The North American natural gas pipeline grid, the world's most extensive, was originally designed to bring gas from the producing areas of the Gulf Coast, the Midcontinent and the Permian Basin to the market areas in the Midwest and the Northeast. Over time, the grid evolved as new supply areas emerged in the Rockies, the Western Canadian Sedimentary Basis (WCSB), and the Gulf of Mexico, and as new market areas like the West Coast and the Southeast emerged. However, the general pattern has remained in place for decades.

In the years immediately following the turn of the century, it was thought that the Rockies constituted the only US region likely to be able to increase production. Pipelines were constructed to deliver Rockies gas to eastern markets (Rockies Express or REX), and the California market (Ruby).

North America's Complex Flow Patterns

Understanding flow patterns on an extensive, heavily interconnected grid like North America's has been likened to understanding the movement of air in a balloon. Squeeze it in one area and it will bulge in another. Gas sellers are always seeking the highest price and buyers the lowest, and the resulting trading activity drives the flows throughout the network. Local prices will move as necessary to entice sufficient supply, subject to capacity constraints, to flow to meet current demand. The effect of fundamental change in one region can drive change in another region. Often, consequences can be felt far from the original change. For example, the completion of the Kern River pipeline in 1992, delivering Rockies gas into southern California, caused Permian gas previously moving to the West Coast to flow north.

Impact of Shale Gale on Supply and Pipeline Flows

With the emergence of the Shale Gale and the decline of offshore production, the geography of supply and, as a result, pipeline flows began to change. The early shale developments - the Barnett, Woodford and Fayetteville - moved the center of gravity of production to the east, and at the same time from offshore to onshore. With more supply available, and with better connectivity between producing and consuming regions, flows and prices began to change. Prices at Henry Hub fell. Wide price spreads across the continent, which IHS CERA dubbed "the Continental Divide," collapsed as new pipeline capacity broke the bottleneck between Rockies supplies and eastern markets at the same time as the initial surge of shale gas added supply to the system onshore, east of the divide. Hurricane Ike, in September 2008, had relatively little effect on natural gas prices, in sharp contrast to Hurricane Katrina just three years before, as more onshore production was available to serve the market.

The rapid and startling growth of the Haynesville shale amplified this trend. For the most part, however, these plays filled the south to north pipeline capacity left behind by the decline of other, typically conventional, gas supplies. The plays required some infrastructure development, but it typically took the form of lines designed to get the production to the major trunklines taking gas to the Northeast and Midwest.

Marcellus Shale - Consequences of Growth 

The growth of the Marcellus shale, in the context of the pipeline grid, poses a far different problem. It is located on the doorstep of the Northeast market and is highly disruptive to traditional pipeline flow patterns. In its initial growth phase, Marcellus production displaced other sources of supply. The first to suffer was Canadian gas delivered to the Northeast at Niagara. As the Marcellus continued to grow it began to displace Gulf Coast gas. Eventually the Marcellus grew to the point where even gas on REX, which needed only to cover the variable cost of transportation and not the sunk demand charges since initial capacity contracts remained in place, lost market share to this new and growing supply source.

As infrastructure projects have allowed more Marcellus gas to connect to the system, production has continued to grow. Marcellus production is now approaching 8 billion cubic feet (Bcf) per day. The Marcellus is running out of displacement opportunities and is now starting to cause pipeline flows to reverse as it seeks to compete for market share in consuming regions outside of the Northeast. The effects of this displacement and flow reversal are spreading. Marcellus gas is now flowing into Canada at Niagara, formerly a point at which Canadian gas was imported into the US. In addition, in December, Great Lakes Gas Transmission, a pipeline designed to bring western Canadian gas to Michigan and Ontario storage and eastern Canadian markets, reversed its flow, taking physical gas from Dawn and Michigan storage facilities and delivering it into Canada at Emerson.

The consequences of this growth go even further. Surplus gas production, driven in large part by Marcellus growth, has displaced record amounts of coal-fired generation (averaging roughly 8 Bcf per day equivalent for 2012, reaching a peak of around 12 Bcf per day equivalent in May 2012), and this has, in part, driven an increase in US coal exports. As Rockies and WCSB gas is displaced from the eastern market, the two main western supply areas are forced to battle it out for western markets. WCSB production has declined from 17 Bcf per day to 13 Bcf per day, despite the presence of significant unconventional resource potential, owing to the competition for market share. High quality resources like the Horn River Basin in British Columbia are now effectively economically stranded. This creates a compelling case for liquefied natural gas (LNG) exports from British Columbia. And the possibility of LNG exports from Cove Point, Maryland, cannot be ruled out.

Looking Forward

IHS CERA expects the Marcellus to continue to grow, albeit more slowly, as import displacement opportunities are exhausted and as infrastructure construction requirements reduce the pace of growth. Its disruptive effects on both flows and price, however, will continue to be felt throughout the North American natural gas market and beyond.

Posted 19 February 2013

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.