As natural gas prices rally for the balance of the summer of 2020 and CAL2021 natural gas prices hit new highs for 2020 trading, one begins to wonder how price responsive natural gas producers will be in this cycle. E&Ps have been chanting the mantra of capital discipline for nearly two years waiting for the moment when the supply and demand imbalance would invert, and natural prices would rally. Today’s Energy Market Insight will explore the historical price responsive of producers and implications on Appalachian basis as a result.
From an empirical perspective, the primary method for analyzing price responsiveness is elasticity of supply, which measures how much supply changed given a change in price. A price elasticity below 1 means supply is inelastic – the change in supply is less than proportional to the change in price. A price elasticity with a value above 1 means supply is elastic – the change in supply is more than proportional to the change in price. For example, a price elasticity of supply of 1.5 means that a 1% increase in price led to a 1.5% increase in supply. Price elasticities can change over time as market dynamics change.
The chart below highlights three instances of price changes over time in Southwest Appalachia, Northeast Appalachia, and the Haynesville, and each region’s price elasticity of supply during each instance. While both Southwest Appalachia and the Haynesville have gotten more price responsive over time, Northeast Appalachia’s price responsiveness has declined over the same three periods.
Northeast Pennsylvania Marcellus producers have been notably more measured in production growth than their peers in other gas-focused regions, especially in 2018 forward. Northeast Pennsylvania production has been less responsive to major moves in pricing and producers have elected to keep production relatively consistent even during the turbulent first half of 2020. Producers in Northeast Pennsylvania seem to be staying the course as new guidance expectations are released with 2Q20 earnings, but any sudden change in plans could shake up this dynamic. The measured approach has kept pipeline utilization out of the region steady and has helped to reduce volatility in spreads and tighten basis spreads between TGP Zn 4 Marcellus in Northeast Pennsylvania and Dominion South in Southwest Appalachia. The reduction in spreads can be seen in the chart below. The chart shows the six-month moving average spread between TGP Zn 4 and Dom South to help smooth out some monthly volatility and show the overall collapse of the spread over time.
In early 2014, TGP Zn 4 blew out to as much as ($1.40)/MMBtu lower than Dom South as growth in both Southwest Appalachia and Northeast Pennsylvania pushed pipeline capacity within the region to its limits. But from early 2019 to present, the spread between TGP Zn 4 Marcellus and Dominion South pricing has tightened considerably. Tightening spreads and less volatile spreads are driven by capacity within the region opening up in tandem with cautious production growth from Northeast Pennsylvania.
As producers have become less price responsive, utilization of takeaway capacity out of Northeast Pennsylvania has been steady between 90% and 95%, while prior to 2018, utilization was more volatile. More consistent utilization of pipeline capacity out of the region has been a major contributor to the tightening spread between TGP Zn 4 and Dom South.
While there will still be periods of volatility in the TGP Zn 4 and Dom South spread, the impact of slower changes in production in response to pricing will continue to mitigate basis volatility in the Northeast. Should producers in Southwest Appalachia and Haynesville follow suit to their Northeast peers then basis volatility may continue to decline as producers take a measured approach to expanding production when new projects enter the market. BTU Analytics tracks infrastructure projects in North America and their expected impacts on natural gas basis in the Gas Basis Outlook, as well as forecasting basis for over 25 points across North America.