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FEATURE: Dominion South rally unlikely to fuel Appalachian production growth in 2020

Highlights

Q1 2021 forwards hit three-month high at $2.61/MMBtu

Marcellus, Utica producers at breakeven over $2/MMBtu

Return-on-equity focus, pipeline challenges limit growth

New York — Rallying forward gas prices at Dominion South are making for a bullish market outlook in Appalachia this winter – a scenario that's often fueled regional production growth in the past. Following pivotal changes to the industry this year, though, most producers are likely to keep output flat heading into 2021.

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On Aug. 6, Dominion forward strip prices for first-quarter 2021 settled at an average $2.61/MMBtu, or their highest in three months, S&P Global Platts' most recently published M2MS data shows.

In early May, as US production was nearing its pandemic-fueled bottom near 85 Bcf/d, forwards traders became increasingly bullish on the value of supply from dry basins like the Marcellus and the Utica, lifting winter gas prices at Dominion South in the mid-$2.60s/MMBtu.

As the recovery in US gas production stumbles this month, a similar market narrative is gripping the industry. In associated basins like the Permian and the Bakken, the restoration of previously curtailed wells appears to have peaked, leaving US output lurching around 87 Bcf/d.

With Appalachia's wellhead gas prices now headed north of $2, an average unhedged producer in the Marcellus or Utica Shale could be operating above breakeven level by autumn, data compiled by S&P Global Platts Analytics shows. For some producers, it could be enough to tempt fate and resume output growth.

Industry shift

According to the chief executive of at least one mid-sized Appalachian producer, though, that outcome is unlikely to play out in 2020, following recent, transformational industry developments this year.

After years of overspending and debt leveraging, many Appalachian producers are now finding their back against the wall with the investment community, says Rusty Hutson, CEO of Diversified Gas & Oil.

"The equity markets have said enough is enough," Hutson said. "In the debt markets, it's extremely hard to refinance – that's why we're seeing so much distress and bankruptcy," Hutson said in a recent telephone interview.

On recent second-quarter earnings calls, two of Appalachia's largest producers, EQT and CNX, said they're keeping production flat over the near term as they confront a low-commodity-price environment that many analysts expect to endure longer term.

Many producers are following suit, but some of the most highly leveraged companies are finding it harder to make the shift to maintenance mode, Hutson says.

"If you can't get your leverage profile down through divestitures and convertible debt, then you can't stop drilling, [otherwise] you'll trip your leverage ratios," he explained.

As bankruptcies, acquisitions and competition narrow the field, Hutson says its making for a healthier industry – one that's more focused on return to equity than production growth.

Over the next five to seven years, Hutson sees Appalachian production flattening out in the mid-30 Bcf/d range. Recent production forecasts from Platts Analytics reflect a similar low-growth trajectory there.

Pipeline development

Following Dominion Energy's recent landmark decision to abandon development of its Atlantic Coast Pipeline, many analysts and market observers see dimming prospects for future interstate projects out of Appalachia – another factor that's likely to limit production growth there over the near term.

"That was a big hit," Hutson said referring to the project.

The Atlantic Coast Pipeline would have delivered some 1.5 Bcf/d of West Virginia Marcellus production to markets in Virginia and North Carolina, but had faced extensive legal and regulatory hurdles.

"The unbelievable thing is that the southeast market is highly underserved [for] natural gas," Hutson said. "There's a lot more demand that could be picked up there."

According to Hutson, the fate of future project is now riding on the November election.

"It going to be very challenging to get pipelines completed if there's an administration change," he warned.