The Word From MUM

In the energy industry, as in marriage, 90% of the times are good, according to Barry Davis, president and CEO of EnLink Midstream Partners LP. So while analysts are mourning the precipitous drop in oil prices, Davis thinks you can always get back to that 90%.

“No matter where we are in this cycle, we will rebound,” he said in late January at Hart Energy’s Marcellus-Utica Midstream Conference in Pittsburgh. “This is a great industry, and we’ve never seen a cycle that we couldn’t come out of.”

Davis emphasized that the energy industry has always been cyclical—and unpredictable. He asked audience members to raise their hands if they had expected prices to fall to less than $3/MMBtu for gas and less than $50/bbl for crude. No hands were raised.

“No matter how many times we have heard, ‘It’s different this time,’ we will never overcome the fact that life is a series of cycles, and in this industry we will never overcome the fact that this is a cyclical industry,” he said. “The good news is, this ain’t our first rodeo.”

This cycle is different in some significant ways, however. Davis compared the fall in crude prices to other downturns from the past 30 years. The current downturn, from last June to January of this year, represents a price decline of 57% over 207 days—neither the fastest nor the most severe of the corrections. From July 2008 to February 2009, oil dropped 77% due to weak global demand. It took 472 days for oil to recover 50% of its original price.

From November 2000 through January 2002, oil prices fell 51%, requiring143 days to regain half of their erstwhile peak because of what Davis called the “Post-9/11 Effect”: a small recession and decreased demand. He recalled a 49% drop in oil prices from October 1997 to June 1998, when it took only 105 days to return to 50% of pre-correction levels. That decline was driven by recessions in Asia, Davis said.

The most relevant past correction to the current downcycle, however, is the 67% fall in oil prices from November 1983 to April 1986. It is the only other price correction driven by supply rather than demand. OPEC changed its pricing structure, and much like today, created an oversupply. It took 465 days to recover.

Based on these scenarios, Davis thinks crude oil prices could rebound in three months to a year.

“So we have good reason to be optimistic, and I am confident that we are going to see great days ahead,” he said, offering this caveat: “I said earlier, ‘This ain’t our first rodeo,’ but it might be our first rodeo with shale-driven production. In fact, I think it’s a possibility that instead of acting like the crude oil cycles of the past, crude oil may act like the natural gas of the last six or seven years.”

Despite this possibility, Davis thinks “oil is going to continue to act like oil, because there are a lot of factors that affect it other than just domestic supply and demand.”

Although Davis predicted a 50% reduction in Marcellus-Utica activity levels this year compared with 2014, he expressed confidence that the region would fare better in this downturn and in the recovery than other producing areas.

“That reduction is going to take all of that activity and reduce it to the core of the core in the best shale plays. The good news is when we look at the Marcellus-Utica, we believe it is the best of the best. It currently occupies, when thinking about it from an oil-price perspective, four of the top five positions in terms of economic return and resiliency to oil prices. When looking at it on the gas side, it actually holds six of the top nine positions.”

Long-term, he thinks the Marcellus and Utica will eventually capture 45% of total U.S. shale production, from 34% forecast for 2015.

A Macro Look

Sunil Sibal, director and senior MLP analyst with Global Hunter Securities, said that shale plays in the Lower 48 have a total resource potential of more than 1 quadrillion cubic feet equivalent. He related that growth to the challenges ahead.

Within the prolific U.S. shale production growth seen in the past five years, 80% of the approximate 20 billion cubic feet per day (Bcf/d) of gas growth has come from the Marcellus and Utica shales combined. Looking at the overall U.S. supply scenario, Sibal said that as of year-end 2014 about 20% of overall U.S. gas production is coming from the Marcellus and 2% from the Utica.

The big challenge for the Northeast shale plays is getting the gas to end customers. There are still bottlenecks because of inadequate transportation infrastructure, which have resulted in low gas prices at the wellhead yet gas price spikes in many regions, despite the available supply. “There is a disconnect between what the producer is getting and what the end consumer is paying,” he said.

Midstream operators have responded by building infrastructure that will provide takeaway capacity of about 20 Bcf/d from 2014 through 2018, according to Sibal. He said there is another 10 Bcf/d to 12 Bcf/d of proposed capacity under discussion, which will probably be rationalized over the next few years, depending on firm transportation demand by E&P producers and other shippers. The total capex on committed projects is about $20 billion, he said.

As the Northeast becomes increasingly self-sufficient for its gas needs, Sibal expects more announcements targeting U.S. LNG exports. He noted that 5.5 Bcf/d of U.S. LNG capacity is under construction and another 6.5 Bcf/d is in the final Federal Energy Regulatory Commission or final investment decision approval stages. Overall, the U.S. has a total of about 12 Bcf/d of U.S. LNG export capacity, with another 11 Bcf/d under evaluation.

“The U.S. LNG export market is facilitating more and more of this continued Marcellus and Utica development as the U.S. Northeast market gets more saturated,” he said.

NGL Production

Liquids production has also inspired takeaway solutions. According to Sibal, in 2014, nearly 250,000 barrels per day of NGLs were produced in the Marcellus region, accompanied by rapid development of processing and fractionation capacity. More than 4 Bcf/d of wet gas volumes were processed in 2014, and NGL fractionation production in the same period was more than 200,000 barrels per day (bbl/d).

At the same time, more regional takeaway solutions are underway, including Mariner West, Mariner East Phase 1 and 2, Utopia and ATEX pipelines, which represent existing and planned capacity of 570,000 bbl/d, of which about 60% to 70% is ethane.

“The challenge is finding a petrochemical end use for this ethane, and ethane export products are getting more acceptance,” he said.

In the meantime, northwestern Europe is showing an increased appetite for U.S.-sourced ethane because of the significant cash cost advantage vs. higher-cost naphtha, which is derived from crude oil. “Just imagine a molecule of ethylene that sells for 45 cents to 50 cents per pound, you can gain an advantage of close to 25 cents to 26 cents per pound if you are sourcing ethane from the Marcellus or the Utica regions,” he said.

This advantage is shrinking with lower crude prices, but U.S.-exported ethane to European petrochemical producers works at even $60/bbl, he said. U.K.-based Ineos has signed up to take ethane from the U.S. Northeast.

Propane production is rising from gas processing plants but there is not enough domestic demand. He reminded attendees that only four years ago, the U.S. was an importer of propane, and now it is the largest exporter in the world, overtaking Qatar last year.

“What’s fueling the export market is the price arbitrage that exists between the U.S. and international markets; U.S. shale production continues to increase, keeping prices low.”

Finally, Sibal speculated on the impact of reduced E&P capital spending on the midstream. “It really has to do with producer economics. From all the information we’ve seen thus far, spending cuts are not resulting in throttling back production because they are getting more efficient in producing this gas. The net impact is that production would be growing considerably in the Marcellus and Utica, probably slow down by 10% to 15%, but will still be growing in excess of 25%.”

Legislation Gridlock

The Marcellus-Utica midstream region is as sensitive to legislative changes as any. John Kneiss, director of Stratas Advisors, a Hart Energy company, said the chances of the 114th Republican-led Congress reaching compromise with the White House on key issues are dim. Kneiss, an energy public policy expert with more than 25 years of experience, is based in Washington.

In the past, a divided government, where one party controlled the Congress and the other party held the White House, has resulted in a more pragmatic government where “things got done,” Kneiss said. “But the good news is gridlocked government can’t do much harm,” he added.

Some progress is being made. Since Congress convened on Jan. 6, the Senate has approved more than 24 amendments, compared to 2014 in which only seven made it through the same body.

Kneiss outlined proposed federal legislation making its way through Capitol Hill that could affect and assist the midstream community: H.R. 351 (Rep. Johnson, R-Ohio) and S. 33 (Sen. Barrasso, R-Wyo.) would require the Department of Energy to issue final decisions on LNG export license applications within 60 days, which would expedite judicial review. Additionally, H.R. 161 (Rep. Pompeo, R-Kan.) would accelerate the FERC’s review of infrastructure/pipelines (passed in the House; administration veto threatened).

Regulatory action to watch is the Environmental Protection Agency’s (EPA) methane and volatile organic compound (VOC) emissions control, which is part of the Climate Action Plan to reduce emissions by 45% by 2025, but only for new and modified oil and natural gas wells, according to Kneiss.

“Of course, the sections of the Clean Air Act that the agency is using may allow them to proceed to develop controls for existing systems,” Kneiss said.

Also worth watching is the EPA’s ozone National Ambient Air Quality Standard. The EPA has proposed lowering the standard from 75 parts per billion (ppb) to between 65 ppb and 70 ppb.

“If they said 65 ppb, it would put as much as 90% of the country in a nonattainment status. It would dramatically increase areas throughout the country that would have to monitor for ground-level ozone, and states would have to modify their implementation plans for how they intend to control VOC emissions, including methane. That could limit manufacturing and E&P. It could be one of the most costly regulatory standards ever developed,” Kneiss said.

Most of Pennsylvania, Ohio and West Virginia would be brought into regulatory requirements.

Kneiss expects states to step up actions on best practices, increase disclosures for fluids used in drilling and disposal of backflow water, and increase recording-keeping and data-reporting. He also highlighted severance tax changes in Ohio and Pennsylvania.

“Interesting recent developments are advisory commissions that are being put in place by states with increased drilling production to help guide the regulatory programs. Certainly permit application requirements will expand. The bottom line is companies will need to ensure adequate regulatory affairs, compliance and safety staffing.

“I know most of you think that a compliance staffer is a cost, but his or her good work could help you avoid litigation,” Kneiss said.

Uncertainty Ahead

Plaintiffs will show increasing sophistication in how they file lawsuits, and there are deeper pockets available to help support those plaintiffs, Kneiss said. “Some of the legal principles involved in shale development aren’t really established.” As a result, court rulings and outcomes are uncertain.

What energy legislation is the president likely to veto? “Anything that moves through Congress that affects the executive branch and how the EPA carries out its mandate, including climate change, greenhouse-gas rules, regulations that try to undercut the EPA’s development of the ozone standard,” Kneiss said.

“These are all pieces of legislation that if the economic impacts are great enough, there may be enough votes in the Senate to get them through. In the House, the Republican majority is sufficient for anything they want to adopt to move to the other chamber.”