How does ‘close to zero’ sound for your natural gas?
At East Daley Analytics, we’ve been warning of a challenging year in 2023 for gas in the Permian Basin. We see the recent market volatility as a warning of what’s likely in store for producers and midstream companies: close-to-zero value for their gas, and close-to-zero hope for a quick turnaround.
For two weeks in December, natural gas at the Waha hub was nearly free. Day-ahead Waha prices traded as low as $0.04/MMBtu on Dec. 8, and the following week Waha traded as low as $0.05/MMBtu on Dec. 13.
Traders pointed to pipeline maintenance for the plunge in Permian natural gas prices. Work on the Permian Highway Pipeline (PHP) removed up to 1 Bcf/d of basin takeaway at times, leaving gas supply bottled in the basin. In early November, Waha prices fell below zero during similar maintenance events on outbound Permian pipelines. Adding insult to injury, the latest collapse occurred as West Coast gas prices traded as high as $45/MMBtu at the Southern California border amid extended below-normal weather across the western U.S. But with Line 2000 of the El Paso system offline, pipeline capacity from the Permian to the West Coast was limited.
While pipeline maintenance is the proximate cause for the market plunge, this fails to capture the big picture. For the real culprit, we look to the industry downturn in 2020-2021. Producers in the Permian slashed spending as commodity prices fell, and midstream companies mothballed pipeline expansions. That lull in planning left the industry unprepared as oil and gas prices rebounded in 2022 and Permian drilling activity rose sharply.
The looming Permian gas pipeline shortage has been a focus of East Daley’s dating back to our 2022 Dirty Little Secrets (DLS) report one year ago. We highlighted in our annual DLS outlook that 68% of U.S. gas supply growth through YE2025 would come from the Permian. This growth puts tremendous pressure on the midstream sector to move growing volumes to markets and would require another large takeaway pipeline from the Permian by 2023. In a follow-up note to clients in March 2022, we warned, “Permian egress capacity steadily tightens in our model through 2022, and dry gas supply hits the effective pipeline capacity leaving the basin by early-to-mid 2023.”
Since then, several pipeline projects moved ahead in 2022. Partners WhiteWater Midstream, EnLink Midstream, Devon Energy and MPLX reached a final investment decision (FID) on the Matterhorn Express Pipeline. New compressor expansions on the Whistler and Permian Highway systems are also moving forward. These projects will add much-needed capacity to industrial markets and planned LNG export projects planned on the Gulf Coast. But building new pipelines requires long lead times, and most of these projects under FID will be too little, too late to address the supply bottleneck in 2023.
East Daley tracks the Permian supply and midstream outlook each month in our Permian Supply & Demand Forecast, including perspectives on gathering and processing and gas pipeline takeaway. We currently expect Permian residue gas supply to grow by 1.6 Bcf/d at YE2022 and add nearly 1.9 Bcf/d of growth by year-end 2023 in our ‘unconstrained’ outlook.
While nameplate pipeline capacity out of the Permian suggests there is room for growth, some portion of this capacity is only used for seasonal demand (i.e. exports to Mexico) or is unavailable due to downstream constraints. More important is the so-called effective pipeline capacity leaving the Permian, which is East Daley’s estimate of the available capacity that determines constraints and thus basis blowouts. With steady production growth, our basin model shows Permian gas supply reaches the upper limits of effective pipeline takeaway as soon as February 2023.
Given that Permian rig activity remains strong and spare takeaway is on a knife’s edge, we see recent price volatility as the new norm. Based on our Permian model, pipeline takeaway in first-quarter 2023 will become a steady constraint on supply that is likely to lead to a daily drumbeat of low prices for shippers trapped in the basin.
Looking ahead, we would expect pressure on Permian gas prices to grow as winter heating demand wanes, cutting some northbound demand for gas. There is no relief in sight until Kinder Morgan completes repairs to its El Paso Line 2000, which we estimate in the spring of 2023. Thereafter, basin operators see only modest relief as compressor expansions are added to PHP and Whistler. In fact, our basin outlook shows a near-constant friction between supply growth and access to markets until the Matterhorn pipeline begins service in fourth-quarter 2024.
In this market environment, pipeline contracts are an increasingly valuable commodity. Operators who planned ahead will separate from those who failed to secure downstream access to markets. And for the midstream sector, systems in the Permian that perform services priced off commodity prices will likely see their financial performance suffer, while fixed-rate providers weather the storm.
In the meantime, buckle up for a wild ride ahead.
Justin Carlson is co-founder of East Daley Capital Advisors in Colorado.