The forward curve for natural gas supports 2019 production growth that is likely to far outpace expected gains in gas demand. This impending supply/demand imbalance suggests that gas prices will be pressured lower. Lower gas prices will boost demand, but there are real limits to how much demand can rise in the short term. What will really be needed to balance the market is for producers in at least a few plays — the Marcellus and Utica among them — to rethink and rework their 2019 production plans. Which raises the questions, how much will production growth need to be cut, and where will the bulk of the pruning occur? Today, we continue our review of key themes and findings in East Daley Capital’s newly updated “Dirty Little Secrets” report on the midstream sector.
Last time, we focused on East Daley’s discussion of the conundrum that while production and midstream-company earnings are rising, the valuations of these same companies have been lagging. The report, which considers a wide range of issues that factor into assessing midstream companies, points out that in the hyper-productive Shale Era, production of crude oil, gas and NGLs continues to increase even when prices sag, and while midstream-sector earnings have been growing with production, these positive trends are not being reflected in valuations, making many investors wary. East Daley’s analysis suggests that low valuations and investor wariness are tied in part to the difficulty of quantifying the risks posed by specific midstream assets. To tackle this problem, they developed a “Treadmill Incline Intensity” (TII) index for assessing each company’s exposure to revenue declines from legacy pipelines, storage and other midstream assets through 2022 — this exposure might be tied to contract roll-offs, marketing risks, tariff rate cases and/or production declines in less-productive basins. The index showed that some midstream companies are in for a real workout, while others are sitting pretty from a TII perspective, with little or no exposure to legacy cash-flow risk.
Today, we consider another timely aspect of the report’s analysis, namely its discussion of the substantive disconnect between the natural gas forward curve, which supports a steep rise in 2019 gas production, and the likelihood that gas demand will rise by only a small fraction of what’s needed to clear incremental gas supply this year. The catch is, gas supply and demand need to balance — not day-to-day, of course (gas can be put into storage), but over time — and the market cannot balance long-term when billions more cubic feet of gas are produced each day than can be reasonably absorbed. Based on the forward strip, East Daley estimates that U.S. gas production in 2019 will average 91.6 Bcf/d, an increase of 8.4 Bcf/d (or 10%) from 2018. Figure 1 shows that nearly two-thirds of the forecasted 2019 gains will come from the Northeast — the Marcellus/Utica region — with most of the rest coming from the Permian and the ArkLaTex area (which includes East Texas and the Haynesville play).