Natural Gas Producers On Roll, Biden Could Be A Roadblock
Dan Eberhart, Forbes, September 10, 2021
After years of tough times, the natural gas industry is booming. The future looks bright – unless the Biden administration targets clean-burning gas in its climate agenda.
In Appalachia, the largest U.S. gas basin, natural gas prices are more than double last year’s average, which has turned producer focus on funding operations by generating free-cash flow into a gold mine.
As a result of those swelling coffers, nearly all of the large independents in the Marcellus and Utica shale plays are reducing debt and getting in a position to return capital to investors within 18 months.
This remarkable turnaround from the dire market conditions of just two years ago has been driven by investor demands for capital discipline that emerged from the severe 2018 and 2019 downturn. These same Appalachian pure plays – dominated by some of the largest U.S. gas producers – were hanging by a thread as capital markets all but slammed shut.
Sticking to capital and production discipline – even with the U.S. gas forward curve in a $3 to $4 per million Btu range through winter 2022-23 — and deploying free cash flow to the balance sheet has become harder as U.S. demand continues to rise along with tempting potential profits. However, the strategy has paid off handsomely.
At current strip pricing, Scotiabank BNS +0.5% notes that all the major Appalachian independents are poised to meet investor expectations to bring debt-to-cash flow ratios to a 1-1.5x range by year-end 2022. Leveraged debt fell 0.15x in the second quarter, pulling the average debt burden of the group to 2.6x, just above the sub-2x targets that most management teams have said must be met before initiating substantial cash returns.
Favorable hedging positions for 2022 — already at a stout 60 percent-plus of output — and robust forward pricing builds confidence that free cash flow will remain abundant.
Scotiabank estimates that E&Ps reaped $210 million in free-cash flow in the first half of this year, up from $61 million in 2020. And based on reported hedging strategies, E&Ps could garner $525 million in free cash flow for full-year 2021 and $808 million in 2022.
EQT, the largest U.S. gas producer, is estimated to generate $716 million in free cash flow in 2021 and $1.4 billion in 2020. This dramatic change in financial health is righting the E&Ps’ once-floundering ships. With debt under control, some firms like EQT could soon attain investor-grade credit ratings.
Once gas-focused producers are back in good financial shape, investors may shift their attention toward growth. Encouraged by a rising gas strip and growing U.S. and international gas demand, some investors are more bullish on gas than oil amid the accelerating energy transition.
Still, “disciplined” growth will be the name of the game as investors will continue to demand cash returns. Some investors were surprised by how fast global gas markets tightened recently and see a brighter future for cleaner-burning gas than oil.
Eyeing growing LNG demand, producers added 1.4 billion cubic feet per day in production over the past year, bringing outbound Appalachian pipelines to 90% of capacity.
The Energy Information Administration (EIA) expects U.S. gas production will average 92.9 Bcf/d during second-half 2021 – up from 91.4 Bcf/d in first-half 2021 – and then rise to 94.9 Bcf/d in 2022, driven by supportive gas and crude prices.
U.S. gas exports – of both liquefied natural gas and pipeline gas – are now at record highs. The EIA now projects U.S. LNG and pipeline gas exports to rise from a combined 14 Bcf/d in 2020 to 19 Bcf/d in 2022. Pipeline exports to Mexico increased from 5.4 Bcf/d in 2020 to nearly 7 Bcf a day in June 2021 due to an increased supply of associated gas from Permian Basin oil operations.
Gas market tightness in Asia and Europe has prompted higher U.S. LNG exports, the super-chilled gas used in power generation that burns 50 percent more cleanly than coal.
U.S. LNG has become the global market’s shock absorber. Record low prices from April-July 2020 during the height of the Covid-19 pandemic, led to up to 200 U.S. cargoes being canceled, and output fell to about 20% of capacity. But as global LNG demand bounced back, so did U.S. production, with plants now producing at capacity.
Supply tightness has pushed prices to record levels. Northeast Asian spot LNG prices are currently assessed at $16.10 per million Btu, versus $3.90/MMBtu this time last year. Prices on the Dutch TTF, Europe’s de facto benchmark, were recently at their highest ever.
The International Energy Agency (IEA) expects the good times to keep rolling for U.S. gas producers and exporters. The IEA projects incremental U.S. gas production to exceed incremental U.S. gas demand by ~5 Bcf/d over the 2021-2024 period. This incremental supply should result in higher LNG exports as liquefaction capacity rises in the market.
But the Biden administration’s climate agenda poses a real threat. Biden’s climate envoy John Kerry has said that natural gas is not “anything near a long-term solution” to help address climate change even while it can help replace coal in certain countries in the near term.
In his full comments, Kerry noted that “gas is still a fossil fuel, and gas is mostly methane, so it leaks and also produces CO2. It’s not, in our judgment, anything near a long-term solution, unless somebody discovers one-hundred-percent abatement.”
That’s near-sighted, considering the widespread use of gas to displace coal in power generation has been the number one reason that U.S. greenhouse gas emissions have consistently fallen over the past 15 years.
The administration has struggled to articulate its position on gas, possibly indicating that it is torn or undecided about gas’ role in the low-carbon energy transition.
Energy Secretary Jennifer Granholm has repeatedly said that shipping U.S. LNG abroad can play an important role in replacing dirtier coal, especially in Asia. She has also pressed the oil and gas industry to do a better job of reducing methane emissions associated with LNG in order to make that case credible. But she has not definitively said how long gas can continue playing a useful role in the clean energy transition.
But Team Biden would be wise to come around on gas given the abundance of reserves the U.S. is blessed with and the fuel’s ability to displace coal in the power sector. Gas with carbon capture and storage can also be critical to generating a “blue hydrogen” business that could help with hard-to-decarbonize industries like steel, cement, and construction.