U.S. natural gas production growth has spurred a massive build-out of natural gas pipeline capacity in recent years, and a lot more is on the way, particularly out of the Northeast. To Marcellus and Utica producers eager to improve returns on their investments, this incremental pipeline capacity is a long-overdue relief valve for the pressure that’s been building in the region from growing supply congestion and low prices. But pipeline development is an expensive, long-term endeavor, and few, if any, pipeline projects are slam-dunks. Also, market conditions initially driving the development of new takeaway capacity may change, putting a project’s relevance—and, in turn, its utilization and profitability—at risk. In today’s blog, we begin a look at how midstream companies and their potential shippers evaluate (and continually reassess) the economic rationale for new pipeline capacity in today’s very changeable markets.
When you consider the fundamentals of any commodity market and what drives price, you may think primarily of supply and demand. In reality, though, the market is a three-legged stool, with the third leg being transportation capacity. In the U.S. natural gas market, that critical third leg is the extensive inter/intrastate pipeline network that connects supply basins (sellers) to demand centers (buyers). The availability (or lack) of pipeline capacity drives prices and price relationships by controlling how supply connects to demand. By getting enough capacity in place, midstreamers and the customers who pay for that capacity can ensure supply reliability, increase optionality and market liquidity, relieve bottlenecks and enable both supply and demand to grow. New pipeline development is driven by either need or opportunity, and more often than not, a combination of the two. The key question pipeline developers and their customers (the shippers) have to consider before ponying up for new capacity is whether it will “pay” to flow gas on the pipeline once it’s built—and for a lot of years after that. To answer this question, developers and shippers have to consider both current and future economics. There are three fundamental factors that drive pipeline economics: 1) future supply dynamics (and the resulting price impact) at the origination point (Point A); 2) future demand (and price) at the destination point (Point B); and 3) the transportation cost to flow gas from Point A to Point B. For the most part, for a pipeline to be “worth it” (i.e. successfully utilized), the supply (origination) price had better be lower than the demand (destination) price by more than it costs to transport over the pipeline. This gets complicated, because as soon as additional capacity is added, the bottleneck that was causing the price differential between A and B gets less “bottlenecky,” so the supply price will increase as access to the market eases, and the demand price will drop due to the access to additional supply.
The Northeast region, marked by rapid natural gas production growth and a shortage of outbound pipeline capacity, in recent years has been the poster child for favorable economics for pipeline development. In five short years (between 2010 and 2015), production from the Marcellus/Utica shales grew by more than 16 Bcf/d, while demand grew by only 3 Bcf/d. As a result of the rapid production growth, the historically supply-short region became increasingly supply-saturated but was still woefully cut off from many of its own destination markets, particularly New York and New England. It also lacked the infrastructure to flow gas out of the region. Ring-fenced by the lack of takeaway capacity, new supply volumes initially were able to displace some of the inbound supply (mostly from the Gulf Coast) that had previously served regional markets (at least the ones it could reach). That emptied out most of the legacy long-haul pipes that used to bring gas into the Northeast — all that inbound capacity got increasingly obsolete. But Marcellus/Utica supply just kept rising, to the point that by 2015, the region was swimming in more supply than it could burn locally—it needed a way out.