Shale oil and gas producers have, arguably, saved America’s industrial future and global strategic position. They are not doing quite so well for their investors.
Consider the share price of the most innovative exploration and production companies in the northeastern US, our new Texas. Range Resources’ shares have declined by 18 per cent this year, Cabot Oil and Gas is off by 17 per cent, and Chesapeake is down nearly 7 per cent. One would think developing a nation-saving set of miracle technologies would pay better.
The E&P’s collective problem is that they are victims of their own success in producing more oil and gas for fewer dollars than almost anyone would have thought possible.
ON THIS STORY
View from the US Kurds and the ruthless compliance tribe
View from the US ‘Hot’ Kurdish oil, cold legal comfort
$1tn of new oil projects ‘uneconomic’
Prepare now for fossil-free future
View from the US Checkmate for cheap unconventional gas
ON THIS TOPIC
Rising shale output disrupts US gas prices
Smart Money Shale investing – sweet spot or sink hole?
Water shortages pose threat to shale gas
Mapping the US oil boom
VIEW FROM THE US
Midterm shootout at the Dodd-Frank corral
It is time to sell momentum and buy value
ECB frontrunner in evil Anglo-Saxon race
Stuck in the re-election waiting room
Six months ago, it seemed as though the E&P companies would finally have a chance to make some serious money, or at least more than they have to spend to get natural gas out of the ground. The rise in gas demand thanks to the polar freeze gave the industry some hope that US prices would start to rise to the $5/million metric British thermal units level.
But no. Oil prices have been weak both in global markets and in the US, but not weak enough to induce deep cuts in the E&P oil-directed drilling budgets. The “associated” gas produced by those shale oil rigs has flooded the US domestic market this year, more than offsetting declines in conventional gas production and older shale gasfields. So the E&P companies could not stop themselves from producing gas at less than the US marginal cost of production.
The E&P companies’ revenues were further squeezed because much of the new natural gas and liquids they have developed was at the wrong end of the country’s existing pipeline system. For the past seven decades, US pipelines have mostly taken oil and gas from the southwest and transported it to the northeast.
The unexpectedly large and rapidly developed Marcellus and Utica
fields disrupted the economics of
this expensively developed system.
Because new pipelines need extensive planning permissions, long term financing and scarce skilled labour, the E&P companies have had insufficient capacity available for their product. There is so much competition for access that gas and liquids can only be sold at steep discounts, or “basis differentials”, to the generally quoted Henry Hub pipeline price, when they can be sold at all.
The other side of this perverse outcome for investors in the highly innovative E&P industry is that the more conservative, you might say bankerly, investors in pipelines have been doing far better than they could have expected a couple of years ago. The owners of pipelines and processing plants have profited from taking on a flood of natural gas liquids from desperate E&P sellers in the northeast.
On top of that, they can demand high rates for whatever space is available on new or planned pipelines. As Andy DeVries of CreditSights says, the “basis differentials are fantastic for owners of long-haul pipelines out of the Marcellus, in any direction.”
Not only can the pipeline owners collect per-mcf rates for new lines that can be up to three times what they were getting just a year or two ago, but the backlog of well connections substantially reduces the risk of supply shortfalls. The result is a deluge of multibillion pipeline deals headed investors’ way, with monopoly revenues underpinned by the approval of Federal regulators. In a world still starved for yield, the investment grade pipeline paper generally pays between 100 and 150 points off the Treasury curve, and the junk bonds over 200 basis points.
Nothing terrifies the Federal and state governments more than the idea of winter blackouts, so permitting delays for the planned pipelines are being minimised. According to Jack Weixel of Bentek in Denver, there are proposals for new pipelines out of the northeastern states that would add 41bn cubic feet per day of capacity; that would cover a bit less than two-thirds of total US consumption. Not all of that will be built, but still, the pipeliners are ambitious.
Does this mean a low-risk, high-return asset boom created by shale oil and gas technology is going to be harvested by Wall Street and Houston financiers aided by their Washington regulatory fixers? In other words, people who read the FT rather than drilling equipment journals? Well, if the pipeline sponsors have their way, it does, except that demand in the US just is not growing enough.
Even with coal generator shutdowns driven by environmental costs and fuel economics, there is going to be a lot of extra gas on tap in America for a long time. The gas industry’s somewhat parochial, North American-focused management will have to be more export-minded. That will probably lead to a lot of M&A activity to develop internationally competitive combinations of pipeliners and E&Ps. That is what the American oil industry did over a century ago.