Back in October 2016, TransCanada held an unsuccessful open season for a lowered Mainline toll rate delivering Western Canadian natural gas to Dawn hub. TransCanada has since altered their service terms for a second attempt, and in recent weeks was successful in securing 1.4 Bcf/d in commitments. With a scheduled in-service of November 2017, the flow and pricing dynamics surrounding the Midwest market are poised to be significantly altered.
Historically, shippers were utilizing the variable rate ($1.33 USD/MMBtu) on the TC Mainline to reach the Dawn market or bypassing the mainline all together and sending gas to the US via Great Lakes and onto Dawn. The new service on TransCanada’s Mainline will have a fixed toll rate of $0.61 USD/MMbtu/d for a 10-year commitment (although provisions have been added for early termination after 5 years). With shippers switching from a high variable cost model to a fixed cost transport model plus fuel, Alberta gas production should transition from acting as a marginal supplier to being an even more competitive supply source into Dawn. This is an important change in the dynamic for Canadian producers, as Canada has been losing market share for years to the Marcellus and Utica and faces increasing threats from Rover and NEXUS. In addition, gas from Western Canada has few alternative market options making the Midwest markets that much more important.
The new tolls for the TransCanada Mainline are around $0.20/MMbtu cheaper than the negotiated rates on Rover to Dawn, giving shippers at the end of the mainline a net back advantage compared to their Appalachian peers competing for the Dawn market. Additionally, Canadian shippers have reduced their variable cost into the Dawn market from the previous $1.33/MMbtu to now just fuel at ~3% compared to the ~1% fuel rate on Rover. AECO pricing now no longer has to discount nearly as steeply versus Dominion South pricing to maintain or take market share in the Dawn market.
With this change in dynamic, the TransCanada toll gives Canadian producers a much more secure position in the Dawn market, able to better withstand low cost gas supply moving in from Appalachia. However, this market has also traditionally been supplied with gas volumes moving north from the Gulf Coast and Midcontinent. But with all this supply headed into to the Midwest, some more supply is going to be displaced.
The chart above shows the net receipts and deliveries onto four major pipelines for all points south of the REX pipeline. A positive value indicates net receipts, and shows that volumes are still flowing north today. However, the pushback in just the last two years is substantial. From 2014 to 2016 over 2 Bcf/d of volumes which typically supplied the Midwest from the Gulf and Midcon (through the ANR, Trunkline, NGPL, and TGT pipelines) have been backed out by the REX reversal carrying Appalachian gas from east to west. With a portion of the Dawn market secure by the new Mainline commitments, and Appalachian gas able to provide the remaining volumes at a low variable cost, it is likely that the remaining 2 Bcf/d of gas flowing north will see displacement pressure.
So how will basis trends surrounding AECO, Dawn, and Dominion South react? As the market in Dawn sees increased supply pressure and shippers hold firm transport on multiple pipelines from various supply regions, competition between supply breakevens (ie. variable costs) will begin to drive new market dynamics. Under this scenario, we would expect a tightening of basis between markets in Appalachia, Midwest, and Canada.
The charts above show historical pricing spreads between the DomS/Dawn and AECO/Dawn markets. When the change to the TransCanada Mainline tariff goes into effect in November 2017, we would expect to see the AECO/Dawn spread begin to tighten. However, with the competition in Dawn, the Dominion South market will also likely stay tight as only the variable rate will need to be covered to incentivize transport to the Midwest. Oversupply and cheaper marginal volumes may cause Dawn to lose its position as a premium market when compared to Henry Hub. Finally, with fewer and fewer gas molecules able to head north from the gulf, additional pressure will be placed on Henry Hub making for a bearish gas outlook towards the end of 2018. For more information on BTU Analytics’ views of the gas market, request a free sample of the Henry Hub Outlook.