US NATURAL GAS-1: Rockies Express pipeline to reshuffle gas supply, trade

June 25, 2007
The opening of the 1,663-mile Rockies Express Pipeline system, running from natural gas producing basins in Colorado and Wyoming to market in the Midwest and Northeast, will provide many US gas consumers with new access to cheaper gas from the Rocky Mountain region.

The opening of the 1,663-mile Rockies Express Pipeline system, running from natural gas producing basins in Colorado and Wyoming to market in the Midwest and Northeast, will provide many US gas consumers with new access to cheaper gas from the Rocky Mountain region. This development will cause a major reshuffling of US gas transportation patterns by allowing consumers to shift their supply portfolios away from traditional supply areas in the Midcontinent and Gulf Coast to more economic production in the Rockies.

This first of two articles examines the background of the REX pipeline project and analyzes the effect on US natural gas markets of REX Phases I and II.

The concluding article will detail the market reorganization expected to be brought about by the combination of REX Phase III’s completion and downstream capacity constraints.

Once the entire REX project is complete, its tariff rate structure will provide significant competitive advantage to REX shippers delivering to either Lebanon or Clarington, Ohio, compared to shippers bringing gas from supply areas in East Texas, South Texas, Louisiana, or the Gulf of Mexico.

This analysis only compares the variable components of each pipeline’s tariff: commodity charge plus fuel loss. The much larger demand component is considered sunk, and must be paid regardless of whether the shipper actually moves any gas. From a market perspective, therefore, decisions about which transportation alternatives influence shipper behavior and market pricing hinge solely on the variable cost.

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Assuming price differentials between market locations in the Rockies (Opal and Cheyenne) and the Gulf Coast are similar to 2006 averages, REX shippers will have a $0.90-1.17 advantage over shippers on Texas Eastern Transmission and Tennessee Gas Pipeline. REX shippers also will have a significant price advantage over shippers bringing supplies north on Columbia Gas Transmission, Texas Gas Transmission, and Panhandle Eastern.

Capacity constraints at Lebanon will restrict the ability of REX East shippers to unload 1.8 bcfd of incremental gasonce the pipeline has been completed. East of Clarington, constraints also will shape the ability of existing pipelines to absorb 1.8 bcfd of incremental volumes.

On peak days, therefore, constraints will exist on all of the takeaway pipelines, preventing absorbtion of incremental supplies. At other times, available capacity will exist to carry REX gas to the regions’ numerous large storage facilities, but during withdrawal periods constraints east of the storage facilities will prevent incremental volumes from reaching customers.

Accordingly, volumes delivered into the takeaway pipelines at either Lebanon or Clarington will, for the most part, need to be offset by reduced receipts from traditional supply sources.

REX volumes may also displace Anadarko and Permian basin volumes during 2008, prior to commencement of service for REX Phase III. The REX price advantage, coupled with the capacity constraints at Lebanon and east of Clarington, suggests that significant volumes of Texas, Louisiana, and Gulf supplies will be displaced by REX supplies, increasing gas-on-gas competition in the gulf area. These gulf supplies will be forced to compete for other markets, presumably in the Southeast and in the Texas-Louisiana intrastate market.

Continuing this domino effect, some of the turned-back volumes will flow into the southeast legs of ANR, NGPL and to Trunkline. When REX volumes begin moving to eastern markets, however, Anadarko and Permian basin supplies should find their way back into their traditional Midwestern markets.

Gulf supplies will also come under pressure from production increases in the East Texas, Fort Worth, Arkoma, and Arkla basins. Increases in Northeast power generation demand could absorb some incremental supplies given new pipeline capacity east of Clarington to deliver REX supplies to the new markets. Lower Canadian imports also could make room for additional REX supplies.

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Each of these developments will reshape regional supply-demand balances as the REX displacements roll through the market.

The REX gas flow displacements and other supply-demand developments will result in a radical realignment of regional price differentials. The Rockies-to-gulf area price realignment will be the most dramatic: Rockies prices will rise to near parity with the gulf and under some scenarios could even rise above the gulf. The differential between Ohio price points such as Lebanon (Columbia and Dominion Transmission-South) and Gulf Coast prices will fall sharply. Once REX East is open to Clarington, Chicago-Ohio price differentials will flatten.

Recontracting on existing pipelines will also fuel realignment. Between 2007 and 2010, a number of contracts for firm capacity will come up for renewal. As local distribution companies hold most of the capacity on these pipelines, the next 3 years may see considerable realignment of their supply portfolios.

REX pipeline

The initial segment of REX Phase I went into service in February 2006 with completion of the pipeline segment formerly called Entrega, a 136-mile leg connecting Uinta-Piceance production in the Greasewood, Colo., area with Wyoming Interstate Pipeline and Colorado Interstate Gas at Wamsutter, Wyo. The segment completed in February 2007 extended REX east to Cheyenne Hub. Through a long term lease with Overthrust Pipeline, REX Phase I can also move up to 1.5 bcfd from the Green River-Overthrust area (near Opal, Wyo.) to Kanda, Wyo., and on to Cheyenne Hub.

REX Phase II is to begin commercial operation in early 2008, extending the system from Cheyenne Hub to Mexico, Mo. Capacity at Cheyenne will increase to 1.6 bcfd with the addition of compression. REX Phase III, planned for completion in 2008 and 2009, will extend the pipeline first to Lebanon and then to Clarington, Ohio, increasing overall capacity to 1.8 bcfd.

When completed, REX will span 1,663 miles and will be one of the US longest interstate pipelines.

Phase I

Within a few days after Phase I was placed into service, gas transportation patterns changed in ways that enabled more gas to flow from southwestern Wyoming to Cheyenne Hub (OGJ, Apr. 2, 2007, p. 56).

Before the shift, Uinta-Piceance gas received into REX in the Greasewood area moved to Wamsutter, where it was delivered to either Colorado Interstate Gas or Wyoming Interstate Co. Gas received by these two pipelines moved either west to Kern River and Questar or east to Cheyenne Hub. Capacity to Cheyenne Hub was usually at maximum utilization.

When REX Phase I capacity from Wamsutter to Cheyenne Hub became available, the gas that had moved to CIG or WIC stayed on REX all the way to Cheyenne Hub. That opened capacity on WIC from Wamsutter to Cheyenne Hub, and that capacity quickly filled. The volume previously moving on WIC from the Uinta-Piceance area was replaced by Green River-Overthrust volumes received from Overthrust pipeline.

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Fig. 3 shows what happened. REX flows into Cheyenne Hub jumped to about 300 MMcfd within a few days. While there was a small initial dip on WIC, volumes have held very steady on both WIC and CIG.

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Fig. 4 shows that basis at Opal averaged $0.73 less than Henry Hub from January 2005 through that summer. The Opal price was well below Panhandle Eastern and NGPL prices during the same period. After the hurricane-related disruptions of 2005, Opal basis again settled into a range averaging about $1.00 less than Henry. But in the summer of 2006 the specter of transportation curtailments emerged, and by November, Opal was running $2.50/MMbtu less than Henry, spiking to minus $5.00/MMbtu Nov. 14 due to mechanical problems at Opal.

REX Phase I brought no relief. In fact, the Opal to Henry Hub differential has widened since February 2007. The month-to-date May 2007 average differential has exceeded $3.00/MMbtu.

Although Phase I has increased capacity to Cheyenne Hub, factors including increased Rockies production, capacity constraints, maintenance issues, and rate-stacked tariffs farther downstream continue to pressure Rockies prices.

Phase II

REX Phase II is scheduled to go into service in January 2008. It will connect REX Phase I to Panhandle Eastern Pipeline, near Mexico, Mo. (Fig. 5). Phase II includes construction of 713 miles of pipeline, several compressor stations along both it and the Phase I pipeline, and an additional supply lateral to Echo Springs, Wyo. Phase II will have the capacity to deliver 1.6 Bcfd to its Missouri terminus.

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Phase II of REX will provide access to five interstate pipelines: ANR, Kinder Morgan Interstate, NGPL, Northern Natural Gas, and Panhandle Eastern. Analyzing available pipeline capacity and flows north of the REX interconnections with these systems shows that the key pipelines moving gas into Midwest markets (ANR, NGPL, NNG, and PEPL) have bottlenecks that will limit the gas they can receive from REX, unless they reduce traditional supplies from the Anadarko or Permian basins.

ANR’s bottleneck constrains the entire mainline system from the Greensburg compressor in southwestern Kansas to points near Chicago. On Northern Natural Gas, the bottleneck is between the field zone and market zone as defined in NNG’s tariff. NGPL’s bottleneck lies where the pipeline crosses into Mills County, Iowa, from Nebraska. The bottleneck on Panhandle Eastern is between its Haven and Houstonia compressors in eastern Kansas and western Missouri.

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Fig. 6 shows the location of each of these constraint points as well as daily flows at each point since Jan. 1, 2005. In 2006 ANR had virtually no available capacity as it ran at an average utilization rate of 98%. Panhandle also was nearly full, having an average utilization rate of 92% throughout 2006. The average annual utilization rate on NGPL was 89%; the summer months averaged 87% while the winter months averaged 90%. Northern Natural Gas was the only pipeline with significant unused capacity. NNG’s utilization averaged 78% of capacity during the year, including 71% during the summer months and 88% during the winter months.

Bottlenecks on these pipelines to move additional supplies into Midwest markets must either constrain volumes moving into these pipelines from REX or back out supplies moving into these markets from their traditional sources of supply in the Permian and Anadarko basins.

The most cost effective supplies will win this gas-on-gas competition and REX has a significant technological advantage over its competitors, allowing it to operate with a maximum allowable operating pressure up to 1,480 psig, compared to 700-900 psig for ANR, NGPL, Northern Natural Gas, and Panhandle Eastern (as measured at their bottleneck points). This advantage translates to lower charges for fuel and “lost and unaccounted for” gas in the REX tariff. Accordingly, the proposed tariff for REX is very competitive as compared to rival pipelines.

The competitive relationship between REX and these four pipelines should lead quickly to significant shifts once REX begins to flow east of Cheyenne Hub. Permian volumes will be the first to realign. Assuming that the existing price relationships between Cheyenne, the Anadarko, and Permian persist, the opening of REX Phase II will push significantly greater Permian volumes back to either the Texas intrastate market or to markets in California and Arizona.

Rockies supply also will realign, with REX cannibalizing volumes from Cheyenne Plains. Shippers on either NNG or PEPL that use Cheyenne Plains to transport Rockies supply to the Anadarko will gain a significant advantage by shifting their supplies to REX. Accordingly, REX will pull significant volumes from Cheyenne Plains.

Finally, competition from REX will cause Anadarko volumes to be pushed back into the Oklahoma and Texas intrastate markets. Assuming the current price differentials between Cheyenne and Anadarko, shippers on Northern Natural Gas, Panhandle Eastern and ANR all would be able to purchase gas at Cheyenne and move it to their respective pipelines at a lower cost than procuring supplies and transportation from the Anadarko. At first quarter 2007 price differentials, REX’s costs are $0.07-0.18/MMbtu cheaper, a significant margin.

How much market share REX ultimately captures will depend on the magnitude of incremental Rockies production in 2007-08. Expansion by Rockies producers at current rates could force significant volumes of Anadarko gas to find markets elsewhere.

The unrealistic assumption that current pricing relationships remain unchanged underpins these supply realignment expectations. Clearly they will not. Employing this assumption, however, reveals the market pressures that will be created by REX II.

The realignment of pipeline flows brought about by the economic advantages of REX Phase II will lead to significant shifts in historical pricing relationships. In the Rockies, the introduction of new transportation capacity, and thus new demand pressure, will raise prices relative to other regions of the market. In the Permian and Anadarko, new competition from Rockies gas will constrain access to markets in the Midwest, decreasing prices relative to other regions.

For example, in 2006 Anadarko prices were typically 11-13 cents higher than prices at Cheyenne Hub. REX will drive Anadarko prices toward parity with Cheyenne Hub and Opal. Permian prices also will fall relative to Cheyenne Hub.

This first wave of flow realignment and shifts in price differentials will be temporary. Less than 1 year after REX II, REX III will create an entirely new array of realignment pressures in the East and Gulf regions, and in some cases will undo the market pressures created by REX II.

Phase III geography

REX Phase III (designated REX East in FERC documents) is scheduled to enter service in two stages over 7 months beginning in December 2008.

Phase IIIa (Fig. 7) extends from the eastern terminus of REX West to Lebanon, Ohio. This segment of REX East is to begin service in December 2008. Phase IIIb, the second segment of REX East, extends from Lebanon to Clarington (Fig. 7). It is to begin flowing in late June 2009. When completed REX East will be able to deliver 1.8 bcfd to Clarington.

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REX East will access four interstate pipelines with the ability to move gas to Eastern markets, six with the ability to move gas to Midwestern and other markets, and several local utilities (see box),

REX East delivery points directly access utility markets primarily in Ohio. Cincinnati Gas, East Ohio, and Vectren (formerly Dayton Power & Light) are the major Ohio gas utilities and all will connect directly to REX. Citizens Gas and Indiana Gas, both in Indiana, will also connect directly to REX.

In addition to these utility markets, REX shippers will be able to supply markets in the Northeast. Northeastern shippers will be able to flow gas through REX to Dominion Transmission, Columbia Gas Transmission, TETCO, Tennessee Gas Pipeline, and to storage fields in western Pennsylvania or other locations east of Clarington.

Gas moving through REX East can also access the upper Midwest. ANR, NGPL, Panhandle Eastern, and Trunkline have interconnections with REX that will enable Rockies’ gas to flow to Chicago, Michigan, and other upper Midwest markets. Since Ohio and northeastern markets have typically carried higher prices than Chicago markets, this analysis assumes that, if economically feasible, Rockies’ gas will move past the Midwest markets to markets in Ohio and the Northeast, yielding higher netbacks to Rockies’ producers.

The concluding article in this series will focus on the competitiveness of the REX East option as a supply source for the Ohio and Northeast markets.

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While customers of the four primary pipelines that will receive gas from REX East-Columbia, Dominion, TGP, and TETCO-obtain their supplies from a variety of sources, the primary source is the gulf region. Fig. 8 shows the origin of the gas that serves these markets.

The authors

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Porter Bennett is president and CEO of Bentek Energy LLC, Golden, Colo. In his early career, Bennett held positions with consulting companies specializing in energy market analysis. He holds an MS in mineral economics from the Colorado School of Mines and an MA in international affairs from Columbia University in New York. He received a BA in history from Lewis & Clark College, Portland, Ore.

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E. Russell Braziel is vice-president, marketing and sales, and chief technology officer for Bentek. He was previously vice-president of business development for the Williams Cos., vice-president of energy marketing and trading for Texaco, and president of Altra Energy Technologies. Braziel holds BBA and MBA degrees in business and finance from Stephen F. Austin University, Nacogdoches, Tex.

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Jim Simpson is vice-president, operations, for Bentek. Before joining Bentek, Simpson modeled large structured transactions in both gas and power for Enron North America. Subsequently he led natural gas marketing and trading at MarkWest Hydrocarbon Inc. Simpson holds a BBA in finance from Texas A&M University.

REX interconnects

Interstate pipelines to eastern markets
Columbia Gas Transmission
Dominion Transmission Interstate
Tennessee Gas Pipeline
Texas Eastern Transmission

Local utilities
Citizens Gas
Indiana Gas
Cincinnati Gas
East Ohio

Interstate pipelines to midwestern markets
NGPL (from Brown County, Kan.)
Texas Gas Transmission
Panhandle Eastern
Midwestern Gas Transmission - has connections with TGP on the southern end of its system and is currently flowing gas that direction.