By OGJ editors
HOUSTON, June 25 -- Natural gas prices have fallen faster in the US Rocky Mountain region than elsewhere in the last 3 months because of increased coalbed methane drilling and resulting pipeline bottlenecks, said Raymond James & Associates Inc. analyst Wayne Andrews.
Henry Hub gas prices have hovered around $3-3.50/Mcf, while Rocky Mountain gas prices have fallen to the range of $1-2.50/Mcf.
Andrews expects the gas price differentials to narrow within 12 months because of pipeline expansion projects. Unfortunately in the meantime, "some gas producers' earnings will clearly be impacted negatively by this recent widening of basis differentials," he said.
In the long-term, however, strong Rocky Mountain gas supply fundamentals are prompting midstream pipeline companies to build additional Rocky Mountain capacity, which should ultimately lead to higher gas prices for the region's producers.
Gas price differentials
"Historically, the Rockies-Henry Hub differential has shown a seasonal trend whereby the gas price differential widens during the summer months when regional consumption of natural gas for heating declines," Andrews said. "Conversely, Rocky Mountain gas price differentials narrow during the winter months, when natural gas demand is at its peak," he said.
Normally in the spring, regional heating demand for gas falls and more Rocky Mountain gas is available for other areas of the country.
"Unfortunately for gas producers, there are simply not enough gas pipelines to transport all of the excess gas supply to other parts of the country. This bottleneck in pipeline capacity then creates gas-on-gas competition between producers to sell gas into the pipeline system, resulting in discounted price realizations for their gas," Andrews said.
Before 2000, increasing export capacity and modest volume increases kept the differential mostly below 50¢/MMbtu. But a drilling boom has caused the region's production to outpace its infrastructure expansion, amplifying the differential problem.
"In fact, the Rockies-Henry Hub differential peaked near $1.25/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. . .While most analysts have proven to be conservative in their benchmark natural gas price assumptions, we suspect that many did not take into account such a wide basis differential," Andews said.
Midstream pipeline expansions
The long-term solution is that midstream pipeline expansion in the Rockies should ultimately eliminate the differential problem, he said.
"The Rockies represent the single largest, untapped, onshore natural gas basin in the US. In other words, if producers expect to significantly increase production from an area over a long period of times, midstream companies must be 'incentivized' to build the pipeline to transport that production to market.
"Furthermore, the long-lived nature of the reserves in the Rockies should allow pipeline companies to capitalize their investment over a longer period of time, creating a higher return on investment. In fact, a number of midstream companies have already stepped up to build more export capacity," Andrews said.