2016-2017 Appalachian Natural Gas Price Dynamics

2016-2017 Appalachian Natural Gas Price Dynamics 

According to the EIA the spread between current gas prices and Jan. 2017 is nearly one dollar and this should lead to faster buying up and refilling of storage gas – as spread to upcoming Jan futures is a typical indicator of whether to fill storage sooner or later. Theoretically, this should lead to moving more gas in the short-term and perhaps to a reduction of the Appalachian negative basis differential.

According to BTU Analytics the inventory of DUCs (wells drilled but uncompleted) and COBS (wells completed but on backlog – often due to midstream constraints) in the Appalachian region could be depleted down to normal inventory level by Feb. 2017 (and possibly sooner) with the bulk of the backlog coming down by Oct. 2016 as gas prices and pipeline takeaway capacity gradually improve. This is expected to have a big impact on supply since it will take time for rigs to re-mobilize due to the need for favorable pricing, access to capital, and time delay for gas to get to market. It still takes a month to drill a 4-well pad and another month to complete it and ready it for market. BTU Analytics also noted that they expect 10.6 BCF of increased natural gas demand by 2021 due mainly to LNG, Mexican exports, and power burn. They note that the bulk of the added production in 2016 will be from DUCs and COBs. Incidentally, the bulk of the DUCs and COBs are thought to be in Southwest PA and West Virginia. BTU Analytics actually predicts a temporary supply deficit sometime in 2017 due to bottlenecks and still limited takeaway capacity in the northeast. They suggest a shortfall of 3 BCF/day by 2018 which would need to be met by other gas plays such as the SCOOP & STACK, Haynesville, Fayetteville, Cotton Valley, and others. I am a bit skeptical but it should be interesting to see how this plays out, especially since the Marcellus and Utica have superior economics and reserves compared to the other gas plays.

  

The Spectra Algonquin Expansion Pipeline from Northeast PA to New England is expected to be in service before this coming winter. This will be available to move an additional 345 MMCF/day out of the region during high winter demand. Other new gas pipeline on the horizon that are not hampered by delays and opposition are the Atlantic Sunrise Pipeline and the Rover Pipeline which combined can add very significant takeaway capacity up to nearly 5 BCF/day. 

In stark contrast the Constitution Pipeline slated to go through upstate New York to New England was delayed for over two and a half years and now has been rejected by the governor of New York. This was a long-awaited big outlet for the glut of northeast PA dry gas – gas with very low methane emissions compared to other areas and the most economic gas producing sub-region in the country. It is a signal from New York and its constituents that “fracked” gas is not welcomed and yet natural gas demand has increased in New York and continues to flow from fracked areas into the state from existing pipelines. Residential and business conversions from home heating oil to natural gas heat have saved New Yorkers significant amounts of money and made the air cleaner in New York City. Meanwhile, others will be denied access to natural gas. Another planned pipeline project from the Marcellus area to Boston, the Northeast Energy Direct Pipeline was also recently abandoned, presumably due to opposition from anti-pipeline activists and the New York DEC. A third planned pipeline, a Kinder Morgan line through New England was also recently abandoned due to lack of firm commitments and other reasons. Losing this takeaway capacity could have an effect on continuing the supply glut although the delayed in-service date for Constitution had already been moved back to late 2017. As interstate pipelines are not typically rejected it remains to be seen whether FERC will challenge the decision in some way. Governor Cuomo also attempted to block Spectra’s Algonquin Expansion Pipeline because it ran too close to the Indian Point Nuclear Plant long after the issue was thought to be settled. His attempt to block that one failed. In terms of business fairness would it be fair for one state to reject delivery of a product in the same manner that other states do not reject and still receive the low price benefit when buying that product?  By making it harder for producers to make money should they still receive the low cost benefits provided by the local production? Should those in the areas beyond New York who would have received more quantities of significantly lower priced natural gas be compensated in some way for their loss of benefit? Is it in effect a tax on producers by not allowing them to move their product through to markets? These are important questions I think. It is not known whether these decisions will affect Appalachian gas prices short-term but they might very well be affected mid-term, into 2018. This added restriction may provide some opportunities for non-Appalachian gas producers from mid-2017 onward as U.S. supply dwindles and yet Appalachian supply is still constrained by takeaway capacity. However, with midstream planning and adjustments it is likely there will be no shortages beyond temporary local ones. It still appears that by late 2017 there should be significantly more takeaway capacity available, even without Constitution, assuming other projects come into service on time. 

Power burn demand, fertilizer and chemical plant demand, industrial, and residential demand are all expected to either remain the same or increase so that should have a positive effect on prices. Weather as always is the wildcard – a hot summer means more A/C now provided in larger measure by natural gas and a cold winter means the same for heat. LNG demand is picking up slowly as more shipments move out from Chenier’s Sabine Pass export terminal and the next trains get prepared for service. Ethane shipments to Europe from the Marcus Hook facility in Pennsylvania, more fractionation capacity, development of ethane storage, and continued takeaway from the ATEX and Mariner West ethane pipelines as petrochemical plants increase processing capacity are expected to contribute to additional ethane demand of 300,000 Bbls/day through 2017 according to the EIA. Some of this new demand will be ‘recovered’ from the existing natural gas stream resulting in as much as 1BCF/day taken from the natural gas stream in the mid-term.

If the Appalachian negative basis is reduced from the current 25% discount to about a 10% discount and Henry Hub goes up into the $3.50 - 4.00 range (App at $3.15-3.60 range) as predicted then drilling should resume in a big way. With current well costs and service costs remaining depressed this should also help the economics. The effects of new federal methane emissions regulations and new state drill-site regulations in Pennsylvania, and the possibility of significant per MCF taxes still looming in both Pennsylvania and Ohio should keep companies a bit cautious against over-spending and over-drilling which could help keep prices and futures buoyed up. 

The most recent EIA monthly gas production data showed a 1.85 BCF/day increase in Ohio + WV+ PA gas production. That was from Nov. 2015 through Jan 2016. That suggests a minimum influx of 185 wells coming online at 10 MMCF/day – without accounting for any production declines – so the number of new wells is likely significantly greater than that. It should be interesting to see what monthly production does over the next several months as the DUCs and COBs wear down. Currently, the rig count is remaining at bottom with 39-41 rigs running for the last several weeks. In Feb 2015 (14 months ago) there were 108 rigs running so we are likely seeing DUCs and COBs from that time period and before. With gas prices and takeaway capacity increasing incrementally we could to see the DUCs and COBs deplete in a similar incremental manner. However, BTU Analytics analysis sees is happening now and the latest Appalachian production boost supports that. I may add an update to this post next week when EIA Natural Gas Monthly report comes out. 

References:

DUCs, COBs, and the Ceiling on Marcellus Production – by Erika Coombs and Matthew Hoza, BTU Analytics, Webinar, April 21, 2016

Algonquin Expansion in New York on Target for Service Next Winter, in EIA Natural Gas Weekly, April 21, 2016

State Rejects Constitution Natural Gas Pipeline on Environmental Grounds: State Cites Failure to Address Water Impacts in Constitution Permit Refusal – by Brian Nearing, in Times Union (timesunion.com), April 22, 2016

EIA Natural Gas Monthly, March 31, 2016