BTU Analytics. A Firm Dilemma. Winners and Losers in the Natural Gas Pipeline Reversal Race. BTU Analytics, LLC

Transcription

1 BTU Analytics A Firm Dilemma Winners and Losers in the Natural Gas Pipeline Reversal Race BTU Analytics, LLC

2 Well Locations INTRODUCTION - North American natural gas arbitrage opportunities closing as Marcellus and Utica producer infrastructure commitments set up a race to the bottom in a demand limited environment. - Producers firm transport pipeline commitments will shift from being an asset to a liability as natural gas basis spreads and capital budgets tighten. - The Northeast gas market is entering a new era where costs dictate growth. The days of growth at any cost are over, and prudent low-cost operators will increasingly have the upper hand. However, hedges, select firm transportation agreements, and backlogs of previously drilled wells will lead to disproportionate impacts to some individual producers. - The best positioned Northeast producers already have the best rock under lease, inventory that provides room to run, and capital to continue activity. These producers are in the process of forcing the market price to levels where second tier producers cannot compete through high-grading. - Enough low cost drilling locations remain in the Marcellus and Utica to only drill wells that breakeven at realizations of $2.50/Mcf and below through Northeast basis will strengthen at the expense of Henry Hub, implying Northeast prices have limited upside to current levels. NORTHEAST PA WELL LOCATIONS BY BREAKEVEN PRICE 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Wells Drilled Through 2014 Sub $2.00 $ $3.00 $3.00-$4.00 Over $4.00 BTU Analytics, LLC July

3 Since development of the Marcellus shale began in earnest in 2008, natural gas producers have been faced with a stark dilemma sign long-term firm transport arrangements (10-20 years) or risk severe pricing differentials and potential shutins should local market demand be insufficient. As early as 2009, Marcellus producers in Northeast Pennsylvania began to strike long-term transport arrangements to facilitate the development of new pipeline infrastructure. Unfortunately for producers, due to continued production volume growth, those early commitments were not enough to prevent transportation bottlenecks that have developed throughout the region. Dominion South and Tennessee Gas Pipeline Z4 spot prices plummeted to just $0.74/MMBtu over the 4 th of July weekend and producers have voluntarily curtailed more than 1 Bcf/d of production since the beginning of 2015 to avoid selling natural gas at exceedingly low prices. Today, producers stand committed to more than 40 Bcf/d of pipeline infrastructure, with some of those commitments spanning the next 20 years. This, despite the fact that prices for both natural gas and crude oil stand at their lowest levels in years. Shale development across the US has occurred in phases. Technological breakthroughs in horizontal drilling and hydraulic fracturing set off an initial land rush which defined the early days and players in the US E&P market. The equity market rewarded companies that took big risks in leasing hundreds of thousands of acres to capture resources and turned a blind eye to the costs of reserve and production growth. Natural gas production grew at such a clip that it necessitated a move to the next phase of shale development, the transition to liquids. Producers again shirked off questions of the costs as incremental revenue buoyed top line growth from NGLs, crude, and condensate. But oil s fall is revealing a new market phase, and the Northeast market is steaming full speed ahead into the next period of transition. In 2015, BTU Analytics predicts the market is entering a new phase in the Marcellus costs limit growth as result of low outright Appalachian supply area gas and NGL prices that are casting a new shadow on the market. But the transitional period from one phase to another isn t pretty. The legacy of investments and commitments made during the previous eras now have to stand the test of time in a low price environment. Market strategies that worked at $90 per barrel oil and $4.00/MMBtu natural gas are no longer winning strategies. In E&P boardrooms, the accountants are now calling more of the shots. BTU Analytics has analyzed Northeast producer s production breakeven economics, pipeline commitments, and hedges allowing us to categorize producers into three groups 1) Growth Focused, 2) Conservative Diversified, 3) Cost Focused Basin Giant each group carries strengths and weaknesses into this new era. The low outright prices that the Northeast is currently experiencing, with Dominion South averaging 2015 YTD at $1.65/MMBtu, have pushed even the best positioned producers to curtail activity and volumes as well as defer completions. These low price levels are the result of Northeast producers continuing to drive production capacity higher despite regional pricing signals to the contrary. Further, improved efficiencies and reduced drilling and completions costs have driven down wellhead economics to the point where low-cost inventory at sub $2.50/Mcf is not a concern for years to come. These events have made BTU Analytics re-think previously held assumptions on production and capacity expansions. Prior to 2015, BTU Analytics analysis always assumed new pipeline expansions would be immediately filled by incremental production, maintaining pipeline flows at full capacity and keeping spreads wide between Henry Hub and Appalachian supply points. This same assumption supports why producers continued to back incremental pipeline projects out of the Appalachian supply area. But now, a combination of supply and demand forces are coming together to where BTU Analytics expects a period in the Northeast where available pipeline takeaway capacity will exceed the amount of production needed from the Appalachian supply area. On the supply side, the market is entering a more capital constrained world due to crude oil and NGL price headwinds for E&Ps. In this world, BTU Analytics expects top-tier producers to approach development with a disciplined eye towards balance sheet maintenance while second and third tier players struggle to survive as raising equity, debt offerings, and asset sales all come at a higher cost to the company. Consolidation of the top tier players is another outcome that must be BTU Analytics, LLC July

4 considered. All of this will result in lower production growth than previously anticipated before the oil price decline in Q On the demand side of the equation, a wide variance exists in the market around expectations for demand growth, with LNG representing the largest potential source of incremental demand. Estimates of as low as 2 Bcf/d (assuming a flooded global market and low US LNG export plant utilization) and as high as over 10 Bcf/d (assuming strong global LNG demand and low US natural gas prices) by 2020 are floating in the market. BTU Analytics base case expectation for LNG exports by 2020 is for approximately 8 Bcf/d of export facilities to be developed with 5 Bcf/d flowing. This new source of demand, plus smaller gains from other demand components including power, residential/commercial, industrial and Mexican exports, is not enough to counter-balance the over 16 Bcf/d of pipeline reversals headed to the Gulf Coast and Midwest. Reduced Northeast drilling activity, in combination with pipe expansions surpassing demand growth, will result in open pipeline capacity between markets and the tightening of basis spreads between those markets towards variable transport costs. In addition to the spreads tightening due to open pipeline capacity, Henry Hub will feel the full pressure of low-cost Marcellus and Utica gas as the Northeast producer becomes the marginal producer setting natural gas prices in North America. The result of these dynamics will be that some producers that have made significant firm transport pipeline commitments will see basis spreads tighten to levels where their long term firm transport (LTFT) fixed costs will exceed the spread between the Appalachian supply area and the market area where they aim to deliver their gas, or said another way, they will be out of the money on their firm commitments. For many Northeast producers, LTFT has been seen as an asset and the only solution to achieve better realizations for their gas. This worked when Henry Hub was above $3.50/MMBtu and when the Appalachian supply area was constrained providing basis differentials in excess of pipeline variable transport costs. However, when pipe capacity exceeds Northeast production in the near future, basis spreads will tighten to less than the cost of pipeline transport leaving some producers stuck with a long-term, cash flow reducing liability. Some producers will be able to defer making tough operational and financial decisions as a result of legacy hedges on the books. Ultimately, producers with the best acreage and diversified pipeline evacuation strategies will win out in a low price environment. In 2017 and beyond, expected low prices and a flat forward curve will eventually force producers to make decisions based on short-term cost and cash flow constraints. The transition to a new phase of development in the Northeast will not come without peril and broad ranging impacts to the North American natural gas market. The current changes taking place will influence the performance of producers, midstream, end-users, and service providers for many years to come. Subscribers to the report will receive a copy of the study and also a webcast presentation from one of the partners of BTU Analytics on the topics and outcomes covered in the paper. BTU Analytics, LLC July

5 An overview of the paper: - Part I Demand will cover macro demand balances for each demand component including LNG exports, power burn, industrial, residential/commercial, and Mexican exports. In addition, regional demand balances will be discussed for the Northeast and Southeast US highlighting the coming imbalances in the supply, demand and infrastructure balance. - Part II Northeast Production and Economics will take a deep dive into the productivity, cost, and product mix of wells across the region, identifying the areas and producers best positioned to compete in a new market era. This work will then extend to cover the inventory of remaining well locations at different natural gas, crude oil and NGL pricing levels for the Northeast Marcellus, Southwest Marcellus and Utica. Based on this analysis and BTU Analytics in-depth understanding of market infrastructure, the report will also provide gas production forecasts as well as an estimate of wells in backlog by Northeast region and how that backlog is worked off through time. BTU Analytics will also discuss how production from the Northeast fits into the US supply stack for natural gas and what additional factors impact the role that Northeast gas can play over the next five years. - Part III Infrastructure and Basis Impacts will review over 60 proposed Northeast pipeline expansions and will filter down to which pipes provide new incremental evacuation capacity and which just move gas within the Northeast supply area. Once the key pipeline reversals have been identified, BTU Analytics will discuss the detailed volumes and timing of each project with coverage on which basis markets will be impacted by how much and when. BTU Analytics will provide basis forecasts for key Northeast basis points and Henry Hub through Part IV Winners and Losers will include a discussion of the companies, groups, and assets that will be best positioned to emerge as leaders in the low-cost era, with analysis of the hedging portfolios of top producers, details surrounding existing pipeline and new project volume commitments as well as other factors impacting the ability to compete in the new environment. For more information contact: Mason Ender mender@btuanalytics.com BTU Analytics, LLC July