Oil production in the U.S. has been growing at a blistering pace. According to the U.S. Energy Information Administration (EIA), output in the U.S. will average 10.7 million barrels per day (BPD) in 2018, which would be 1.3 million BPD higher than last year's average and smash the record set in 1970. Meanwhile, the EIA sees output rising another 1 million BPD in 2019, which is 400,000 BPD higher than its initial forecast from earlier this year.
However, that growth rate for 2019 seems overly optimistic given that the country's main oil growth engine -- the Permian Basin of western Texas and southeast New Mexico -- appears as if it will stall out in the coming months due to pipeline constraints. Consequently, the U.S. oil patch could be in for a challenging year, which is something investors need to keep on their radar.
Rapidly approaching maximum capacity
Oil companies in the Permian Basin produced an average of 3.4 million BPD last month, or 46% of all the oil produced from shale, according to an estimate from the EIA. As a result, it's closing in on the region's 3.6 million BPD of pipeline capacity. With output in the Permian currently growing at an 800,000 BPD annualized pace, it's only a matter of time before pipelines run out of space.
On a more positive note, pipeline companies are building new lines as fast as they can. Plains All American Pipeline (NYSE: PAA) is working to accelerate the development of its two oil pipeline projects to get them into service sooner than the current timeline of January 2019 for its Sunrise project and the early part of next year's fourth quarter for partial service of Cactus II. Plains All American Pipelines is doing that by incurring additional costs to expedite material deliveries and vendor services as well as installing temporary generators until permanent utility power is in place. However, even though pipeline companies like Plains All American are working as fast as they can, the industry's capacity problems likely won't go away until the end of next year when the first wave of new pipelines enter service.
Warning signs are getting louder
"These challenges will likely have a dampening effect on production growth, wellhead prices, and investment levels in the coming year," according to the CEO of oil-field services giant Schlumberger (NYSE: SLB). That's why the Schlumberger CEO believes the market view that Permian production will climb by 1.5 million barrels per day annually (when including natural gas output) is "starting to be called into question."
We're already starting to see signs of a slowdown. Fellow oil-field services giant Halliburton (NYSE: HAL) recently warned that while "we thought there would be a downturn in activity [in the Permian] due to budget constraints and takeaway issues... it's more than we expected." This higher-than-anticipated slowdown has created more vacancy on its calendar, which is putting pressure on service prices. Because of that, and some other issues, Halliburton's earnings in the third quarter will likely come in $0.08 to $0.10 per share below expectations.
This weakness in drilling activities in the Permian could intensify over the next year. Driving that view is that drillers can't grow their output in the region next year since their only outlet to move that crude is by truck or train, which is much more expensive than pipelines. As a result, many drillers will likely reallocate their activities to other regions, which don't deliver the same returns or production as the Permian.
Near-term challenges could present compelling long-term opportunities
The U.S. oil industry is on pace to produce a record amount of crude this year, fueled in large part by the low-cost resources of the Permian Basin. However, with that region running out of room on its pipelines, production growth could slow to a crawl next year. Investors should keep this issue on their radar since it could ding the growth prospects of Permian-focused producers as well as the profitability of oil service companies. With new pipelines coming on line by the end of 2019, the region should reaccelerate in 2020, which is why investors should keep an eye out for opportunities that could emerge from the current slowdown.
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