PERMIAN MASSIVE POTENTIAL, INFRASTRUCTURE COMMITMENTS NEEDED SOON

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1 PERMIAN MASSIVE POTENTIAL, INFRASTRUCTURE COMMITMENTS NEEDED SOON Copyright 217 Cornerstone Macro. All rights reserved. This report is prepared exclusively for the use of Cornerstone Macro institutional clients and may not be redistributed, retransmitted or disclosed, in whole or part, or in any form or manner, without the express written consent of Cornerstone Macro.

2 IT S THE ECONOMY, WHY START HERE A LATE CYCLE SPURT In our central oil and gas forecast scenarios, global GDP growth accelerates modestly though NOT in a Synchronized way. We see fewer headwinds with key economies hugging different phases of their business cycles. Out of Sync in 218, from Nancy Lazar s Global Eco Outlook link In the US Nominal GDP accelerates next year; While a recession is unlikely until 22 Fears on China recede We expect decelerating growth and stability A late cycle spurt, keeps the pressure on Permian pumpers Source: CSM Economics Team 1

3 RISING CALL ON AMERICAN SHALE: $6 WTI ROUGHLY BALANCES $6 WTI; $2.8 HH Levels (Mb/d) Y/Y Growth (kb/d) Call on Shale (crude + NGLs)* ,8 9 Supply ,97 2,31 Shale (crude+ngls) ,37 1,8 Mideast Opec crude ,9 Libya crude Nigeria crude Venezuela crude Other Opec crude Opec NGLs Non-Opec ex Shale Russia crude Demand ,62 1,69 1,6 OECD US Other OECD Non-OECD ,16 1,1 1,6 China India Other EM Asia Mideast LatAm Other Non-OECD $6 WTI; $2.8 HH End Year Level (million barrels) Y/Y Change (kb/d) Inventory 7,1 7,4 7, Surplus Inventory** *Sets surplus inventory to for end 218 and end 219. **Based on commercial inventory demand cover relative to average. There is plenty of room for shale to grow, assuming: 1. Oil demand stays on track 2. Opec + Russia maintain the production agreement through Q3 217 (or there about) The table to the left shows the bigger moving parts of our global oil supply/demand balances, and how they fit together to leave room for US producers to balance the market at ~$6/b WTI. That is to say, how, at ~$6/b WTI, our modeled shale growth roughly matches the Call on Shale. We wrap up the Opec et al. agreement at the end of Q3 217, when we expect nominal OECD inventories will cross below their trailing five year average (a stated Opec target). Aside from supply projections for Mideast Opec and Russia, the other key pieces of the balance are the pace of inventory draws, steady demand growth, and relative stability in Libya, Nigeria, and Venezuela (which declines but does not implode). For the Call on Shale, we assume inventories decline to the ~ average demand cover. Different metrics for surplus inventory could lead to slightly more or less room for shale, and this metric errs on the conservative side. This leaves room for shale crude oil and NGLs to grow ~1.26 M/b per annum the next two years (annual average, not Q4/Q4). We model ~1.23 Mb/d of annual average growth per annum at $6/b WTI, just a hair below the call. Source: IEA, JODI, BP, Rystad Energy, Petrologistics, HPDI, EIA, Company Estimates, Country Data, The BLOOMBERG PROFESSIONAL TM Service, CSM Research 2

4 GLOBAL OIL SUPPLY RISKS RISING Mb/d Our Base Case: Continued stability in Libya and Nigeria Libya & Nigeria fcst Liby & Nigeria Oct ' Mb/d Venezuela declines acclerate slightly, then level off Venezuela fcst exports to the US (rhs) Jan-16 Jan-17 Jan-18 Jan-19 We do not project any major supply disruptions in our central scenario, leaving upside to our price outlook if something big falls over. And risks are rising, with tensions flaring up in the Mideast and Nigeria, Libya in a precarious political position, and the clock ticking on Venezuela. Reports of Venezuelan crude contaminated with water and falling exports to the US (which pays in cash, not debt forgiveness) are two red flags indicating that production/processing in Venezuela may be hitting some roadblocks. We accelerate declines in our central scenario, before leveling off in 219 but clearly there is risk of a larger disruption and we continue to monitor the situation. Meanwhile unrest in Nigeria is one again threating to take supply offline and conflicts across the Mideast appear to be intensifying. Steady growth through may be a lot to ask, and still depends more on above ground issues than field capacity. 1. Jan-16 Jan-17 Jan-18 Jan Mb/d Mideast Opec: An increasingly unstable neighborhood 23. Jan-16 Jan-17 Jan-18 Jan-19 Venezuela fcst. Source: IEA, JODI, BP, Rystad Energy, Petrologistics, CSM Research 3

5 PERMIAN OFFERS SIGNIFICANT POTENTIAL IF THERE IS TAKEAWAY Permian Production Forecasts Actuals 6. MMB/d Permian Associated Gas Growth Actuals 13 Bcf/d Permian Crude Takeaway Basin Centurion West Texas Gulf Longhorn BridgeTex Cactus Permian Express II Refineries BridgeTex (expansion) Cactus (expansion) Permian Express II Midland to Sealy Permian Express III Other (1) Other (2) Other (3) Permian Production Permain Production (Extra Midland Gains) 2 Permian Natural Gas Potential CA/AZ Mid-Con Texas Mexico New, 1 New, 2 Gas Potential Extra Productivity Gains Source: HPDI, PXD, EPD, CSM Research 4

6 CONSTRAINTS ON SHALE RAISE OIL PRICE-SPIKE RISK The model says: Price sensitivity of US shale should be a soft price cap $1 $/b What if: Global oil demand growth accelerates more; while Nopexus underperforms and Opec restraint extends Then: Call on US shale would exceed infrastructure constraints by a wider margin Prices at the front would spike Price Shale Crude + NGLs Shale Crude Scenario Y/Y Growth (kb/d) Q4/Q4 Growth (kb/d) Y/Y Growth (kb/d) Q4/Q4 Growth (kb/d) WTI $ $ $ $6 1,37 1,8 1,3 1, $6 2,4 1,66 1,98 1,49 1,46 1,19 1,4 1,8 $9 $8 $7 What if: A supply shock takes out 1 Mb/d and there s no line of sight on return Then: Longer term concerns would/should inflate the back end as well $6 $ 11/6/217 11/7/216 $ Source: HPDI, EIA, Company Estimates, The BLOOMBERG PROFESSIONAL TM Service, CSM Research

7 PERMIAN : PRODUCTION PER RIG SHARPLY HIGHER, THOUGH A DIP IN RECENT EIA DPR Source : EIA 6

8 MIDLAND RESOURCES : AMONG WORLD LARGEST OIL FIELDS Source : PXD 7

9 LARGE AERIAL EXTENT IN DELAWARE AND MIDLAND Source : PXD 8

10 FORECASTING SHALE PRODUCTION : A TRICKY PROBLEM 8 rigs running in the US key shale basins = 8+ wells per year Shale Growth is a function of Current Well Recoveries Future Technology Improvement Long run unknowns (decline rates, GoR ratios) Cash availability (cash margins, balance sheets) Drilling and completion costs Supply cost inflation Inventory and high-grading Animal spirits (outspend) Development (efficient) vs delineation (inefficient) Infrastructure spending Infrastructure availability The macro environment The global Call on American Shale Hmmm small changes in well productivity magnified over 1 s of wells could lead to high forecasting error Shale s Are Helpful For Scenario What-If s Source : Cornerstone Macro 9

11 PRODUCTIVITY HAS BEEN IMPROVING AT THE WELL LEVEL Source : Drilling Info, Cornerstone Macro 1

12 DELAWARE STATELINE : PROPPANT AND PRODUCTIVITY Source : Drilling Info, Cornerstone Macro 11

13 MIDLAND CORE : PROPPANT USE & PRODUCTIVITY Source : Drilling Info, Cornerstone Macro 12

14 PXD S 3Q17 VERSION 3.+ UPDATE Source : PXD 13

15 DELAWARE STATE LINE : STACKED PAY AND MONSTER WELLS CXO In Red Hills, we recently brought online the Viking Helmet 1H, a Wolfcamp Sands well with a 2- day peak rate of more than 3, barrels of oil equivalent made up of 8% oil Source : CXO 14

16 THE PERMIAN IS VAST : SUB-BASIN TRENDS ARE KEY Source : Drilling Info, Cornerstone Macro 1

17 RIGS ARE SPREAD ACROSS THE PERMIAN, DELINEATING THE PRIZE As the industry finalized delineation, one would expect the rigs to start focusing on the best areas. We can change sub-basin activity in the model Source : Drilling Info, Cornerstone Macro 16

18 OUR PERMIAN PRODUCTIVITY TRACKER & FORECASTS 2 Boe Midland 3 Month Cumulative Boe/ft 2 Bbls Midland 3 Month Cumulative Oil Bbl/ft Given productivity is so important here are the current inputs to the Permian model The dotted line shows an extrapolation of the trend in productivity since 214. shows our projections On the left we show productivity based on total volumes produced (oil and gas). On the right we show oil only volumes 2 Boe Delaware 3 Month Cumulative Boe/ft 2 Bbls Delaware 3 Month Cumulative Oil Bbl/ft It is interesting to see that Midland productivity dipped in 2H17 and so did the Delaware We think sub-basin delineation plays a part read on! We use 3 month cumulative production per lateral foot drilled as a productivity proxy Source: HPDI, CSM Research 17

19 MIDLAND WELL PRODUCTIVITY TRACKER 1 Boe Midland Core 3M Cume Boe/ft In the Core Midland, we assume productivity gains should extend Bbls Midland Core 3M Cume Oil Bbl/ft 1 Boe Midland East 3M Cume Boe/ft 1 Bbls Midland East 3M Cume Oil Bbl/ft 1 1 In the Eastern Midland, the trend is rising over time but recent data have been flatter Source: HPDI, CSM Research 18

20 Cumulative Production MBoe MIDLAND CORE PRODUCTION PROFILE COMPARISON 3 Midland Basin Day Production Profile PXD FANG PE Days of Production Production for each data series is linearly adjusted to a 9 ft lateral Source: HPDI, PXD, FANG, PE, CSM Research 19

21 MIDLAND WELL PRODUCTIVITY TRACKER (CONT.) 1 Boe Midland Howard 3M Cume Boe/ft 1 Howard County is in delineation but new completions have delivered stronger productivity and oil cuts are rising Bbls Midland Howard 3M Cume Oil Bbl/ft 1 1 Boe Midland Northwest 3M Cume Boe/ft 1 1 Bbls Midland Northwest 3M Cume Oil Bbl/ft In the North West of the Midland, there has been strong improvement in productivity which we expect will increase productivity into Source: HPDI, CSM Research 2

22 MIDLAND WELL PRODUCTIVITY TRACKER (CONT.) 1 1 Bbls Midland South 3M Cume Oil Bbl/ft The legacy southern Midland continues to be an area of weak productivity Boe Midland South 3M Cume Boe/ft 1 Boe Midland West 3M Cume Boe/ft 1 Bbls Midland West 3M Cume Oil Bbl/ft 1 1 As you move closer to the Central Basin Platform, there are potential resources which we include in Midland West this area has only a few rigs running Source: HPDI, CSM Research 21

23 IMPROVING DELAWARE WELL PRODUCTIVITY Boe Delaware Stateline 3M Cume Boe/ft Bbls Delaware Stateline 3M Cume Oil Bbl/ft The Delaware State Line has been the standout shale performer in the last 18 months Boe Delaware South 3M Cume Boe/ft 2 1 Bbls Delaware South 3M Cume Oil Bbl/ft There has also been strong improvement in the Oily Southern Delaware Source: HPDI, CSM Research 22

24 IMPROVING DELAWARE WELL PRODUCTIVITY Boe Delaware Central 3M Cume Boe/ft The Central Delaware has been underperforming even though the rocks have been strong. As the key operators move into development mode, we expect strong improvement Bbls Delaware Central 3M Cume Oil Bbl/ft 2 2 Boe Delaware Culberson 3M Cume Boe/ft 2 1 Bbls Delaware Culberson 3M Cume Oil Bbl/ft Culberson is gassier with strong cumes overall, but a lower oil cut Source: HPDI, CSM Research 23

25 IMPROVING DELAWARE WELL PRODUCTIVITY Bbls Delaware NM Slope 3M Cume Oil Bbl/ft Recent wells have been encouraging for the New Mexico Slope in the Northern Delaware Boe Delaware NM Slope 3M Cume Boe/ft Boe Delaware Pecos 3M Cume Boe/ft Bbls Delaware Pecos 3M Cume Oil Bbl/ft Some operators are finding success in Pecos county in the Southern Delaware but the average remains low Source: HPDI, CSM Research 24

26 IMPROVING DELAWARE WELL PRODUCTIVITY Boe Delaware East 3M Cume Boe/ft The Eastern Delaware bumps up against the Central Basin Platform and should have strong oil cuts Bbls Delaware East 3M Cume Oil Bbl/ft Boe Delaware NM Shelf 3M Cume Boe/ft Bbls Delaware NM Shelf 3M Cume Oil Bbl/ft Some operators are finding success in Pecos county in the Southern Delaware but the average remains low Source: HPDI, CSM Research 2

27 SO FAR SO GOOD, BUT WHAT ABOUT TAKEAWAY Permian Production Forecasts Actuals 6. MMB/d Permian Associated Gas Growth Actuals 13 Bcf/d Permian Crude Takeaway Basin Centurion West Texas Gulf Longhorn BridgeTex Cactus Permian Express II Refineries BridgeTex (expansion) Cactus (expansion) Permian Express II Midland to Sealy Permian Express III Other (1) Other (2) Other (3) Permian Production Permain Production (Extra Midland Gains) 2 Permian Natural Gas Potential CA/AZ Mid-Con Texas Mexico New, 1 New, 2 Gas Potential Extra Productivity Gains Source: HPDI, PXD, EPD, CSM Research 26

28 US NATURAL GAS SUPPLY AND DEMAND Source: EPD 27

29 PIPELINE TRADE: EXPORTS UNDER THE WALL TO MEXICO Bcf/d Pipeline Exports to Mexico Pipelines to Mexico are running below % utilization. Exports to Mexico underperformed our expectations in 217, trending broadly flat, even with ~2. Bcf/d of capacity adds from Comanche Trail and Trans-Pecos out of West Texas. We apply a more conservative forecast to above ground pipe this time around. Additional South Texas export projects include the 2.6bcfd Sur de Texas Tuxpan subsea line. 2 1 history fcst Much will depend on domestic demand growth and domestic production decline trends. '9 '1 '11 '12 '13 '14 '1 '16 '17 '18 '19 Hydro Nuclear electric Energy 4% Coal1% % Renewables 2% Oil 4% Natural Gas 43% Source: EIA, KMI, Company Estimates, CSM Research 28

30 1 Bcf/d SHIFTING TRENDS: EXPORTS, THE POWER OF LNG LNG Export Forecast Sabine Pass Cove Point Freeport Elba Island Cameron Corpus Christi Liquified Natural Gas exports How much capacity comes on line and what might its utilization be Big chunks of export capacity began to come on line last year. That capacity nearly doubles by late next year to 4 Bcf/d and then more than doubles over the course of 219 to nearly 9 Bcf/d With both NWE and Asia spot markets tracking higher than last year, the arbs from the US opened earlier 18.bcfd of FERC approved projects, 9.7bcfd of projects under construction, another 2bcfd pending approval Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul $/MMBtu LNG Economics (cash costs) Exports to Europe Henry Hub arbitrage threshold NBP $/MMBtu Henry Hub arbitrage threshold Sling LNG Economics (cash costs) Exports to Asia Jan-14 Jul-14 Jan-1 Jul-1 Jan-16 Jul-16 Jan-17 Jul-17 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct Source: The BLOOMBERG PROFESSIONAL TM Service, EIA, Company Estimates, CSM Research 29

31 PERMIAN DIFFS HERE TO STAY Discounts have emerged for Waha gas and could persist for some time Discounts for WTI-Midland are also likely to persist for much of 218 Source: The BLOOMBERG PROFESSIONAL TM Service, CSM Research 3

32 IF THE PERMIAN HITS A BOTTLENECK BAKKEN HAS IMPROVED SIGNIFICANTLY CLR : Improving Completions WLL : Improving Completions Source: CLR, WLL 31

33 PXD TALKS GOR This is from all the vertical drilling that we've done over those 4 years, but you hit about 4, cubic feet per barrel after about 1 years and then you ultimately reach an asymptote of about 4, after 4 years. [ED start at 8% trend towards 6% over three years] Source : PXD 2Q17 32

34 SELECT LONG RUN WELL PERFORMANCE AND GOR 4, Midland Core GORs GOR GOR 8, Midland East GORs GOR GOR 3, Midland Howard GORs GOR GOR 3, 6, 2, 2, 2, 4, 1, 1, 2, 1, , Midland Core Type Curves Type Curve Type Curve 1, Midland East Type Curves Type Curve Type Curve 1, Midland Howard Type Curves Type Curve Type Curve Source: HPDI, CSM Research 33

35 SELECT LONG RUN WELL PERFORMANCE AND GOR 2, Midland Northwest GORs GOR GOR 1, Midland South GORs GOR GOR 4, Midland West GORs GOR GOR 2, 1, 1, 1,, 3, 2, 1, , Midland Northwest Type Curves Type Curve Type Curve 1,2 Midland South Type Curves Type Curve Type Curve 1, Midland West Type Curves Type Curve Type Curve , Source: HPDI, CSM Research 34

36 SELECT LONG RUN WELL PERFORMANCE AND GOR 8, Delaware Central GORs GOR GOR 2, Delaware Culberson GORs GOR GOR 3, Delaware East GORs GOR GOR 6, 1, 2, 2, 4, 1, 1, 2,, 1, , Delaware Central Type Curves Type Curve Type Curve 1, Delaware Culberson Type Curves Type Curve Type Curve 1,2 Delaware East Type Curves Type Curve Type Curve 8 1, , Note: We have assumed drilling activity is focused on the oilier parts of the Delaware Central region Source: HPDI, CSM Research 3

37 SELECT LONG RUN WELL PERFORMANCE AND GOR 3, Delaware NM Shelf GORs GOR GOR 4, Delaware NM Slope GORs GOR GOR 4, Delaware Pecos GORs GOR GOR 2, 2, 3, 3, 1, 2, 2, 1, 1, 1, Delaware NM Shelf Type Curves Type Curve Type Curve 1, Delaware NM Slope Type Curves Type Curve Type Curve 8 Delaware Pecos Type Curves Type Curve Type Curve Source: HPDI, CSM Research 36

38 SELECT LONG RUN WELL PERFORMANCE AND GOR 3, Delaware South GORs GOR GOR 6, Delaware Stateline GORs GOR GOR 2,, 2, 4, 1, 3, 1, 2, 1, , Delaware South Type Curves Type Curve Type Curve 1,2 Delaware Stateline Type Curves Type Curve Type Curve 8 1, Note: We have assumed drilling activity is focused on oilier parts of the Delaware South and Stateline regions Source: HPDI, CSM Research 37