Activity continues to pick up in the Northeast despite weaker pricing versus last year, growing Permian pressure, and mounting investor pressure to focus on capital discipline; meanwhile, the rig count in the Marcellus and Utica is at its highest point since July 2015. With these challenges facing the market coming out of winter, is Appalachia production growth at risk?
Appalachian producers have an incentive to grow production, even if the basis weakens this summer, because of firm transportation agreements on new projects. Rover Phase 2, Nexus, Atlantic Sunrise, Mountain Valley Pipeline, Atlantic Coast Pipeline, Gulf XPress, and other projects are under construction, and producers are ramping up drilling in advance of project completions.
Appalachian producers have outspent cash flow in recent years, and it seems intuitive that if prices haven’t improved but activity has continued to accelerate, outspending should continue in 2018. However, producer hedging is contributing to lower outspend in 2018. Antero, for example, has hedged all of its production in 2018 and 2019 at nearly $3.50/MMbtu. If we look more broadly at other major producers in Appalachia, nearly two-thirds of 2018 volume is hedged from the sample of Appalachian producers.
While hedging can offset some of the potential outspend, the pace of activity is still greater than what cash flow alone can support. To get a directional sense of magnitude, we can compare the output from two of BTU Analytics’ proprietary models featured in our monthly Upstream Outlook service. Our cash flow model is a simplified, conceptual way of looking at the world where basins are closed systems that rely on cash flow from operations to fund activity; hence, activity is tied directly to cash flow. On the other hand, our base case model incorporates many “real world” factors including infrastructure, DUCs, IP rates, spud-to-sales time, E&P capital allocation, etc. (for more on the two models, check out the analysis we published that looked at the impacts of capital discipline).
Using the current 5-year strip pricing for both WTI ($55.05) and Henry Hub ($2.82) in the cash flow model along with regional differentials, the output illustrates that production in Appalachia in the cash flow-limited world could be over 12 Bcf/d lower in 2020 than what BTU Analytics is currently forecasting, but hedging and improved netbacks account for a large portion of this delta.
As investor sentiment continues moving towards capital discipline, will producers curtail growth plans in lieu of increasing shareholder returns? Is the downside risk to Appalachia’s growth profile swelling as the Permian seeks to grab market share? For more on the interplay between capital discipline, Appalachia, and the Permian, particularly as new pipelines come online over the next 18 months, check out our complimentary webinar later today and inquire about our Upstream Outlook.