andeavor, and another partner. Finally, the private equity–backed EPIC crude pipeline is also expected to start construction by the end of this year, which would put it in service by the second half of 2019.

Another wave of pipelines is already underway for 2020 and beyond. A joint venture between Energy Transfer Partners (ETP), Magellan Midstream Partners (MMP 1.34%), and two other companies recently approved the construction of the Permian Gulf Coast pipeline. The 600-mile line should be operational by the middle of 2020 and transport crude to Energy Transfer's Nederland terminal as well as Magellan's East Houston terminal. Meanwhile, Plains All American Pipeline and oil giant ExxonMobil (XOM 0.12%) are teaming up on a joint venture to build a new oil pipeline in the Permian. The partners are planning a more-than-1 million-BPD pipeline that would ship oil produced by Exxon and others to the coast. The project is part of Exxon's long-range planning to ensure that nothing derails its ambitious strategy to grow its Permian output fivefold by 2025.

Short-term pain for some long-term gain

The pipeline squeeze in the Permian has pinched producer profitability in the region this year. However, with a new line starting up in November and more capacity additions on the way, oil prices in the Permian should improve over the next year. That's why investors should consider taking advantage of the region's current issues to position their portfolios for the profits that appear likely as the Permian's pipeline problems ease in the next year.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Magellan Midstream Partners and Union Pacific. The Motley Fool has a disclosure policy.

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