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Tight supply, elevated prices test Appalachian producer commitments

Highlights

Southwestern hedges estimated 65% of 2022 production

Cabot Oil & Gas, bullish on 2022 market, stays unhedged

As Appalachia's natural gas markets turn increasingly bullish, one the of the region's bellwether producers, Southwestern Energy is keeping its cool, opting for a conservative hedging strategy that promises a guaranteed price for most the company's production through 2022.

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In its latest quarterly earnings call, company executives announced an eye-raising increase in total 2022 hedged production to 726 Bcf, equivalent to over 65% of Southwestern's estimated annual output. The recently added positions expand the company's total hedged production from 453 Bcf in the first quarter and lift its average hedged price by 4 cents to $2.72/MMBtu.

Southwestern's cautious approach to Appalachia's gas market, which prompted intense questioning from analysts on the company's July 30 earnings call, comes as upstream prices there hit historic highs.

In July, cash prices at Eastern Gas South, formerly known as Dominion South, averaged nearly $2.90/MMBtu – up from $2 in early June and just $1 last summer.

Eastern Gas forward markets have also rallied recently. Peak-winter prices at the benchmark location have gained nearly $1 over the past eight weeks to trade near $3.50/MMBtu. Calendar-year prices for 2022 have climbed to the $2.60s recently – up from the low $2s in early June, S&P Global Platts data shows.

As Southwestern takes a step back from Appalachia's bull-market frenzy, other regional producers are opting to throw the dice. Among them are Cabot Oil & Gas, whose market approach stands in sharp contrast to that of Southwestern. In Cabot's recent quarterly earnings call July 30, executives said the company would keep its 2022 production unhedged with a plan to grow quarterly output 4% in Q3, followed by another 10% in quarterly growth in Q4.

Strategy

According to Southwestern Energy CEO, Bill Way, the company's hedging strategy reflects its overall enterprise risk management strategy, which prioritizes achievable milestones over near-term income.

"As we look across the forward 36 months, which is our kind of our rolling program, we take into account the various enterprise opportunities, whether that's balance sheet strength or cash flow or debt targets." Way said on the company's quarterly conference call.

The cautious approach extends to the company's capital investment program too. As Southwestern looks to consolidate its technical and operational know-how, it has opted to develop the company's dry gas production from its Ohio Utica acreage before delving into its more liquids-rich Marcellus holding.

In the second quarter, Southwestern kept its NGLs production largely flat at 17% of the company's total output – despite a more-than 35% rise in Mt. Belvieu propane prices since early January.

"One of the things that helped us lean towards starting in the dry gas window was the added benefit that was going to have for us around our legacy existing Utica inventory ... to get the wells drilled with our rigs, with our team and get that knowledge to prove that we can bring the cost down," Way said.

Market environment

Southwestern's easy-does-it, incremental approach to the Appalachian gas business reflects a larger shift taking place among the region's publicly traded producers – a pivot away from growth to value model.

The emerging paradigm prioritizes free cash flow, low debt ratios and returns to shareholders with an emphasis on sustainable capital investments, responsible production and environmental stewardship. In quarterly earnings presentations from Southwestern and others, those metrics have figured prominently, outweighing the once ubiquitous emphasis on current market conditions.

For many of Appalachia's producers the temptation to chase current strip pricing is there this summer, given the market's tight fundamentals and strong prices.

As of late July, gas inventories in the East region are estimated at 583 Bcf, or more than 8% below the five-year average and 17% below year-ago levels, according to data from the US Energy Information Administration. Appalachian gas production, meanwhile, has lagged this year. In July, combined output from the Marcellus and the Utica averaged just 33 Bcf/d – down from about 33.5 Bcf/d in January, data from S&P Global Platts Analytics shows.

Stronger regional and neighboring-market demand for Appalachian gas has added to the bullish sentiment. According to Platts Analytics, the trend should continue through the upcoming winter months, potentially lifting upstream hub prices to historic highs during the peak demand months of January and February 2022.