The growth story for key gas-focused US shale plays such as Appalachia and Haynesville may be over in the short term due to the recent Henry Hub price weakness. Of course, we may see growth being restored in the medium term, but in our view a sustainable Henry Hub gas-price environment of at least $2.5 per MMBtu is needed for this to happen. However, the growth story is in no way over for nationwide gas production, largely thanks to the Permian basin. Although the Permian keeps struggling with flaring and insufficient takeaway capacity for gas, its low-cost oil supply potential even at WTI of $50 per barrel has been proven across many parts of the basin. The zero-cost associated gas does not add much to revenues in this basin at the current local gas and NGL prices, but it inevitably follows oil production growth. We expect Permian gross gas production to increase by more than 4.5 billion cubic feet per day between the fourth quarter of 2019 and the fourth quarter of 2021, with the volumes gradually becoming visible in the market when the Permian Highway and Whistler pipelines enter into service or when Mexico is able to absorb a bit more of Permian gas.
We should stress that we do not expect any significant buildup in the gas-oil ratio (GOR) across the Permian basin in the short term. In fact, a modest decline is possible in 2020. Nevertheless, we are seeing a significant number of publications arguing that Permian production is becoming structurally gassier. Typical arguments include a buildup in the gas-oil ratio on older vintages and a shift of new activity towards gassier zones. While the former is undoubtedly true as almost every reservoir exhibits increasing GOR when wells becomes older, we also need to keep in mind the typical shale well decline profile: it is very steep initially. Each year, the new well vintage accounts for half of total basin production by December, whereas older vintages decline dramatically over the first 12 months. While base production gets gassier over the 12-month period, the overall production decline makes this increase in base GOR only marginally significant in the context of basin-wide gas production. What is really important each year, however, is the gas content of the new vintage. With this in mind, we do not think Permian gas production will necessarily outpace oil in 2020 as long as the activity level stays robust and operators intentionally decide to focus on the areas and zones with the maximum oil content. In fact, this is exactly what the industry is going to do in 2020 given the limited outlook for additional gas pipeline capacity and persistent gas and NGL price weakness.
Basin-wide GOR increased by more than 10% between November 2018 and November 2019 and currently stands at around 3,500 cubic feet per barrel, returning to a level last seen in 2016. In 2016‒2018, operators systematically focused on oil-rich, highly productive zones, which was sufficient to push down basin-wide GOR. The gassiest sub-basin, Midland South, has seen quite flat development of GOR since 2015 as it fluctuated around 5,000 cubic feet per barrel. Oil-rich Midland North saw a 5‒7% increase in GOR over the past 12 months – a result of stabilizing activity and maturing base production. In the hottest part of the Permian these days, Delaware New Mexico, the industry has been able to maintain GOR below 4,000 cubic feet per barrel since late 2017 as more oil-rich modern activity replaced legacy Abo and Yeso gas volumes. The most alarming trend at first glance is the recent GOR buildup on the Texas side of the Delaware basin, where GOR increased by more than 10% in 2019. It should be noted that Delaware Texas accounts for almost 40% of total Permian gas production as of late 2019. Hence, any structural increase in Delaware Texas GOR becomes very visible in the context of the entire basin.
Is it really true that an activity shift toward gassier parts of the basin is having an additional impact on the increasing GOR? We do not think this is the case. Why would operators prefer such a strategy when they are facing Waha Hub gas prices close to zero? The contribution of Delaware TX to basin-wide gas production increased from 25% to 39% between late 2015 and early 2019. Yet when gas bottlenecks became particularly severe in 2019, Delaware TX even saw temporary production declines (March‒April 2019). To be precise, after a 1.9 billion cfpd expansion between February 2018 and February 2019, Delaware TX saw only 300 millon cfpd of growth between February 2019 and July 2019, losing its market share to more oil-rich sub-basins. Then the Gulf Coast Express came on line, triggering 800 million cfpd of additional growth from Delaware TX over the four-month period from July to November 2019.
Zooming in on Delaware Texas, there are significant differences in gas-oil ratios across different counties. The eastern part of the sub-basin is in fact very oil-rich: Loving, Winkler, Ward and Pecos counties have seen pretty flat GOR evolution of 2,700 to 3,100 cubic feet per barrel recently, with no signs of increases. The gassiest county, Culberson, hosts some of the most productive Upper Wolfcamp wells in the Permian on a boe (6:1) basis. However, gas accounts for almost two-thirds of the gross production stream. The profitability of these wells is in fact very sensitive to local gas and NGL prices. In our view, Culberson producers did an excellent job in 2019 focusing on the locations with the highest possible oil content. This helped achieve almost reduction in county-wide GOR of almost 10% between May and November 2019.
So it is all about Reeves County, the largest gas-producing county in Delaware Texas and in the whole Permian Basin. Not only did Reeves gross gas production surpass 3 billion cfpd in the final months of 2019 (up from less than 400 million cfpd in December 2015), it also saw persistent increase in GOR in the last few years.
The reality of the activity in Reeves is very complex. The eastern portion of the county is represented primarily by oil wells with initial GOR rarely exceeding 2,000 cubic feet per barrel, while western Reeves has significantly gassier wells and is not that different from Culberson county. Finally, we should not forget about Apache’s Alpine High activity, with very few wells showing GOR below 20,000 cubic feet per barrel. Additional GOR complexity is associated with the exact landing zone targeted. Figure 4 shows distribution of peak-month GOR for 2018‒2019 vintages for the 10 largest operators in Reeves County. It should be noted that most producers have significant optionality and can easily high-grade their activity toward low GOR locations without leaving the county borders. Needless to say, many of these large independents have more oil-rich options outside of Reeves County. Finally, Apache accounted for almost one-third of total gross gas production growth in Reeves in 2017‒2019. This growth largely came from the Alpine High development. With Apache reallocating most of its capital from Alpine High toward oil-rich parts of the Permian, we find it very likely that GOR in Reeves County will stop growing temporarily in 2020. Moreover, basin-wide GOR is also expected to stabilize and potentially decline. We expect that 2020 will definitely be a year with record-high average oil content among new well completions.