We’ve all heard of the Gold Rush. In the 1800s, Australia, California and Alaska all had prominent gold rushes. In my opinion, we are seeing the Permian Produced Water Rush. Let me explain, TPG announced the potential acquisition of Goodnight Midstream. When that deal fell apart, Tailwater invests another $500 million into Goodnight. WaterBridge buys water infrastructure from Halcon, and Halcon, their new client, declares bankruptcy.
Normally bad news, but Singapore sovereign-wealth fund GIC buys a stake in WaterBridge in a deal that values WaterBridge at $2.8 billion. You see, normally an acquisition falling through or a major client declaring bankruptcy is bad news, but in a “Gold Rush,” there is no bad news. And this Produced Water Rush is all about the water midstream.
Oil’s PR Problem
What makes this all that much more remarkable is this is happening within an industry that is having a terrible public relations problem.
The oil and gas industry is becoming the new tobacco. We have presidential candidates calling for bans on oil, an uninformed child speaking before the United Nations attacking the oil and gas industry while gaining international attention and Rachel Maddow calling oil the “excrement of the devil” in her new book.
Not that I respect these loons, but they do represent a growing sentiment in this country. And you can see how that sentiment even has investors becoming anti-oil, while money is drying up for the oil and gas industry.
According to Raymond James in their latest Energy Outlook, there is a negative consensus, preventing oil prices from climbing. In addition to the negative sentiment toward the oil industry, they report that there is a belief that there is excess OPEC capacity and production in the U.S. will grow at $50/bbl.
Neither is valid as the Saudi’s inventories have been declining, and there is an expectation than non-U.S. production will be declining after 2021. We are already seeing a slowdown between $50-$60/bbl here in the U.S.
As I stated earlier, the Permian Produced Water Rush is even more remarkable when you consider this is all happening within an industry that’s taking it on the chin from a public relations standpoint. You would think that the oil and gas industry’s public relations problem would be bad news for the Great Permian Produced Water Rush, but even that is good news.
You see, lack of capital for drilling in completions is leading some companies to sell their water infrastructure to the water midstream, and the Produced Water Rush just keeps going.
Believe me, the Great Permian Produced Water Rush is here. Water midstreams are flush with cash and growing even in an industry under attack. E&Ps valuation have more to do with acreage and production numbers. So, it makes sense for some E&Ps to sell water infrastructure that isn’t a big contributor its value to a midstream. It also reduces CAPEX spending on water infrastructure.
If you look at Diamondback, which trades a just more than 5xEBITDA and look at their spinoff, Rattler Midstream, which was trading at more than 8xEBITDA after its IPO, you can see how these water assets are more valued in a water midstream structure, but that makes sense, as well.
When a water midstream buys a water asset, they end up getting with it a 10-to-15 year contract. Talk about low risk investing. How many industries can tie their revenue to 10-to-15 year contracts?
In addition to that, midstreams are tied to the same geographical constraints of a single E&P. They can grow their network by tying into neighboring E&Ps and increase the utilization of their water infrastructure. This helps make the value of these assets greater to water midstreams than it is to E&Ps.
Now, consider that water volumes are growing and expected to continue growing. It doesn’t matter whether your source is Rystad Energy, IHS Markit, Raymond James or the many others. Produced water volumes will continue to grow even under the most conservative estimates on oil prices.
The attacks on Saudi Arabia and an Iranian tanker should have had a more dramatic effect on oil prices. And there are other signs that tensions in the Middle East are escalating. Even with this “black PR cloud” sitting over the oil and gas industry, an escalation in the Middle East must start moving oil prices upwards. In a rising oil-price market, water volumes will grow more rapidly.
Now, compare investing in drilling and completions when you may have a possibly flat oil price, where demand is flat to declining depending on to whom you talk and a negative consensus within the investment community is keeping oil prices down against investing in a water midstream and getting 10-to-15 year contracts where you know your demand is growing and guaranteed to continue growing.
This explains why money is moving into the water midstream and away from drilling and completions. Lack of capital for drilling and completions then drives E&Ps to sell water infrastructure, helping to fuel the Great Permian Produced Water Rush.
As the water midstreams grow, you are beginning to see the development of “super systems.” According to Raymond James, the water midstreams with “super systems” include H2O Midstream, WaterBridge Resources, Hillstone Environmental, Goodnight Midstream, Gravity Oilfield Services and Oilfield Water Logistics, to name a few.
The super system is all about scale. By tying into neighboring E&Ps, they can increase utilization, and with scale, they can drive down cost. For E&Ps, this provides a formula for lower costs while for water midstream, this is a formula for higher profits. As these super systems grow, you now have multiple E&Ps tied into multiple saltwater disposal wells (SWDs) allowing, as we stated earlier, increased utilization and lower costs.
The concept of super systems allows for the type of scale that no single E&P could develop on its own. The next step in this evolution is the combining of super systems and the beginning of the “mega system.”
There really seems to be nothing stopping this growth. The market is there. The money is there. So, where’s the risk? Well, if there is risk, it is seismicity.
With seismic events increasing in the Delaware Basin, we are seeing longer permitting and capacity restrictions on new permitted wells. Additionally, new permits allow for even further restrictions if seismic events occur near the permitted wells.
The advantage of a super system is the availability of other networked SWDs allowing the water midstream to move water to different SWDs, helping mitigate some of the risk. But again, capacity restrictions are still a risk that deserve serious consideration. Some water midstreams have actually built pipelines from the Delaware to the Central Basin to hedge against seismicity risk.
What About Recycling?
I believe produced water recycling is the hedge the industry needs against seismicity. And I’m not just saying this because I’m in the recycling business. Recycling costs have dropped dramatically over the last four years. It’s really become a simple formula— use my existing infrastructure for oil and solids control at my tank batteries and gun barrel systems at SWDs, then add oxidation, storage and aeration. Simple formula.
Some people like to add additional solids control to prevent solids from going into their storage, but that’s it. For systems we are installing, recycling is lower cost than the SWD. Increasing produced water recycling helps hedge against longer permitting times in the Delaware and reduced capacity in newer permitted wells.
And when you consider that it can be done in a way that is lower cost than an SWD, you can see why everybody considers produced water recycling/ reuse to be a significant growth area for oil-field water management. I’m not saying recycling will replace the SWD, but rather will augment capacity.
You see, produced water recycling needs SWD infrastructure to remain low cost, allowing their gun barrels to be part of the process. Additionally, recycled produced water needs an active completion program to supply. As oil prices change, so do completion programs. Other impacts like takeaway capacity can also interfere in a completion schedule. With an unreliable outlet for recycled produced water, you need your SWD. Recycling isn’t a threat to the SWD, but a partner.
We’ve talked about the scale of the water midstream. What does that do to recycling? Well, we’ve seen the first commercial recycling facilities emerge. I’m not convinced this will become the preferred recycling method. Having talked to many operators, most have serious concerns about using other E&Ps’ produced water, concerns over compatibility.
What we’re seeing from commercial recycling is a higher cost to recycle to mitigate the compatibility concern and an increase in blending with brackish or fresh water. This will work against the scale advantage by using less produced water with a higher cost to treat. Many operators are increasing their use of recycled produced water and can do so comfortably knowing that their produced water is coming from the same formation they are drilling into and will avoid the compatibility concern.
But that isn’t going to stop water midstream. We are already supplying recycling equipment with water midstreams in locations where they have dedicated pipelines for specific E&Ps and can recycle that specific E&Ps produced water. On the commercial recycling side, I think a water midstream will find that sweet spot where scale and blending reduces the cost to offset the higher treatment costs. But that may take time.
My last point here is being in an industry already under attack, we should be doing everything to recycle produced water and reduce the use of fresh and brackish water. Why brackish? Because in drought-prone areas like West Texas, brackish water is the next best source of drinking water. We need to improve our reputation.
Believe me, the Great Permian Produced Water Rush is real, and if we want it to be sustainable, we have to pay attention to how we manage the precious resource of water.
Authored by Mark Patton
Mark Patton is president of Hydrozonix. He has more than 25 years’ experience in the development, design, implementation and operation of treatment technologies. Mr. Patton’s oil and gas background includes treatment systems for waters, wastewaters, drilling muds, tank bottoms and process residuals. He holds one produced-water patent with two additional patents pending.
Mr. Patton earned his B.S. in chemical engineering from the University of Southern California in 1985.