Natural Gas Production Is About To Plummet

by: Daniel Jones

Summary

As one of the seven largest natural gas producing regions in the U.S., the Eagle Ford is a significant area to understand for natural gas-oriented investors.

In this article, I dig into the government's data regarding production and forecast what output should look like by year-end.

What I discovered is that, if something doesn't change fast, we should see production fall materially in the region this year, which is bullish news for investors.

In the past, I've written articles regarding the Eagle Ford and the oil production trend that we've seen coming out of the region. However, I have yet to analyze the amount of natural gas to come from the area and to see what the production trend of that commodity should look like moving forward. Now, after having the opportunity to dig into the data from the EIA's (Energy Information Administration) Drilling Productivity Report, and after recognizing the massive drop in rig count in the Eagle Ford, I've concluded that, if nothing changes fairly soon, we can expect a significant drop in output throughout this year, a move that should be bullish for long-term investors in this space.

A look at the Eagle Ford

Located along the southern and eastern portions of Texas, the Eagle Ford is the third-largest region for the production of natural gas in the U.S. (behind the Marcellus and the Permian) and the second-largest for the production of oil (behind the Permian). As one of the most prolific regions in the industry, it has commanded a great deal of attention and investment from companies extracting these products but, as the price of both oil and natural gas plummeted over the past year and a half, the drilling activity there has fallen like a rock. In the image below, you can see where the Eagle Ford is located relative to the six other major energy-producing regions in the country.

Click to enlarge

In the table below, you can see that time hasn't been so kind to the Eagle Ford, especially when stacked up against rivals like the Permian and Haynesville, both of which have seen their natural gas output rise between December of 2015 and what the EIA (Energy Information Administration) believes will be the production level of each area in March of this year.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

Things are about to get a lot worse

If you think that these declines are bad, wait to see what the picture looks like moving forward. However, before I get to that, I need to touch on the core assumptions I had to make to get me to my final conclusion. Using historical data from the EIA, I previously forecasted (in my Eagle Ford article regarding oil) that rig counts will fall by seven units per month. I've had to make some adjustments due to recent news but I am sticking to that, starting with a total of 59 units for the month of February and moving down in the months to come. I know this may sound like a harsh assumption but, given the current price of natural gas, it's only a matter of time before more rigs come offline.

The next assumption I had to make regarding the Eagle Ford involves the change in drilling rig productivity over time. In the graph below, you can see the historical trend that rig productivity has taken on a month-to-month basis. Overall, there seems to be a great deal of volatility here but the general path has been toward lower improvements in productivity almost every month since last May, with the EIA forecasting the March-to-April productivity level at 0.91%. Recognizing the significant disparities that can exist, however, I will use an estimate of 1.5% for now, with the intention of lowering that in the future if the EIA's forecasts turn out to be accurate.

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*Source: Created by author with data from the EIA's Drilling Productivity Report

Finally, I had to make some assumptions regarding decline rates in the region. In the graph below, you can see what the picture has looked like for every month since January of 2007 (data doesn't go back any further than that). Right now, the trend seems to be moving higher into the upper 5% range but I've had instances in the past where the EIA has revised these numbers lower a month or so out. Because of this uncertainty, I will look at a conservative scenario, whereby decline rates will average 5% each month, a moderate scenario, whereby they will average 5.5% per month, and a liberal scenario, whereby we can expect decline rates to be 6% per month.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

Now that we have these three base assumptions, it's possible to create a realistic forecast regarding the future of natural gas production in the Eagle Ford. In the table below, you can see the results of my analysis, which indicate that, regardless of which of the three scenarios I adopted, natural gas production in the region should fall quite meaningfully (thanks largely to my forecast for rig counts) in the months to come. If the EIA's data is accurate and my assumptions are spot-on, investors should anticipate production in the region to come out to between 4,350,082 Mcf per day and 4,715,479 Mcf per day by December of this year.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

In the next table, you can see what this looks like when you stack my estimates up to what happened in December of 2015. Based on the data provided, the conservative scenario should see production fall by about 32.1% year over year. Meanwhile, the moderate and liberal estimates yield expected declines in total output of 34.8% and 37.4%, respectively.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

Takeaway

Right now, Mr. Market is very bearish regarding natural gas, but I have a hard time understanding why. Yes, we are experiencing a bit of a glut at the moment (though I believe those fears have been overblown), but production in some key areas should take a heck of a beating if rig counts continue to fall and/or if rig productivity levels don't soar sometime soon. One of the main areas to watch for clues regarding future output is the Eagle Ford, which is likely to experience some of the most significant declines.

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.