Pure-play shale gas drillers gave Wall Street what it wanted in their second-quarter results: no spending for growth despite current higher commodity prices and free cash flow to pay down debt and set up returns to shareholders in 2022.
"Maintenance mode remains the plan for Appalachian gas companies as they are not incentivized with the severely backwardated forward curve and wide in-basin differentials," veteran shale analyst Gabriele Sorbara with Siebert Williams Shank & Co. LLC said. "Return of capital to shareholders is accelerating with more attractive frameworks unveiled" as companies such as EQT Corp. hinted they would begin distributing free cash with variable dividends as soon as 2022.
The shale gas group, most operating in the Appalachian shales, reversed year-ago operating losses and negative cash flows as commodity prices rose off near-record lows in 2020 and kept climbing.
Several Appalachian producers, including EQT, the largest, saw their second-quarter GAAP results dinged because of noncash charges they had to take when their hedging portfolios lost value as the hedged price undershot futures prices that galloped from $2.50/MMBtu to above $4/MMBtu over the spring and summer.
Hedging hampers upside
In reaction to 2020's $2/MMBtu gas market, producers hedged significant production to ensure their revenues and reassure lenders and bondholders. Now, those prices have undershot the 2021 futures strip and are capping the ability of shale gas drillers to make the most of higher prices.
"Gas equities hedged away a lot of the potential upside from the most recent move higher in 2022 gas price strip, now at $3.50/mcf, with operators now at 51% hedged on average (60% excluding Cabot Oil & Gas Corp.)," Mizuho Securities USA LLC oil and gas analyst Vincent Lovaglio said. "For the gas equities, the hedges lock in balance sheet reduction to sustainable leverage ratios roughly 1.5x or lower [debt/EBITDA], setting up for their own wave of cash return announcements likely starting early next year."
Most gas exploration and production companies lock in a guaranteed value for their production using swap contracts pegged to a specific price. If the futures price is less than the swap price, the E&P is paid. But when the futures price is higher than the swap contract's notional price, the driller pays the bank that wrote the contract. The noncash charges occur as the value of the hedging portfolio is marked to market at the end of each quarter and future payments are accounted for on a noncash basis.
Eye on emissions
Shale gas producers used part of their second quarter results to highlight their environmental efforts or corporate responsibility reports as pressure grows on the industry to strip carbon, particularly the potent global warming gas methane, out of its production flows.
While gas giant EQT reminded the market that it has signed on for increased methane monitoring and the replacement of all its pneumatic controllers on well pads and pipelines, New York integrated gas company National Fuel Gas Co. is leveraging its utility experience to explore turning the waste from local dairy farms into renewable natural gas for sale.
"ESG [environmental, social and governance] efforts are evolving and becoming a larger part of the discussion," Siebert Williams Shank said.
Future prospects
Looking to 2022, analysts expect Appalachia's producers to continue to keep production at current levels as little new pipeline capacity has been built and their cash flow is assured with their hedges in place.
"Given the offtake constraints currently facing Appalachia, we expect operators to optimize free cash generation by constraining resource development until there is assurance on offtake," Mizuho said. "But even with a pickup year over year in Appalachian and associated gas volumes by ~1.5bcfd, we still forecast the market in 2022 not meeting incremental demand needs."
With Appalachia limited, that gas is likely to come from Louisiana's Haynesville Shale where the mergers and acquisition market has heated up, analysts said. "Southwestern Energy Co. recently acquired Indigo Natural Resources LLC. and plans to build scale within Haynesville. We note this week Chesapeake Energy Corp. announced the acquisition of Vine Energy Inc. in Haynesville for $2.2 billion," Goldman Sachs oil and gas analyst Neil Mehta said Aug. 15.