East Daley Capital Advisors Inc. has taken a decidedly bullish approach toward natural gas prices in its annual “Dirty Little Secrets” midstream report, a result of constraints prompted by the COVID-19 pandemic and in anticipation of the impact of Biden administration energy and climate regulations.

The drawback: the higher price of gas could create an opening for coal to regain market share in power generation.

For midstream companies themselves, the collapse in capex will result in positive cash flow of more than $160 billion for the top 10 North American midstream companies and partnerships over the next four years.

“Aggregate midstream free cash flow is improving and will gain momentum as an expectation rather than an exception,” the report said.

The price of U.S. benchmark Henry Hub was just under $2.90 per million British thermal units (MMBtu) on the afternoon of Feb. 8, with its futures over the next year ranging from $2.86/MMBtu to $3.24/MMBtu.

When it struck, “COVID became a strange and unexpected ally to the U.S. gas market, ending the consensus view of growing U.S. oil production,” the report said.

With oil production down sharply, associated gas output also plunged and E&Ps quickly adopted disciplined approaches to production. This confluence might lend itself naturally to bullish price sentiment in the near term, but East Daley believes it will stick.

“The COVID-induced impacts on gas production are likely to live into the future as the downturn has clearly sped up a trend already in motion for many E&Ps, a shift from production growth to a focus on free cash flow,” the report said. “Most E&Ps have now promised shareholders to produce annual free cash flow, an impossible vow at current prices if they drill more.”

‘Law of Unintended Consequences’

Soon after taking office, President Joe Biden rescinded the permit for construction of TC Energy Corp.’s Keystone XL pipeline. His administration’s “whole of government” approach to climate policy includes directives for federal agencies to purchase pollution-free electricity as well as emission-free vehicles for government fleets. He also ordered a pause on oil and gas leasing on federal lands and offshore.

On the surface, that would appear to be across-the-board doom and gloom for the oil and gas industry. In the midstream, for example, any plans to build interstate pipelines could be said to be in doubt. On the other hand, for those whose pipelines have already been built, things might be OK.

“That, I think, is the silver lining to the impact on fossil fuels policies from the Biden administration,” Ethan Bellamy, East Daley’s managing director for midstream strategy, told Hart Energy. “If you cut off resource access and transportation, and you limit supply, that tends to … increase utilization on existing assets.”

Berkshire Hathaway’s July 2020 purchase of Dominion Energy Inc.’s natural gas transmission and storage assets fits that description. The $9.7 billion deal—which included assumption of $5.7 billion in debt—included 100% of Dominion Energy Transmission, Questar Pipeline and Carolina Gas Transmission; and 50% of Iroquois Gas Transmission System. Left out of the deal was the proposed Atlantic Coast Pipeline, which Dominion canceled prior to announcing the Berkshire Hathaway transaction.

Warren Buffett’s Berkshire Hathaway Buys Dominion Gas Business Worth Nearly $10 Billion

East Daley assumed a moderate demand bump from this winter and increased gas exports to Mexico from the Wahalahara pipeline system, which allows Permian piped gas to displace LNG imports.

Tighter supplies will result from reduced production and increased export demand. Combine that with governmental policies that restrict new drilling and the price of natural gas will naturally rise. That means that utilities using gas for power generation will turn to a cheaper alternative, which is … coal?

“Yes, that absolutely will occur,” Bellamy said. “This is the law of unintended consequences. To the extent that politicians are suppressing gas pipelines, suppressing supply, that’s going to raise the price of natural gas. You will see the power sector shift back to coal. It’s what happens when you interfere with the markets.”

East Daley is not alone in its projection for increased coal use.

“At the current forward prices, coal could make a comeback in 2021 at the expense of gas in the United States,” the International Energy Agency said in its first-quarter 2021 Gas Market Report.

In its Short-Term Energy Outlook, released Feb. 9, the U.S. Energy Information Administration (EIA) said it expects the share of gas-generated electric power to slip from 39% in 2020 to 37% in 2021 and to 35% in 2022. EIA attributes this to forecast increases in the price of natural gas. EIA also forecasts coal’s share of power generation to rise from 20% in 2020 to 21% in 2021 and 22% in 2022.

Other Highlights

Ark-La-Tex: East Daley said it expects the Ark-La-Tex region of East Texas and North Louisiana to benefit from rising natural gas demand because of the region’s strong well results, geographic location and ability to build low-cost takeaway. Most producers in this basin are private and do not provide guidance so the analysts study rig counts and forward prices to project production growth. East Daley forecasts 1.1 Bcf/d of growth in Ark-La-Tex for 2021.

Permian: The basin most critical to midstream growth will continue to be the Permian, which East Daley sees as the only major basin able to grow production with crude priced in the range of $40 to $50/bbl. The near-month price of West Texas Intermediate on Feb. 9 was around $58/bbl but that strength is expected to fade later in the year. The April 2022 price on Feb. 9 was just under $53/bbl.

Growth: For the next few years, growth will take a backseat as companies focus on clawing their ways back to previous peaks. An era of stunted production growth will put a premium on every barrel and cubic foot of natural gas they send through their pipelines. Outside of the Northeast and Permian, gathering and processing assets can be expected to lose cash flow as a result of stagnant production. In particular, small-caps will struggle.