Issue for Rocky Mountain Gas Producers Is Export Capacity

Abstract: Oil and gas producers are on the verge of gaining greater access to develop hydrocarbons on federally managed lands out West. Without additional export pipeline capacity, operators may find themselves creating a regional gas bubble.

Analysis: Take your pick of metaphors. Is it the cart before the horse phenomenon, the chicken or egg theory, or an example of a catch-22?

Each in its own way describes the tangled situation in the Rocky Mountains where oil and gas drilling is on the verge of expanding in a region where producers suffer price differentials, or discounting, because there is not enough pipeline capacity to get the gas to market.

While the prospect of expanded access to public lands makes operators giddy, the end result could further exaggerate the price-discounting phenomenon through regional gas-on-gas competition just as the situation seemed to improve when the Kern River Gas Transmission pipeline expansion opened in May.

The Rockies feature a complicated matrix of competing interests over federal land management. At opposite ends of the continuum are those who favor greater access to and development on and under federal lands versus those who oppose it, usually for environmental reasons. At various stages in between are diverse interests that have access to the surface for agrarian or domestic living arrangements.

Within the last couple of years, those favoring tight control on access have won significant lawsuits at the federal level contesting how the U.S. Bureau of Land Management has managed the permitting process for oil and gas-related activities in Colorado and Utah.

On the other hand, those favoring greater mineral and surface development have gained significant political clout and are at work attempting to influence federal policy. This past month marked the initial meeting of the Rocky Mountain Energy Council in Denver, a regional committee studying the permitting and review process involved in overseeing oil and gas drilling, pipeline projects, and other aspects of federal land management.

The RMEC is a pilot program sponsored through the Council on Environmental Quality, a committee that is formulating environmental policy for the current administration in Washington as part of the White House-sponsored Task Force on Energy Project Streamlining, which was outlined in George W. Bush’s May 2001 energy plan.

Concurrently, members of Colorado’s Congressional delegation are seeking to insert a provision creating tax incentives to expand oil and gas drilling and pipeline construction in Colorado and the Rockies in the current House/Senate conference committee on energy policy.

Against this backdrop, a number of E&P companies have announced expanded drilling programs in recent weeks for areas such as the Piceance and Uinta basins in western Colorado, typically involving tighter spacing on public lands.

Although much of the rhetoric in the debate has focused on access to minerals on federal lands, the real issue for gas producers in the Rockies is export capacity.

Rocky Mountain gas remains seasonally stranded because there is not enough pipeline capacity to move it to areas of high demand nationally. Regionally, consumption remains flat, production is growing, and surplus gas continues to pool because recent expansions in pipeline capacity have not kept pace with production.

For producers in the Rockies, price differentials, or the discount versus the spot market, have ranged from 20 cents per Mcf in 1999 to more than $1.80 per Mcf over the last few years. The differential has grown larger as regional gas production has increased.

It is not unreasonable to assume that adding more production before creating the infrastructure to take it to market will only make the problem worse.

If export capacity is the issue, why not take a “field of dreams” approach and just build pipeline infrastructure? This is being done to some extent. There are more than 20 pipeline projects under discussion for the region, though not all will come to fruition.

Furthermore, pipeline construction is expensive. The Enron collapse removed liquidity from the sector and decreased the number of marketers who normally purchased gas for resale, hardening the market. And with gas market restructuring, or deregulation, pipeline construction has evolved from an anticipatory process among state or federal agencies into a reactionary process based on the vagaries of supply and demand, which carries higher risk.

Historically, pipeline construction entailed decade-long agreements with gas marketers to cover the revenue requirements of building and operating a pipeline at the user end. That mechanism has unraveled. The financial burden is devolving towards oil and gas producers as the primary underwriters for pipeline construction in the Rockies.

However, most pipeline companies--and their financiers--want a 10- or 15-year contract commitment on the production side, while producers, typically, strain to guarantee production volumes five or six years into the future.

It is a classic standoff. Producers have said they will add wells when pipeline capacity is built, but pipeline companies indicate they will only add capacity when evidence of deliverability is demonstrated.

While it now appears producers are going ahead with the wells anyway, it won’t be that simple on the pipeline side. Currently, it can take up to five years from the time a project is proposed until a formal certificate application is made with the Federal Energy Regulatory Commission.

But some progress is evident. The state of Wyoming expanded the bonding capacity on its Natural Gas Pipeline Authority to $1 billion in 2003. The authority was established 25 years ago with a $250 million bonding capacity to plan, finance, build, or buy pipelines.

Wyoming seems to have become the bellwether for the challenge facing gas development in the west. The state exports 4.4 Bcf/d of natural gas, though Wyoming gas can sell for 25 percent below national spot gas prices at various times of the season.

There are two illustrations of pipeline promise and peril. As for the promise, the Kern River pipeline connects southwestern Wyoming with markets in California. It was built more than 10 years ago with an initial capacity of 850 Mcf. Capacity was expanded in May 2003 to 1.7 Bcf/d and the pipeline achieved 95 percent of its new capacity in the first few weeks of operation.

When the Kern River expansion opened in May, the spot price of Wyoming gas increased from $3.12 per Mcf to $4.26 per Mcf.

But the perils are hinted at in other projects, such as an El Paso Corp.-sponsored pipeline that will add 540 Mcf/d in capacity connecting the hub at Cheyenne, Wyoming to Greensburg, Kansas. The project, as envisioned, can be expanded to one Bcf/d and is scheduled to open by 2005. But it has been a tough go. Natural gas producers verbally expressed interest in up to one Bcf of daily capacity, but have been reluctant to come forward with firm contracts.

Financiers prefer contracts over promises.

With natural gas production set to move higher, the Rockies need an outlet. But the main push appears to be over increasing federal land access and expanding gas production. Without a concerted effort to expand pipeline infrastructure, it won’t matter what the spot price for natural gas is nationally. In the Rockies, it will be less.