- Widening Marcellus differentials may remain the #1 concern for Marcellus stocks, with Cabot being no exception.
- Macro factors notwithstanding, Cabot's operating results remain very strong and highlight the exceptional productivity of its core Marcellus asset.
- The announced Atlantic Sunrise deal is a major development that provides a takeaway solution for 850 BBtu/d of the company's future production.
- Despite potentially slower-than-expected production ramp-up in the next two years, Cabot's "story" remains intact.
Cabot Oil & Gas' (COG) report of widening Marcellus differentials and less-than-optimistic overtones in the discussion related to the near-term price realizations were the primary drivers behind the stock's 8% sell-off during Friday's trading session. The overproduction of natural gas in Pennsylvania's Northeast region may indeed make a dent in the company's cash flow and growth rate in the next two years relative to prior expectations. Some uncertainties with regard to the in-service date for the Constitution Pipeline (now possibly a 2016 event) likely added to the pressure on the stock.
However, concerns over the Marcellus basis should not overshadow the company's exceptionally strong operating performance during the reported quarter and the fact that permanent solutions for its low-cost production will eventually be put in place (such as the announced 850,000 MMBtu/d Atlantic Sunrise deal).
Cabot remains a highly compelling 2016-2017 story.
Concerns Over The Marcellus Differentials
Cabot reported that through the first two months of the year, its natural gas price realizations, before hedges, have been between $0.60 and $0.65 below NYMEX settlement prices. Cabot has access to three major interstate pipeline systems and multiple (approximately four hundred) sales contracts in place, selling a relatively small percentage of its production into the day market. Therefore, the strong discount indicates that the trend is impacting a variety of pricing points and, given continued growth of production volumes from the region, will likely persist.
On the pricing side, while we have experienced strong NYMEX prices this winter, regional differentials remain wider than originally expected. Despite these wider than anticipated differentials, based on the current NYMEX strip prices for the remainder of 2014, our implied rate of return on a typical Marcellus well would be over 200 percent.
Cabot indicated that it is planning its 2014 operating activity under the assumption of wellhead price realizations in the $3.00-$4.00/MMBtu range. While this assumption may be perceived as alarming given that the front-month Nymex contract is trading around $6/MMBtu and the average Nymex price for the remainder of the year is $5/MMBtu, it would be incorrect to equate the company's $3.00-$4.00/MMBtu budget assumption to a natural gas price estimate.
Still, it is difficult not to connect Cabot's decision to run six rigs in 2014 in the Marcellus, instead of the seven originally planned, with the outlook for potentially lower (and certainly more volatile) price realizations in the Northeast. Cabot still plans to complete 2,600-2,800 frac stages during the year, however, the company now plans to draw upon its 1,000-stage pre-drilled well inventory to substitute for the seventh operated rig. The company does not believe that this would impact its growth in 2015.
The Marcellus differential is indeed an "800-pound gorilla in the room" that will continue to impact investors' perception of the Marcellus stocks. While in the short term pricing volatility is almost inevitable, help is on its way in the form of many additional pipeline projects and more disciplined "to-capacity" planning decisions by operators that will ultimately provide solutions to the problem.
Production Guidance Clarified
Maintaining the Marcellus rig count at six rigs will reduce Cabot's 2014 capital budget by $75 million to the $1.3-$1.4 billion range. Cabot stated that previously announced levels of absolute production for the year will not be affected.
Cabot clarified its production guidance for 2014, which is "unchanged" at 519 Bcfe to 598 Bcfe (guidance was originally issued on September 26, 2013, and implied 30 to 50 percent production growth on the mid-point of 2013 guidance at the time of issuance). However, this new guidance now implies only 25%-45% from the production levels actually achieved in 2013 (and some investors may actually see this guidance as slightly lower than hoped).
Cabot also reported that it has seen its production volumes so far this year impacted by unscheduled weather-related downtime. The impact may have been as high as 75 MMcf/d on average during January and February. Cabot is also seeing longer spud-to-sales durations for larger, multi-well pads (which has been anticipated). As a result of these two factors, the company anticipates relatively flat production levels for the first half of the year (which is similar to 2013).
Constitution Pipeline Update
Based on the commentary, the risk is now higher that Constitution Pipeline may not be in-service until 2016, given the slow pace of the approval process (including the state-level reviews). While the process is moving along, obtaining State permits and Federal permits has taken longer than anticipated.
2013 Marcellus EURs Averaged 17 Bcf
Cabot reported average EUR per well of 16.9 Bcf for its 2013 drilling program in the Marcellus, up an impressive 20% from the 2012 average. This is precisely in line with my 16.5-17.3 Bcf estimate discussed in previous notes. While being an absolutely outstanding result, the EUR improvement was driven primarily by the longer average lateral length, while per-foot recoveries have improved by a more moderate 6% year-on-year.
The company estimates that its 2013 wells will recover 3.6 Bcf per 1,000' of lateral (23% higher than the next closest Marcellus operator, according to Cabot).
Cabot confirmed that its 2014 drilling campaign will see even longer average laterals ("In 2014, Cabot will continue to extend its average Lower Marcellus lateral lengths…"). This will likely result in even higher EURs per well and is again in line with my earlier observations. Assuming an additional 3% improvement in per-foot recoveries (half of the 2013 rate) and a 15% increase in the average lateral length to ~5,400', the average EUR per well would be in the 20 Bcf/well range in 2014.
The increase in the lateral length will result in somewhat higher drilling & completion cost per well, which Cabot now sees in the $6.8-$7.2 million range in 2014.
In terms of drilling economics, Cabot remains in a class of its own. Cabot estimates rates of return in excess of 100% assuming $3.00/ MMbtu at the wellhead. While the volatility of the Northeast Marcellus basis may make the $3-handle wellhead price realizations an unfortunate reality in the near term, the exceptional productivity of the asset should help Cabot continue to realize excellent drilling returns during the two-three year transition period before the 1.35 Bcf/d of newbuilt takeaway capacity becomes available to Cabot.
The table below highlights the program comparisons between 2012 and 2013.
Lateral length (Ft.)
Maximum lateral length (Ft.)
(Source: Cabot Oil & Gas)
500-Foot Downspacing Update
Cabot's management commented that they are "very pleased" with the results of the downspacing pilot drilled last fall and that it fits well on the company's type curve. While a significantly longer production history will clearly be required to gain full confidence in the economic competitiveness of 500' spacing relative to wider spacing, the comment is clearly encouraging. (In fact, the 500-foot downspacing may not even represent the economic limit of well density.)
As a reminder, last year Cabot brought on line a 10-well pad that included a 3-well pilot that tested 500-foot downspacing in the Lower Marcellus. The three wells were completed with a total of 62 frac stages with an IP rate of 62 MMcf/d and a 30-day production rate of 56 MMcf/d, which seemed in-line with the company's 2012 14-Bcf type curve.
Upper Marcellus: Substantial Improvement In Estimates
The biggest positive surprise comes from the recoveries achieved in the Upper Marcellus. In its year-end reserves, Cabot booked Upper Marcellus recoveries at 75% of the Lower Marcellus, or 2.7 Bcf per 1,000' of lateral. This puts Cabot's Upper Marcellus wells among the most prolific wells across the entire Marcellus play.
The new ~12.7 Bcf EUR estimate is a very significant increase from the prior EUR estimates that were in the 7-9 Bcf per well range. While the increase is explained in part by the longer laterals, the primary driver is the greater confidence gained from a larger well sample and longer production histories.
While Cabot will continue to prioritize drilling Lower Marcellus wells for the foreseeable future, the Upper Marcellus adds significant economic resources to the company's multi-year backlog. The new estimate adds confidence in the company's estimate of ~3,000 future drilling locations on its Susquehanna acreage position.
Well Performance Drove Strong PV-10 Growth
Cabot reported year-end proved reserves of 5.5 Tcfe, an increase of 42% over year-end 2012. Undrilled proved undeveloped (PUD) percentage remained flat at 36%, and the drilled PUD percentage flat at 4%-5%. Of note, Cabot's PUD bookings remains conservative at 10 Bcf EUR per well, with 0.75 booked PUD locations per each well drilled.
Cabot's year-end PV-10 value of proved reserves increased to $6.25 billion, driven by strong well performance and, to a lesser degree, price improvements. It is important to note that the PV-10 estimate reflects only ~200 booked PUD locations of the total ~3,000 remaining potential drillsites.
New Major Pipeline Deal Announced
Cabot entered into a binding agreement with Transco, a Williams (WMB) company, for a new pipeline to be constructed by Transco, with committed takeaway capacity from Cabot's acreage position in Susquehanna County, Pennsylvania. Cabot will be the anchor shipper on the new 177-mile pipeline segment, referred to as the Central Penn Line, which will extend from the Zick area of Susquehanna County to an interconnect with Transco's mainline in Lancaster County, Pennsylvania. These new facilities will be an integral part of Transco's recently announced Atlantic Sunrise project. Cabot will own 850,000 MMBtu/d of firm capacity on Atlantic Sunrise, and will also be participating as an equity owner.
Simultaneously, Cabot signed a new long-term marketing contract for a significant portion of natural gas to be carried on the Atlantic Sunrise pipeline. The Gas Sale and Purchase Agreement with WGL Holdings (WGL) will provide for 500,000 MMBtu/d of natural gas to be sold to WGL for a primary term of 15 years, commencing with the in-service date of Transco's Atlantic Sunrise expansion project currently scheduled for in-service in the second half of 2017. This new long-term sales agreement combines with Cabot's previously announced deal with Sumitomo for delivery to Cove Point LNG export terminal of 350,000 MMBtu/d of gas.
Collectively, Cabot is adding 850,000 MMBtu/d of baseload sales to its portfolio, while securing a firm path for these volumes through the 850,000 MMBtu/d firm capacity on this newly announced pipeline.
The transaction is similar to the approach Cabot took with its Century Pipeline project.
Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.