- The final Environmental Impact Statement for Constitution Pipeline is now expected by October 24, 2014, a two-month delay.
- The lack of certainty with regard to the pipeline’s in-service date has been a significant headwind for Cabot’s stock.
- Despite the Constitution delays, Cabot’s investment thesis remains intact.
The construction schedule for Constitution Pipeline, which is an important element of Cabot Oil & Gas' (NYSE:COG) growth strategy in the Marcellus, is slipping by another two months. The final environment impact statement ("EIS") by FERC that was anticipated this month is now expected by October 24, 2014, which is a second two-month delay relative to the original schedule. The slippage is a result of changes to the pipeline's routing that likely reflect local opposition in certain areas and Constitution's decision to consider alternative paths on several segments.
After the final EIS is issued, it may take another three months for the Federal Authorization Decision to be obtained.
The delay makes the in-service date for Constitution Pipeline most likely a mid-2016 event, assuming no additional delays. The risk of additional slippages, however, exists, given the complexity of the permitting process in the Northeast region and frequent activism by local communities and environmental groups.
I estimate the impact of a one-year delay to the Constitution construction schedule (a worst-case scenario, in my opinion) on Cabot's intrinsic value at approximately 5%. However, the actual impact on the stock price due to the uncertainty sentiment surrounding Constitution and the project's crucial role for the company's near-term growth rate appears to have been more significant.
Constitution Pipeline Is Strategically Important To Cabot
As a reminder, the ~124-mile interstate Constitution Pipeline is being designed with a capacity to transport 650,000 dekatherms of natural gas per day from Susquehanna County in northeast Pennsylvania to major northeastern markets, including New York, New England and Canada. The project is led by Williams (WMB, WPZ) and is currently estimated to cost ~$683 million. Cabot is the anchor shipper on Constitution Pipeline with 500,000 dekaterms of capacity and owns a 25% equity stake. Piedmont Natural Gas (NYSE:PNY) and WGL Holdings (NYSE:WGL) are the other two equity partners in the project.
It is difficult to overstate the importance of Constitution to Cabot. The pipeline is the single largest addition to Cabot's takeaway capacity in the next two years and holds the key to the company's ability to sustain its spectacular (at least, until recently) growth rate. Furthermore, Constitution is an elegant transportation solution that helps bypass the takeaway bottleneck that has developed in the Marcellus North area and bring Cabot's gas to pricing points that are less impacted, or not at all impacted, by heads-on competition with production volumes from either Marcellus North or Marcellus South/Utica. For Cabot, Constitution is, therefore, not just an incremental takeaway capacity but an important, margin-enhancing diversification component of the company's marketing portfolio.
When Constitution comes in service, the pipeline will be carrying only about one-fifth of Cabot's Marcellus volumes. However, its incremental contribution to Cabot's EBITDA may be substantially greater, given the outlook for persistently wide local basis. It is not a surprise, therefore, that the complications and delays related to Constitution's permitting process have been a headwind for the stock. Once the uncertainty disappears, the share price should react very favorably.
(Source: Cabot Oil & Gas, August 2014)
The following map shows Constitution's proposed route. Buried underground, the 30-inch pipeline would extend from Susquehanna County, Pa., to the Iroquois Gas Transmission and Tennessee Gas Pipeline systems in Schoharie County, N.Y. The proposed project route stretches from Susquehanna County, Pa., into Broome County, N.Y., Chenango County, N.Y., Delaware County, N.Y., and terminates in Schoharie County, N.Y.
To understand the nature of the complications that the project is facing obtaining rights of way and permits one needs to consider the fact that the pipeline is expected to cross more than 700 land tracts and require negotiations with many land owners and other constituents. As can be seen from the map below, Constitution is considering alternative routes for the pipeline to help manage these uncertainties.
(Source: Constitution Pipeline Company)
The Permitting Process
To begin construction, the Constitution Pipeline must first obtain a federal Certificate of Public Convenience and Necessity from the FERC, in addition to various state and local permits.
The FERC is the primary approval agency and, as such, serves in a coordinating role with relevant federal and state agencies. The U.S. Environmental Protection Agency, the U.S. Army Corps of Engineers, the Federal Highway Administration, and the New York State Department of Agriculture and Markets participate as cooperating agencies in the preparation of the EIS.
Constitution Pipeline Company initiated a pre-filing environmental review of the proposed pipeline route in April 2012 and filed an application with the FERC on June 13, 2013.
The FERC pre-filing process is intended to solicit early input from citizens, governmental entities and other interested parties to identify and address issues with potential facility locations. The company hosted a series of public open houses during the summer of 2012 in the affected areas to formally introduce the proposal to the public and solicit feedback. Public input strongly impacts the final project route.
The FERC process is currently in the stage of the final environmental impact statement which is an important milestone in the permitting process for a new pipeline, as explained on the flow chart below.
The draft EIS for Constitution Pipeline was issued by the FERC on February 12, 2014, concluding that environmental impacts would be reduced to "less than significant levels" with the implementation of proposed mitigation measures by the company and FERC. The draft EIS assesses the potential environmental effects of the construction and operation of the project in accordance with the requirements of the National Environmental Policy Act. Under the initial schedule, the issuance of the final EIS was expected on June 14, 2014, following the public comment period.
(Source: Constitution Pipeline Company)
In its notice to Constitution Pipeline and Write Interconnect Project (that interconnects Constitution in the pipeline's terminal point in New York State with Iroquois Gas Transmission System) that was issued on August 18, the FERC advised that it was unable complete its review before the initially scheduled issuance date "due to proposed changes in project facilities and routing." However, the FERC commented that "staff has now received all the information necessary on the project facilities to complete [its] review." Below is the full text of the notice.
Constitution Pipeline's in-service date strongly impacts Cabot's near-term (2015-2016) growth trajectory and cash flow estimates. However, impact on the stock's intrinsic value is minor.
Cabot's resource base remains in a class of its own in terms of acreage productivity and rivals any unconventional oil, gas or combo play in terms of drilling returns. The delay in Constitution's in-service date only defers a portion (albeit a significant one) of the company's future production, most likely by six-to-nine months relative to the initial realistic expectation. This production will ultimately come online. I estimate the value impact of such delay at approximately 5% as the high end of the estimate range.
The important question, of course, is whether there is a risk of Constitution not being approved. Such risk, in my opinion is very low, given that there is objective economic need for this project (as evidenced by the support letter below) and given that the project is managed by a highly experienced pipeline operator (Williams). The question, in my opinion, is not "if" but "when."
Once the FERC Certificate for Constitution is received, the market will likely price in the expected incremental production growth back into Cabot's stock valuation.
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.