As natural gas prices in the Rocky Mountain region over the last few months have fallen much further than other areas of the country due primarily to transportation constraints, the question becomes, why is the region currently experiencing a frenzy of exploration and production activity, when pricing signals point toward restraint? The answer, according to Raymond James & Associates analyst Wayne Andrews, is that new pipeline infrastructure is on its way to the region, and in a big hurry.
“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 said 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 out of the region 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.”
But 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, the analyst 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 also help.
As for the long run, Andrews said that midstream 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 and expansion projects totaling over 3 Bcf 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 announced plans in January for a 200 MMcf/d expansion of capacity on its system (see Daily GPI, Jan. 18). 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 on Monday 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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