Blog February 21, 2020

Permian associated gas production has been running at or above transportable capacity since 2018. While local gas prices have struggled, gas production growth has continued to grow faster than outbound pipeline capacity due to the strong prices for oil and NGLs.

In 2019, Kinder Morgan’s first new 2 Bcf/d intrastate export pipe – Gulf Coast Express – rescued local cash prices from near-zero levels by adding a path to southern Texas. Kinder Morgan’s second intrastate, the 2 Bcf/d Permian Highway Pipeline (PHP) will run from the still-constrained Permian Waha market to just south of Katy near the coast.

While the need for the pipeline is clear – production has already filled and overtopped the GCX addition – PHP has struggled to acquire Right of Way (ROW) through the central Texas Hill Country and obtain the last few necessary permits for construction. For the western section near Waha, PHP received the all-clear and began construction on the pipe in late 2019, but the eastern portion of the pipe has been waiting on the issuance of the U.S. Army Corps of Engineers (USACE) Nationwide 12 permit.

While Kinder Morgan awaited the permit, another roadblock has threatened PHP’s construction – a lawsuit petitioning for a stop-order due to concerns over deforestation and contamination of waters along the route – sending Waha basis futures prices into a freefall.

The Case Against PHP: A Timeline

Plaintiffs: City Of Austin, City of San Marcos, Travis County, Hays County, Barton Springs Edwards Aquifer Conservation District, Larry Becker, Arlene Becker, Jonna Murchison, and Mark Weiler

Defendants: Kinder Morgan Texas Pipeline, LLC, Permian Highway Pipeline, LLC, United States Department of Interior, David Bernhardt (Secretary of the Interior), U.S. Fish and Wildlife Service, and Aurelia Skipwith (Director USFWS)

Wednesday, February 5: Suit Filed in the District Court for the Western District of Texas

The plaintiffs’ chief argument alleges improperly shortened permitting practices relating to the federal Endangered Species Act (ESA) that skirts proper environmental consultation and skips necessary permits. If true, the construction of the project will illegally impact/kill various endangered and threatened species along the route.

Additionally, the plaintiffs requested that the Court issue an injunction to stop Kinder Morgan from further construction on PHP before the legal process is completed; the plaintiffs originally asked for an Emergency Hearing on a Preliminary Injunction to be granted prior to February 15 to prevent Kinder Morgan from rushing to clear habitat along the Right-of-Way (ROW).

Sunday, February 9: Kinder Morgan Files its Response

Kinder Morgan notes in its initial response that it has complied with the full requirements of the law, including all aspects of the Endangered Species Act, which are satisfied by the US Fish and Wildlife Service (USFWS)’s Biological Opinion and agreed-upon mitigation efforts. Once the missing USACE permit is authorized, PHP construction would be constrained around the March 1-July 31 breeding season of the golden-cheeked warbler (GCW), an endangered songbird endemic to the Hill Country, giving Kinder Morgan just about two weeks to clear ROW prior to restriction. If tree felling or other habitat-clearing activities are not completed in time, PHP could face a six-month delay that would increase construction costs by at least $135 million and cause approximately $33 million in lost revenues for each month of in-service delay past Q1 2021.

As an appendix to the first letter filed February 9, Kinder Morgan attached the corrected Biological Opinion for PHP, issued February 3, 2020, which notes that while the construction of the project will have impacts on the GCW, the “level of anticipated take is not likely to jeopardize the continued existence of the [GCW]... taking into consideration the status of [the] species, the degree of impact to the species cause [sic] by the proposed pipeline, and consider the conservation measures for the conservation of [the] species to which the Applicant has committed.”

Thursday, February 13: Kinder Morgan Receives the Nationwide Section 12 Permit from the USACE, Which is in Full Compliance with all Requirements of Law

This permit was the last barrier keeping Kinder Morgan from beginning construction on the eastern sections of the pipeline.

The USFWS re-submitted the Biological Opinion under its own cover on Thursday, February 13, pointing out its own adherence to proper procedure and that the Biological Opinion covers the full length of the project -- both the area under the USACE jurisdiction and Kinder Morgan’s privately held land. In particular, the USFWS highlighted that the Biological Opinion contains an incidental take statement that applies to all parts of the project, which minimizes impact to the GCW as a species. The lack of a specific kind of incidental take permit is one of the pivotal arguments laid out by the plaintiffs as part of the improperly shortened permitting process.

In its full opposition document (also submitted on Thursday), Kinder Morgan laid out the legal standing supporting the USACE and USFWS documents as well as the regulatory process for applying for and evaluating permits under the Endangered Species Act. Kinder Morgan also notes its receipt of the Nationwide Section 12 permit earlier in the day and affirms its planned compliance with restrictions therein.

Friday, February 14: Hearing for a Temporary Restraining Order to Halt Habitat Clearance

Shortly after the afternoon hearing, the presiding Judge Robert Pitman denied the plaintiffs’ request. He found that the issuance of a restraining order at this point in the suit would not be appropriate, as the requirements of such an extraordinary measure have not been met; chiefly, the plaintiff’s claim of injury to the GCW does not rise to the level of being irreparable due to restrictions set out by the USFWS in its Biological Opinion. He ordered Kinder Morgan to adhere to all restrictions in the USACE/USFWS documents during the construction process.

PHP Construction Commences

Kinder Morgan began construction along PHP this week instead of needing to wait until a restraining order was lifted. This is bullish for the pipeline to continue along its previously charted construction plan targeting a Q1 2021 start. However, there remains an elevated risk of delay with only a few weeks between the work authorization and the return of the GCW from Mexico.

View southwest over a forested area in the projected PHP path
Figure 1: View southwest over a forested area in the projected PHP path through Hays County, circa January 2020. Source: Genscape

Market Reaction

Movements in Waha basis futures prices (as reported by NGI) over the last few weeks have reflected PHP suit developments, indicating that while the temporary restraining order was undecided, the market was anticipating a delay (and thus Permian export constraints to persist) approximately two months past the end of Q1 2021.

After the announcement of the suit in the first week of February, prices for the April 2021 contract plummeted sharply and those for May 2021 dipped, though less severely; both separated from June 2021, which remained relatively steady. These movements indicated widespread expectations that PHP was still likely to be operational by June 2021, but moderately less likely to be operating by May and much less likely to be operating by April.

On the day of the February 14 hearing, Waha basis for April 2021 had the largest drop of any of these months, falling 35 cents relative to its mark at the beginning of February. Over the same period, prices for March 2021 and May 2021 fell 17 and 19 cents, respectively.

Relative to its average across January’s trading, Waha basis futures for April 2021 had lost 44 cents. January and February 2021 had also dropped by more than 40 cents vs. January 2020 trading averages, indicating a fade in optimism that PHP might come online early.

Since the denial of the temporary restraining order, 1H 2021 Waha futures prices have continued to trend downwards along a similar trajectory, with the April 2021 contract crossing the 40-cent barrier (relative to February 3) and dropping 52 cents from January’s average trade price.

Change in 2021 Waha Basis Futures from February 3, 2020
Figure 2: Change in 2021 Waha Basis Futures from February 3, 2020. Prices sourced from NGI

In general, current prices still reflect market confidence that PHP will be online by Q3 2021. Waha basis for June 2021 has flattened since the end of last week, parallel to July-September prices. The July to September contracts are only about 10 cents below their marks from February 3’s trading: they dropped only four cents initially following the PHP suit news and were recovering going into the weekend; the overall slide this week across all 2021 contracts is likely related to influencing factors other than PHP.

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