Analysis: Waha gas forwards rally eases as doubts over capacity crunch linger

A surge in natural gas forwards prices at the West Texas Waha hub during the week ending March 13 appears to be easing as the market reevaluates the likelihood for any meaningful decline in Permian Basin gas production this year.

On Thursday, the Waha balance 2020 forward curve dipped to an average 93 cents/MMBtu, down about 20 cents, or 18%, from a settlement at $1.13/MMBtu earlier in the week, S&P Global Platts data shows.

In February, the balance 2020 curve at Waha averaged just 12 cents, with calendar-month contracts for March, April and May posting consecutive month-long daily settlement prices in negative territory.

Following Monday's rout in global oil markets, though, forward valuations at Waha remain sharply higher as many market participants now anticipate a slowdown in Permian oil drilling – one that could be sufficient to keep growing associated gas production in West Texas from eclipsing the region's midstream transportation capacity.

The market's subsequent retracement could reflect lingering uncertainty over producer commitments to slow Permian drilling this year, and potentially, doubts over the impact of such a slowdown on the basin's emerging gas capacity crunch.

CAPEX, DRILLING DEFERMENTS

Starting just hours after Monday's oil market collapse, Diamondback Energy and Parsley Energy both announced cuts in drilling activity and capital expenditures. In the days following, similar cuts were announced by Occidental Petroleum, Marathon Oil, Matador Resources, Devon Energy, Apache and Murphy Oil.

For North America's most efficient shale operators, breakeven production prices that approach the current WTI price around $31 to $32/b, could allow them to remain in maintenance mode this year. Producer price hedges in the low- to mid-$40s/b could even allow some operators to eke out a narrow profit in the short term.

Immediate, short-term actions taken by operators such as Apache, which moved aggressively to halt Permian drilling this week, could be short-lived, though, depending on the oil market's price trajectory this year.

Assuming WTI crude prices remain in the low-$30/b range, even a modest slowdown in Permian oil drilling may not be sufficient to meaningfully trim gas production in the West Texas shale basin.

ASSOCIATED GAS PRODUCTION

According to S&P Global Platts Analytics, associated gas production in the Permian and other US shale basins tends to be sticky, owing to the production profile of a typical horizontal well.

In the Permian, a completed well in its first month of production typically yields a gas-to-oil production ratio of around 2.5 Mcf per barrel of crude oil. By the time that same well reaches its 12th month in production, though, the gas-to-oil ratio rises to about 4.5 Mcf/b.

In 2016, a sustained decline in oil prices saw combined production from the Permian, Eagle Ford, Denver-Julesburg, Bakken and SCOOP/STACK fall by some 300,000 b/d, year over year, to 4.8 million b/d.

While gas-to-oil ratio curves have actually shifted upwards since 2016, a similar aging-well production effect at the time allowed combined gas production from those basins to rise by some 100 MMcf/d over the same 12-month period.

The recent rise in gas flaring in the Permian is another factor that could allow the basin's associated output to remain relatively flat this year, even in the face of declining oil production. Currently, operators in West Texas flare about 500 to 800 MMcf/d of associated gas. Potential easing in utilization of the basin's midstream capacity could allow at least some of those volumes to be captured, replacing declines.