The Coming Natural Gas Supply Crisis

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Includes: BOIL, CHK, DGAZ, UGAZ, UNG
by: HiddenValueInvestor

Summary

Almost all of North America's natural gas supply is produced in North America. Unlike oil, North American natural gas is not part of a global market.

Severely depressed oil and natural gas prices are causing a collapse in the North American rig count.

The warmest fourth quarter in the last 121 years in 2015 is masking the coming supply crisis. The EIA Drilling Productivity Report is forecasting significant natural gas production declines.

The latest EIA Weekly Natural Gas Storage Report shows natural gas storage is above the normal range for this time of year, and 473 Bcf above the five year average as of January 15, 2016. The cause is not excess production nor rapid production growth, but weather. According to the National Oceanic and Atmospheric Administration the fourth quarter of 2015 was the warmest October through December period for the lower 48 contiguous U.S. States in 121 years of recorded history. The current natural gas storage glut is masking the coming natural gas supply crisis.

Last January I first started reporting on the EIA Drilling Productivity Report and its analysis on the impact of the falling rig count in the article Falling Rig Count Could Cause Natural Gas Production Decline. Based on the methodology used by the EIA explained in the above article, it predicted that a further reduction in the rig count by 25% would cause natural gas production growth to stop and start to slowly decline. Since then the rig count has fallen by over 60%. Pipeline capacity additions in the Northeast and the completion of a couple of major projects in the Gulf of Mexico have allowed total natural gas production to remain relatively flat since last year despite production declines in fields like the Eagle Ford. That is now about to change and production should soon start rapidly falling.

This is a look at the latest year over year natural gas production estimates by the EIA Drilling Productivity Report for February of 2016:

The lighter shade of blue shows the actual production growth in all of the seven basins followed by the report for February of 2015. Fast forward to 2016 and the darker shade of blue shows the estimated drop in overall natural gas production from four of the seven basins. The estimate is based on the average rig count in December for each basin.

Here is a look at the Baker Hughes North American rig count for the week of January 22, 2016:

What jumps off the page is the gas rig count for the lower 48 States has fallen to 127 rigs. Just seven weeks ago the natural gas rig count was 192. A much larger month over month natural gas production decline should be predicted for March of 2016 based on the latest rig count. The Haynesville has lost 10 of the 28 rigs reported just seven weeks ago. The Utica has lost 7 out of 20. The loss of those rigs, if it is sustained, should cause both of those basins to also fall into month over month declines. There are many natural gas fields not followed by the report, like the Barnett for example, that have also lost rigs in the last seven weeks.

Without much higher natural gas prices more rigs will be dropped. Chesapeake (NYSE:CHK) is the nations largest natural gas producer. Here is a look at the PV-10 breakeven point for their fields in the Haynesville, the Utica Wet, and the Marcellus:

Click to enlarge

Natural gas futures prices for the 12 month strip currently average less than $2.50 per mcf. Chesapeake loses money on any rig program it chooses to run in its three best and most significant natural gas fields. They don't have money to burn, and neither do most drillers in the industry. At some point prices for natural gas will have to rise towards $4 per mcf or supply will keep sinking.

It is not clear when the market will move prices higher. Weather has created excess natural gas in storage and may continue to do so throughout the winter. No one has a clue what the weather this summer or next winter will be like. If the weather turns more bullish prices will rally sooner rather than later. So keep an eye on the forecasts. What is certain is that at current natural gas prices a supply/demand imbalance is coming. Putting rigs back out into the field is not like turning on a production switch. It may take 6 months to have enough drilling to start growing supply again even after prices rise. Investors who do not want to play natural gas with highly indebted companies like Chesapeake could consider a natural gas ETF.

ETFs To Which Natural Gas Fundamentals Are Relevant:

  • The United States Natural Gas ETF, LP (NYSEARCA:UNG)
  • VelocityShares 3x Inverse Natural Gas ETN (NYSEARCA:DGAZ)
  • VelocityShares 3x Long Natural Gas ETN (NYSEARCA:UGAZ)
  • ProShares Ultra Bloomberg Natural Gas ETF (NYSEARCA:BOIL)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.