In 2012, Cabot Oil & Gas (NYSE:COG), along with partnering companies Williams (NYSE:WMB), Piedmont Natural Gas (NYSE:PNY), and WGL Holdings (NYSE:WGL) announced plans for the laying of the Constitution Pipeline. Constitution Pipeline is expected transport 650 dekatherms of natural gas a day through a 30-inch pipe that stretches 124 miles. The natural gas would be "exported" from the gas-rich Susquehanna County in north-eastern Pennsylvania to parts of New York, New England, and Canada. In order to begin constructing the pipeline, a number of permits, surveys, and other clearances must be obtained. This has led to delays in the planned in-service date of the Constitution Pipeline, which is currently expected to be sometime in late 2015-early 2016.
Currently, COG and its partners are attempting to acquire a federal Certificate of Public Convenience and Necessity from the Federal Energy Regulatory Commission (FERC). In order to obtain the certificate, companies must complete each of the steps shown below.
As you can see, clearance for the pipeline is now dependent on the FERC's environmental impact statement (EIS). Initially, an EIS was expected on June 13, 2014. However, in a recent document issued by the FERC, the final issuance date of the EIS has been delayed until October 24, 2014. The two-month postponement was due to changes in proposed project facilities and routing. The alterations did not supplement the FERC enough time to completely review and issue a final EIS.
Constitution Pipeline is essential to Cabot Oil & Gas' growth strategy in the Marcellus Shale area for multiple reasons. Currently, over 97% of the natural gas produced by COG wells comes from areas in the Appalachia region. Due to the gas-rich nature of this region of Pennsylvania, realized natural gas prices are depressed. In order to put this into perspective, the average realized natural gas price reported by COG in the second quarter of 2014 was $3.44 per Mcf in the Appalachia region, compared to $4.65 per Mcf elsewhere.
Cabot Oil & Gas has the rights to use up to 500 dekatherms of Constitution's total 650 dekatherm per-day capacity. This would allow for ~485,217 Mcf of gas to be transported outside of the Appalachia region every day, resulting in higher average selling prices. Examining this further, my model shows that the average selling price of natural gas for Q2 would have increased by $.43 (assuming COG uses all 500 dekatherm capacity) if Constitution Pipeline was in-service during the quarter.
Without any production increase from the Marcellus wells, revenue would have grown 8% due to the increase in average selling price. This, in combination with a decrease in total unit costs, would have lead to margin expansion 34% higher than what was reported in the quarter, resulting in ~$32 million of additional operating income.
In COG's Q2 conference call, the company gave an expected in-service date for Constitution Pipeline of late 2015-early 2016. With the recent delay from the FERC, I now expect the in-service date to fall closer toward the latter part of the range. Also, CEO Dan Dinges stated on the call that he expects to keep the Marcellus rig count at six through 2015, while adding to the company's reserve book. This leads me to speculate that COG will have a capital allocation plan along these lines:
2015: Acquire acreage in the Appalachia region to increase reserve book until Constitution Pipeline is in-service.
2016: Increase rig count to maximize production in the Appalachia region while utilizing Constitution Pipeline to realize higher average natural gas selling prices.
Following this plan, I believe that COG can increase its production in the Marcellus Shale by 38%-40% over the next two years. This will allow for significantly more free cash flow, resulting in share repurchases and an aggressive dividend increase in the out years.
Cabot Oil & Gas has consistently been among the fastest-growing producers of natural gas in the entire country. In addition to its growth-oriented nature, COG also shows astounding efficiency. This is exemplified by the fact that it owns and operates 14 of the top 20 wells in the Marcellus Shale formation, while maintaining a rig count below that of other fracking companies in the area. Constitution Pipeline will only be accretive to COG's growth and operating efficiency in the future. The value-adding potential that the pipeline presents makes Cabot Oil & Gas a must-own.
Disclosure: The author is long COG.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.