Investors patiently waiting for natural-gas to break out of its trading range of roughly $3 to $4.50 per million British thermal units have been sorely disappointed, with the exception of a short-lived, weather-induced rally during the 2013-14 polar vortex.
Despite a dramatic reduction in the gas-directed rig count, output from the nation’s shale plays has climbed to new highs, fueled by accelerated drilling activity in basins that also contain significant volumes of natural gas liquids (NGL), a higher-value group of hydrocarbons that includes ethane, propane, butane and natural gasoline. (Read more about this shift in Breaking Down the US Onshore Rig Count.)
Over the past half decade, Appalachia’s prolific Marcellus Shale has emerged as the premier gas-centric resource base in the US unconventional market, with production from this play surging by more than 200 percent over the past three years. In fact, the Marcellus Shale last year accounted for 20 percent of US gas production.
Leading US gas producers have touted improvements on the demand side of the equation as laying the foundation for a recovery in domestic prices.
Cheap natural gas and stricter regulations have encouraged electric utilities, especially in the South, to shutter coal-fired capacity and build high-efficiency power plants that burn natural gas. Meanwhile, industrial and manufacturing concerns have announced plans to expand their presence in the region to reap the benefits of America’s energy advantage (See The Empire’s New Textile Mills.)
Mexican demand for inexpensive US natural gas and NGLs also looks set to grow in coming years, as utilities and industrial companies south of the border look to lower their energy costs. The start-up of Cheniere Energy Partners LP’s (NYSE: CQP) Sabine Pass facility and other projects to liquefy and export natural gas will provide another demand outlet.
Range Resources Corp (NYSE: RRC), for example, routinely highlights estimates from Simmons & Company, an energy-focused investment bank, that call for 19.9 billion cubic feet per day worth of incremental demand for US natural gas through 2020.
Disregarding any quibbles we might have with this forecast, this focus on the demand side obscures the primary reasons that investors shouldn’t expect a sustained recovery in natural-gas prices:
In recent months, some analysts have argued that US natural-gas prices could rally, as the sharp decline in drilling activity will reduce the volume of associated gas produced from liquids-rich plays.
Data from the US Energy Information Administration indicates that four major oil-producing plays—the Bakken Shale, Eagle Ford Shale, Niobrara Shale and Permian Basin—last year accounted for 17 percent of total US natural-gas output.
Our outlook calls for US oil production to prove more resilient than many investors would like; we don’t expect a huge upsurge in natural-gas prices to occur. And rest assured that any uptick in natural-gas prices from lower production would be met by a flood of gas from producers eager to take advantage of higher prices.
Rather than focusing on natural-gas prices, prospective investors should target names that boast solid balance sheets and acreage with low production costs; these operators will be best-positioned to win market share and take advantage of incremental demand growth.
Many of the names that meet these criteria operate in the Marcellus Shale, where surging output continues to reshape natural-gas flows in the US.
Over the past two years, huge production gains in this region have overwhelmed local demand and takeaway capacity, depressing regional prices relative to Louisiana’s Henry Hub, the official delivery point for the futures contracts that trade on the New York Mercantile Exchange.
For example, natural gas delivered to the Leidy Hub in Pennsylvania currently fetches $1.41 per million British thermal units, a discount of $1.34 to the Henry Hub price.
These widening differentials have prompted the midstream industry to develop a number of pipeline projects that will enable gas produced in the Marcellus Shale to flow to end-markets in Canada, New England, the Midwest, the Gulf Coast and the Mid- and South Atlantic states. (See Making Sense of the Marcellus Shale’s Midstream Madness.)
Expect this outflow of volumes to ratchet up competition in these regional markets, displacing volumes and pressuring Henry Hub Prices.
Unfortunately, at this juncture in the shale gas revolution, the market is well-acquainted with the best players in the Marcellus Shale, most of which trade at significant premiums. The opportunity for value discovery appears slim, though potential downside risk also appears limited for many of these names.
Moreover, there’s a reason that companies such as Anadarko Petroleum (NYSE: APC), EOG Resources (NYSE: EOG) and Noble Energy (NYSE: NBL) have prioritized their oil-bearing acreage over their positions in the Marcellus Shale: superior profit margins, even after the huge downdraft in crude-oil prices.
We prefer to focus on names that will provide infrastructure solutions to producers in this region, especially Spectra Energy Partners LP (NYSE: SEP) and Markwest Energy Partners LP (NYSE: MWE).
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Elliott and Roger on Mar. 20, 2018
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