For the first time in years, we find ourselves bullish on natural gas price direction. There’s still some <$2/mmbtu pain to go as we enter the shoulder season, but by mid-2020, we see the confluence of rapidly slowing U.S. supply growth and ramping demand normalizing balances and setting up a 1H16-like period, when NYMEX jumped from <$2/mmbtu to $2.75-3/mmbtu within three months. The key to all of this lies in U.S. LNG exports and based on our outlook, we see the U.S. entering an undersupplied position in 4Q20 to support higher prices. Within, we provide our updated U.S. natural gas supply/demand model through 2025.
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Yesterday, the EIA Drilling Productivity Report (DPR) provided updated estimates across the key unconventional basins and is finally showing a crack in the rampant pace of natural gas growth over the past two years. In aggregate, the EIA’s updated forecast now shows a -0.1Bcfpd sequential decline from January to February and -0.17Bcfpd estimated decline from February to March. There’s still some growth from the Permian, but the March estimate shows back to back months of decline in Appalachia, with the Anadarko Basin also witnessing declines. It’s equally important to see the Haynesville flattening as well, especially after the 2-2.5Bcfpd annual growth trajectory the basin was on throughout 2019. Directionally, we see the trends as in line with our basin expectations, supportive for natural gas price and perhaps, the start of shut-in volumes in Appalachia. See page 3 for a breakdown of the EIA’s supply growth by region versus our estimates.
For the week, our E&P Index was -4.1% vs. the S&P500 +1.6% and WTI +3.4%.
While natural gas prices continue to fall, US LNG net exports continue to reach new highs. With Cameron and Freeport Train 1 now online, export volumes averaged 8.4Bcfpd in January, up 8% versus the December 2019 average and well above the 2019 annual average of 5.6Bcfpd. So far in February volumes have averaged 8.8Bcfpd as net exports continue to rise in the face of declining global prices. There’s an additional upward bias this year as Cameron Train 2 starts up, but exports need to be tightly watched as it is the only significant source of demand growth and key to balancing out the current oversupply situation. We currently forecast 7.7Bcfpd of LNG exports in 2020, which if hit, would be a big positive for domestic natural gas prices. The next big wave of projects will be in the 2023-24 time horizon, with FID on multiple projects also a positive sign for l-t domestic demand growth.
For the week, our E&P Index was -0.1% vs. the S&P500 +3.2%, and WTI -2.4%. After a brief moment in the sun on Wednesday (2/5/20), it was right back to business as usual for the sector Thursday and Friday as coronavirus fears picked back up again.
On back of the 16% decline in WTI and HH prices, our E&P Index fell by 21.3% in January, with all but one producer (APA) finishing in negative territory. We’ve gotten a little reprieve to start February as coronavirus fears may be subsiding, but the macro environment is still challenging sector performance and so far, 4Q earnings season hasn’t helped the cause. COP and PE remain our Top Picks.
While a few more formal 2020 outlooks are still to come, it’s looking more likely that the publicly traded Northeast natural gas producers collectively point to flat volumes from 4Q19 levels. This is a new world for the basin as production has been on the rise since Marcellus activity started in 2004, but it’s the right move to combat the current <$2/mmbtu environment and persistent growth out of the Haynesville and Permian. Further, we believe the Northeast producers should already be thinking about extending the period of flat volumes into 2021 for two key reasons: 1) the world clearly doesn’t need more supply right now, with declining global prices putting downside risk in U.S. LNG export demand and 2) financial positions will weaken from a return to growth as spending would need to rise while 2020 hedge benefits roll off.
COP reported a mixed 4Q with EPS/CFPS and oil volumes missing offset by better Lower48 sequential growth. The 2020 volume guide was moved 2% lower on third party issues as well. Despite the hiccups, we continue to view COP as a Top Pick based on the sustainable return of cash profile, with the increased buyback to $25Bn in line with the commitment to this effort, while also downplaying corporate M&A. With a 2.8% dividend yield and $3Bn in planned repurchases this year (at $50/bbl WTI), COP offers a 7.8% return of capital yield that we view as competitive vs. energy and the broader market.
It’s been a challenging start to 2020, as the promising outlook of a $60+/bbl year has evaporated and unfortunately for the E&Ps, there’s no quick fix until uncertainty around the U.S. political landscape and the coronavirus impact on GDP/crude oil demand clears. The positive turnaround path is still there and we see supportive messages coming out of the 4Q updates, but until a better macro setup takes hold, we see a lid on sector performance and plenty of volatility. We’re staying selective, preferring Large over SMID Cap, Permian over multi-basin, and keep COP and PE as top picks.
Last week we had the opportunity to meet with senior management at PE-backed Indigo Natural Resources, gaining some insight into the Haynesville Shale. It’s a basin that’s been somewhat of a black box in the domestic supply picture as it’s changed hands from public to private operators over the last 10 years, with new technology deployment and advantaged location pushing regional supply towards 12Bcfpd – double 2016 volumes (per the EIA DPR). However, after a multi-year period of 2+Bcfpd/annual growth, we see y-o-y volume gains slowing in 2020, with the rig count decline from 53 to 43 over the past six weeks (per Baker Hughes rig count) suggesting the basin is already starting to feel the impact of the lower price environment. Within, we provide some detail around Indigo and the Haynesville.
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