Why Are Natural Gas Producers Expanding Production So Aggressively?

While the price of natural gas is in the dumps, U.S. producers continue to expand production. Why? Oh I think it's pretty obvious. And it's nothing to do with the magical V shape recovery in the U.S.

As I often say, people mix natural gas and crude together as if it's the same thing (hey "it's energy"); unlike crude which can benefit from economic growth in Asia, natural gas is largely a domestic commodity despite efforts to make it more transportable. [Mar 24, 2009: Will Liquified Natural Gas Turn this Commodity Global?] In fact the divergence between the price of oil and natural gas tells you all you need to know about the reflective economies of the globe versus U.S.

Global economy - huge drop in 2008 and then stabilization as weaker parts of the world offset stronger for the better part of 10 months



US economy - weak, weak, weak, weak, stabilizing the past 4 months at ... weak. No real bounce in the real economy even with constant feeding of money, taking from future generations.


It really is as simple as that when you break it down in the language of commodities.

But as this Bloomberg report says - the natural gas producers continue to churn out product: Gas Glut May Grow as XTO Energy (XTO), Devon Energy (DVN) Wells Prove Prolific

• The largest U.S. natural-gas producers may be doing too well at the wellhead for their own good, pumping so much of the heating and power-plant fuel that prices won’t soon recover from last year’s market collapse.
• XTO Energy and Devon Energy, two of the five largest producers of U.S. gas, yesterday reported record output and smaller declines in earnings than analysts estimated. Anadarko Petroleum Corp., London-based BP Plc and Chesapeake Energy. previously reported second-quarter output gains that helped them beat estimates.
• Even as they lament a gas glut, the companies have been reluctant to let revenue and profits fall further in the short term by being the first to curtail output. Second-quarter production at Fort Worth, Texas-based XTO jumped 32 percent, and Devon of Oklahoma City had a 12 percent gain.

CEO talking to other CEO: "you go first." "no you!" "no you!!"

"there is no way I'm cutting my production because my bonuses are based on stock prices going higher... my genius is reflected in the stock price. I don't care if the price of the commodity is going through the floor, I need my bonus." "good point! no one cuts!"

Ah the "market" efficiencies that arise when the self interest of those who build generational wealth as long as they hold their jobs for a few years.

• “I think they might be cutting off their nose to spite their face here,” said Jim Byrne, an analyst at BMO Capital Markets in Calgary who rates Anadarko, Devon and XTO at market perform. “Everybody’s kind of worrying about themselves, and obviously that’s going to happen, but it doesn’t really bode well in our view, certainly for gas prices.”
• “We’re growing production too fast,” said Scott Hanold, an analyst at RBC Capital Markets in Austin, Texas, who has outperform ratings on XTO, Devon, Chesapeake and Anadarko. “We need to slow down..."
• The companies are pumping more gas than ever in the face of a demand slump and a supply surfeit that caused prices to plunge 72 percent from their 2008 high. U.S. gas supplies are 19 percent above their five-year average, driven by output from so- called shale plays. The U.S. Energy Department estimates that industrial gas demand will drop 8.2 percent this year.

Clearly our "price mechanisms" are broken in market after market when "the carrot" for those running the companies is based on things that have very little to do with adjusting to the market. Mmmm... love it; really no different from the banks. I wonder if the decisions would be different if CEOs made European style CEO wages and bonuses were based on 5 year targets that had nothing to do with stock price stoking. Nah.

• One consequence of overproduction amid a recession-driven slowdown in demand is narrowing profit margins. For instance, Devon’s net income per unit of production tumbled 78 percent from a year earlier.

So how do you get around that problem? Just pump more of an increasingly unprofitable product into a supply glut. I mean if you can't make it up on margin, make it up on volume... anything to get that EPS to the "right spot".

• Anadarko, based near Houston, raised its production forecast Aug. 3 and said it’s responding to low prices by cutting costs rather than slowing production.

*Scratching head*

*Pulling out Economics 101 High School Textbook* - ah yes right here: the rational response to lower prices, and gluts of supply are to curtail production of said item (sic). The New American edition of said Textbook: the rational response to lower prices and gluts of supply is to lay off workers and increase production of said item - hence maintaining EPS, retaining bonus, while still flooding the market with more of said product.

It's all connected folks - dysfunction throughout the system based on "free market" (free market as in fellow C-level executives and ex-politicians setting your pay) compensation packages for a select few based on completely incorrect short-sighted measures.

• Oklahoma City-based Chesapeake said all U.S. gas-storage facilities will probably be full by the end of this year, increasing pipeline pressure and forcing production lower.

Then what? haha. Maybe they will sell natural gas to Goldman Sachs (who will not actually take delivery of it but let the producers shoot it off into the atmosphere) in return for future investment banking business. Anything to keep this silly game going. CEOs say "hey we found a buyer" and Goldman just racks up that future backlog of investment banking fees. We are all winners here.

And who better to display the excess CEO compensation than Aubrey C himself [Apr 3, 2009: Chesapeake Energy CEO with New Shady Compensation Deal, Old Deal Suddenly Replaced with New 5 Year Contract - I was Right in my Prediction]

• “There was no reason for us to voluntarily curtail gas when pretty soon, everybody is going to start involuntarily curtailing gas, and so we didn’t see any reason to take it on the chin for the team more than we did,” CEO Aubrey McClendon said this week on Chesapeake’s earnings conference call.

That would be funny if not for the fact none of the major parties are curtailing production. But there is hope on the horizon. Foreigners!

• International oil majors, not producers like XTO, will drive voluntary output cuts, Chief Financial Officer Louis Baldwin said.

Aha. So someone will blink - it just won't be anyone under U.S. C-level compensation practices. Thank gosh for those international guys - go team Europe! They don't have much to lose compensation-wise by adjusting to the market in a rational way. Whew, our saviors.

So the international guys will take one for the "team" and the U.S. guys know where their bread is buttered... mmmm

• Investors are rewarding companies for production gains. Devon rose 3.3 percent in New York trading yesterday after reporting higher-than-estimated output and profit. Chesapeake and Anadarko also had gains after their reports. XTO, which rose as much as 1.8 percent after its earnings statement went out, ended the day down 1.5 percent as all but four of the 19 oil companies in the Standard & Poor’s 500 fell.
• “There’s a pretty clear correlation between production growth and stock performance,” Hanold said. “These exploration and production companies want to take advantage of that.”

And that folks is the reality of natural gas - at least my version of it. Even when the CEO's do stoopid things to destroy their net wealth, like going on leverage and selling all their shares via margin calls [Oct 11, 2008: Chesapeake Energy CEO Forced to Sell Nearly All Shares to Meet Margin Call]- the company is there to support them with perks like new compensation deals just 1 year into an old 5 year contract ... struck on New Year Eve's when no one is paying attention. Right Aubrey? You know all about taking one for the team? As long as its not you - and it's your company that took it for the team ... the team named Aubrey.

• Chesapeake, an oil and gas producer in Oklahoma City, awarded the $75 million to Mr. McClendon as a result of a new, five-year employment agreement struck on New Year’s Eve by directors and the executive. Mr. McClendon’s new agreement replaced a relatively new, five-year contract struck in 2007 that, obviously, had yet to run its course.
• ... the board also awarded him the $75 million bonus.
• “Given that Chesapeake’s earnings dropped by half,” said Marc I. Gross, a senior partner of Pomerantz, Haudek, Block, Grossman & Gross, which represents the Louisiana retirement system, “the $75 million bonus appears not attributable to Mr. McClendon’s exemplary performance but rather to the extraordinary losses he sustained when his Chesapeake shares declined by 60 percent. As such, the bonus appears to be a C.E.O. bailout, while ordinary shareholders got stuck with their losses.”
• So who are the Chesapeake directors? In addition to Mr. McClendon, they are Don Nickels, former United States senator from Oklahoma; Richard K. Davidson, former chairman of the Union Pacific Corporation; Breene M. Kerr, an M.I.T. trustee; Charles T. Maxwell, an oil industry analyst; Frank Keating, former governor of Oklahoma; Merrill A. Miller Jr., chief executive of National Oilwell Varco, an oilfield services company; and Frederick B. Whittemore, an advisory director of Morgan Stanley.

There is an "I" in team in our public corporations. It's all about the brilliant and 1 in a million talent than runs the US public troughs... err, public corporations. [Sep 27, 2008: Heads We Win, Tails We Win] Throw out your economic text books - supply and demand is for Europeans (i.e. socialists).

[May 6, 2009: Natural Gas Continues its Run, XTO Energy Reports]

[May 4, 2009: EOG Resources - Solid Execution in a Horrid Environment]

[Jun 27, 2008: Natural Gas 75% Gain Speeds Horizontal Drilling]

[Feb 29, 2008: Natural Gas Focused Exploration & Development Companies Continue to Shine]

Disclosure: No positions

Comments

[John Galt:]

I'm a capitalist, I'm a market guy, but you punish fraud, you punish stealing, lying, bad business. I don't know why anybody would own a single share with the crap that CEO and his oil and government buddies are pulling.

Increasing production when the price and demand are down? Where do we get these people from?

Aug 07 09:01 AM

[kmi:]

Does it matter?

Cheaper energy during a economic slowdown is a good thing, and I would assume sorta necessary for a turnaround.

Why such frustration about NG?

I think it's a great thing personally since energy makes up such a large part of my fixed costs.

Also - 80% or the costs of NG are the initial drilling costs, after they're in it doesn't cost them much to pull it out or continue to pull it out. High prices last year encouraged more drilling and we are seeing the results today.

Aug 07 09:16 AM

[Ferdinand E...:]

"...feeding with money taken from future generations." I almost tuned out after reading that nutty observation - as if the present government is the first to do that. Mr George W's government was one of the champions at that operation.

But I stuck with it, and I'm glad that I did. This is really a very good, well written article. And yes, things have come to a point where many corporation executives don't give a damn what happens to future generations, as long as they can keep increasing their net worth.

Aug 07 09:17 AM

[Steven Ward:]

Very good article. No one needs to buy NG until fundamentals and chart patterns show the uptrend. To guess the turnaround in NG is catching the proverbial falling knife.

Maybe the internationals won't help either. XOM by 2011 can ship LNG to the states for $3.00, that includes trans costs.
Talisman says they will get their shale plays profitable at $4.00 gas.

Turning NG to liquid fuels? Export LNG to Europe? It might help.

Aug 07 09:25 AM

[happycajun:]

First, a technical correction - you don't "pump" natural gas (or any vapor phase material), you compress it. Gas wells flow or they don't flow - you don't pump them. If the pipeline pressure that you have to overcome to get the gas into the pipeline is higher than the wellhead pressure, then you add compression at the wellhead, downstream from the separators.

Second - the "why" wells are being drilled with prices down is more complex than you characterize. One must look at oil & gas law and how mineral rights are acquired to understand why an oil or gas lease is a "use it or lose it" proposition. When a landowner leases his/her minerals, it is by way of an agreement in written form that stipulates that the lessee has a limited amount of time to drill a well, or the leasehold rights revert back to the land owner. In the Haynesville, for example, it common for leases to provide that the lessee must drill a well in two years, or the lease goes away. There is usually an option to "renew" the lease for an amount of money generally equal to the original lease payment or "bonus" that was the consideration for the lease initially. The lease bonus in the Haynesville has been in the $5,000 to $10,000 per acre range generally. If gas and condensate are produced, then the lessor gets a percentage of the gross production at the wellhead, typically 25% of the volume - which the producer generally markets for the owner, who then gets the $$ that his 1/4 of the gas is sold for.

Now, to put this in an economic context. The basic "unit" being formed in the shales is the section - or a 640 acre nominally square area. This unit is developed by a single horizontal well that is spudded (the surface penetration of the drill bit) near the center of one side of the square, and which goes down vertically to the shale formation, then "kicks" horizontal and runs about a mile - this is the section of the well that is "completed" - where the gas flows from the rock into the tubing, then to the surface.

The lease bonuses for 640 acres is a sunk cost of about $3 - 6 million. A well costs a little more than that. If you don't drill, you lose the lease, or have to pony up another $3-6MM to hold the lease - which you will still lose if you don't drill - all you are buying is time. Having shelled out the $$$ for a lease, and or for a well - it is simple matter of cash flow that you have to generate revenue to produce some return on the investment. The lease also has shut in provisions, which require that a lease be produced once a well is drilled, or it reverts to the land owner - if a lease is shut in more than thirty days - you can lose the lease.

The above is much simplified - but it shows that the economics and risks are more complex than you characterize. This is why the upstream E&P business is best analogized as a game of stud poker - you have to ante up at each stage of the game, and you don't know if you have won or lost until the last card is dealt.

Aug 07 09:27 AM

[happycajun:]

Mr Galt, I'll tell you were they get these people.

The majors recruit the finest engineering, geology and mba programs in the world, looking for the best potential. I have known many with undergrad degrees from US Naval Academy, US Military Academy, Texas, Texas A&M, Rice, Oklahoma, MIT, Harvard, Michigan, Penn, Duke, Purdue - just to name a few who I know who made it to the top ranks of E&P businesses. They then put them in the trenches - ALWAYS analyzing the economics of any investment decision. ALWAYS. The independants tend to hire from the majors - because the majors are better able to afford to train and develop the raw recruit. The young professional is taught about legal and regulatory aspects of the business - and HEAVILY INDOCTRINATED to NOT do anything wrong or unethical. I know some armchair quarterbacks will jear this assertion, but the majors all have a culture of being ethical, honest businesses - WAY more so than what I have seen from the wallstreet financial crowd.

There some bad apples, as in any business, but after the last great oil boom/bust, and all of the scrutiny focused on the industry over the nearly forty years I've been around it - the culture is shareholder focused, while operating legally and ethically. Anyone have some specific factual charges - take them to the SEC.

Aug 07 09:48 AM

[Mark Anthony:]

TraderMark:

Your observation is correct. But it is NOT the whole picture. So your conclusion is wrong. You missed two pieces which tells the story of the bigger picture:

1. At current natural gas price, it is far below production cost of the shale gas wells, although it is in par with conventional gas wells. Shale gas is the marginal production needed to keep the market supplied. CHK is a conventional gas producer, not a shale gas producer. They probably don't care much if they can still at least break even or even make a slight profit. Shale gas producers do care about the price being too low.

2. The telling sign is drilling rig count has collapsed from a year ago figure. Clearly producers are not rushing to drill more and produce more at loss. Rig count is the most important thing to tell us what the future production will be, as shale gas wells deplete fast. You have to keep drilling more wells to keep production up.
www.rigzone.com/news/a...

seekingalpha.com/autho...

Aug 07 09:56 AM

[Leftfield:]

Thanks, happycajun, for some further explanations.
Still, the board of Chesapeake is all to similar to other troughs-of-directors in US corporations. They are connected, interlocking, an ingrown obscenely overpaid group and have no special insight or expertise in the business. Look at GM.
The system rewards the haves at all costs. Even I see the dice are loaded towards their short-term bonuses regardless of long-term risks assumed and resultant debacles.
They have circled the wagons. They control the public "green shoots" discourse via MSM and sold-out politicians. The $trillions of bailouts are not to reward the unique successes of the "1 in a million talents that run the US public troughs... er, public corporations." Except for their lobbying power and crony status.

Aug 07 09:58 AM

[John Galt:]

Trust me when I say this, I am on your side.



On Aug 07 09:48 AM happycajun wrote:

> Mr Galt, I'll tell you were they get these people.
>
> The majors recruit the finest engineering, geology and mba programs
> in the world, looking for the best potential. I have known many with
> undergrad degrees from US Naval Academy, US Military Academy, Texas,
> Texas A&M, Rice, Oklahoma, MIT, Harvard, Michigan, Penn, Duke,
> Purdue - just to name a few who I know who made it to the top ranks
> of E&P businesses. They then put them in the trenches - ALWAYS
> analyzing the economics of any investment decision. ALWAYS. The independants
> tend to hire from the majors - because the majors are better able
> to afford to train and develop the raw recruit. The young professional
> is taught about legal and regulatory aspects of the business - and
> HEAVILY INDOCTRINATED to NOT do anything wrong or unethical. I know
> some armchair quarterbacks will jear this assertion, but the majors
> all have a culture of being ethical, honest businesses - WAY more
> so than what I have seen from the wallstreet financial crowd.
>
> There some bad apples, as in any business, but after the last great
> oil boom/bust, and all of the scrutiny focused on the industry over
> the nearly forty years I've been around it - the culture is shareholder
> focused, while operating legally and ethically. Anyone have some
> specific factual charges - take them to the SEC.

Aug 07 10:30 AM

[Trinvester:]

the reality is that unless some sort of domestic Nat Gas cartel can be formed, similar to OPEC for oil, that can effectivly tie together the fates of the US nat gas companies, thus providing them with an incentive to cooperate, its going to be a long wait for a martyr amongst them.

and even if there was a collective reduction in production in an attempt to revive the price, we can already see who's the most likely to cheat. (cough cough Aubrey cough cough)

Aug 07 10:37 AM

[madrejesica:]

Happycajun,
Great post explaining the process.
My family has leases located in three different sections with three different companies. So far, three wells to date in one section. One permit request for another section has been presented to the Oil and Gas Commission for the last three months and then delayed for another 30 days. The lease for that section is up for expiration and/or renewal in October. In three months we will know if the company wants to keep tabling that permit request or renew the lease.
The price fluctuation downward has drastically impacted royalty payments. Production has been stable, but the payments are based on a high of $8 downward each month to a recent $3.80.
There are two new pipelines under construction that will be on line in 2011 to bring more gas to markets from abundant resources in the Fayetteville Shale.
I have a question..... you said
" The lease also has shut in provisions, which require that a lease be produced once a well is drilled, or it reverts to the land owner - if a lease is shut in more than thirty days - you can lose the lease."
I read a recent post that said a company had drilled a well , but it was not near a pipeline yet, and the well has set for two years, not producing, therefore no royalties for the owner. Based on that post, perhaps not all leases revert back to the landowner.
Question: Do state laws differ so that in some areas, Marcellus Shale versus Barnett Shale, etc. a shut in will not revert the property back to the owner? Or perhaps, a shut in only has to produce one - three months out of twelve, to retain a lease?

Aug 07 12:10 PM

[JAC:]

Making Sense of all the above and more only for buying, selling, shorting purposes tells me there is no clear cut case for any action.

CONTEXT
UNG is way down but the 7 primary/large mostly gas producing firms are up and not strongly correlated with the price of gas, esp. short term (CHK, APC, HK, DVN, XTO, APA, SWN).

Their lows corresponded roughly with the S&P's low in March when they were roughly half or less their 2008 highs.

DEMAND PLUSSES
Co. prices probablly rising since March because they were so low and hopes of a economic turnaround that results in more gas demand. Looks like demand won't go down from here and may be encouraged higher by cap and trade, green etc.

DEMAND MINUSES
Can't think of any highly probable ones.

SUPPLY PLUSSES
Rig count has dropped almost 55% in 12 mo. so many have to be expecting higher prices in future for gas as Mark Antony pointed out.

SUPPLY MINUSES
Current supplies are at nearly all time highs; near capacity and polls of industry folk show that condition is expected to persist probably because of horizontal drilling and the idea expressed by several above that they have to keep producing and selling for many reasons.

LNG from overseas is a $4 possibility sooner rather than later.

My conclusion is long stability of approximately $4 natgas. And if you take that and analysts following the 7 company's EPS estimates for the next two quarters, you see estimates about where they are for the just reported quarter. So if they can make OK money now at $4 they can do it for some time. I don't expect any substantial changes in the prices of the company's stock.

Aug 07 12:11 PM

[happycajun:]

"John Galt" - sorry, I missed your irony initially! Where there is misconduct, by golly letstake the miscreants to task, conspiracy theorists - please stick to the authenticity of the moon landings, JFK, ect.

Madrejesica - oil & gas property rights are governed by state law, hence each state has its own set - but there is a significant similarilty in how the operating companies and landowners have approached the legal issues. Regarding the shut-in provisions, the typical lease provides for a "shut-in royalt" that holds the lease when a lease is shut-in awaiting facilities. Following is an example:

"should Lessee be unable to operate said well because of lack of market or marketing facilities or governmental restrictions, then Lessee's rights may be maintained beyond or after the primary term without production of minerals or further drilling operations by paying Lessor as royalty a sum equal to one dollar (1.00) per acre of land covered hereby per year, the first payment being due . . ."

There are a variety of general lease forms that have been used over time, and you must read each one to make sure what it says! If you have a significant sized tract (forty acres or more) you would be well advised to have an oil & gas lawyer take a look at things for you before you sign. My VERY generalized explanation above is just that - generalized. Whole legal treatises on the subject of Oil & Gas law such as "Williams and Meyers" (which my old friend Pat Martin edits) are written on the subject, so this is an over-simplification at best!

Aug 07 12:56 PM

[DrT:]

Good article but it left out another important factor; the impact of hedging. Big producers like Chesapeake and Encana have locked in big cash flows with hedging and are continuing to drill because they can. In previous cycles the cash flow squeeze would have forced them to stop drilling.

Aug 07 03:06 PM

[iggyDalrymple:]

A possible reason the producers continue to produce may be because it's profitable. I read a recent article that stated that Exxon could make money by giving away natural gas because NG was a byproduct of a process that produced other more profitable products.

Aug 07 05:46 PM

[OilFinder:]

If anyone wants to understand the current state of NG production, the following article is an ABSOLUTE MUST read. All 7 pages of it:
www.rigzone.com/news/a...

Aug 07 09:28 PM

[Responsibility:]

Can anyone comment on the usefulness of NG as substitute for oil? What is the meaning of $3.8 or $4 price of NG?

Aug 08 07:38 AM

[H. T. Love:]

Great read! Thanks very much for the link!

HardToLove


On Aug 07 09:28 PM OilFinder wrote:

> If anyone wants to understand the current state of NG production,
> the following article is an ABSOLUTE MUST read. All 7 pages of it:
>
> www.rigzone.com/news/a...;a_id=78944

Aug 08 09:10 AM

[H. T. Love:]

Great comments from so many folks above! Thanks to all.

For TraderMark: there are other reasons companies might continue to supply into a glut. The ones in the comments above cover most of the "fundamental" ones.

There is also the nature of cycles. We are entering a period when NG prices tend to rise (although I predict the rise will be muted this year). And if you look at the futures contracts, you see a rise reflected in the contango.

Following links from the original given by OilFinder, there is a nice zone chart that shows big disparities in the cost between, e.g., Texas and the gulf region and the new shale plays in the northeast. Many of these are producing at a cost near or even below the current depressed price and *well* below (pun intended) the futures prices.

If they have hedged their output, they will be profitable, which is one of the main points of their production. Unlike some previous years, if the prices stay depressed the hedges will be profitable for these companies. I'm new at this stuff, so I could be misinterpreting what I see, but my only concern is that last time I looked, there was not sufficient open interest and volume (NYMEX HH contracts) to indicate that a lot of longer-term hedging was occurring (I may not have looked far enough out).

There are two plausible reasons for this, I think. The first is that the inventory cycle is now at the point where replenishment must be done. All the talking heads are doing the usual yammering about this and predicting prosperity is now just around the corner (so what's new?). Re-stocking will give a short-term boost to GDP, incomes, jobs (temporary jobs or increased average hours worked), etc. This will increase energy use and the use of NG as feedstock for certain manufacturing. These companies could be factoring this in and hedging only longer-term production, figuring that they'll see the usual seasonal price increases augmented by the replenishment process. Look here for an overview of what I've found about the seasonality.

static.seekingalpha.co...

The second reason is less optimistic, but possible I guess. There could be too many "Larry Kudlow" types running many of these companies that are absolutely certain of explosive turn-around in the U.S. economy. I tend to believe that is unlikely. There are no doubt a few, but the majority are more prescient.

HardToLove


For confirmation of the normal trend, look here static.seekingalpha.co...

Lastly, keep in mind that most of the folks running the good companies look beyond the end of their noses - they are not looking at only near-term trades (if the shareholders are lucky). If that is the case, they may be, as I am, a near-term bear but a long-term bull. If so, they will be making decisions that encompass all the factors detailed in the great comments above and others not even mentioned.

We can all hope they are making the correct ones.

Disclosure: long UNG short calls for near-term play until I can see the signs for an investment. Working on that article now, but there is so much to consider I don't know how long until I'm done with it.

HardToLove

Aug 08 09:53 AM

[H. T. Love:]

I forgot to mention, the months in the chart start with October to emphasize the seasonality. I could've started with September, but it has been less consistent in starting the up-trend.

HardToLove
On Aug 08 09:53 AM H. T. Love wrote:

> <snip>

> For confirmation of the normal trend, look here static.seekingalpha.co...

Aug 08 09:56 AM

[a3A:]

Who is this rambling, babbling pinhead?

Aug 08 10:17 AM

[H. T. Love:]

On Aug 08 07:38 AM Responsibility wrote:

> Can anyone comment on the usefulness of NG as substitute for oil?

I'm new at this, but what I'm aware of so far includes transportation, electricity generation, home and industrial heating, energy for manufacturing, feedstock for many chemical processes (such as plastics manufacturing).

> What is the meaning of $3.8 or $4 price of NG?

Look at these two charts. Huge price spikes in the recent past, when folks thought the traditional oil:NG price ratios were in effect and the economy was apparently blasting higher, presented a profit opportunity. This was combined with improvements in shale gas processes that lowered cost. Lots of companies jumped in and produced an oversupply when the economy tanked.

The ultimate meaning, I guess, is that some players will not survive and others will do well as the margins winnow the less astute.

For companies that use NG, improvements in profit margins or survivability enhanced by being able to offer service/products at lower prices (alwyas a good thing when defaltion is occurring).

For folks who don't do their DD and jump on plays like UNG as a good long-term investment, "haircuts".

Disclosure: long UNG short calls as a near-term trade.

HardToLove

Aug 08 10:20 AM

[H. T. Love:]

Forgot the charts!

Sorry,
HardToLove

static.seekingalpha.co...

Aug 08 10:21 AM

[pockyclips ...:]

The big boys (+$10 B) might survive on $4 mcf, but I doubt anyone else can. Deflation or not, production costs on these new technologies has to closer to $8 mcf.

Aug 08 12:24 PM

[376602:]

It's not the revenue stream the Investment Bankers for the Companies had projected. It's the borrowed money for the lease costs and dead iron at current Natural Gas Prices.

Peak hurricane season is late August to mid-September. If there is not significant supply disruption -watch out. Price target: $1.00

Aug 08 01:01 PM

[Suncatcher:]

This is a great outcome for the consumer. So, unlike a lot of businesses that expand and contract based on demand, the NG business has set themselves up to have to sell into a bad market. I guess this glut will continue unabated until demand catches up with supply.


On Aug 07 09:27 AM happycajun wrote:

> First, a technical correction - you don't "pump" natural gas (or
> any vapor phase material), you compress it. Gas wells flow or they
> don't flow - you don't pump them. If the pipeline pressure that
> you have to overcome to get the gas into the pipeline is higher than
> the wellhead pressure, then you add compression at the wellhead,
> downstream from the separators.
>
> Second - the "why" wells are being drilled with prices down is more
> complex than you characterize. One must look at oil &amp; gas law
> and how mineral rights are acquired to understand why an oil or gas
> lease is a "use it or lose it" proposition. When a landowner leases
> his/her minerals, it is by way of an agreement in written form that
> stipulates that the lessee has a limited amount of time to drill
> a well, or the leasehold rights revert back to the land owner. In
> the Haynesville, for example, it common for leases to provide that
> the lessee must drill a well in two years, or the lease goes away.
> There is usually an option to "renew" the lease for an amount of
> money generally equal to the original lease payment or "bonus" that
> was the consideration for the lease initially. The lease bonus in
> the Haynesville has been in the $5,000 to $10,000 per acre range
> generally. If gas and condensate are produced, then the lessor gets
> a percentage of the gross production at the wellhead, typically 25%
> of the volume - which the producer generally markets for the owner,
> who then gets the $$ that his 1/4 of the gas is sold for.
>
> Now, to put this in an economic context. The basic "unit" being
> formed in the shales is the section - or a 640 acre nominally square
> area. This unit is developed by a single horizontal well that is
> spudded (the surface penetration of the drill bit) near the center
> of one side of the square, and which goes down vertically to the
> shale formation, then "kicks" horizontal and runs about a mile -
> this is the section of the well that is "completed" - where the gas
> flows from the rock into the tubing, then to the surface.
>
> The lease bonuses for 640 acres is a sunk cost of about $3 - 6 million.
> A well costs a little more than that. If you don't drill, you lose
> the lease, or have to pony up another $3-6MM to hold the lease -
> which you will still lose if you don't drill - all you are buying
> is time. Having shelled out the $$$ for a lease, and or for a well
> - it is simple matter of cash flow that you have to generate revenue
> to produce some return on the investment. The lease also has shut
> in provisions, which require that a lease be produced once a well
> is drilled, or it reverts to the land owner - if a lease is shut
> in more than thirty days - you can lose the lease.
>
> The above is much simplified - but it shows that the economics and
> risks are more complex than you characterize. This is why the upstream
> E&amp;P business is best analogized as a game of stud poker - you
> have to ante up at each stage of the game, and you don't know if
> you have won or lost until the last card is dealt.

Aug 08 01:06 PM

[Northstar10000:]

found a way to play the liquid side. once they reach critical mass they will be forced to cut production or liquify. Bet they liquify.

Aug 08 01:34 PM

[H. T. Love:]

Just this last week, got confirmation of milder than normal hurricane season. In fact, it was now projected even milder than the milder they had previously projected.

That from CSU. That brings them in line with Joe Bastardi (thanks Freya).

HardToLove


On Aug 08 01:01 PM 376602 wrote:

> It's not the revenue stream the Investment Bankers for the Companies
> had projected. It's the borrowed money for the lease costs and dead
> iron at current Natural Gas Prices.
>
> Peak hurricane season is late August to mid-September. If there is
> not significant supply disruption -watch out. Price target: $1.00

Aug 08 01:42 PM

[wendling_r:]

All the bantering about CEO salary's and the like is meaningless. It is the specialist in charge of these companies that needs to be watched. He dictates stock price regardless of data from companies. He is the one you want to mirror in order to profit from his movements.

I have just posted a report on CHK explaining his movements for the coming months. If you are interested in reading it click on the link attached with this post and click on the free reports page. The information may be helpful to you.

It costs you nothing except the amount of time it takes to read the data and any other articles you find interesting.

Richard W. Wendling

Aug 08 01:53 PM

[renim:]

I would not call this a glut, just reasonable rent on a long term dependable energy source. Extraction (via land based) well of fluids is cheaper than solids mining. Natural Gas should become cheaper to produce than coal. An interesting scenario.
So we could have natural gas taking its pricing from coal and not oil (as gas/coal are used at power station / but oil is used by vehicles)
If you were to run a car on natural gas it would be a fraction the cost of gasoline. In Australia its very dependent on which state you are in, I suspect the US is similar as transport costs of gas may be related to government 'monopoly/trust' regulations.

As natural gas does not have refining costs, and transport/distribution is mostly a sunk cost, a fuel efficient hybrid (ie Kia Forte) running on natural gas can compete with its oil equivalent even if oil was at zero dollars per barrel.
Ie, the cost of natural gas in a cheap hybrid car can be less than the refining and distribution costs only of gasoline in a oil based non hybrid car.

Aug 08 02:16 PM

[Ricard:]

I still remember T Boone Pickens's call about replacing gasoline for natural gas for America's transportation system (automobiles). I know he's had a horrible time as of late, but this call seems to look more and more valid as NG prices decline to this level.


On Aug 08 02:16 PM renim wrote:

> If you were to run a car on natural gas it would be a fraction the
> cost of gasoline. In Australia its very dependent on which state
> you are in, I suspect the US is similar as transport costs of gas
> may be related to government 'monopoly/trust' regulations.
>
> As natural gas does not have refining costs, and transport/distribution
> is mostly a sunk cost, a fuel efficient hybrid (ie Kia Forte) running
> on natural gas can compete with its oil equivalent even if oil was
> at zero dollars per barrel.
> Ie, the cost of natural gas in a cheap hybrid car can be less than
> the refining and distribution costs only of gasoline in a oil based
> non hybrid car.

Aug 08 03:26 PM

[koolsool:]

Renim has it right. If you want Obama and his crew to consider a new energy policy that uses clean north American natural gas instead of imported oil for transportation. And natural gas to replace dirty coal for electricity generation. You must prove that there can be sustained cheap supply. The USA has enough natural gas to do these things. There is enough supply for 50 more years at least, even if you double or triple demand.

Aug 08 06:45 PM

[H. T. Love:]

If you're talking about making LNG for export, the only place we have now is in Alaska. I understand that it's expensive and long-lead time to build a liquification plant.

Plus, there is so much being produced in other countries that everyone is worried about the imports to here (we have lots of off-load facilities and more in planning or under construction).

The only thing that might reduce that is if the dollar weakens sufficiently to make other countries with stronger currencies and demand more attractive to the exporters.

HardToLove

On Aug 08 01:34 PM Northstar10000 wrote:

> found a way to play the liquid side. once they reach critical mass
> they will be forced to cut production or liquify. Bet they liquify.

Aug 08 09:40 PM

[User 170262:]

Let's see, more production, storage facilities overflowing, when exactly does the price of NG to the consumer get lowered. My guess is never. This is just another Ponzi scheme to set us up. Isn't it time that the real Amercian people took control of this country.

Aug 08 09:43 PM

[H. T. Love:]

The problem for now is twofold: infrastructure and regulatory restrictions. Until there are enough refueling stations, consumer use will be limited.

A conversion kit costs a few thousand, but then you have very high licensing fees in states like California that effectively restrict the new entrants to conversion services and restrict profits.

To make this feasible, the policy must be set at a national level that encourages the development of the infrastructure and eliminates the entry barriers for conversion providers, while maintaining necessary saftey standards.

With the owned clowns in D.C., not much chance of that.

HardToLove

On Aug 08 02:16 PM renim wrote:

> I would not call this a glut, just reasonable rent on a long term
> dependable energy source. Extraction (via land based) well of
> fluids is cheaper than solids mining. Natural Gas should become
> cheaper to produce than coal. An interesting scenario.
> So we could have natural gas taking its pricing from coal and not
> oil (as gas/coal are used at power station / but oil is used by vehicles)
>
> If you were to run a car on natural gas it would be a fraction the
> cost of gasoline. In Australia its very dependent on which state
> you are in, I suspect the US is similar as transport costs of gas
> may be related to government 'monopoly/trust' regulations.
>
> As natural gas does not have refining costs, and transport/distribution
> is mostly a sunk cost, a fuel efficient hybrid (ie Kia Forte) running
> on natural gas can compete with its oil equivalent even if oil was
> at zero dollars per barrel.
> Ie, the cost of natural gas in a cheap hybrid car can be less than
> the refining and distribution costs only of gasoline in a oil based
> non hybrid car.

Aug 08 09:59 PM

[OilFinder:]

Some conversion info here:
www.onlineconversion.c...
Also here:
www.eppo.go.th/ref/UNI...

Natural gas is priced in terms of 1,000 cubic feet. 1000 cf. of natural gas contains 1,030,000 Btu's. The current price is about $3.67.

1 barrel of oil contains about 5.6 million Btu's or about 6 times the energy content of 1,000 cubic feet of natural gas. Actually it's 5.6 times the energy content, but most people just round it off to 6. ;-)

So, multiply the current price of natural gas to get the price-equivalent of oil. $3.67 x 6 = $22.02 = oil-barrel price equivalent of natural gas right now. Or if you want to be more technically accurate multiply $3.67 x 5.6 = $20.55 oil-barrel price equivalent.

It's easy to just use the "rule of 6" to give you rough gas-oil conversion figures. For example, a natural gas discovery of 6 trillion cubic feet is roughly the energy equivalent of a 1 billion barrel oil discovery. And the 489 trillion cubic foot Marcellus shale is roughly the energy-equivalent of an 82 billion barrel oil field:
www.rigzone.com/news/a...

On Aug 08 07:38 AM Responsibility wrote:

> Can anyone comment on the usefulness of NG as substitute for oil?
> What is the meaning of $3.8 or $4 price of NG?

Aug 08 11:30 PM

[scfranklin94:]

The author is concerned about why producers would drill during times of perceived 'low' prices, so his explanation is that executives are lining their pockets.

It's a bit more complex than that:

1) HappyCajun pointed out the economics of drilling is a use it or lose it proposition.

2) The producer isn't hedging at the spot price, but at something more in line with annual prices (adjusted for declining production monthly). The prompt month is at $3.674, but the average for the next twelve months is $5.307 at Henry Hub; if a producer decides to drill a shale well today, it will take at least ninety days to set up, drill the well, and get tied into the gathering system, the annual forward price of gas 3 months out is $5.68 (there's a ton of production costs and basis considerations that I don't have time to get into).

3) Once a well is drilled, the bulk of the production costs are over, but the borrowed debt is still on the balance sheet. So shutting in a well just because prices are low is usually not option for most producers, because they have monthly interest payments they have to make. When a producer decides to shut in wells due to low prices (as opposed to being shut in due to pipeline oversupply), it says a lot about the strength of the producer's balance sheet.

4) There is a wide range of breakeven costs for shale wells out there. Many estimates are based off of the high leasing costs of June 2008 and the drilling costs from that time; virtually every cost has declined substantially since that time. So what is the breakeven for a shale well in the Haynesville? Some will claim it's $6.50, while I've seen analysis that it's closer to $4.75 for new leases. If you've already paid the leasing fee a year earlier, you might as well drill if the estimated production is calculated to pay you something over the actual drilling costs.

Aug 09 12:26 PM

[renim:]

but an additional advantage of Natural Gas is that there is now refining cost, and distribution is fully piped.

tonto.eia.doe.gov/oog/...

take a look, for gas you can probably exclude all the refining component and the transport component varies considerably depending on location, so even if oil and gas were to be same price, gas could still be much cheaper

On Aug 08 11:30 PM OilFinder wrote:

> Some conversion info here:
> www.onlineconversion.c...
> Also here:
> www.eppo.go.th/ref/UNI...
>
> Natural gas is priced in terms of 1,000 cubic feet. 1000 cf. of natural
> gas contains 1,030,000 Btu's. The current price is about $3.67.<br/>
>
> 1 barrel of oil contains about 5.6 million Btu's or about 6 times
> the energy content of 1,000 cubic feet of natural gas. Actually it's
> 5.6 times the energy content, but most people just round it off to
> 6. ;-)
>
> So, multiply the current price of natural gas to get the price-equivalent
> of oil. $3.67 x 6 = $22.02 = oil-barrel price equivalent of natural
> gas right now. Or if you want to be more technically accurate multiply
> $3.67 x 5.6 = $20.55 oil-barrel price equivalent.
>
> It's easy to just use the "rule of 6" to give you rough gas-oil conversion
> figures. For example, a natural gas discovery of 6 trillion cubic
> feet is roughly the energy equivalent of a 1 billion barrel oil discovery.
> And the 489 trillion cubic foot Marcellus shale is roughly the energy-equivalent
> of an 82 billion barrel oil field:
> www.rigzone.com/news/a...;hmpn=1
>
> On Aug 08 07:38 AM Responsibility wrote:

Aug 09 11:37 PM

[renim:]

oops that should have said NO refining cost for natural gas

Aug 09 11:42 PM

[OilFinder:]

Some (most?) natural gas requires a small amount of refining - particularly sour (high sulfur) gas - but in essence you are correct in that NG's refining needs are miniscule compared to oil.

Aug 10 12:05 AM

[Biggnick19:]

1. As someone already said, you don't pump natural gas. By saying this it made me question if you even know what natural gas is. Nothing in the gas phase can be "pumped".

2. The reason they are still drilling is because they have learned from past mistakes. The energy industry is so incredibly cyclical that companies are now trying to stay ahead of the curve. Normally drilling shuts down when prices fall this far and then we have the huge spikes on the other end. Look at the Natural Gas futures and you'll see people are still drilling.

3. The main reason oil and gas have diverged so much doesn't have much to do with US vs. Worldwide economies like you suggest. It's due to the tremendous amount of gas being pumped from shales. We have an oversupply of gas produced and ridiculous amount of recoverable gas underground, but have already passed peak oil. Thus oil more expensive than gas on a per BTU basis.

4. to the person below... Actually CHK is a HUGE shale gas producer


On Aug 07 09:56 AM Mark Anthony wrote:

> TraderMark:
>
> Your observation is correct. But it is NOT the whole picture. So
> your conclusion is wrong. You missed two pieces which tells the story
> of the bigger picture:
>
> 1. At current natural gas price, it is far below production cost
> of the shale gas wells, although it is in par with conventional gas
> wells. Shale gas is the marginal production needed to keep the market
> supplied. CHK is a conventional gas producer, not a shale gas producer.
> They probably don't care much if they can still at least break even
> or even make a slight profit. Shale gas producers do care about the
> price being too low.
>
> 2. The telling sign is drilling rig count has collapsed from a year
> ago figure. Clearly producers are not rushing to drill more and produce
> more at loss. Rig count is the most important thing to tell us what
> the future production will be, as shale gas wells deplete fast. You
> have to keep drilling more wells to keep production up.
> www.rigzone.com/news/a...;hmpn=1
>
> seekingalpha.com/autho...

Aug 10 12:39 AM

[renim:]

happycajun

So in America, do the farmers/landowners effectively get a 25% royalty on the gas produced from under their property? If so, that must be very good for the rural economies.

Aug 13 12:03 AM

[Shale Gas:]

Tradermark,

here's an interesting article on natural gas staying below $4 for years:

www.rigzone.com/news/a...

Aug 13 06:59 AM

[renim:]

a comment on the rigzone article. Shale gas is becoming more of a real estate/engineering play than conventional gas which is an exploration play (my spin - this is another example of gas tending to behave more like coal than like oil in production not just in use)

Aug 14 07:05 AM