Growth in U.S. Natural Gas Production Expected to Reverse

After remaining essentially flat for almost 9 years (1998-2006), natural gas production in the Lower 48 started trending up last year and really accelerated this year. Production increased around 5.5% in 2007 and remains on track to grow in excess of 9% in 2008..

What has been driving this growth spurt? And, given the economy's cloudy outlook and continued credit-market turmoil, can this production growth momentum be sustained going forward?

Favorable prices prompted increased natural gas drilling, with the total onshore rig count making a new all-time high this year. Also, technological improvements enabled the industry to economically develop resources that could not be cost effectively developed in the past. At the forefront of the technological improvement has been the widespread use of 'horizontal' drilling (as against the conventional vertical drilling) to develop the so-called unconventional resources.

Horizontal drilling rigs now account for approximately 28% of the total rig count, up from the 1990's average of about 5% of the total. Texas has been at the forefront of the current growth spurt, accounting for roughly half of the total growth this year. The state now accounts for about one-third of all Lower 48 natural gas production. The bulk of Texas' growth resulted from the use of horizontal drilling of a long-known geological formation, the Barnett Shale, most of which is located beneath the city of Fort Worth.

A combination of low prices and restricted access to capital is expected to reverse the recent production-growth momentum. Exploration and production companies, the dominant natural gas producers in the U.S., were spending heavily on drilling activities in the last few years. Over the last 2 years, companies in our E&P coverage universe were spending, on average, about 25% in excess of their internal cash flows, with the capital markets making up the shortfall. With that avenue essentially closed, E&P companies are constrained to live within their means; by cutting back capital expenditure plans for 2009. The resultant fall off in drilling (the rig count could drop in excess of 30% from its peak) is expected to reverse the production-growth momentum of the last 2 years.

We believe that reduced natural gas production over the coming quarters will set the commodity up for a rise in prices late next year and into 2010. Our top E&P picks, XTO Energy (XTO), EOG Resources (EOG), EnCana (ECA), and Chesapeake Energy (CHK), are a play on this outlook.

Comments

[DrT:]

all true but nothing new.

2008 Dec 23 09:03 PM

[John Polomny:]

A bit early to buy Nat Gas producers however it is interesting to note that the new shales gas wells deplete vary rapidily, something like 45% in the first couple of months of production. I agree that the lower investment in E&P will lead to a substantial increase in price by this time next year. If you like these shares, and they will benefit from an increase in the gas price, then selling puts at these levels seems like a good trade. You pick up some nice premium money and if the stock gets put to you then you get the shares you were planing to buy anyway.

2008 Dec 24 02:38 AM

[Paul Killinger:]

Zack and John,

You both make good points. The benefits of this unique fuel are as remarkable as they are diverse. It can generate electricity, operate vehicles, heat homes and even grill food in its natural state. It is environmentally friendly, safe and can be shuttered in to compensate for different demand cycles. Just wait a few years until we learn how to produce gas hydrates!

2008 Dec 24 01:30 PM

[searcher:]

Re: rapid depletion of horizontally drilled gas wells. Since they're directional by definition, can the same parcel present another (though less optimal?) profitable radial? Does the geo-technology allow the grading of the radials as to prospects for profitability? What is the percentage of overhead saved if the site could be 'redrilled' at a different radial? Is this already SOP?

2008 Dec 24 01:40 PM

[Paul Killinger:]

Horizontally drilled gas shales are akin to their oil rich brethren in the Bakkens. They require hundreds of shallow drills, rather than just a few deep ones. The economics of recovering both oil and gas this way are very competitive. And gas can be shut in in the same manner when demand slackens.

2008 Dec 24 02:18 PM

[Paul Killinger:]

Oh, and dry holes are a LOT cheaper.

2008 Dec 24 02:20 PM

[OK Oil Boom:]

You are forgetting one factor, and that's demand. Natural Gas prices aren't going to rise just because there is a major cutback in production. We are in a viscous cycle right now in the Natural Gas world. When demand rises production far exceeds demand causing a surplus, which in turn causes a dramatic fall in prices, even more so if demand falls as it did in the end of 2008.


On Dec 23 09:03 PM DrT wrote:

> all true but nothing new.

Mar 03 08:49 PM