scfranklin94

Why Are Natural Gas Producers Expanding Production So Aggressively?

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.

Natural Gas Should Get a Boost from China's New Demand

I think 20 billion cubic meters equates to 540 bcf, which is a lot, but then this demand was more than anticipated; check out how Qatar had to sell 250 bcf of LNG to Sempra for 2010 (which will bring the gas in via Cameron, La), because their target market, China and India doesn't need the gas.

Everyone is waiting and hoping for the 'big ramp up' in US nat gas prices, because it seems so obvious that prices 'have to go up soon'; meanwhile incremental LNG production for 2010 is having trouble finding a market (Note how Russia had to sell 128k mcf/day to Sempra for Baja import, because neither Japan or South Korea would take the gas).

We know we're going to completely fill storage this fall and it would take a very severe winter (like 1976) to deplete the inventory levels. It's more likely that we'll have a winter similar or more mild than last year, so there's a real possibility that we exit the winter with near record storage inventory in April. If nat gas demand hasn't returned to early 2008 levels (which is most likely) then the drop off in nat gas production for 2010 will be offset somewhat by all the LNG coming here. So it's very possible that nat gas prices for next summer that are currently in the $6+ range will fall to $5 or $4.

The only scenario that makes NG prices extremely bullish for 2010 is that the US economy comes screaming back to life in the next six months. If you think the US economy will grow gradually, if at all, in the next six months (like I do), then UNG is a poor investment for the near term.