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Overbuild in Marcellus Said Several Years Away

The Marcellus Shale's location near high-consumption centers, its bountiful reserves and its chameleon-like ability to produce wet or dry natural gas in abundance have made it a worthwhile destination for midstream operators, and it should remain so for several years, according to Fitch Ratings.

An indepth review of the play by Fitch credit ratings analyst Ralph Pellecchia and his colleagues outlined the challenges and opportunities in the midstream and pipeline sector. They found a lot of opportunities.

What sets the Marcellus apart from other basins is its "favorable location...to high-demand consumption centers in the Northeast and Atlantic Coast." But it's not perfect. The Marcellus market is isolated from Gulf Coast petrochemical markets for natural gas liquids (NGL) and it's early stages to figure out how liquids will be managed.

Still, business looks good -- even with "political, environmental and logistical impediments," said Pellecchia. Project sponsors should continue to benefit from the "very large reserve base and relatively low breakeven costs." Midstream service contracts generally have been "credit-positive, master limited partnership-friendly, long-term, fee-based arrangements with minimal commodity price exposure."

Fitch counts seven "major" Marcellus gas pipeline projects and two "major" NGL pipeline projects now being developed by a variety of sponsors with varying initial capacity:

A lot of other gas pipe and NGL projects of various sizes and configurations are being developed but many proposed have not been sanctioned or are not considered "key" to Marcellus takeaway, according to Fitch.

The reach of the Marcellus has led to competition from other producing basins and "capacity utilization on certain supply-driven pipelines" -- such as Rockies Express LLC (REX) "will be diminished," which may increase recontracting risks for those systems.

"During the winter months of 2012 system utilization [on REX] dropped to approximately 70% after running mostly full from the time REX became operational," noted Pellecchia. "While in theory REX could take advantage of changing markets by connecting with Marcellus and Utica supplies to backhaul to the Midwest, the construction of pipeline laterals could require a significant financial commitment." Uncertainty about REX has led credit ratings agencies and energy analysts to scrutiny the pipeline's prospects (see NGI, May 14).

However, some pipeline systems may in fact benefit from accessing and shipping Marcellus Shale gas, particularly "demand pull" systems that serve high-demand regional markets, noted the Fitch team. In any case, a "high percentage of capacity" of firm shipper commitments probably would be secured before a lot of money was committed. "Due to growing production, current lack of infrastructure, increasing regional demand and contractual support, we would expect that an 'overbuild' scenario in the Marcellus is several years away."

In late 2010 Societe Generale analysts had predicted that a lack of capacity to carry Marcellus gas to New York City along the eastern Pennsylvania border would lead to a supply glut in 2011 (see NGI, Jan. 3, 2011). However, as gas prices stagnated, producers turned to wet gas to make up the difference. Operators then began installing more liquids infrastructure, which appears to have eased the oversupply situation.

Fitch analysts see roads widening for some Marcellus operators to consider consolidating. Because it's a core area for many smaller entities and a "high priority" for committed capital, consolidating could offer a route to improve credit quality for some of the small fry by "larger, better capitalized companies."

According to Fitch, "key" upstream players in the Pennsylvania portion of the Marcellus are Chesapeake Appalachia LLC, Talisman Energy USA Inc., Cabot, Range Resources Appalachia LLC, EQT Production Co., Anadarko E&P Co. LP, Royal Dutch Shell plc subsidiary Swepi LP, National Fuel subsidiary Seneca Resources Corp., Southwestern Energy Production Co. and Chevron Appalachia LLC.

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