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Permian gas price crash highlights tight market, demand for new pipeline

Natural gas prices in the Permian Basin have gone negative, and the pain for producers may continue into autumn or beyond as shale oil production booms and pipes carrying gas out of the basin remain full.

Producers focused on shale oil have proved willing to pay buyers to take the gas off their hands because the gas must be stripped out of higher-priced crude before the oil can be sold. Burning gas off at the wellhead — flaring — is one way producers can dispose of unsellable gas, but it is only a temporary solution since it makes landowners and state regulators uneasy as they watch royalties go up in flames.

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"Though near-term market concerns have faded on an expectation of less stringent flaring regulations, [the] dramatic swing in spot differentials highlights continued tightness in Permian natural gas market," analysts at energy investment bank Tudor Pickering Holt & Co. said March 22. "Updated U.S. production outlook sees little improvement for Permian natural gas takeaway dynamics as ~2.0 Bcf/d of annual residue gas growth maintains pressure on infrastructure despite greenfield capacity adds of 4.0 Bcf/d from [ Kinder Morgan Inc.-led] Gulf Coast Express and Permian Highway projects over next two years, indicating natural gas problem (or midstream opportunity) isn't going away soon."

With limited local appetite for flaring and without enough pipe space to get the commodity outside of the basin, the gas has been dumped into the local market. Drillers so far have shown no plans to cut back on shale oil production, even if it means having to pay a buyer to take the gas.

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A March 18 outage at two compressor stations on El Paso Natural Gas Co. LLC's pipeline west out of the basin clipped roughly 200,000 Mcf/d of capacity off the basin's estimated 8.7 Bcf/d total.

That disruption was enough to unbalance the already precarious market and push prices into negative territory. The price drop-off gained momentum, going from a few pennies on the minus side to as much as minus-79 cents/MMBtu at Waha on March 27, according to S&P Global Market's Intelligence Platts' Gas Daily. Spot prices at four of eight pricing points in the Permian were in negative territory March 27, Gas Daily said.

"This upheaval feels different," the natural gas market consultants at RBN Energy said March 28. RBN predicted last year that the Permian gas market would crack up with the potential to go to "negative infinity."

"The price crash has reached a new level of drama, with day-ahead spot prices at West Texas' Waha hub now settling below zero — some days by more than $0.50/MMBtu," RBN said.

Expect low spot prices in April and further out on the strip, Jefferies shale oil and gas analyst Zach Parham told his clients March 21. "April Waha basis futures are currently trading at $2.23/MMBtu off NYMEX [Henry Hub], and we expect little relief on Waha basis until gas pipelines to the Gulf enter service in late 2019."

The nearly-2-Bcf/d Gulf Coast Express project — under development by Kinder Morgan, Targa Resources Corp., Altus Midstream Co. and DCP Midstream LP — is scheduled to come online in the third quarter, according to S&P Global Market Intelligence's project database. The 2-Bcf/d Kinder Morgan-led Permian Highway project, which has also reached a final investment decision, is scheduled to start up in late 2020.

Kinder Morgan estimates the Permian needs at least 2 Bcf/d per year of new capacity after 2020, according to Goldman Sachs' oil and gas analyst Brian Singer.

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The Permian's plight is a familiar one for Appalachian drillers. They suffered price discounts of $1/MMBtu or more for years when compared to the benchmark Henry Hub as they were forced to dump gas into glutted local markets, sometimes for as little as 10-cents/MMBtu. The opening of four new lines in 2018 Williams Cos. Inc.'s 1.7 Bcf/d Atlantic Sunrise, Energy Transfer LP's 3.25 Bcf/d Rover Pipeline LLC, Columbia Gas Transmission LLC's 1.5 Bcf/d Leach Xpress and DTE Energy's 1.5 Bcf/d NEXUS Gas Transmission LLC dramatically shrunk that discount, or basis – to pennies, sometimes as soon as the new line's valves opened.

"We've seen rock-bottom prices before... in the Rockies, in the Marcellus/Utica," RBN's Permian expert, Jason Ferguson, manager of energy fundamental analysis, said March 27. "A major difference is that unlike the Rockies and Marcellus, the Permian is oil-focused and driven by oil, not gas, drilling economics."

Analysts agree that more capacity will help balance the Permian's gas market but midstream developers have focused on building oil pipelines to export terminals on the Gulf Coast because there is not much demand for gas at the other end of the pipe.

"The next pipeline must be linked to LNG," said Cynthia Walker, Occidental Petroleum Corp.'s senior vice president of marketing and midstream. With demand for U.S. LNG picking up and prices for domestic gas fetching higher prices in both Europe and Asia, Permian producers see opportunity. LNG facility developers do too.

"We need that takeaway capacity from the Permian… They need that takeaway capacity," Freeport LNG Development L.P. CEO Michael Smith said early in March at CERA Week. "There's a huge basis differential ... because they can't get the gas out."

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S&P Global Market Intelligence and S&P Global Platts are both owned by S&P Global Inc.