A constant conundrum for investors in the exploration and production sector is deriving a valid valuation based on normalized pricing for the commodity produced. The issue has come to the forefront with the quick rise of shale regions that see explosive growth that outstrips infrastructure, leading to lower pricing realizations for a period of time. Typically, it's only a matter of time before the bottlenecks are worked out; the short-term impact is difficult to derive, however.
A prime example is Cabot Oil & Gas (NYSE: COG ) . The company achieved production of 1 trillion cubic feet (Tcf) in the Marcellus shale within six years of starting drilling. Due to this massive production growth, the company is struggling with the price it obtains for natural gas. In the first quarter, Cabot only obtained a price realization of $3.74 per million cubic feet (Mcf) compared to substantially higher prices. In total, the company had price realizations of $0.60 to $0.65 below NYMEX settlement prices.
The good news is that hope is on the way. New pipelines are scheduled for completion by 2017 in the form of the Constitution and Atlantic Sunrise pipelines in development by Williams Partners (NYSE: WPZ ) .
Constitution pipeline details
The Constitution Pipeline is a 124-mile project designed at capacity to transport 650,000 dekatherms of natural gas per day (enough to serve approximately 3 million homes.) The project involves a 30-inch underground pipeline that extends from Susquehanna County, PA, to the Iroquois Gas transmission and Tennessee Gas Pipeline systems in Schoharie County, NY. The pipeline is already fully contracted with long-term commitments.
The pipeline is now 41% owned by Williams Partners, 25% by Cabot Oil & Gas, 24% by Piedmont Natural Gas, and 10% by WGL Holdings (NYSE: WGL ) . Williams Partners will provide construction, operation and maintenance, and Cabot will supply 500,000 dekatherms per day of production from the Marcellus.
In the recent earnings call, Cabot projected the pipeline to start delivering in late 2015.
Atlantic Sunrise pipeline details
The Atlantic Sunrise Pipeline is an expansion project of the Transco pipeline system operated by Williams Partners. The project plans to provide transport capacity of 1.7 million dekatherms of natural gas by connecting the Marcellus producing region in northeastern PA with growing demand centers along the Atlantic Seaboard. The project has binding 15-year commitments for 100% of the capacity and an expected in-service date in the second half of 2017.
The project is expected to cost $2.1 billion and adds to other investments from Williams Partners that equate to around $5 billion; the intention is to add 50% more capacity to the Transco system. In total, the project adds 178 miles of new greenfield pipe along with facilities additions and modifications to existing facilities to allow gas to flow bi-directionally.
As part of the deal, Cabot will own 850,000 MMBtu per day of firm capacity on Atlantic Sunrise. The company agreed to sell 500,000 MMBtu per day of natural gas to WGL for a term of 15 years.
Unfortunately, neither of these projects operated by Williams Partners will resolve any of the pricing realization issues that will hurt Cabot Oil & Gas over the next couple of years. The company estimated that April prices were affected by $0.75 to $0.80 per Mcf, so the impact is substantial. Cabot expects significant improvement when the Constitution Pipeline goes into production, hopefully by late next year. Until then, investors will need to invest with the understanding that normalized cash flows and earnings will obtain a substantial bump during 2016 and 2017.
At the same time, Williams Partners and WGL Holdings provide opportunities for participating in the infrastructure needs of Cabot while paying investors solid dividends to wait. Right now, Williams Partners offers a very attractive 6.8% yield with the ability to grow that rate based on the Constitution and Atlantic Sunrise projects.
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