Bentek Energy, the oil and analytics group of McGraw-Hill Financial's (NYSE:SPGI)Platts unit, has just released its 10-year outlook for the Utica shale. It's a whopper of unparalleled data and analysis, and it doesn't shy away from conclusions. Two make our headlines today.
Not only will the usual natural gas production and consumption map turn upside down in the next 10 years, according to Bentek, but also, natural gas prices will rise 9% by the end of the period. Given even tiny inflation, that's flat, or down, in real terms.
From north to south
Rocco Canonica, Bentek's director of energy analysis and lead author of the outlook, stated, "The Northeast is poised to switch from the nation's largest demand region to a net supply region, and the U.S. Southeast is racing to become a much larger net demand region after being a major supplier to the U.S. gas market."
This is due to the explosion of natural gas coming online in the Utica and Marcellus shale plays. Together, these cover a massive area of Ohio, Pennsylvania, and south into West Virginia. Because production there is growing so quickly, there will be so much more gas production than needed for rigid northeast winters and hot summer demand, that to make money, producers will have to find markets elsewhere.
Fortunately, Bentek Energy says demand will increase in the Southeast.
More than one-third of the U.S. natural gas production increase from 2013 to 2023 -- or 9.1 billion cubic feet per day (Bcf/d) -- is expected to come from the Utica and Marcellus shale formations in the northeastern U.S., while nearly half of U.S. demand growth, or 9.4 Bcf/d, is expected to occur in the Southeast over the same period.
How regional pricing works
Motley Fool senior analyst Michael Olsen observes that pricing in the Marcellus has been at a discount to Henry Hub, the natural gas spot price we normally see quoted, currently at $3.72/MMbtu. According to Olsen: "Whenever an area is oversupplied because of takeaway and/or processing constraints, you get a regional discount to spot. The Marcellus has seen that in spades, because there's so much production and the list of destinations is limited by shortage of takeaway and end markets." That hurts producers in those regions.
But, according to Bentek Energy, the Marcellus and Utica producers have an out in the Southeast market. Being able to sell into that region "will contribute to making the Southeast a premium market relative to most other regions, pulling increasing amounts of gas from the Northeast, Texas and the Midcontinent," said Tony Sweet, Bentek Energy senior energy analyst. A premium to Henry Hub sure beats a discount.
Good things for these companies
Investors may be interested in smaller companies that have the potential to gain more from an outlet for their Marcellus and Utica production, and better pricing in the Southeast. This may correct their current problem -- that investors lose more in a company concentrated in this region, with pricing at a discount to Henry Hub. Instead, their investors would gain relatively more value if the companies can obtain premium pricing in the Southeast.
Along these lines, Olsen points out three smaller producers to consider, Range Resources (NYSE:RRC), Ultra Petroleum (NASDAQ:UPL), and Southwestern Energy (NYSE:SWN): "Ultra and Southwestern have meaningful exposure in the Marcellus. Range has a significant presence in Marcellus wet- and dry-gas regions, but also has a large acreage footprint in the Utica."
Hope for pricing ahead?
Looking further out, any sustained natural gas pricing into the $4.00 range and up would deliver superb returns for Range, Ultra, and Southwestern, and pretty much any number of natural gas producers, not least because they could lock in hedges for some of their production at higher prices.
This is important for second-largest producer Chesapeake Energy (NYSE:CHK), as well. Chesapeake's new CEO has quickly improved company finances through cost-cutting, asset sales, debt paydowns, and moving capex spend from natural gas to more rewarding oil and natural gas liquids production. This has boosted the stock price, as it should, but Chesapeake needs sustained natural gas above $4, and hedges above that to really bring home the stock price bacon from the mid $20s today to $30, $40, and even beyond. After all, with the way energy works, and Chesapeake and everyone moving to oil at these high prices per barrel, Chesapeake may find itself with poorer oil pricing, and may need revenue from its natural gas assets
Unfortunately, any consistent good news for pricing may have to wait a decade or more. Bentek Energy forecasts that over the next 10 years, total U.S. natural gas demand will rise 27%, but U.S. supply will climb nearly 38%. This suggests pricing will be weak and, indeed, Bentek sees prices rising only 9% during the decade.
The contrarian natural gas investment case has suffered, especially when the warm winter of 2011-2012 saw natural gas spot prices dip below $2.00 in April 2012, and may be down for the count. While it appears there is some relief coming for strapped Marcellus and Utica producers to sell into higher pricing in the Southeast, the overall pricing picture is unlikely to change much for the next decade, according to this excellent and detailed -- 114 pages -- Bentek Energy report.