May 2020, Vol. 247, No. 5


New Year Greets Marcellus/Utica Shale With New, Unexpected Challenges

By Richard Nemec, Contributing Editor  

Earlier pipeline construction through farmland in southern Lancaster County, Pa.

In the early weeks of the coronavirus (COVID-19) onslaught, Mike Chadsey, communication director for the Ohio Oil and Gas Association (OOGA), was trying to figure out how his world had flipped so completely in such a short time.

At year-end 2019 and during the first days of the new year, the vaunted Utica shale play was still experiencing increased production, and rig counts were holding steady. Projections for a supply glut-driven global slowdown were not causing major worries among OOGA’s members.

Then came the global market impacts of the coronavirus and the Russian-Saudi crude price war, and all hell broke loose in March. “We’ve taken it on the chin, right there!” said Chadsey, who was still unaware of any serious Utica production cutbacks when he spoke to P&GJ in mid-March. Nevertheless, at that still-early part of the growing national crisis, he acknowledged that “there are lots of challenges ahead for us.”

Like every corner of the United States since midway through the first quarter of the year, the buzz in the Utica and Marcellus shale gas plays has changed significantly with the outset of the pandemic. Outlooks quickly changed from bright and sunny to deep, dark gray. No industry or individual is quite the same. And in the natural gas-rich Appalachian Basin covering parts of Ohio, West Virginia and Pennsylvania, that is very much the still-unfolding scenario that no one saw coming at the end of 2019.

The veterans of this robust shale gas play, however, seem to be living the old adage that, when facing adversity, they are “bent-but-not-broken” by the events of early 2020. “Early in the year, we saw a softening in price and producers, both regionally and around the country, so we took action by reducing planned capital spends and holding production steady,” said David Spigelmyer, president of the Marcellus Shale Coalition (MSC) that focuses on Pennsylvania. “Some of those plans are being revised further to reflect demand challenges tied to the global oil supply and the pandemic.” 

Spigelmyer also reiterated that Marcellus producers feel very strongly that they are “still very much in the early innings” of shale development in Pennsylvania. He cites the September 2019 revised biennial report from the U.S. Potential Gas Committee at Colorado School of Mines, which estimates that the nation has a record natural gas supply, led by reserves from the Appalachian Basin. “We’re optimistic about the continued production opportunity this basin holds,” he said.

The Northeast Gas Association’s (NGA) 27-page, year-end 2019 report that describes bountiful natural gas supplies from the Utica and Marcellus shales was upbeat with the U.S. gas-producing mecca as part of its backyard. The NGA summary cited the Potential Gas Committee’s increased estimates for U.S. technically recoverable gas resource potential at 2,374 Tcf – its highest gas resource potential in the 54-year history of the report.

Royal Dutch Shell delayed construction of a 1.6-mtpa ethane cracker in western Pennsylvania because of the coronavirus. (Photo: Shell)

“Future supply of domestic natural gas continues to increase due to the advancement of key technologies that unlock gas production from reservoirs such as shale formations,” NGA’s year-end assessment noted.

With the International Energy Agency (IEA) world outlook predicting “strong growth worldwide” in natural gas, the NGA year-end 2019 assessment had no reason to inject caution. IEA wrote that its 2011 prediction of a global “Golden Age of Gas” apparently was “very close” to arriving this year. 

NGA noted that the IEA outlook also cited global headwinds for gas, too, such as commercial and environmental challenges that now have been exacerbated by the pandemic. Nevertheless, in 2019, dry gas production (92 Bcf/d) and overall gas consumption set records in the United States. Pennsylvania production reached a new high last year at 6.9 Tcf – up from 6.2 Tcf in 2018 and 4.8 Tcf in 2015.

Nationally, the Energy Information Administration (EIA) reaffirmed all of this as part of its 2020 Annual Energy Outlook, which saw “continued development” in the Marcellus and Utica shale plays. EIA lauded U.S. operators’ “technology advancements and improvements” for lowering production costs and increasing the amounts of recovered oil and gas per well. So, Marcellus/Utica seemed very well positioned just a short time ago for continued strong production in 2020,” said Steve Leahy, the NGA’s vice president of Policy & Analysis.

In a March 2020 review of prior-year energy markets, the Federal Energy Regulatory Commission (FERC) concluded that shale formation production in places like the Marcellus in 2019 allowed for continued growth in U.S. gas production, offsetting declines from existing wells in conventional reservoirs. Marcellus and Utica combined represented the largest national increase, adding 3.5 Bcf/d of supplies last year.

FERC noted that Appalachian shale growth was enabled by recent additions in pipeline takeaway capacity from Rover Pipeline, NEXUS Gas Transmission, Mountaineer Xpress, and other transport lines from Ohio, West Virginia and Pennsylvania to markets in the Midwest, Northeast and Gulf Coast.

Growth in the rest of 2020 is a large question mark, and insiders like Leahy at NGA are watching it closely as the economic slowdown progresses with the virus. “Incremental projects are expected online this year in the Northeast, but several projects have been delayed by state regulatory review,” Leahy said. Meanwhile, in late March, units of Royal Dutch Shell were announcing cutbacks in LNG export development and a pause in construction in western Pennsylvania at the 1.6-mtpa ethane cracker because of the coronavirus.

Then, on the last day of March, Pennsylvania Gov. Tom Wolf vetoed a state bill (HB 1100) that would have provided a tax credit for using state-produced natural gas to make petrochemicals or fertilizer, industries that might flourish in the midst of the Utica/Marcellus supplies. Wolf reasoned that the state must protect its limited resources as it battles the coronavirus outbreak. He also chided the absence of employee wage provisions in the bipartisan-supported bill.

“The required capital investment from companies and required job-creation thresholds that must be met in order to receive the credits must adequately align with the level of economic development incentive,” Wolf noted in his veto message. “Furthermore, this bill does not guarantee the creation of jobs paying prevailing wages that Pennsylvania’s workforce deserves when a project receives this level of financial commitment from the commonwealth.”

In response to Wolf’s veto, MSC’s Spigelmyer expressed deep disappointment in the governor’s action as a slap at the state’s workers. “This bipartisan plan would create hundreds of much-needed manufacturing jobs that pay family-sustaining wages and benefits. Abundant, affordable natural gas is driving opportunities for generational manufacturing growth, and this bill would help attract much-needed, job-creating investment,” he said at the time.

Earlier in 2020, the eight-year quest by developers of the Constitution Pipeline Project ended abruptly when Oklahoma energy giant Williams Cos. canceled plans for the interstate natural gas pipeline, which would have crossed through New York’s Catskill Mountains. The project had faced fierce environmental pushback and years of legal battles over a critical water permit. Along with its partners, Duke Energy Corp., Cabot Oil & Gas Corp. and AltaGas Ltd., Williams confirmed that it halted investment in the proposed 125-mile (201-km) pipeline.

“While Constitution did receive positive outcomes in recent court proceedings and permit applications, the underlying risk-adjusted return for this greenfield pipeline project has diminished in such a way that further development is no longer supported,” Williams said in a statement released at the time.

Energy infrastructure was a major issue at NGA at the end of last year, and it promises to be a focus throughout the ongoing fight to rein in the coronavirus. While the energy sector has always had to deal with various sources of pushback during the siting of new infrastructure, NGA’s year-end appraisal noted that fossil fuel projects had reached a new level of obstructions in both the United States and Canada, driven by climate change considerations.

NGA had accelerated replacement/repairs ongoing last year for older pipeline system components, resulting in enhanced safety and environmental protection in the transmission and distribution operations in the region; however, the year-end report noted mounting pressure for operators and utilities to incorporate more methane-reduction efforts in the ongoing infrastructure maintenance work. “The U.S. Pipeline and Hazardous Materials Safety Administration [PHMSA] continues to urge action on repairing older, potentially leak-prone systems,” according to NGA.

MSC’s Spigelmyer notes that infrastructure constraints create problems for consumers as well as oil/gas operators. He cited prices exceeding $90/MMBtu in New York and New England winter gas markets when “every utility in Pennsylvania delivered the commodity to consumers at less than $5/MMBtu.” Commodity prices in Pennsylvania are anywhere from 56% to 76% lower now in the Quaker state than they were in the winter of 2008, and wholesale electric prices are down more than 40%, Spigelmyer contended, adding that gas/electric consumers save $1,100 to $2,200 annually, as a result.

Ongoing economic woes, whether from the virus or oil prices, will impact U.S. and Utica/Marcellus infrastructure buildouts, said NGA’s Leahy. He calls it an issue to watch. “Incremental projects are expected online this year in the Northeast, but several other projects have been delayed by state regulatory review,” he said, again citing the Constitution Pipeline.

NGA’s year-end 2019 regional outlook cited five interstate pipeline enhancements for the year: Millennium’s eastern system upgrade; Transcontinental Gas Pipe Line’s Rivervale, south-to-north project; two projects by Portland (Maine) Natural Gas Transmission System – Portland Xpress and Westbrook (Phase 1); and Enbridge Inc.’s Lambertville-East project.

In late March, Moody’s Investors Service analyzed the oil/gas sector’s added risks coming with the Saudi-Russian price war and the pandemic to last for much of the year. The virus, Moody’s speculated, could run its course through the second quarter while analysts expected “improving economic fundamentals” beginning in the second half of 2020. 

“The large integrated oil companies have demonstrated resilience in previous downturns, which should temper the degree of negative rating actions,” said Moody’s New York City-based spokesperson Patricia Fortunato da Silva.

Moody’s Managing Director Steven Wood noted in a March 20 analysis that “continuing concerns about coronavirus have led to market expectations of weaker economic growth that, in turn, has resulted in oil prices much lower than our [earlier] medium-term fundamental outlook.” At the end of March, as President Trump extended the national lockdown for the month of April, S&P Global Ratings said “global events” had created a perfect storm for the oil and gas industry’s midstream sector, saying what S&P called “falling dominoes” were likely to significantly affect the North American midstream credit quality. 

“The supply shock of a possibly prolonged oil price war between Saudi Arabia and Russia, coupled with a significant demand shock from the global spread of COVID-19, has management teams on the defensive,” said S&P Global Ratings credit analyst Michael Grande. “Indeed, a few companies have announced capital spending and distribution cuts, and we expect more to come.”

Appalachian players who talked to P&GJ indicate that their prolific dry gas basin may be able to avoid the worst of this projection. In March, there was real concern about the Appalachian gas market for this summer. “You have to figure a double impact on the gas markets now – the global price war and the coronavirus response,” said Andrew Bradford, CEO of Colorado-based Btu Analytics, Inc.

The concerns for the summer market were amplified in January and February by a mild winter in the U.S. Upper Midwest and the East, Bradford contends. So, storage was expected to be “long” in most markets, including the Northeast, he said. The only exception is the Gulf Coast, where Btu Analytics has forecast a net 2-Bcf/d shortfall due to exports. That’s based on 4 Bcf/d of incremental LNG export demand, and only 2 Bcf/d of incremental supply.

“What does that mean to Appalachia and how things have changed?” he asks rhetorically. “We still expect this summer to be long and, that being said, we have been predicting a relatively flat Appalachia [production] for some time. But because of all that has happened in only a few months, the associated gas [in the Permian] story hurting dry gas production is starting to fall apart,” Bradford said. “Not so much this year, but in 2021-2022 with the lag in effect.”

Going into the winter of 2020-21, the gas market is looking like it will need to bounce, according to Bradford. There will need to be more price incentives, particularly for the dry gas plays like Appalachia. “We’re modeling for dry gas to fall by 3.9 Bcf/d this year until January 2021, given the uncertainty surrounding the amount of LNG export demand and Europe coming out of a mild winter with storage full at surplus levels [in March],” he said.

Erected barriers divide a residential area and the Mariner East II pipeline construction site in Chester County, Pa.

A useful barometer on the turnaround in the market dynamics in the first months of 2020 will be the amounts of decreases in capital expenditure (capex) budgets. Bradford points out that the global excess LNG export supplies and the U.S. gas market could see demand further reduced as U.S. operators continue to slash capex budgets. “While U.S. operators are slashing capex in the face of falling oil prices, the risk of demand shocks to the system may overwhelm the capex declines,” Bradford wrote in a March analysis of the economic downturn’s impact on gas demand.

In his late March analysis concluding the persistent low oil prices imply added risk for producers, Moody’s Wood acknowledged that “many E&P companies already have announced capital spending cuts, which, in turn, will result in lower revenue and earnings for drilling and oilfield services companies,” with the larger operators having better technology, equipment and customer relationships “in which to weather this downturn.” Smaller, less diversified service companies will suffer the most, he said at the time.

While the industry observers collectively think Utica/Marcellus will continue to fare the best among U.S. basins if the national economic slowdown turns into a prolonged closure, even Appalachia is bound to feel the pain of greatly reduced LNG exports, the oil price war and a halt to job-creating infrastructure projects. Moody’s most recent assessment of the midstream, for example, cited limited direct commodity price exposure, but said if the downturn persists, “produced volumes of oil, natural gas and natural gas liquids will drop, reducing both revenue and earnings.”

In late March, Moody’s already had seen the demand for refined products “drop precipitously” as economic activity slowed to a crawl and credit metrics began to weaken in the oil/gas sector, but the rating agency still thought it unlikely that big national oil companies would falter and be downgraded in their credit ratings.

“For investment-grade E&P companies, we would expect mostly negative outlooks or possibly reviews for downgrades, especially since their ratings are lower coming into this downturn compared to 2015-16,” said Moody’s Fortunato da Silva.

As the nation continued to shutter business and avoid face-to-face human interaction, most of the players in the Appalachian Basin were, like NGA’s Leahy, struck by how fast pre-Covid-19’s lingering expectation for energy demand turned into what he called the post-Covid-19 “considerable uncertainty.” Still, overall, he sees natural gas in his region as well-positioned.

“The coronavirus outbreak and its economic repercussions have unsettled all markets and outlooks,” Leahy said. “The economic shutdown is obviously reducing demand at all levels – even with now being the off-season or ‘shoulder season’ for electricity and gas demand. How long will this shutdown last and what will be its impact on production levels, on the pipeline 2020 construction schedules, on financial and capital investments for energy sources – for renewables to oil and gas? We will see. It’s unprecedented, extraordinary and unknown.”

In Ohio, OOGA’s Chadsey noted that today’s gas production from Ohio, Pennsylvania and West Virginia equates to the third-largest production area in the world behind all of the United States and Russia, but he wonders what it all means, given current challenges. He cited a veteran producer who noted that, when he graduated from college 40 years ago, gas was fetching higher prices than in 2020.

“What else – homes, cars or milk – is cheaper than it was 40 years ago?” Chadsey asked rhetorically. “It’s a challenge, but it is also an opportunity; good for consumers and good for manufacturing.”    

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