TVG

Natural Gas ETF: Nowhere to Go but Up, Yet It Keeps Going Down

The big question is.... how forward looking IS the market on these issues...that all that you said is already priced in to the incredible decline?????


On Jul 09 10:36 AM skrangeo wrote:

> here's the deal with natural gas (and the reason I've made money
> buying/selling puts on UNG)
>
> With the boom in prices came a boom in drilling. And, at the higher
> prices, the exploration plays like the Haynesville were very economic.
> And along with the drilling came a soaring production increase. And
> along with everything else came a HUGE drive up in prices for acreage
> (especially exploration acreage, up from $2k an acre a couple of
> years ago to around $30k an acre in the hottest areas).
>
> As production soared, and demand dropped (economic downturn, mild
> weather), oversupply has become a HUGE issue. The storage of natural
> gas has just literally smashed old records. There is ~30% more natural
> gas in storage right now than the past 5 year average. Simple economics,
> supply >>>> demand = huge drop in prices.
>
> As prices have dropped, many areas have become uneconomic. It’s pretty
> widely known that the breakeven economics for the Barnett is around
> $5 - $5.50/mcf. Right now, it is around $3.45/mcf. Thus, drilling
> programs have been slashed all over. The rig count is down 55% since
> October.
>
> Well, you would think that the major drop in rigs would lower production
> and help the situation. Unfortunately, here is the kicker. These
> new shale plays, being drilled up through the use of horizontal wells,
> are bringing on MONSTER wells. A vertical well in an “average” formation
> might come on at 1 mmcfd. These new Haynesville wells are coming
> on at 15-25 mmcfd. So, one new Haynesville well basically take the
> place of 15 “average” wells. So while the rig count has dropped drastically,
> the wells coming online right now are so much stronger that production
> hasn’t hardly been affected.
>
> If that weren’t bad enough, here is kicker #2: most of that high
> $$$$ acreage was exploration acreage (meaning, no production to hold
> the leases yet). And, most of those leases were 2 year leases. Now,
> if you take a section (640 acres), you only need 1 well producing
> on that lease to hold it. And, at 40 acre spacing, there is the potential
> per section for 640 / 40 = 16 drill locations. Now, at $30k/acre
> and 640 acres in a section, you already have $19 million in sunk
> costs per section. You have literally hundreds of millions (billions?)
> of dollars tied up in non-producing acreage with a shortly expiring
> time clock. If they don’t get at least one well drilled and online
> to hold the lease, they risk losing all of that sunk money.
>
> So, even if wells are uneconomic now, they are still drilling to
> get one well per section online to hold the lease. This allows them
> to have that backlog of the remaining 15 locations so that when prices
> recover, they have access to those reserves. They are willing to
> drill an uneconomic well today so that they don’t lose the lease
> that they have already spent tons of money on. And, since they have
> to keep drilling for this reason, it just continues to add to the
> current oversupply (regardless of prices).
>
> Having said all of that, we are going to start seeing physical limitations
> on natural gas storage (you can’t cram 6 lbs of shit into a 5 lb
> bag). There is already more natural gas in storage in the central
> region than at the peak of last year (2nd week of November). And,
> we still have 3.5 months of storage to go! Yikes! Due to this, the
> price is going to get driven down sharply because there will be nowhere
> for the natural gas to go. Once natural gas prices get driven down
> into the low $2s, companies WILL start shutting in production and
> dropping even MORE rigs. This well help the oversupply get worked
> off, and only THEN will prices start to turn upwards.

Why I'm Committed to the UltraShort Financials ETF

In order to be successful, you not only have to be RIGHT, but RIGHT at the RIGHT time. I don't think you have that last one "right"!