Associated methane production from crude focused drilling in West Texas has undeniably impacted the overall North American natural gas market over the past several years. Following the price collapse in Q1 2016 (WTI and NYMEX NG) a rebalancing of both crude and natural gas markets was set in motion. In particular, the crude focused rig count in West Texas skyrocketed in response to the ‘deliver more liquids’ price signal.
For approximately 3 years the WTI strip continued to deliver this price signal, and producers in the Permian did not disappoint. Crude and natural gas production exploded. Of course there is always a lag effect between the price signal to increase supply, and the ultimate delivery of incremental hydrocarbon molecules. Crude production in the Permian was within 100,000 barrels per day of the 2 million mark from mid-2015 until late 2016, and then the rig additions finally began to bring on waves of new supply. By Q1 of 2020, crude production, per EIA data, had risen to just under 5 million barrels per day.
Drilling activity in the Permian fell to 135 active rigs in Q2 of 2016, and responding to price, subsequently increased to just under 500 rigs by November of 2018. Chasing improved returns on a crude barrel created a noteworthy amount of ‘unwanted’ natural gas. According to the same EIA data set (DPR) natural gas production in the Permian climbed from just under 7 Bcf/d in Q1 of 2016 to over 17 Bcf/d by the first quarter of 2020. It is important to note that natural gas production in this EIA data set, as well as in state reported production data, does not disaggregate the dry and wet streams of natural gas. In other words, NGLs are lumped in with methane, with the whole lot being deemed natural gas.
Prior to the events noted above there was already a mountain of crude takeaway projects planned and underway. When WTI was trading more than $100 per barrel in 2013-2014 crude producers were eager to sign up for both brownfield and greenfield pipeline capacity to get barrels to the Gulf Coast. By early 2015 a steady slate of large diameter high-capacity crude takeaway projects began entering service. From November 2014 until Q1 of 2018, these pipeline expansions created a free-flowing path to the Gulf Coast. Other than a 9-month period in 2018 a West Texas crude barrel has been anything but constrained, and presently the bid to fill crude pipeline capacity from West Texas to the Gulf Coast remains strong.
Over much of this period, new natural gas takeaway capacity was overlooked. This stands to reason since Waha basis hadn’t yet created material concern for producers, which in turn creates the opportunity for pipeline companies to sell new capacity. Basis blowouts, whether already present or imminent, are the ideal time for those players to sell capacity for a handsome return. From 2014-2017 the average Waha Index price realized at a $0.20/MMBtu discount to Henry Hub, on a range of -$0.69 to +$0.42.
It took until May of 2018 before ground was broken on the first large diameter natural gas takeaway project from the Permian to the Gulf Coast. For this discussion, we are leaving out the pipeline expansions from West Texas to Mexico, and acknowledge they are decidedly relevant yet worthy of a Friday Focus of their own. The May 2018 ground-breaking for the Kinder Morgan Gulf Coast Express pipeline occurred almost precisely at the moment when Waha basis began to crater. The May 2018 Waha index price was $1.41 behind Henry Hub and the prior month was similar at -$1.37.
Although the 2 Bcf/d Gulf Coast Express project was completed in the fall of 2019, it wasn’t until the Kinder Permian Highway Pipeline entered service (approx. 1 year later) that Waha basis snapped back to a level which made producers in West Texas more aware of the value created by a methane molecule. Over a 3 year period from January of 2018 to December of 2020 Waha index prices realized at a $1.41 discount to Henry Hub, which coincidentally is squarely on top of the levels observed at the beginning of the Waha basis blowout. In absolute terms the value of a Waha facing methane molecule in the month ahead market was a paltry $1.18/MMBtu in this same 36-month period. At its worst Waha indexed at -$0.29, which was the third such instance of negative month ahead pricing in West Texas from Jan 2018 to Dec 2020.
At present there has been 4 Bcf/d of greenfield pipeline capacity to enter service with a West Texas to Gulf Coast linkage. This seems to have solved any issues in West Texas re: constrained methane molecules. Importantly, the additions are not done yet with the WhiteWater Midstream Whistler Project (2 Bcf/d) set to enter service in late 2021. The combination of the two already in-service projects has allowed Waha forward basis prices to improve such that a West Texas producer is now capable of seeing a forward NG revenue estimate of approximately $2.50 from May 2021 through December of 2022, which represents roughly a $0.15 discount to Henry Hub. The contribution of Whistler capacity in 2022 will at the very least prevent a retracement of the recovery of West Texas NG prices.
Although the contribution of methane revenue to the overall margin equation for a West Texas producer is small relative to the value of a crude barrel, the higher an individual producer’s % of NG in the stream is the more impactful stronger Waha forwards become. From a fundamental perspective, we continue to see greater upside v. downside risk to the NYMEX benchmark location, and would advise producers holding open Waha exposure to consider the asymmetric impacts of either A) hedging NYMEX exposure only, or B) ignoring a $1.00+ per MMBtu rally for in-basin pricing.
Zane Curry
Zane has been with Mobius Risk Group since February of 2016. His primary responsibility is a fundamental analysis of the North American natural gas market. Additionally, he assists in the valuation of gathering, processing, transportation, and physical sales agreements. His experience in energy has been focused on natural gas, however, as the North American hydrocarbon value chain has become a more integrated system his knowledge has expanded to crude oil, petroleum products, and seaborne LNG. Prior to joining Mobius, Zane spent 6.5 years with a Houston based hedge fund (Goldfinch Capital) with AUM of approximately $750M. In his time with Goldfinch Capital, Zane was tasked with developing detailed models of the North American natural gas market, including 1st derivative components such as power generation by fuel source, supply side impacts of liquids focused drilling, etc. Zane is a graduate of Rice University, and a former member of his alma mater’s baseball program as both a player and coach.