Moving SMID Natural Gas Sector To Market Weight. With our natural gas price outlook remaining $2.50/mmbtu through 2021, the sub-sector down 20% since our mid-Summer update, -36% YTD, and for some producers >90% off all-time highs, risk/reward is more balanced, and we move the group to Market Weight from Underweight. There are still challenges facing the natural gas producers in a $2.50 environment, but Consensus estimates are now more aligned around this price outlook, asset values remain below Strip pricing, and we see flat $2 pricing as lower probability scenario over the next 6-12 months given the supply response already occurring at $2.50.
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The Wolfe Utilities and Power team updated its 5-year outlook for U.S. power supply and we again incorporate the data into our macro supply/demand model. The key takeaway from the update is all about the accelerating trend of renewable capacity additions at the expense of other fuel sources, with natural gas additions decelerating following a long period of being the replacement for coal. After +5Bcfpd of growth from 2017-2019, based on the current slate of projects in development, we forecast only 1.2-1.4Bcf/d of new capacity growth in 2023 over 2019 or less than 0.3Bcf/d per year.
It was another volatile week for the E&Ps this week as sector performance got off to a good start, faded towards the middle, and then rallied back on Friday to finish +6.9% for the week vs. the S&P500 +1.0% and WTI -2.8%. Performance between the sub groups continues to be split, with the rally in gas names continuing for a second week.
While the E&Ps have strongly bounced back over the past two weeks, in part due to the market shift towards Value over Growth and Momentum, the sector is still -34% YTD vs. the S&P500 and increasingly has the feeling of being left for dead. Whether due to fear over oil prices heading below $50/bbl on weakening demand/plentiful supply, the rise of renewables, Energy shrinking to <5% of the S&P500 pie, or historical sector value destruction, we see the market’s perception of the E&Ps more about concern than opportunity. There’s still plenty for the E&Ps to prove, but with the sector pricing in $45/bbl WTI and trading at the widest margin (6.5x) to the S&P500 on NTM EV/EBITDA going back to 2001, we see good value in the E&Ps and believe this short rally could wake up the market to an improving outlook.
While natural gas storage levels have remained below the 5-year average YTD, the deficit has been steadily declining over the past few months with last week’s injection putting total stocks to less than 100Bcf below the historical trendline. Total natural gas storage now sits at only a 3% deficit versus the 5-year average compared to the 30% deficit seen at the beginning of injection season, with all regions in the L48 now within 10% of their historical averages and the Midwest region even exceeding its norm for this point in the year. The return towards normal storage has largely been due to the roughly 4Bcfpd supply growth since YE18, along with higher injections in the South-Central and Pacific regions that were drawn down heavily in February & March due to a prolonged winter season. Despite the narrowing storage gap, which would normally suggest downward pressure on price, near-term pricing has strengthened, likely as a result of warmer weather across half of the U.S. and short covering. This likely means we’re in for another volatile 4Q pricing period, just as we saw in 2018, but we’d note that the 2020/21 curves continue to remain around $2.50/mmbtu, so the forward outlook has remained relatively unchanged.
Inside this week we have two features, the first is we look at the S&P 500 Energy Index vs. the ISM Index as it broke 50 this week. FYI, Energy was the best performing sector this week. Second, we sat down with HES this week for a catch up, with notes inside.
After trading as low as negative $8/mmbtu earlier this year, Waha pricing has recovered with the startup of the Gulf Coast Express pipeline. In August, Waha Basis averaged -$1.24/mmbtu below Henry Hub, a $0.60/mmbtu month over month improvement, and the trend has continued in early September with spot prices now only $0.65-.70/mmbtu back from Henry Hub driven in part by a Texas heat wave. The outlook for the remainder of 2019 has improved as well, with Dec. 2019 pricing just touching $2/mmbtu again, putting the differential near -$0.50/mmbtu. While the 2020 curve currently does fall back to a -$1/mmbtu differential, the short-term boost in natural gas prices should provide a tailwind for heavier natural gas Permian producers (XEC, CDEV, LPI) along with APA’s Alpine High volumes. Additionally, the impact of the 2Bcfpd Permian Highway Pipeline (2H20) and the 2Bcfpd Whistler pipeline (2H21) have improved the outlook for 2021 differentials to -$0.56/mmbtu. See page 5 for Waha historical basis prices and forward curve.
It’s back to the grind this week and in preparation for the upcoming conference season, inside this weekend we provide a list of sector and company level questions across our coverage universe. We touch on the key issues around growth rates, return of capital, M&A, and asset specific questions/catalysts that can drive sector and stock performance through the rest of the year.
Mexico Announces Natural Gas Pipeline Contract Renegotiations. Earlier this week, news sources reported that Mexico has reached a deal with pipeline operators on natural gas delivery contracts. As part of the renegotiations the contracts fees will now be held flat rather than increase annually, and the terms of the contract were also extended. The deal focused on seven natural gas pipelines run by four different operators including Canada’s TC Energy, Mexico’s Carso Energy and Fermaca, and Ienova, although these renegotiations did not include Fermaca which operates two of the seven pipelines. With the renegotiations now complete, several pipelines including the 2.6Bcfpd Sur de Texas-Tuxpan pipeline may begin operations over the next few weeks. The Sur de Texas-Tuxpan pipeline has been mechanically complete since June but the CFE has held off formally putting the pipeline into service until the contract renegotiations were complete. We view the deal as a positive sign for natural gas pipeline operators in Mexico and it should help to increase natural gas deliveries across the county. This is also a positive for Permian and South TX producers for export volumes, as supply to Mexico has historically disappointed versus expectations due to delays. In our model, we are forecasting almost 4Bcfpd of incremental exports to Mexico by 2025, bringing our average 2025 export number close to 9.7Bcfpd. Our upside case assumes the full incremental 4.5Bcfpd of capacity comes online on time and is fully utilized, while our downside case assumes further delays and lower utilization.
US LNG Net Exports Peaked at Over 6Bcfpd In July . It’s been an up and down year for domestic LNG export supply, but the four operational export facilities (Corpus Christi, Cove Point, Sabine Pass and Cameron) continue to reach new highs with July averaging 5.9Bcfpd (+78% y-o-y), including a peak 6.3Bcfpd in mid-July according to Bloomberg. So far August has averaged 4.5Bcfpd, a 24% decrease vs. July as exports have followed the choppy YTD pattern with volumes falling to 4Bcfpd before rebounding to a current 6Bcfpd. Looking forward, the commercial startup of Corpus Christi Train 2 and Cameron Train 1 should keep volumes moving higher with Elba Island Train 1 and Freeport Train 1 starting up later this year, followed by additional trains in 2020. We currently forecast 7.7Bcfpd of LNG exports in 2020, up 3.2Bcfpd y-o-y, with the next big wave of projects in the 2023-24 time horizon pushing exports over 18Bcfpd in 2025.
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