May 12, 2022 - Likely contributors to recent price movement:
Producers hedging: When producers hedge with swaps, they take a short position – they sell swaps. These hedges are almost always placed with trading counterparties or swap dealers. These positions eventually show up on the exchanges as the counterparties place offsetting positions to lay-off their risk.
The best explanation for decreasing Waha basis is increased selling pressure from hedging. U.S. producers showed little interest in locking in future prices at the beginning of 2022. Habits apparently changed as both oil and gas prices rose. If AEGIS clientele is a representative sample (and we think it is), U.S. producers have increased their gas hedges these past few months. The main reason? Prices are higher, and there is a perceived looming constraint in west Texas, which in the past, has caused price blowouts.
Total production growth: The supply-demand balance in the gas market is supporting prices and, therefore, drilling activity.
According to EIA, U.S. gas stockpiles have sharply declined, and inventories are 16% below the five-year average for the week ending May 12.
As of May 12, 2022, drillers have added 106 more rigs in the Permian over the past year, bringing the total number of active rigs to 335, according to Baker Hughes statistics. So far, in 2022, the number of gas-directed drilling rigs has increased by 38%, to 146. Some analysts project the Permian rig count to hit 400 by the end of the year.
AEGIS recommends costless collars for oil hedges. We prefer these upside-friendly structures partly because of our belief that the futures curve is undervalued. Each client's portfolio has different needs, so check with your trading contact for specifics.
Increased rig counts indicate that operators are attempting to increase output or at least offset declining wells. Planned production growth is likely contributing to weakening Waha basis prices and pipeline constraints.
Public companies have been remarkably conservative in their growth estimates. However, private companies in the Permian basin have been much more active. This does not mean “zero” growth from the publics: there have been some prominent public producers that are increasing production there, such as Exxon Mobil and Chevron. Yet, on average, the publics have said they will grow by about 5% this year as of the 1Q earnings calls. In our view, privates will grow faster than that, and they are adding rigs at a faster pace. Production is already increasing; as of the end of April 2022, the average dry gas production in the Permian was 15.91 Bcf/d, up from 13.39 Bcf/d in December.
Expectation of constraints. Cheaper basis prices, or large discounts to Henry Hub, usually imply some sort of egress capacity constraint or increased need for capacity out of the basin. The recent weakness for Waha suggests the region could run into takeaway capacity constraints as soon as Summer 23.
With production growing fast and demand rising from the LNG export plants on the gulf coast, Energy Transfer announced their new Warrior pipeline linking Permian gas to the DFW area.
WhiteWater plans to expand the Whistler pipeline to 2.5 Bcf/d, an increase of 0.5 Bcf/d. Although the significant pipeline expansion over the last two-and-a-half years has been advantageous, it may not be sufficient to meet all production growth in the next 24 months.
Kinder Morgan is planning to increase capacity on its Permian Highway Pipeline and Gulf Coast Express Pipeline by up to 1.2 Bcf/d as soon as 4Q2023, as of the 1Q earnings call.
Perhaps recent weakness in Waha basis will lead to more pipeline development and new-pipeline announcements. Typically, pipeline companies first require long-term agreements from producers before committing to a new project. Even after these contracts and financing are in place, projects take time to come to market.
With a long lead time for pipeline projects, the risk in the Waha basis curve is far from over.
Waha basis can be hedged with swaps. Waha is usually hedged as part of a complete natural gas hedge. The general recommendation is to hedge NYMEX Henry Hub natural gas and Waha basis in two steps, but simultaneously. Contact us at email@example.com if you need to work through the details.