U.S. E&Ps Not Banking on Strong Natural Gas Prices in ‘23, but Will Rig Count Decline?

By Carolyn Davis  April 25, 2023  www.naturalgasintel.com

Weak natural gas prices and inflation are likely to be big topics as North American producers and midstream operators unveil their quarterly results in the coming weeks.

SLB Ltd., which has its fingers on the pulse of exploration and production (E&P) customers, has revised its North American outlook for 2023 because of languishing natural gas prices. No big LNG infrastructure is set to ramp this year in the United States either, which may have a negative impact on development.

NGI spoke with analysts and culled various notes to clients to provide a window into what investors are expecting in this round of quarterly results. Analysts noted that the gyrations in the natural gas market would be of particular interest. 

Are E&Ps going to continue to reward shareholders at a quick pace as they did last year? Is merger and acquisition (M&A) activity likely to expand beyond bolt-ons in the Lower 48? Are there any more liquefied natural gas projects likely to reach a positive final investment decision (FID) this year? And where are gas prices headed? 

All of the above, said NGI’s Patrick Rau, director of Strategy & Research.

“LNG continues to be the driving force behind both global and domestic natural gas demand, so naturally investors want to know which projects are going to reach FID and when,” Rau said. 

So Goes Mexico…

“I’m particularly looking forward to hearing updates on the various North American projects, including and maybe especially those LNG projects in Mexico. 

“Developments in Mexico could very well affect natural gas activity in the U.S., and several of these proposed Mexico projects have an excellent chance at being greenlighted.”

Producers are “sitting on cash,” he noted, “and investors have been concerned about future drilling inventory for a good number of publicly traded E&Ps. M&A is certainly one way to address that.”

SLB has reduced its view on North America this year, but the services giant “actually reported an increase in international exploration spending, so it sounds like some are addressing the inventory equation via the drillbit as well,” Rau said. 

Expect to hear about how E&P and pipeline permitting delays can be alleviated too. Congressional Republicans and Democrats, along with the industry trade groups, are wrangling to reduce the red tape they claim has stalled oil and gas infrastructure. 

“Permitting activity and anything that can cause pipeline delays remain at the forefront of investor concerns,” Rau said.

“Obviously, everyone wants to know about the progress of Mountain Valley Pipeline,” the beleaguered gas system to transport more Appalachian gas. Energy Secretary Jennifer Granholm signaled this week that the Biden administration supports the system. 

Also on the table is the Permian Highway Pipeline expansion to move more natural gas to the Gulf Coast. The expansion is unlikely to be completed until later this year, but Permian watchers want to know if it will help alleviate congestion in West Texas.

“Of growing interest among investors is the potential for additional underground storage facilities, especially given growing gas production, the next wave of LNG buildout and wild price volatility,” Rau said. 

“The U.S. simply hasn’t added much incremental storage capacity in the last decade, and that second wave of LNG export facilities will likely add significant strain to the existing system. The time to start planning for storage is now.”

Rau questioned whether producers were planning to drop rigs in the gassy Haynesville Shale or Appalachia, “given recent Henry Hub prices that have challenged $2. Investors want to know whether the publics are holding onto their rigs.

“If not, are they shifting them to say oilier formations?” he asked. “Are oilfield services prices starting to come down at all?”

Haynesville Dropping?

The underperformance in natural gas to date is likely to lead to “another round of activity cuts from producers…especially from Haynesville producers” based on current gas futures, according to Goldman Sachs analysts led by Umang Choudhary.

“While on its own it is likely not enough to drive a sufficient supply response to balance the market,” Choudary said, “we look to commentary around further supply cuts from the privates to get more positive on the outlook for gas, with the expected step-up in export demand from LNG terminals in the second half of 2024 and acceleration of demand in 2025.

“If the supply response is not sufficient, we see further risks to 2024 futures, which have derated to $3.50/MMBtu.”

Could gassy E&Ps still outperform if there are more cuts to supply? The Goldman analysts “continue to believe further supply cuts are needed to balance the market, given current oversupply. So far, we have seen only modest rig cuts in the Haynesville.”

The de-rate in natural gas prices year-to-date should lead to more activity cuts, particularly from Haynesville-focused E&Ps. However, “we look for confidence in the size and scope of supply cuts to get confidence in an improving natural gas price outlook,” Choudary said.

Most of Goldman’s covered E&Ps have indicated a potential 10-20% increase in capital expenditures (capex) this year because of inflation. 

“Rig counts and completion stimulation are lower relative to the peaks in the fourth quarter,” Choudary said. “However, we see a risk of further reduction given cuts from gas producers following lower prices…”

Cleaner Earnings?

Morgan Stanley Research analysts led by Devin McDermott said first quarter results are likely to be aided in part by OPEC’s decision to reduce crude oil production. 

“So far this year, several of the risks we highlighted in our 2023 outlook have materialized,” the Morgan Stanley analysts said. “Natural gas prices have corrected significantly lower,” with Henry Hub down by half, Japan-Korea Marker off by 55% and Title Transfer Facility by 40%.

Following the “noisy” fourth quarter results and weak 2023 guidance, “the setup into first quarter earnings seems much cleaner,” according to the Morgan Stanley analysts. “While we are roughly in line for oil E&Ps this quarter, for gas producers we are 7% above consensus on capex,” driven by spending plans weighted in the first half of the year.

“That said, limited operational issues and weather-related downtime should make expected production achievable for most of our E&P coverage. At the same time, plateauing costs and early signs of deflation should limit capex risks, potentially even creating a tailwind for some in the second half of 2023.”

The analyst team at Mizuho Securities USA LLC said investor sentiment for the oil and gas sector is relatively mixed “given commodity price volatility. But we expect a relatively positive message from these companies.”

Mizuho’s team said key themes for E&Ps are likely to include how rising oilfield service costs may impact free cash flow (FCF). “But as activity levels in shale come down, service costs appear to be plateauing with some signs of potential cost savings in the second half of 2023 based on contractual provisions or spot price weakening.”

Some of the big U.S. natural gas E&Ps may reduce capex from prior guidance because of weak prices.

“However, most other gas-focused E&Ps are likely to reiterate spending plans in anticipation of natural gas price improvements in the second half of 2023,” Mizuho’s team said. The domestic E&Ps also “remain committed to capital discipline and the prospect of higher oil prices due to recent OPEC-plus cuts likely to increase FCF generation and shareholder cash returns.”

Lower Price Forecasts

Siebert Williams Shank has adjusted its U.S. natural gas price outlook for the year, with the full-year forecast average reduced to $2.97 from $3.30. Analysts expect 2Q2023 gas prices to average $2.00, with a 3Q2023 average of $2.75. In the final three months, they see gas prices averaging $3.60.

“With consensus estimates materially off for the gassy E&Ps (likely due  to  stale  pricing  relative  to  the  current  strip)  and  with  the  shoulder  season  approaching, we  think  the high beta gassy E&Ps could be challenged in the near term; however, we remain positive 2025-plus on the expected increase in LNG export demand,” the Siebert analysts said. 

“With the gassy names currently discounting sub‐$3/Mcf, we see a huge opportunity longer term, as we expect $4‐5/Mcf in 2025-plus, in line with strip prices…”

Because of weak near-term pricing, the Siebert analysts are looking for “another round of cuts to activity levels for the dry gas E&Ps, particularly in the higher cost Haynesville Shale. With service cost inflation plateauing, there may be a benefit to spending in the second half of 2023 and beyond…”

BMO Capital Markets’ analyst Phillip Jungwirth noted that natural gas “has gone from bad to worse, with the 2023 Henry Hub strip now $2.65/MMBtu, dragging 2024 down to $3.48.”
E&P activity has been slow to respond, “despite unsustainable low prices,” Jungwirth said. 

“We expect further trimming from Haynesville producers, but it feels too little, too late, while pipeline expansions de-bottleneck Permian near year-end.”

Natural gas is the only area in the energy sector below mid-cycle, Jungwirth noted, but “we think it’s too early for a relief rally with supply likely to be resilient.”

Haynes and Boone LLP’s spring 2023 Energy Bank Price Deck Survey holds no positive news for gassy E&Ps either.

The mean gas base decreased by 35%, “from $4.34/MMBtu (Henry Hub) in fall 2022 to $2.79/MMBtu in spring 2023, reflecting greater weakness in natural gas markets relative to crude oil,” the Haynes Boone team said.

“This weakness in near-term natural gas prices could have a negative impact on this spring’s borrowing base redeterminations for gas-heavy producers,” said Haynes Boone’s Buddy Clark, co-chairman of the Energy Practice Group.

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