Plenty of Natural Gas: Exploration and Production Companies Keep Increasing Oversupply

The EIA reported that U.S. gas storage on September 4, 2009 stood at 3.4 trillion cubic feet, approximately 17% higher than year-ago levels and 17% higher than the five-year average. It looks like E&P companies are not doing much to change the excess inventory in natural gas and are continuing their production levels from Q2. E&P companies are much more focused on delivering production growth to their shareholders and are not letting high storage levels get in the way of their business. Below is a table of Q2 natural gas production results for some of the top U.S. producers.

^{Companies Mentioned: XTO, BP, APC, CHK, DVN, COP, ECA, CVX, XOM, EOG, SWN.}

This action by E&P companies as a whole could be shortsighted. If production continues to increase without a proportionate increase in demand, gas E&P companies may be forced to curtail production. Besides the threat of further price declines, which could render some exploration and production activities uneconomical, the biggest restraint could actually be diminished storage capacity (estimated at about 4.0 trillion cubic feet). As EOG Resources CEO Mark Papa mentioned after the company reported Q2 earnings, “…if gas storage fills across the nation, pipeline pressure could go up, increasing pressure back at gas wells. That could result in automated curtailment pretty much across the board…Then, production would just drop for everybody."

While there have been rumors of increasing the storage capacity, that should hardly be the solution for a commodity that is severely oversupplied. The U.S. should not be encouraging more production by adding more storage. Furthermore, one could argue that these storage levels are not a true reflection of available inventory, as they do not take into account the gas located in the immeasurable number of shut-in wells ready to be opened with any sign of inventory reduction. For the sake of E&P companies, let’s hope that the winter is cold and that industrial production picks up significantly. Otherwise, shareholders might be disappointed with lower future production growth.

Disclosure: In the next few days, may buy puts on a company mentioned above.

Comments

[mekats:]

another nat gas expert......just watch storage and production and you have all the answers. author conveniently overlooks the years of lead time involved in the capital decisions to drill, develop, hookup wells, pipelines, etc. E&P companies try not to turn it on and off like a light switch which paper shuffling analysts would recommend as optimal "economic behavior". After buying your puts you may be treated to a lesson in self correcting economics as reduced drilling and depletion "take care" of soft demand and low prices.

Sep 11 08:33 AM

[mekats:]

another nat gas expert......just watch storage and production and you have all the answers. author conveniently overlooks the years of lead time involved in the capital decisions to drill, develop, hookup wells, pipelines, etc. E&P companies try not to turn it on and off like a light switch which paper shuffling analysts would recommend as optimal "economic behavior". After buying your puts you may be treated to a lesson in self correcting economics as reduced drilling and depletion "take care" of soft demand and low prices.

Sep 11 08:34 AM

[Mad Hedge F...:]

wrwrm Just when I get comfortable with my view on Natural Gas, I get a scratchy, reverberating cell phone call from one of the major formations telling me that I’m being way too bullish. Gas won’t bottom at $2. The free fall will continue until it hits $1. National storage will be completely full imminently top out, and when it does, theproducers will have to shut down completely. Since these guys are leveraged up the wazoo, this will trigger a string of bankruptcies, and the majors will fall like dominoes. A hedge fund bust won’t define thisbottom, as these guys are all playing from the short side. UNG can’t step in as a buyer of last resort, as the SEC won’t let it issue morestock, and the current shares are trading at a ridiculous 20% premium.One thing we do agree on is that the bottom will look ugly, whatever the spark is. You often get Armageddon type views near market bottoms,but this guy has been dead on right until now. Well, it takes two to make a market. Conclusion: keep NG nailed to your screen, as the widow maker is where the volatility lives.

Sep 11 09:56 AM

[Skip Olinger:]

Well done article but I have a question for you and the 2 previous commenters.

As I understand it, NG demand has fallen significantly primarily due to a drop in industrial demand and utility demand. Supply has increased as new unconventional plays have gone into production. So producers, who cannot just shut off wells like a light switch, have started to store gas in hopes of higher prices down the road. Storage is becoming full. Once full wells may be forced to shut down. Pressure in the system will fall so even pipelines won't be making revenue as no gas will be moving. Voila, end of the world. Do I have this correct?

But wait, if you want to sell your gas at say $4.50 rather than $2.73 all you would have to do is sell a futures contract for Dec delivery. That is 3.5 months away! There must be plenty of producers that have sold their production forward for winter delivery and intend of delivering. And, if you want $5 all you have to do is sell for June '10. What am I missing here?? I would appreciate some help.

Also, the economy seems to be turning around a bit. That should start to increase industrial and utility demand. How do you see that playing out??

Lastly, how do you see the Pickens theory play out with conversion to NG use away from Petroleum. I suspect that is a ways off but some government car fleets are now being converted?

Thanks to all for your help

Sep 11 10:31 AM

[BSexposer:]

mekats - the guy is like 19 years old - would you REALLY trust him for investment advice and predicting NG prices??? Let him gamble with options - this casino attitude isn't real investing.

Sep 11 11:09 AM

[Raymond Chung:]

There should still be revenues, a build up in storage is just the net of production minus production sold.

My article isn't necessarily a call on natural gas prices, but it does hint that investors reward companies with higher organic production growth with higher multiples versus those that have to rely solely on price for growth. This is common for many commodity companies.

Selling futures could result in higher locked in future prices, and many companies do do this. Many companies, not all, try to neutralize the effect of price on their business, and thus experience less price volatility then the actual spot. In reality most companies neither benefit as much when prices are good nor get hurt as much when prices are bad. This thus leads to why individually production growth is important.

Industrial usage represents 38 percent of total demand, and utility usage is usually determined by weather. We'll see if demand increases enough to draw down storage.

Pickens is making a big effort. I do agree with you that it is a ways off. However, it's not just building cars that run on natural gas, it's also builiding the infrastructure so that consumers could fill up like they do now. That's probably more onerous as that requires land, permits, etc.





On Sep 11 10:31 AM Skip Olinger wrote:

> Well done article but I have a question for you and the 2 previous
> commenters.
>
> As I understand it, NG demand has fallen significantly primarily
> due to a drop in industrial demand and utility demand. Supply has
> increased as new unconventional plays have gone into production.
> So producers, who cannot just shut off wells like a light switch,
> have started to store gas in hopes of higher prices down the road.
> Storage is becoming full. Once full wells may be forced to shut down.
> Pressure in the system will fall so even pipelines won't be making
> revenue as no gas will be moving. Voila, end of the world. Do I have
> this correct?
>
> But wait, if you want to sell your gas at say $4.50 rather than $2.73
> all you would have to do is sell a futures contract for Dec delivery.
> That is 3.5 months away! There must be plenty of producers that have
> sold their production forward for winter delivery and intend of delivering.
> And, if you want $5 all you have to do is sell for June '10. What
> am I missing here?? I would appreciate some help.
>
> Also, the economy seems to be turning around a bit. That should start
> to increase industrial and utility demand. How do you see that playing
> out??
>
> Lastly, how do you see the Pickens theory play out with conversion
> to NG use away from Petroleum. I suspect that is a ways off but some
> government car fleets are now being converted?
>
> Thanks to all for your help

Sep 11 11:44 AM

[Raymond Chung:]

Clarification, should be production minus production consumed, what is not consumed is the excess that adds to inventory.


On Sep 11 11:44 AM Raymond Chung wrote:

> There should still be revenues, a build up in storage is just the
> net of production minus production sold.
>

Sep 11 11:51 AM

[experienced:]

Regarding the Pickens plan for using NG for transportation, it is a mystery to me why more public officials haven't endorsed the idea. Perhaps the lobbying for continued use of gasoline and diesel has discouraged attempts to use NG. While it might be difficult to convert general use cars and trucks to NG, it certainly would be practical for school buses, local truck and taxi fleets, and other primarily local applications.

The fundamentals for oil have not changed: The rate of growth in demand, spurred by huge increases in transportation demand in China and other developing nations, is greater than the rate of growth in proven reserves. Put another way, less new oil is being discovered than is being consumed. This means the price trend for crude is up. Meanwhile, the low prices for NG, if nothing else, should provide incentives to switch to NG where NG is a viable alternative. All this ignores pollution related issues, which should provide further incentives for NG.


On Sep 11 10:31 AM Skip Olinger wrote:

> Well done article but I have a question for you and the 2 previous
> commenters.
>
> As I understand it, NG demand has fallen significantly primarily
> due to a drop in industrial demand and utility demand. Supply has
> increased as new unconventional plays have gone into production.
> So producers, who cannot just shut off wells like a light switch,
> have started to store gas in hopes of higher prices down the road.
> Storage is becoming full. Once full wells may be forced to shut down.
> Pressure in the system will fall so even pipelines won't be making
> revenue as no gas will be moving. Voila, end of the world. Do I have
> this correct?
>
> But wait, if you want to sell your gas at say $4.50 rather than $2.73
> all you would have to do is sell a futures contract for Dec delivery.
> That is 3.5 months away! There must be plenty of producers that have
> sold their production forward for winter delivery and intend of delivering.
> And, if you want $5 all you have to do is sell for June '10. What
> am I missing here?? I would appreciate some help.
>
> Also, the economy seems to be turning around a bit. That should start
> to increase industrial and utility demand. How do you see that playing
> out??
>
> Lastly, how do you see the Pickens theory play out with conversion
> to NG use away from Petroleum. I suspect that is a ways off but some
> government car fleets are now being converted?
>
> Thanks to all for your help

Sep 11 11:52 AM

[toobad41:]

Your sentence "The action by E&P Companies as a whole could be short sighted" is a flat out stupid sentence. E&P Companies are independent of each other and seldom (if ever) act as a whole.

Sep 11 11:53 AM

[BrotherMaynard:]

excellent point about shut-in storage -- it should be considered inventory. the future supply problem b/c of lower rig counts is overblown. that's why curve flattening should be the next stage of this cycle.

just to expand on the EOG comment, stephen schork today:

"several Northeast pipelines started issuing operational flow orders (OFOs) in an apparent attempt to limit shippers exceeding their contractual limits...In addition to the Labor Day holiday, last week’s report also comprised the ratchet clause rollover. Injection ratchet clauses in the East require shippers to inject working gas through scheduled stages in order to preserve operational integrity. By September 01st no more than 80% of storage can be filled....According to the latest estimate from the EIA, maximum storage capacity in the East is 2.178 Tcf. As of two reports ago, week ended August 28th, estimated storage was 1.78 Tcf. That calculation was already 81½% of capacity or 1½ points above the ratchet. In other words, storage in the East over the last two reports was at operational capacity. Thus, the OFOs were a likely means to hold storage below the 80% threshold...What’s so bullish about that? Absolutely nothing."


here's the rest of schorks note: www.cnbc.com/id/327973...

Sep 11 11:56 AM

[Aricool:]

mekats, I think your view is dangerously over simplistic and not at all rigourous enough to even be taken seriously. Maybe you can address the who picture instead of perma-bull hand-waving talk.

The current pop up is just massive short covery and rabid bull sector rotation desperation. Why can't Nat Gas (NG) go under $2? If most of the producers are 100% hedged for '09 (hence likely why their stock prices are not in the toilet w/ NG price) and they have to produce to keep their valuable leases and we have a 100 year supply, then why stop production at any price when you're getting top (hedged) $ any how??? Someone needs to explain to me why will they given these (and many other simar) factors.

Besides, did you notice that rig counts bottomed in early June and actually started to uptick in July-Aug. Also, day rates never came down enough. Not a good sign if you believe in major production cuts.

Also, if you look at the last recessions NG droped to around $2.5-2.7 in real terms (adjusting for inflation); however, that was when US NG production was believed to have peaked, which is why we later created infrastructure for LNG imports- and those lows were before we became the Saudi-Arabia of NG with massive supplies. So, it would stand to reason that we'll see below $2 easy; esp. since we got so quickly to $2.5 w/o resistance.

Moreover, I'm very concerned about the long term pricing of NG. I'm trying to see it as bullish as you do, but many long-term factors seem like it might keep it very low- not the least of which is LNG imports from Russia and Arabs when NG gets back over $4.

Have a look at the LNG import spike between end '06 and early '07 and it tracks *exactly* with a step down of NG price from 7 to 5. This is insane that LNG could crush prices during a robust US economy. I'm very scared now that with the paltry 2% trend growth expected for the US (and EU?) going forward that they'll dump excess Euro LNG onto the US and repeat that '06/'07 event. This would almost certainly keep NG prices under $4 in the expected weak situation for '10. This is a huge uncertainty in playing '09 weakness esp. if buying into NG driller/services securities to play the "perfect storm" against NG. That is, the LNG would dump just enough supply to easily keep the storage full, thus keeping NG exploration and cap ex down to a minimum, and b/c most NG producers are only partially hedged for 2010 (maybe 30% or less?) then they would get killed in 2010 making there hedged supported stock prices 2009 quite high. This uncertainty really sucks! Can you discount this scenario?

the EU is expected to recover more slowly than the US so why (in the context of those reports/articles I sent you) won't the LNG plays dump what ever they can on the US. As I analyze the charts, the LNG chart tells me a very bad story. That is, the June '09 LNG was sold at only ~ $4.3 while volumes where a little above that just before the '06 event (see above) when NG price in '06 was ~7, and then dumped 2X the volume for 6 months and were more than happy to collect only $5 in that time. Again, this was when the EU and US were heading into a peak earning cycle. This tells me that the LNG players will keep US NG prices in the toilet (<$4) until the US (and EU?) are in a full recovery. Very, very bad for NG sector stocks for 2010. Please debunk this gloom and doom scenario! It seems all too possible if the magal V-shape recovery does not materialize in early 2010. Hence, why with a weak EU they'll dump there LNG at a (double? june '09) high rate and keep the US storage near max, thus NG prices in the toilet.

I'd really hate to additionally bet on a V-shape recovery on top of the structural NG risks I've discussed. There are much more (risk adjusted) profitable bets on a V-shape recovery in the market.

Betting on a V-shape recover is over the top for a NG bet at this point. Also, how can you be so sure that that '06/'07 event (see above) won't repeat in 2010?

In summary, NG prices seem destined to go well under $2 well into November, and while it may rebound next year LNG will keep it near $4 and kill/hurt most US NG producers until the economy fully recovers (1-2 years) and get NG price in the $5-6 range.

So, you can try catching a falling knife or put your money in soaring NG stocks which will collapse next year when there hedges are gone and NG is kept too low b/c of LNG. Seems like NG is a bad bet until at least Nov.

Cheers,
Ariel-



On Sep 11 08:34 AM mekats wrote:

> another nat gas expert......just watch storage and production and
> you have all the answers. author conveniently overlooks the years
> of lead time involved in the capital decisions to drill, develop,
> hookup wells, pipelines, etc. E&amp;P companies try not to turn it
> on and off like a light switch which paper shuffling analysts would
> recommend as optimal "economic behavior". After buying your puts
> you may be treated to a lesson in self correcting economics as reduced
> drilling and depletion "take care" of soft demand and low prices.

Sep 11 12:00 PM

[Dryspell:]

Correct. In fact it would be illegal for them to collude on price. There are several factors at play that keep many of the independent E&Ps drilling away. First, many have significant hedge positions that allow them to weather the low prices for now. More importantly, mineral lease terms are usually short (1-3 years) and these companies paid dearly for shale gas acreage. They either drill it and establish production or lose rights (or pay expensive lease renewals if available). As long as the hedges stand they are incentivized to continue drilling, holding acreage, and hope for a price recovery. If prices do not recover and they cannot maintain their hedges (give it a year), they are doomed whether they continue drilling or not.


On Sep 11 11:53 AM toobad41 wrote:

> Your sentence "The action by E&amp;P Companies as a whole could be
> short sighted" is a flat out stupid sentence. E&amp;P Companies
> are independent of each other and seldom (if ever) act as a whole.

Sep 15 01:28 AM

[Dryspell:]

Raymond - good article. The only way the companies could effectively "collaborate" on reducing natural gas output would be via the state oil and gas regulatory agencies. A few operators have asked the Oklahoma Corporation Commission to lower the well allowables across the state for example. If this were done in a coordinated manner in most of the producing states, it might have an impact on supply. I do not see this happening as highly hedged highly leveraged operators with lots of acreage to drill and hold will be opposed. It also would probably not sit well with the public as it a form of priced manipulation. However, as many of the producing states get a significant amount of revenue from various oil and gas taxes, it might be in the states' interest to try and increase prices and therefore tax receipts. Natural gas is essentially being given away free at the moment (nowhere near the price of oil on an energy equivalent basis).

Sep 15 01:39 AM

[kstock:]

One area of Utility demans, is CNG powered Bus fleets in the U.S. public transportation system. The CNG buses already account for 25% of sales, and will no doubt increase due to heavy government subsidies by the Obama administration. Yahoo Finance has a great article about CNG:
finance.yahoo.com/news...

Sep 22 10:35 AM