By Belinda Petty, Enerdynamics Instructor
As I discussed in Part I of this article, Rockies Express or REX was slated to be among the biggest, most impactful pipeline projects in U.S. natural gas history. The project, which commenced in 2004, could alleviate the problem of producers with gas trapped in the low-price Rockies region by moving huge volumes of pent-up supply while simultaneously moving the gas toward the east coast – the highest-priced market in the U.S. But a combination of construction delays, cost overruns and a boom in Marcellus shale production on the East Coast turned Rockies producers’ high hopes into potential failure. So what happened? And was REX a mistake?
The majority owner and operator, Kinder Morgan Energy Partners, was able to hedge both steel and certain labor costs associated with REX. Owning the pipeline would have been a financial disaster without this cost containment. Even so, right-of-way issues and rising skilled labor costs were a big factor in cost overruns.
Lawsuits combined with local and state regulatory delays were very costly in terms of extra time, dollars, and public image. Instead of partnering with stakeholders like city officials and landowners, it appears as if REX rammed the project through. While no one ever expects 100% stakeholder approval, the reputation REX earned has left a negative industry impression with some stakeholder groups. Public/customer relations could have been better managed.
From an asset owner perspective, the project has been moderately successful. The pipeline was fully subscribed, meaning owners have locked in the reservation rate as minimum cash flow for the first 10 years of operation. Thus shippers who signed firm contracts, not the pipeline owners, carried much of the risk. However, given the lack of delivery market price differential, the pipeline is not being fully utilized today, and pipeline owners are not fully recovering expected profits since revenues associated with flowing gas are not being realized.
The street forecast does not change this fact for the next several years. In fact, one of the minority owners, ConocoPhillips, recently attempted to sell its 25% ownership but withdrew the offer for lack of interest. The expectation for the near and intermediate future is that price differentials will not support the $1.10/Dth transportation rate. As the original firm contracts expire or are released, the asset owners might expect cash flow to drop.
For Rockies producers/shippers, REX has provided a much-needed outlet to ship and sell production away from the local market. Initially, gas sellers were able to capture a higher market price in the Midwest and East that more than paid for their pipeline cost. However, as Marcellus production has ramped up, that price differential (known as basis) between the Rockies and the Midwest/East has shrunk. Today, the basis modestly covers the variable pipeline cost plus only a portion of the reservation cost on most days. This means shippers do not collect enough extra value to pay for the reservation charge they are obligated to pay.
So, even though gas can move to market, that elusive higher netback has not materialized. While the pipeline may have contributed to higher prices in the Rockies than would have otherwise occurred, it also has significantly contributed to a differential collapse throughout the U.S. While it has given Rockies producers a new, big option, the cost of transportation into a production-rich market is prohibitive. On one hand, REX has been a godsend to producers. On the other hand, REX has been just another margin bubble that has burst.
If REX had been completed just two years earlier, Rockies producer/shippers and pipeline owners would have been rewarded by capturing huge netback premiums while building market share in the eastern market. If REX had been proposed two years later, it most likely would never have been built. Since gas markets can change rapidly, the jury is still out on whether REX will be deemed a success or a very expensive mistake. But shippers on REX shouldn’t feel singled out; there are also a number of new LNG terminals in the U.S. that are heavily underutilized, too!