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While in recent months much attention has been given to how lower oil prices are driving crude oil producers to slash their capital budgets and drilling activity, there has been much less space devoted to the effects on the midstream and downstream oil and gas industries. Although there have been some announcements of pullback in spending from some pipelines companies, these have been much less than the spending cuts set forth by exploration and production companies, and according to Industrial Info's Industrial Project Database the pipelines sector is on track to remain one of the Oil & Gas Industry’s “bright spots” in regard to near-term project activity for a number of reasons.
Continued Increase in Crude Oil Production
One of the primary reasons for the sustained strength in the Pipelines Industry is the continued high output from U.S. oil and gas producers. At the time of writing, the U.S. Energy Information Agency's latest forecasts in regard to oil production predict that domestic oil production will continue rising over the next few months, before showing a decline in the third quarter.
However, the agency doesn't seem to think that this decline in drilling and production from new wells will last long: “With projected WTI crude oil prices rising in the second half of 2015, drilling activity is expected to increase again as companies take advantage of lower costs for both leasing acreage and drilling services, resulting in growing production despite the relatively low WTI price,” the EIA says in its February 2015 Short-Term Energy Outlook.
The agency is currently forecasting that U.S. oil production will reach a low point in September before picking up again in the fourth quarter of 2015 and will continue growth through 2016. “Forecast U.S. crude oil production increases from an average of 8.6 million bbl/d in 2014 to 9.3 million bbl/d in 2015 and 9.5 million bbl/d in 2016.”
With this continued production growth, additional amounts of crude oil must be delivered to storage terminals, refineries, or (depending on how future political winds blow) to ports for export. And producers are always looking for the most economic way to ship crude, which is generally a pipeline. With today's low crude oil prices, this becomes more important than ever.
Crude Oil Economics
Obviously, the lower price of crude is squeezing the profit margins of crude oil producers, and one of the primary ways that producers can lower their per-barrel costs is through transportation infrastructure. Pipelines significantly reduce costs for both the gathering and long-haul transmission of crude oil.
For example, gathering crude by truck for continued long-haul transportation and delivery could add $2 to $2.50 to the cost of a barrel of oil, while a pipeline gathering system could reduce this cost by 75%. In areas such as the Bakken Shale and Western Canada, which rely heavily on rail transportation, the savings is even greater.
As an example, a substantial portion of North American crude is shipped to the U.S. Gulf Coast region, where approximately 50% of U.S. refining capacity is located. The cost of shipping crude from Western Canada to the Texas Gulf Coast by rail could add around $12 of shipment costs per barrel, whereas shipping to and from the same regions via pipeline may cost only $5 to $6 per barrel.
In short, when producers have a lot of profit margin, they are much less concerned about the costs of transporting crude--they simply want to move the crude out and pull in those high prices. In leaner times, those transportation costs become a much higher percentage of total costs, making producers want to cut savings where they can — and pipeline transmission is a key way of accomplishing this.
Natural gas and natural gas liquids (NGLs) continue to be a strong driver of pipeline construction in the U.S. The EIA estimates that natural gas production in the U.S. will increase by 2.9 billion cubic feet per day in 2015 and continue growing through 2016. Industrial Info is tracking more than $18 billion of active projects involving natural gas and NGL pipelines with a planned start date of 2015-16, a higher value than crude oil pipelines. While some of this activity could possibly be pushed out to a later date, get caught up in permitting, or canceled completely, fallout in this sector is expected to be minimal, as production of cheap and abundant natural gas is driving other industrial development, making natural gas production and its subsequent delivery a cornerstone of continued U.S. economic development.
This is occurring for a number of reasons. Increasingly stringent environmental requirements are forcing many coal-fired power plants into retirement, particularly in the Great Lakes region. In the wake of these retirements, several natural gas-fired power plants are being developed, furthering the construction of natural gas pipeline networks. This is particularly prominent around the Marcellus and Utica shale regions, as natural gas producers strive to supply both regional markets and those in other areas, particularly New England and the Mid-Atlantic.
In the U.S., exports of NGLs, which include propane, butane, and ethane, have reached unprecedented levels over the past few years, resulting in NGL pipeline build-out. This is accompanied by the construction of multibillion-dollar liquefied natural gas (LNG) projects, concentrated along the U.S. Gulf Coast, which will liquefy billions of cubic of feet of natural gas per year for export, leading to further natural gas production and pipeline construction.
Also driving the need to move natural gas is the build-out of chemical projects that are springing up in the U.S. to take advantage of inexpensive natural gas feedstock, including ethylene, methanol and agricultural chemical production.
Geography & Pipeline Development
The U.S. Southwest market region remains relatively even when comparing the value of planned crude oil and natural gas/NGL pipeline projects, thanks largely to the large amount of upstream, midstream and downstream oil and gas facilities in Texas. However, pipeline activity in other U.S. geographies is very much in either the natural gas or crude oil camp. For example, in the Northeast and Great Lakes region of the U.S., home to the Utica and Marcellus shale formations, pipeline companies are working overtime to move natural gas from where it is produced to where it is needed. This includes additional natural gas pipeline construction to power plants in New England, which severely suffered from a lack of natural gas transmission infrastructure during the “polar vortex” in early 2014, as well as in the Great Lakes region, which is seeing a large amount of natural gas-fired power generation construction to replace aging coal-fired power plants slated for retirement.
There is a bit of a balancing act involved in the development of crude oil pipelines, as existing pipeline infrastructure can encourage drilling and exploration programs, but pipeline developers want firm shipping commitments before beginning pipeline construction. However, the movement of crude from Canada and the Bakken Shale to refineries and potential export locations in the U.S. is encouraging pipeline development through the Midwest and down to the Gulf Coast, while increased production from Colorado’s Niobrara Shale is helping drive development of pipeline infrastructure in the Rocky Mountains region.
For crude oil pipelines, a significant amount of construction will continue in spite of slower drilling, as it’s really not a question of if oil will be extracted from various North American regions, but rather when, and pipeline developers will want to be well-positioned when correction in the oil market is finished and recovery is under way.