As Texas oil output surges, cash crude discounts near two-year lows

NEW YORK/HOUSTON (Reuters) - Surging West Texas oil production has pushed the value of the region’s spot crude to its lowest discount to the U.S. oil benchmark in nearly two years, as an exuberant shale industry pumps more to take advantage of higher prices and demand from refiners who have seen supplies cut by top global producers.

An oil pump jack can be seen in Cisco, Texas, August 23, 2015. REUTERS/Mike Stone

OPEC and non-OPEC suppliers are working toward cuts of 1.8 million barrels per day, around 2 percent of the 92 million bpd global market, as they try to bring down record oil inventories and raise prices.

But supply cuts by exporters worldwide have given an incentive and opportunity to U.S. shale producers to do the opposite. They have sent rigs back into the field and are working to boost output after more than a two-year industry recession.

The Permian Basin is the biggest U.S. oil field and the most prized U.S. locale for shale activity because of its strong reserves and low production costs. But even as investors flock to the region, some traders and analysts caution that activity may be moving too fast.

“Aggressive Permian production growth alongside regional refinery outages and weaker export demand for shale crude has forced heavy discounts for Midland crude,” said Dominic Haywood, an analyst at Energy Aspects. “It’s now falling towards levels that’s making it economical to ship on certain pipelines on a spot basis.”


Rising production has come before record U.S. oil stockpiles have had time to drain, putting pressure on regional prices.

On Friday, even as benchmark U.S. crude futures rebounded to a one-month settlement high of $52.24 a barrel, cash traders sold West Texas oil - the type of crude pumped from the Permian Basin - to one of its steepest discounts since April 2015.

Last week, WTI at Midland, Texas for May fell to a $1.65 a barrel discount to the U.S. benchmark. Four months ago, it traded at a $1.05 a barrel premium to WTI. That means producers in the Permian are effectively receiving nearly $3 less a barrel than they were at the start of the year.

While Midland prices rallied late last week due to Canadian outages, the price remains relatively weak compared with recent months or years.

“Right now, the Permian is obviously the hottest place to drill. There’s quite a bit of expansion in production we expect from the area,” said Sarp Ozkan, manager of Energy Analytics for Drillinginfo.

OPEC’s cuts are draining storage of oil at sea, in the Caribbean and other parts of the world. But they are having little impact on U.S. inventories as a wave of Permian output keeps storage brimming. Permian output is expected to rise to 2.29 million bpd in April, up 15 percent from a year ago, according to the U.S. Energy Information Administration.

The operating rig count in the region has doubled in a year, and some producers who have left drilled wells uncompleted, opting to leave the oil in the ground ready to pump when prices rise, are turning on the spigots.

Producers had left a record number of wells unfinished in Permian, but now appear to be whittling them down.

In the Delaware Basin, the number of wells drilled but uncompleted outside the normal six-month spud-to-production range, or the beginning to the end of drilling a well, known as deferred completions, has fallen to 110 from 237 in the past six months, according to Drillinginfo.

In the Midland Basin, the number of DUCs dropped to 94 from 163 in the same period.


Pipelines out of the region also show that the Houston area, a destination for Midland crude, is flooded with other supply.

For example, Magellan Midstream Partners’ BridgeTex pipeline, which flows to Houston, ran at slightly more than half-full at the end of March, according to energy information provider Genscape. It costs about $4 a barrel to ship from Colorado City, Texas, to Houston on that pipeline. That is higher than the $2.75 to $3.00 a barrel differential between Midland and Houston, making it not economical to send oil along that route.

Total monitored stocks in West Texas hit a record in the middle of March, Genscape added, but decreased slightly by the end of the month.

To relieve swelling inventories in West Texas, regional oil prices must fall relative to other markets to cover the cost of transportation on pipelines that flow to places such as Houston, or to make it economical to export the oil to international destinations, according to Sandy Fielden, director of oil and products research at Morningstar.

Editing by Simon Webb and Matthew Lewis