Natural gas production will grow, but at a moderate rate
Natural gas is a clean-burning energy fuel used for heating, cooking, and generating electricity. In the U.S., it’s primarily used as a source for generating electricity. It’s also used by industrial, residential, and commercial sectors. According to the U.S. Energy Information Administration (or EIA), the total consumption of natural gas in 2013 was 71.4 billion cubic feet per day (or Bcf/d). In its Annual Energy Outlook 2013, the EIA has projected that the U.S. natural gas production will increase an estimated 44% over the next 30 years. Most of the production is expected to come from shale gas plays. Shale gas is projected to grow to 16.7 million cubic feet (or MMcf) in 2040.
Generally, most of the midstream companies enter into contracts with the producers of natural gas, such as Chesapeake Energy (CHK) or Range Resources (RRC). Production volumes of these upstream companies are directly correlated with the pipeline utilization of the midstream companies. Higher volumes result in higher pipeline utilization. They present more opportunities for investment in the midstream energy sector. As a result, midstream operators, particularly those that operate gathering pipelines and provide processing services, benefit when the rate of natural gas production increases.
We’ll discuss how natural gas production drives growth for gathering and processing midstream operators like Williams Partners (WPZ), Kinder Morgan Partners (KMP), Boardwalk Pipeline Partners (BWP), and DCP Midstream Partners (DPM).
WPZ’s projects in the Marcellus Shale
WPZ operates primarily in the Marcellus and Utica, Gulf Coast, and Rockies. These locations, Marcellus in particular, have abundant natural gas supplies. Therefore, WPZ’s growth projects focus on transporting natural gas to and from these locations. This can be seen from its Transco expansion. WPZ stated that it will be spending $5 billion by 2017 on expanding capacity in Transco—one of the nation’s largest interstate natural gas pipeline systems. The $5 billion includes $2–$3 billion for a project called “Atlantic Sunrise.” WPZ has made several investments into the Marcellus Shale in 2013, including the Susquehanna Supply Hub, Three Rivers Midstream LLC, etc.
Why BWP was hurt by higher gas production
According to Boardwalk Pipeline Partners (BWP), the difference in natural gas prices between traditional supply markets and traditional consumption markets (such as the northeast U.S.) used to be greater. The influx of natural gas coming from the Marcellus and Utica shales, which are located in the northeast, has caused the basis differentials to compress. This new natural gas production has changed regional supply and demand dynamics.
BWP had much of its natural gas transportation service contracted out. However, as these contracts approach expiration, the company is being forced to renew contracts at much lower rates given the changed natural gas supply and demand environment. Also, any new contracts are signed at lower rates than the company could have bargained for a few years ago. BWP stated that during 2013, the amount of revenue garnered with capacity reservation charges under firm transportation agreements was $45 million lower than during 2012. Capacity reservation charges are fees that parties pay to hold a portion of transportation capacity free in order to get their natural gas production to end markets. BWP commented that it expects this trend to continue. It may not be able to contract out all of its capacity. Also, it may not be able to roll over contracts at attractive rates. This ultimately affects earnings.
Natural gas production drives growth for gathering and processing midstream operators like Williams Partners (WPZ), Kinder Morgan Partners (KMP), Boardwalk Pipeline Partners (BWP), and DCP Midstream Partners (DPM). WPZ, KMP, NGLS, and DPM are all a part of the Alerian MLP ETF (AMLP). KMP is one of the significant components of AMLP.