U.S. oil differentials to blow out as output gains slow: Morgan Stanley

FILE PHOTO: An oil pump is seen operating in the Permian Basin near Midland, Texas, U.S., May 3, 2017. REUTERS/Ernest Scheyder/File Photo

HOUSTON (Reuters) - Crude oil production growth in the largest U.S. shale field could shrink by nearly two-thirds next year because of limited pipeline capacity that will blow out already wide differentials in the region, analysts at Morgan Stanley said on Thursday.

Drilling by U.S. oil producers in the prolific Permian Basin of West Texas and New Mexico have pushed the nation’s crude output to a record 10.46 million barrels per day (bpd). The nation’s production will average 11.80 million bpd next year, the U.S. Energy Information Administration forecast this week.

But pipeline constraints could cap 2019 output growth in the Permian at 360,000 bpd, below Wall Street expectations of about 634,000 bpd, and down from this year’s projected 960,000 bpd growth. The slowing gains will push 12-month forward Midland-to-WTI differentials to a discount of $25 to $30 a barrel, from the prompt month $15.50 a barrel discount now, the report said.

“This discount will be required to prevent too much production,” Morgan Stanley analysts wrote, though the forward differential could fall back to a discount of about $2 a barrel as “ample new takeaway capacity” comes online in mid-2020.

The reason for its outlook lies with limited capacity to move new oil out of the Permian, which accounts for two-thirds of U.S. oil production growth. The Permian’s 3.56 million bpd of pipeline space is nearly full with oil production now close to 3.47 million bpd, Morgan Stanley said, and potential construction delays could limit capacity additions for another two years.

Other options to bring oil in the Permian Basin to market - by rail or by truck - will only provide minor increases until 2020. The result of slowing production growth will be that U.S. oil prices could rise to $79 per barrel later this year, it said.

Reporting by Collin Eaton; editing by Jonathan Oatis