Summary
- Investors tend to think about natural gas prices based on Henry Hub, but that is just one listed price for gas.
- Permian producers frequently sell some or all of their natural gas locally, or rely on spot shipments on pipelines to get gas to market.
- Given natural gas in the Permian just fell to near zero, what implications are there for companies in the region?
Those that follow the oil and gas markets closely have long been worried about natural gas in the Permian. Prices have routinely blown out and gone to zero for periods of time since the discovery of the play. Those fears have returned, and for the better part of a year now, concerns from both upstream producers and the midstream companies that serve them have revolved around whether there would be enough takeaway capacity to handle all of the gas expected to be produced. Even without any interruptions or unforeseen activity, pipelines were expected to fill before relief would be on the way from boosted compression. Too much gas and too few pipelines is what leads to these basis blowouts.
It's happened now. Spot prices in Waha, the Permian gas benchmark, traded for as little as $0.20 per mmbtu recently - a stark discount to Henry Hub. While temporary, this shows how dire the setup is heading into 2023. In my view, the question that should be on investor minds is: Which publicly-traded companies are at risk and who stands to benefit?
Waha Gas Prices
In order to serve massive growth in gas production from the Permian, three major pipelines have come online over the past several years: Gulf Coast Express, Permian Highway, and Whistler. These three in total represent 6.0 Bcf/d in takeaway capacity combined, or a bit more than a third of dry gas takeaway. All three of these are running to the east to bring this gas to market. Pipelines need repair work from time to time and last week, Kinder Morgan (KMI) took Gulf Coast Express offline due to maintenance on three compressor stations, which ended up cutting daily flows by 0.6 - 0.9 Bcf/d. While this work was expected and of course temporary, Waha prices plunged as gas was stuck in the basin without a place to go given limited local storage.
This exemplifies the tight capacity going into 2023. Current dry gas production is up around 14.5 Bcf/d, with expectations for year over year growth of around 10.0% next year. That means that by this time next year, incremental Permian production growth will far exceed the capacity taken offline by this outage, and there is no meaningful expected change in capacity coming over the next six to nine months. Permian Highway and Whistler both have plans to boost capacity via adding additional compression, but that relief will not come until late in the year - and that's assuming all goes to plan.
Interestingly, the Gulf Coast Express open season has not yet had enough contracts to secure the expansion, with management pegging the blame on it being the last project to be pitched to market. Many producers have opted into the Matterhorn greenfield project instead (2.5 Bcf/d, online by late 2024 or early 2025) or the other compression expansions, leaving Gulf Coast Express mainly dealing with private producers that were slow to the negotiating table. As always, smaller firms are less likely to agree to the ten year (or more) duration contracts necessary to underwrite an expansion these days.
Zero prices might seem like it would cause producers to change their activity - but it might not for some. Crude oil pipelines do not have this issue, and in fact are underfilled to the point that spot shipments are incredibly cheap. So long as oil prices stay where they are, we're going to end up in the same situation as what occurred in the past: natural gas flaring by smaller producers that have not made ESG commitments. Broadly, since breakevens remain in the $30.00 - 40.00 per barrel range even assuming zero money received for natural gas, private players are still deep in the money with current oil prices. There is little reason to stop exploration as return on investment is still strong as a result, and without firm regulatory restrictions in Texas to limit flaring materially, expect privates to drill until spot market capacity for gas (hopefully) arrives.
Public Producers Low Exposure
Publicly-traded producers do not have this optionality. Pressured by activist investors and the market at large, nearly everyone has made at least some commitment to cut Scope 1 / Scope 2 emissions versus prior year levels, and increasing flaring versus prior levels would make those commitments dead in the water. If they did not have takeaway, there actually could be incentive to cut production just to keep some shareholders happy when it comes to these emissions goals.
Luckily though, pretty much every company I cover on the upstream side has already locked in enough firm takeaway to cover their 2023 production or has bought sufficient hedge protection via basis swaps. In fact, several firms (APA Corporation ( APA ), Diamondback Energy ( FANG ), Occidental Petroleum ( OXY )) have more firm takeaway than production, which means their marketing teams will have the opportunity to buy natural gas at Waha and sell on the other side for profit. That is not universal though, and some firms do have limited coverage. For instance, Marathon Oil ( MRO ) has no firm takeaway commitments, so they have full exposure to their Permian gas production, albeit balanced by their diversified product exposure. Others have limited exposure, so there is some mild potential hit (Ovintiv ( OVV ), Pioneer ( PXD )). But in basically all cases, even assuming absolute bear case assumptions, the issue is basically immaterial in the grand scheme of things.
Takeaways
Luckily for investors, this is a nothing burger when it comes to bearish prognostications - for now. Expect some companies to take advantage and make additional money on the marketing side - some examples above - but most are not going to see material shifts in their earnings outlook. But it does show just how important getting political and regulatory parties on board with expansions or new construction is. Without it, the Permian is going to be effectively capped when it comes to production growth.
For further details see:
Permian Gas Prices Plunged To Near Zero: What Is The Fallout