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Well Declines, COVID-19 Could Disrupt Gathering, Processing Tailwinds

Source: S&P Global Market Intelligence, Allison Good, June 5, 2020

While some oil and gas drillers are detailing plans to reverse production shut-ins amid stabilizing crude prices, North American midstream companies with gathering and processing operations are not necessarily out of the woods yet.

Energy industry analysts told S&P Global Market Intelligence that even though production reached “trough” levels earlier than expected, natural well declines and a potential second COVID-19 outbreak could jeopardize those gathering and processing operators’ volumetric tailwinds.

Many U.S. and Canadian pipeline firms were forced to cut spending and or investor payouts in the wake of Russia’s oil price war with Saudi Arabia and an increase in coronavirus shelter-at-home orders, but midstream stocks are recovering gradually alongside West Texas Intermediate crude prices, which have bounced back from historic lows to settle in the $35 to $40 per barrel range.

That prompted drillers like Parsley Energy Inc., Concho Resources Inc. and EOG Resources Inc. to indicate in recent days that they are working to bring curtailed wells back online. According to Ryan Smith, a senior director of research at East Daley Capital Advisors Inc., drilling likely reached its lowest levels toward the end of May, whereas some pipeline companies had anticipated production bottoming out in June or July.

“I think it’s fair to say we’ll be in the recovery stage in July and August, with June being a transition period,” East Daley’s Ryan Smith said in an interview.

Targa Resources Corp. expects the shut-in volumes “to come back and perform well,” CEO Matthew Meloy said May 7, while Energy Transfer LP Chief Commercial Officer Marshall McCrea said May 11 that the pipeline giant had already seen about a quarter of its volumes shuttered in the production basin around Midland, Texas, turn back on.

CBRE Clarion Securities analyst Hinds Howard said in an interview that gathering and processing companies with exposure to the lowest-cost basin can afford to have a more optimistic outlook as Permian volumes rise. Once prices move into the $40 to $45 per barrel range, he added, “then you start to get more excited about those with exposure to the DJ Basin and then eventually the Bakken, so it goes in terms of tiers of exposure.”

East Daley’s Smith, however, noted he sees prices of about $40-per-barrel range persisting in 2021 and 2022. “We’re not just going to ramp up [crude production] back to where we were in March,” Smith said. “There’s going to be a delay.”

And more headwinds could be coming. Morningstar’s Stephen Ellis in an interview advised that “you also have to keep in mind that there’s a good chance of a second COVID-19 outbreak in the second half of the year” that could stunt any progress made in reversing shut-ins. At the same time, curtailed wells have declined without any new completions replacing those losses.

Second-quarter earnings will reflect the demand destruction caused by reeling crude prices and the coronavirus pandemic, CBRE’s Howard said, although he noted they “will be better than it was estimated to be” during the first-quarter earnings season.

But natural production declines absent any impact from the coronavirus-driven shelter-in-place orders are also on the horizon, according to the U.S. Energy Information Administration’s “Short-Term Energy Outlook” released Jan. 14.

“The end of curtailments won’t offset production declines that likely bottom in mid-2021. The pain has only really just begun fundamentally,” Robert W. Baird & Co.’s Ethan Bellamy said in an email. “With very few exceptions, however, the U.S. hydrocarbon infrastructure network is overbuilt for the next three to five years, so we may be beyond the drama of negative oil prices but we are still deep in the woods.”