The Daley Note: May 31, 2023
Are oil and gas producers ready to turn the page on natural gas flaring practices? Operators in the Permian Basin face tough decisions over the next 12 months due to a mismatch between production capacity and pipeline infrastructure, according to a new study by East Daley Analytics and Validere.
East Daley collaborated with Validere, a measurement, reporting, and verification SaaS company, to quantify the environmental consequences of a shortfall in gas pipeline takeaway from the Permian. For over a year, our Permian Supply and Demand Forecast has pointed to bottlenecks starting in early 2023 as a result of rapid supply growth. Low and sometimes negative Permian gas prices since 4Q22 confirm egress pipelines are not adequate for current production levels.
The study, “Emissions Critical: Flaring, Methane, and the Cost of Looming Permian Gas Takeaway Constraints,” considers several market outcomes for the Permian. In the base case, excess gas production (gas supply exceeding local demand and effective pipeline takeaway capacity) averages 200 MMcf/d over 17 months and peaks at ~500 MMcf/d in May 2024. We also looked at a scenario with flat Permian rigs (rigs decline in East Daley’s base case given the backwardated WTI price curve) and a third scenario assuming delays in new pipeline projects (see figure).
According to Validere, each 100 MMcf/d of flaring adds 2.2 million tons of CO2 emissions per year, and methane emissions contribute an additional 1 million tons of CO2 equivalent emissions per year, based on a 20-year greenhouse gas impact at 98% combustion efficiency. In the base case, we estimate excess gas averages 146 MMcf/d in 2023; if E&Ps flare all this gas, the Permian midstream bottleneck would generate ~4.7 million tons of CO2e.
The excess gas problem grows worse if Permian rig counts are higher than we assume or if new pipeline projects face delays. Under any future scenario, the expected start of the 2.5 Bcf/d Matterhorn Express Pipeline in mid-2024 will be critical to re-aligning the gas supply chain. Compressor expansions planned on the Permian Highway and Whistler pipelines in the back half of 4Q23 will also add 1 Bcf/d to help alleviate the bottleneck.
In the “Delayed Pipeline” scenario, we assume the two compressor expansions are delayed by three months while the more complex Matterhorn is delayed six months. The scenario is topical given the industry is already seeing slippage in construction timelines. On its 1Q23 earnings call, Kinder Morgan (KMI) guided to a one-month delay for the Permian Highway expansion, to December 2023, citing supply chain issues procuring equipment and materials. Assuming producers do not further reduce drilling in response, excess gas production in the Delayed Pipeline scenario would spike to over 800 MMcf/d at YE23 and 1.6 Bcf/d at YE24, or double the base case.
Of course, flaring isn’t the only option for producers; they could opt to slow drilling, defer completions or shut-in wells. The industry saw a similar scenario play out in 2019, the last time infrastructure failed to keep pace with Permian supply growth. The associated surge in Permian flaring rates brought increased environmental scrutiny, and new commitments by industry to curtail or end flaring as part of Environmental, Social and Governance (ESG) frameworks.
Given the recent history, it is unclear whether producers can lean on flaring once again to manage through the pipeline bottleneck and keep oil flowing. In mid-2024, when East Daley estimates the excess gas problem to be at its worst, producers would need to take the equivalent of 200 Mb/d of oil production offline to avoid flaring. If flaring is off the table, operators must plan ahead to avoid a potentially devastating outcome.
The new East Daley and Validere study is available here. – Justin Carlson, East Daley Co-Founder & Chief Commercial Officer. Tickers: KMI.
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