As earnings season continues, the theme of deeper cuts and balance sheets that need higher crude prices to achieve cash flow neutrality persists. Each day prices remain weak, many companies are one day closer to bankruptcy, perpetuating unease and anxiety throughout the industry. However, there is a silver lining to be found in low crude prices.
As activity slows, significant volumes of natural gas production are being eliminated. For example, in the Fayetteville, Southwestern (SWN) has cut rigs to zero placing the basin into decline and production is expected to average 2.3 Bcf/d in 2016 compared to 2.7 Bcf/d in 2015. At the same time investment in supply is shrinking, investments in demand are coming to fruition. Cheniere (LNG) has begun loading the first cargo for export, new pipelines to Mexico are under construction, and coal plants continue to be replaced with natural gas fired generation.
Turning back to production, ignoring our estimates of backlogs and DUCs for a moment, if drilling activity in the Lower 48 does not rebound, the US is on track to be 8 Bcf/d short of gas in 2017 with all of this new demand.
Now, due to an extensive backlog in the Marcellus, this shortage in 2017 will likely be significantly less as new pipelines are completed and production out of the region grows due to higher realized pricing. However, every day weak crude and gas pricing continue to slow activity, the backlog of wells waiting in the wings gets smaller and jeopardizes the total available gas production in 2016 and beyond. The gas balance in 2017 is already balanced on a knife’s edge, so any hiccup in the system,from hot summer weather, or a strong cold snap like 2013 could lead to a much stronger cash price at Henry Hub in 2017 than the average $2.62/ MMbtu that the forward market is currently expecting. Through 2017 due to anticipated project delays, pipeline constraints out of the Northeast limit the amount of gas that could potentially be available to offset declining gas production in the balance of the country. So should any of these disruptions occur, Henry would need to rise enough not just in the cash market but in the forward market to attract capital to gas plays like the Haynesville, the SCOOP, and the STACK to meet incremental demand growth.
In order for this to happen, strip pricing for 2017 needs to move higher than its current average of $2.72/MMbtu in 2017. As mentioned in Economic Hope for the Haynesville blog, there are large areas of the Haynesville that breakeven at $2/MMbtu to $3/MMbtu and Devon and Continental continue to deploy capital in Oklahoma inspired by promising results that suggest both the STACK and SCOOP could be sub $3 plays depending on the price of crude and NGLs. Additionally, in 2015 and 2016, Northeast gas producers have slowed activity enough that without higher prices to attract outside capital or grow producer cash flow, there will be no backlog to fill new pipeline projects that come online in 2018 and pipeline utilization of new projects will be extremely low tightening spreads across the country.
This scenario extends the potential gas shortage into 2018 and further illustrates the need for a stronger Henry or significantly higher volumes of associated gas production in 2017 and 2018. If the market misses this potential imbalance, we could see not only increased volatility at Henry, but also stronger gas pricing to attract new investment capital. For additional analysis on the outlook for natural gas supply, demand, infrastructure constraints, and impacts to pricing check out BTU Analytic’s Northeast Quarterly.