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US natural gas production holding steady despite low prices

Summary:
Why and how is North American natural gas production not plummeting in this low price environment? I and other folks at Platts and Bentek Energy spend a considerable amount of time trying to find a half-decent answer to this question. Commodities are well known to go through cycles with booms and busts. As commodities go through these sequences, media outlets clamor and fret about how low or high prices could go. As many commodities are down at the moment, it is sometimes difficult to explain that one is down more than others and why it stands out from the pack. The graph below, brought to my attention by Richard Meyer, at the American Gas Association, gives a great visual example of how natural gas has done compared to other commodities since 2005. The data is compiled using IMF primary commodity prices. Despite a brief rise in prices in 2008, natural gas prices have been depressed compared to other commodities. Prices On August 18, 2008, the national average price for next-day gas was .52/MMBtu. Exactly a year later, in 2009, in the doldrums of the financial crisis, the next-day average price was .12/MMBtu. The national average for next-day gas on August 18, 2015, was .67/MMBtu. Yes, the price of natural gas is lower today than during one of the nation’s largest economic downturns. Production In 2009, US natural gas production averaged 58.7 Bcf/d.

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Why and how is North American natural gas production not plummeting in this low price environment? I and other folks at Platts and Bentek Energy spend a considerable amount of time trying to find a half-decent answer to this question.

Commodities are well known to go through cycles with booms and busts. As commodities go through these sequences, media outlets clamor and fret about how low or high prices could go.

As many commodities are down at the moment, it is sometimes difficult to explain that one is down more than others and why it stands out from the pack.

The graph below, brought to my attention by Richard Meyer, at the American Gas Association, gives a great visual example of how natural gas has done compared to other commodities since 2005. The data is compiled using IMF primary commodity prices.

Despite a brief rise in prices in 2008, natural gas prices have been depressed compared to other commodities.

pedersen-commodity-prices

Prices

On August 18, 2008, the national average price for next-day gas was $7.52/MMBtu. Exactly a year later, in 2009, in the doldrums of the financial crisis, the next-day average price was $3.12/MMBtu. The national average for next-day gas on August 18, 2015, was $2.67/MMBtu. Yes, the price of natural gas is lower today than during one of the nation’s largest economic downturns.

Production

In 2009, US natural gas production averaged 58.7 Bcf/d. At this time, Platts unit Bentek displayed US production by region. Take notice of where gas was being produced just six years ago at the end of 2009.

Source: Bentek Energy

Source: Bentek Energy

In 2015, US natural gas production has averaged 72.2 Bcf/d. Take a look at where gas is being produced today. The growth in production has almost completely come from the Northeast.

Source: Bentek Energy

Source: Bentek Energy

Lessons from key players

Every quarter, the Natural Gas Suppliers Association publishes a list of the top 40 US natural gas producers.

Chesapeake Energy is the nation’s second largest natural gas producer, after ExxonMobil. As the largest producer in the Marcellus and Utica basin, Chesapeake can give some insight into how they have achieved efficiency gains over the past few years.  Some highlights from their most recent investor presentation include:

  • In the Marcellus, annual spuds per rig have increased from 14 in 2013 to 30 in the first quarter of 2015.
  • Average lateral length increased from 5,400 feet in 2013 to 6,900 feet in in first quarter of 2015.
  • Average stages per well were at nine in 2012. This year, they have averaged 28. Staging in the Utica increased even more, averaging 43 stages per well, up from 10 in 2012.
  • With more stages and longer lateral lengths, average costs per well have dropped in the Marcellus, but risen in the Utica.
  • Chesapeake’s Eagle Ford operations have had a 20% reduction in capital cost per lateral foot year over year.
  • In the Powder River Basin, average spud to spud was 35 days in the first half of 2014, but has dropped to 21 days in 2015. Average drill costs have fallen from $4.5 million a year ago to $3.3 million today.

Even with these impressive efficiencies, Chesapeake is having a tough year, currently trading in the $7.50 per share range, after having traded around $25 a year ago.

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Production on the horizon

In the graph below, EIA data shows that since the beginning of 2012, the Marcellus and Utica regions have accounted for 85% of increases in production from the selected shale regions. These basins help the Northeast set a new regional production record on Sunday, August 16, at 20.203 Bcf/d.

pedersen-gas-production

Looking ahead, though, it appears the Utica basin is poised to have some major growth. Platts gas reporter Arjun Sreekumar notes that there have recently been some highly promising initial results from operators drilling in the mostly undeveloped deep dry gas play in southwestern Pennsylvania. Recently, a well by EQT in Green County shattered the existing initial production record for the Utica, with a 24-hour test rate of 72.9 MMcf/d, or 22.6 MMcf/d per 1,000 feet of lateral.

RBC Capital Markets analyst Scott Hanold estimates that the core deep dry gas Utica could achieve a 70% internal rate of return at a wellhead price of $3.50/Mcf, based on his assessment that EQT’s Scotts Run well could be trending towards a 30-Bcf estimated ultimate recovery. Other recently drilled dry gas wells have EURs in the 15 to 20 Bcf range, and in a recent note to investors Hanold stated, “These wells could generate a 15 percent ‘break-even’ near $2/Mcf.”

Another dry gas Utica well drilled by Consol Energy in Westmoreland County, Pennsylvania, delivered an impressive 24-hour test rate of 61.0 MMcf/d, or 10.4 MMcf/d per 1,000 feet of lateral.

Why: A question if you’re a glutton for punishment

This all leads to the question of why producers continue to pump copious amounts of gas when the financial incentive or financial return is so low.

In discussions around the office and talking with analysts, I have heard the following arguments and theses:

  • Leasing arrangements between producers and landowners. If producers do not start producing gas, they could be at risk of losing the lease or paying a fine.
  • Leasing arrangements between producers and midstream operators. (Chris Helman at Forbes gives a great overview here.)
  • Producers getting their ducks in a row in anticipation new demand from LNG exports or power burn.
  • The chickens will finally come home to roost in regards to the perpetual decline in oil and gas rigs. When supply finally drops off, prices will rebound.
  • Financing debt and capital obligations. Some operators are so cash-strapped that the mindset could be that smaller revenues are better than no revenues at all.
  • Producers have found ways to have healthy IRRs with even lower prices.
  • Efficiency gains have come more pronounced in the gas window than the oil and NGL window.
  • The change in price-to-BTU ratios of hydrocarbons have made it so that oil and NGLs are no longer a clear favorite.

As this is an extremely complex issue, there are no clear answers. Every region, company, and basin has its own peculiarities. I invite readers to share their thoughts in the comment section on why they believe producers continue to maintain high levels of supply and how production has stayed so robust amid such low prices.

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