While most E&P players would balk at natural gas prices as low as $3 mmBtu, there is one player, Cabot Oil & Gas Corporation (NYSE:COG), that can realize a BTAX IRR (before tax internal rate of return) of 102% in the Marcellus shale at that price. A major Marcellus player, Cabot was able to grow its adjusted net income by 102% last quarter to $109.7 million, even as 96.6% of its 119.9 Bcfe of production was dry gas.
To achieve such strong income growth, Cabot Oil & Gas has been steadily decreasing its production costs. Total unit costs per thousand cubic feet, or one million British thermal units (mmBtu), of production was 19% lower than in the same quarter last year.
One big thing that's holding Cabot back from its true potential is the wide differential it receives versus Henry Hub pricing for natural gas. In the first quarter of 2014, Cabot Oil & Gas received an average price of $3.74 mmBtu for its dry gas production, a 8.4% improvement versus the same quarter last year yet still ~$0.65 lower than Henry Hub prices. Imagine Cabot's potential if it could boost its realized natural gas prices. At $4 mmBtu, a normal Marcellus well for Cabot Oil & Gas would yield a BTAX IRR of 206%!
In pursuit of such outstanding returns, Cabot has teamed up with Williams Partners L.P. (NYSE:WPZ) to build out natural gas infrastructure in the Marcellus region, so Cabot can sell its production to markets with higher prices.
In the spirit of 1776
Williams Partners L.P. is building the Constitution pipeline, which will be 75% owned by Williams Partners and 25% owned by Cabot Oil & Gas. The pipeline will be online sometime in late 2015 or early 2016, and will carry 500 million cubic feet of gas a day of Cabot's production to "premium markets" via the Iroquois system and the Tennessee 200 line.
Luckily for Cabot Oil & Gas, Williams Partners L.P. doesn't plan on stopping there. The Atlantic Sunrise Project is an expansion of Williams Partners' existing Transco system, and should be completed in 2017. Through the expansion, Williams Partners will transport an additional 850 million cubic feet a day of Cabot Oil & Gas' production that is currently being shipped to other markets. By using Williams Partners' new infrastructure, Cabot will be able to support higher levels of production in the future and receive better prices for its dry gas output, creating a very bullish long-term growth story.
The opportunities are endless, as Cabot Oil & Gas is forecasting output growth of 28%-41% this year, and by 20%-30% next year. Cabot has 200,000 net acres in the Marcellus shale, and with six rigs Cabot plans on completing 110 net wells this year. While Cabot is off to a relatively rocky start this year due to the harsh winter, management expects production growth to be weighted toward the second half of the year. With the building blocks of future growth being built "as we speak," expect Cabot Oil & Gas to outperform over the next few years as higher production levels combine with higher realized prices to propel the bottom line.
For Williams Partners L.P., these two projects are part of a broader plan to support and grow its 6.8% distribution by alleviating the bottleneck that has built up in the Marcellus/Utica region. Investing in an area that is expected to see output rise by 5 billion cubic feet a day over the next two years alone is a smart move, as the current level of midstream infrastructure is woefully unprepared to cater to the shale revolution.