Pipe Capacity on the Way to Relieve Rockies Bottleneck

While hasn't there been a slow-down in the frenzy of exploration and production activity in the Rockies since gas prices in the region have plummeted in the last few months while prices in other areas of the country have experienced much softer declines? The answer, according to Raymond James & Associates analyst Wayne Andrews, is that significant new pipeline infrastructure is on its way to help relieve continuing constraints.

"While Henry Hub gas prices have fallen from the mid $7/Mcf range to below $4/Mcf, Rocky Mountain gas prices have fallen from the mid $7/Mcf range to below $3/Mcf," Andrews noted in the company's Stat of the Week report. "This basis pricing differential between the Rockies and other areas has widened considerably as pipeline limitations have created a gas supply chain bottleneck."

Andrews explained that the Rockies/Henry Hub differential has historically widened during the summer months, and narrowed during the winter when gas demand is at its peak. The fluctuation occurs because midstream companies can charge higher transportation rates when demand is low, forcing producers to realize a discount price for their gas.

"Nevertheless, prior to 2000, increasing export capacity from the Rockies and modest volume increases kept the differential below $0.50/MMBtu," Andrews said. "More recently, however, the boom in drilling activity during the past several years has caused production to outpace additions to infrastructure, effectively amplifying the differential problem. In fact, the Rockies/Henry Hub differential peaked near $1.30/MMBtu last summer before receding during the winter months, and has already reached that level again this summer. Consequently, some Rocky Mountain natural gas producers may not be able to meet expectations for earnings and cash flow because they are realizing lower prices."

However, studies have shown that the area is large and filled with precious long-life reserves, and once adequate pipeline infrastructure is in place, the exploration and production (E&P) companies in the region will be able to produce at capacity.

Andrews suggested that while many analysts normally take the conservative route regarding natural gas price assumptions, many this year did not take into account such a wide basis differential. In the near term, he advises production companies in the area to hedge production and/or the basis differential when the pricing environment is favorable. He also said that locking in firm transportation capacity agreements to erase seasonal peaks and valleys in the differential can help.

Pipeline expansion in the Rockies will "ultimately eliminate the differential problem." According to the Independent Petroleum Association of Mountain States (IPAMS), more than nine new pipes and expansion projects totaling more than 3 Bcf/d of incremental capacity are currently expected to be complete before November 2003, with four additional projects with unreleased in-service dates.

To accommodate the growing Powder River Basin production, Fort Union Gas Gathering LLC is expanding by 200 MMcf/d (see NGI, Jan. 22). IPAMS said the company now expects to be finished with the expansion ahead of schedule this month, as opposed to the company's previous expectations of the fourth quarter.

Also jumping into the fray, Duke Energy Field Services (DEFS) and BP America Inc. reported last week that they have entered into a 12-year agreement to expand gathering and processing infrastructure and services to accommodate BP's Greater Green River Basin drilling program in Wamsutter, WY (see related story this issue).

"Overall, this expanded infrastructure will enable new gas supplies to be delivered to consumers within the Midwest market areas," said Steve Blossom, asset manager for BP.

"The bottom line is that widening Rockies/Henry Hub basis differentials will likely prove to be a short-term, seasonal issue and not have a material longer-term effect on activity or company valuations in the Rockies," Andrews said. "That being said, the potential for those basis differentials to remain large or even widen further, increases the possibility of some producers falling short of their earnings estimates in the near term."

Andrews added that many E&P companies in the region have already taken measures to protect against the differential and will not be affected greatly. The hustle and bustle of recent E&P and pipeline activity in the region are evidence of the vastness and potential of the Rocky Mountain play, he said.

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