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S&P Cuts Henry Hub Price Outlook With Shift to Appalachia, Lower Marginal Costs

Standard & Poor's Ratings Services (S&P) analysts on Thursday revised lower the firm’s price assumptions for crude oil and Henry Hub natural gas to reflect the shift in near-term futures price curves and a projection that marginal production costs would be lower because of improved drilling efficiencies by exploration and production companies.

The gas price assumption remains flat this year at $2.75/MMBtu, but it's expected to decline over the next two years as operators shift to the lower cost but highly productive formations in Appalachia, the Marcellus and Utica shales, said primary credit analyst Thomas Watters in a report Thursday.

For 2016, gas price assumptions were reduced to $3.00 from $3.25, and they were cut by 25 cents in 2017 to $3.25. Beyond 2018, gas prices are expected to average $3.50/MMBtu under S&P assumptions.

"We continue to see a fundamental shift occurring in the U.S. natural gas production profile; production has veered from the Southeast to the prolific Marcellus and Utica shale plays in the Northeast," Watters said. "We don't believe Marcellus and Utica have reached their full production potential, given the wide price differentials in those areas.”

However, the significant build-out of takeaway capacity scheduled over the next few years should narrow the differentials in Appalachia and lead to an uptick in output.

"These plays are extremely low cost and can quickly meet any uptick in demand," Watters said, from increased power generation, industrial production or liquefied natural gas exports, which effectively would create a cap on prices.

The shale boom also has led to more associated natural gas output. S&P analysts expect associated gas production to decline as oil-directed rigs are dropped, but "the decrease will likely be offset by production growth from the low-cost Marcellus and Utica shales."

S&P's expectation that Appalachia gas is going to offset losses in associated gas production is shared by Raymond James & Associates Inc., which issued an analysis earlier this week (see Daily GPISept. 21).

S&P also trimmed its assumptions for West Texas Intermediate (WTI) and Brent crude oil. WTI price assumptions have been reduced by $5.00 to $45/bbl for 2015, and by $10.00 to $50 for 2016. For 2017, price assumptions also were slashed by $10 to $60/bbl, while in 2018 and thereafter, the price assumption was set at $46. Brent prices for 2015 were cut by $5.00 to $50/bbl, and for 2016, they were reduced by $10.00 to $55/bbl. In 2017, S&P is forecasting Brent to average $65/bbl, $5.00 less than previous assumptions, while beyond 2018, the price was set at $70.

"Although our fundamental view of the industry over the next 12-24 months hasn't changed since our last update in March, the decline in our oil price assumptions represents the prospects of a more prolonged recovery," Watters said. "We believe some members of OPEC, particularly Saudi Arabia, are committed to maintaining production quotas for geopolitical reasons and to preserve market share, and we don't expect them to deviate from this position any time soon."

Even though many U.S. producers have trimmed their capital expenditures for 2015 by 30-40%, with gas and oil prices often lower than all-in drilling and production costs, "we haven't seen a significant decline in oil production," Watters said.

New wells drilled in the final three months of 2014 are continuing to support production, while exploration operators have shifted their capital to their most productive and profitable wells.

"In addition, we estimate that oilfield services costs have declined between 30% and 35% this past year, lowering breakeven costs," he said. "Moreover, many lower rated producers have above-market hedges in 2015, making it economically feasible for them to continue drilling."

Most producers also have enjoyed "abundant access" to capital so far this year, which has enabled them to continue to outspend cash flows.

S&P expects a "substantive" supply response to emerge late this year and into 2016 as hedges roll off, access to capital tightens and the natural decline curves in unconventional plays begin to have an effect.

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