TOPIC #3
Natural Gas: An Unsettled Outlook
Global dynamics, gas-power interdependence, policy changes, and capital needs complicate the gas industry.
Supply Hangs On: Meeting the Challenge of Demand
- Domestic demand for natural gas has grown through September 2022, as post-pandemic activity has increased residential and commercial consumption in 2021 and 2022 and cold temperatures drove higher demand in the first half of 2022. Electricity generation demand for gas has increased significantly in 2022, as numerous and lengthy hot spells increased air conditioning demand. Further, as low coal stocks, coal deliverability constraints, and coal plant retirements limited coal-fired generation, generator demand for gas increased in 2022 despite high gas prices.
- Natural gas production continues to grow in response to this demand growth, in part incentivized by high prices, domestic demand, and strong global demand for liquefied natural gas.
– This continued production growth comes despite more measured capital spending in the upstream sector. U.S. producers have been able to run through their drilled but uncompleted well inventories, reducing incremental capex needs.
– The International Energy Agency has observed that production growth is “caught between short-term caution on spending and longer-term optimism on export (i.e., LNG) growth potential.”
- While U.S. production has kept up with demand, gas in storage remains at recent-year lows going into winter 2022-23. A cool winter and spring transitioned quickly into a warm summer, limiting storage buildup in Q2 2022.
KEY TAKEAWAYS
Natural gas supply, demand, and prices are being roiled by competing drivers of demand, policy changes, and potentially increasing effects of the global market.
The war in Ukraine, and related stoppage of pipeline gas imports to Europe, has made Europe a more significant purchaser in LNG markets, and U.S. gas producers and midstream participants are increasing exports insofar as capacity permits.
Gas-power interdependence continues to be an issue for regions across the United States, with gas-fired power as an incumbent and flexible resource to support the clean energy transition. However, supply constraints remain an issue, and system operators and regulators are looking for ways to ensure reliability and energy adequacy in the near and long term.
Natural gas supply, demand, and prices are being roiled by competing drivers of demand, policy changes, and potentially increasing effects of the global market.
The war in Ukraine, and related stoppage of pipeline gas imports to Europe, has made Europe a more significant purchaser in LNG markets, and U.S. gas producers and midstream participants are increasing exports insofar as capacity permits.
Gas-power interdependence continues to be an issue for regions across the United States, with gas-fired power as an incumbent and flexible resource to support the clean energy transition. However, supply constraints remain an issue, and system operators and regulators are looking for ways to ensure reliability and energy adequacy in the near and long term.
Figure 3.1: Monthly U.S. Natural Gas Marketed Production (Trillion Cubic Feet per Month) (Jan. 2006-Jun. 2022)
Source: EIA
Figure 3.2: U.S. Lower 48 Weekly Working Gas in Underground Storage (Billion Cubic Feet)
Source: EIA
Figure 3.3A: Selected Drilled but Uncompleted Monthly U.S. Gas Well Inventory (No. of Wells by Play)
Source: EIA
Figure 3.3B: Selected Drilled but Uncompleted Monthly U.S. Gas Well Inventory (No. of Wells)
Source: EIA
Figure 3.4: Henry Hub Natural Gas Monthly Average Spot Forecast and Forward Prices ($/MMBtu) (Jan. 2017–Dec. 2023)
Source: EIA
Natural Gas Prices: Short-Term Spike or Long-Term Trend?
- After years of quiescence, natural gas prices have ticked higher, responding to the supply-demand forces described earlier. Henry Hub prices generally remained below $4/MMBtu until late summer 2021. After a dip in late 2021–early 2022, by March 2022, monthly average prices rose above $5 and have remained elevated.
- A central question for gas market participants is whether and for how long these higher gas prices will last. There are several competing considerations:
– Demand response/destruction: Persistent high prices may reduce gas demand, particularly in applications where there is more price elasticity of demand. In Europe, for example, gas-reliant industries have reduced or stopped production when input prices make the product uneconomic. This has not yet been seen on a widespread basis in the United States.
– Global price pressure (or not?): The United States and Canada are net exporters of gas, meaning that global LNG prices do not necessarily affect domestic prices, although LNG export facilities have been running at capacity. As new export facilities are completed (see LNG discussion later), those exports may be significant enough to compete with domestic demand and impact U.S. pricing.
– Renewables vs. coal retirements: Some analysts note that increasing focus on renewable generation development will reduce total demand for natural gas despite potentially acute needs for balancing in tight power resource conditions. However, offsetting this potential reduced gas demand for power is the continued planned retirements of coal-fired power plants in several regions.
– Capex and production: After years of financial challenges, gas producers have been tightly managing capital for new gas development. It is unclear whether uncertainty about U.S. medium- to long-term hydrocarbon policy (development and end use), long-term European climate policy (for LNG export volumes), and concerns about a slowing economic outlook could reduce or discourage production.
– Associated gas: Prolonged higher (>$100/barrel) oil prices could also continue to motivate oil production, with resulting associated gas volumes.
– Weather: Increased demand due to weather, as was seen earlier in 2022, could provide price signals that would encourage more production which could moderate price increases.
LNG to Grow as a Demand Driver
- War in Ukraine and related loss of Russian pipeline exports to Europe in 2022 has added to global LNG demand, as Europe has begun to compete with Asian (especially China, Japan, South Korea, and India) LNG demand.
- Even before this year, U.S. LNG exports in 2021 had grown 50% from 2020 volumes, from 44.8 million tons to 67 million tons. The United States was the third largest LNG exporter in 2021, accounting for 18% of global net exports. Part of this growth is driven by the initial commercial operation and high utilization of five large liquefaction trains beginning in 2020, specifically Cameron LNG 2-3, Corpus Christi 3, and Freeport LNG 2-3.
- U.S. LNG exports have risen 12% over 2021 levels, with volumes totaling 74 billion cubic meters, or nearly 54 million tons through the end of August. And while LNG exports to supply global demand are expected to continue given global pricing, new U.S. liquefaction capacity totaling 3.27 Bcf/d is not expected to go online until 2024-25.
Figure 3.5: Historical and Projected Monthly U.S. LNG Export Volume (Billion Cubic Feet per Day) (Jan. 2017–Dec. 2023)
Source: EIA
LNG to Grow as a Demand Driver (Cont.)
- As noted above, real uncertainty exists for long-term demand (2030 and beyond) given European climate change targets. Nonetheless, for now, European buyers are locking in some LNG contracts with American exporters:
– European-based Engie signed a 15-year sales and purchase agreement (SPA) for 1.75 million metric tons per annum (MTPA) with NextDecade's Rio Grande LNG project in Texas.
– German utility RWE signed a 15-year heads of agreement (HOA) with Sempra's Port Arthur LNG project in Texas for 2.25 MTPA.
– Poland's PGNiG signed an HOA with Sempra at its Cameron and Port Arthur facilities.
– German utility EnBW signed two 20-year SPAs with Venture Global LNG for 1.5 MTPA from the Plaquemines and Calcasieu Pass 2 facilities, starting in 2026.
– British chemical company INEOS announced plans to begin trading LNG with a 1.4 MTPA deal with Sempra projects.
- Key questions for this development are whether increased global LNG demand is here to stay and at what level might U.S. LNG exports affect domestic gas pricing.
Figure 3.6: U.S. Historical and Projected LNG Export Nameplate Peak Capacity (Billion Cubic Feet per Day) (Jan. 2016–Dec. 2025)
Source: EIA
Figure 3.7: Historical and Planned U.S. Natural Gas Pipeline Additions (Billion Cubic Feet per Day) Approved, Completed, Partially Completed, and Under Construction
Note: Data as of July 29, 2022.
Sources: EIA; ScottMadden analysis
Pipelines: Moving Ahead or Pipe Dream?
- Because of the dynamics noted above, pipelines have been increasing focus on takeaway capacity that can support LNG growth. For example, the Permian Basin, relatively near Gulf of Mexico export terminals, has 5.5 Bcf/d of incremental gas takeaway capacity projects announced by midstream operators.
- Permitting and certification remains a wild card. Gas pipeline development has been shadowed by FERC’s April 2018 announcement that it would revisit its pipeline certification policy with a view to incorporate an assessment of a project’s potential greenhouse gas emissions as well as effects on communities. FERC released draft policy statements in March 2022, soliciting comments. While that has not factored into several project approvals to date, new policy statements have not yet been issued.
- Marcellus/Utica takeaway pipeline expansion is needed to further develop those fields, but remains challenging, exemplified by the inability to finish and activate the nearly completed Mountain Valley Pipeline (MVP). Permitting reform, which focused in part on completion of MVP, was proposed by Sen. Manchin (D-WV) as a condition of signing on to the Inflation Reduction Act of 2022 (IRA). However, that provision was removed from the continuing budget resolution passed in late September. It is unclear whether, how, and when it will be reintroduced.
Mixed Impacts of the Inflation Reduction Act of 2022
- Gas utilities and pipelines have been interested in renewable natural gas (RNG) development as a decarbonization strategy, and some gas utilities are allowed to participate in ownership of RNG infrastructure. The American Gas Association has identified ~2 Bcf/d to 6 Bcf/d of RNG potential. The IRA provides some incentives for decarbonized infrastructure and low-carbon fuels like RNG. However, low-carbon fuel standard credit prices have been declining, offsetting some growth, particularly in the transportation market.
- Kinder Morgan, for example, has created an energy transition ventures group that looks at “attractive opportunities likely to be synergistic with [its] existing infrastructure and expertise.” These include opportunities investable today (RNG, renewables), in 1 to 5 years (carbon capture and sequestration), and 5 to 10+ years (hydrogen). Hydrogen is getting an assist from the IRA with a $3/kg subsidy.
- Of course, of particular interest in the IRA are methane fees, which phase in from $900/ton in 2024, rising to $1,200/ton in 2025, and $1,500/ton in 2026. At $900/ton, this yields $277 million. Note that $900/ton and $1,500/ton equate to an implicit CO2 cost of $36/ton and $60/ton, respectively. Those methane fees are applicable to facilities currently required to report emissions to EPA under its Greenhouse Gas Reporting Program (i.e., facilities that emit 25,000 metric tons of CO2e per year).
– The EPA’s latest estimates are that the entire gas transmission and storage segment emitted about 41 million tons of CO2e in 2020. Reporting onshore gas transmission pipeline and compression facilities and underground gas storage are estimated to emit 7.7 million tons of CO2e.
– One group has estimated that the U.S. oil and gas industry will incur a $3.3 billion liability for methane emissions if unremediated.
– Using a rough CO2 to methane conversion yields about 0.31 million tons of methane for the gas transmission/storage sector. This estimate is slightly higher than is likely to be charged because of emissions thresholds and potential exemptions.
Figure 3.8: 2020 Gas Transmission and Storage Methane Emissions by Source (Total: ~41 MMTCO2e)
Source: EPA
"We know that the root of New England’s winter electric system reliability challenge is the significant dependence on natural gas in these extreme conditions, along with gas supply constraints.”
-FERC Commissioner Allison Clements
Gas-Power Interdependence: New England’s Coal Mine Canary Keeps Chirping
- Gas-power interdependence, long a phenomenon since cheap and lower carbon-emitting natural gas significantly expanded in the early 2010s, continues. And some of the pipeline development difficulties and weather-related disruptions continue to cause concerns for regions heavily dependent on gas-fired power, including those that use gas power to backstop variable energy resources. Certainly, grid issues in Texas and the south-central United States during February 2021’s winter storm Uri illustrated the challenges of interdependence across the nation.
- New England has long dealt with this issue, as limited additional gas import capability has been developed despite Marcellus gas a few hundred miles away. The region’s energy adequacy/reliability issue is particularly acute during cold spells and extreme winter weather. And resistance to local gas infrastructure development has been an additional constraint for both home heating and power generation. As FERC Commissioner Clements noted, “I’m struck by how long this conversation has been going on.”
- In a letter to the Department of Energy, New England’s system operator and state governors have called for DOE support in ensuring fuel security. They note that a clean energy transition requires in the near term flexible balancing resources—namely gas-fired—that manage variability of clean energy resources as well as provide home heating.
– New England is the only region that depends on imported LNG, particularly during winter months. While these imports can be expensive (recently as high as $100/MMBtu in the forward market), they are a key swing resource for the region. The ISO-Governor letter urges continued operation of the Everett LNG facility and exemptions from the Jones Act for LNG deliveries. Currently, there are no U.S.-flagged LNG tankers, and New England must procure from the international market due to Jones Act restrictions.
– They also propose consideration of an “energy reserve” which would be available through extended periods of severe weather or supply constraints. Market solutions have failed because of the lack of long-term revenue commitments for generators (thus not undertaking longterm fuel commitments) and state-federal jurisdictional gaps and overlaps for issues such as cost recovery.
- FERC conducted a forum in early September to discuss issues and potential solutions. Actionable next steps have not yet been proposed. In the meantime, New England utilities and system operators will have to hope for a normal winter and prepare for potentially high costs for power and gas this winter.
IMPLICATIONS
Gas production, pipeline development, and LNG exports continue to provide attractive business opportunities for the gas sector in the near term. With the passage of the Inflation Reduction Act, many “carrots” for decarbonized gas infrastructure—hydrogen, renewable natural gas, carbon capture and sequestration, and related pipeline build—may provide investment opportunities.
Gas infrastructure will be needed for the foreseeable future to ensure reliability even through an energy transition. However, uncertainty about future regulatory and policy treatment of that infrastructure could impede further investment. Gas producers, midstream companies, and local distribution companies will have to assess how public policy and demand drivers might affect investments in the medium to long term.
For now, with significant focus on reliability (including gas-power interdependence) and meeting critical energy needs, industry participants will likely seek ways to make the most of existing infrastructure.
CONTACT OUR EXPERTS
On Natural Gas Developments
RECENT INSIGHTS
Available at scottmadden.com
ScottMadden posts energy and utility industry-relevant content and publications on a regular basis. The list below is a sample of recent insights prepared by our consultants.
