Natural Gas: It's All About the Drills

| About: iPath DJ-UBS (GAZ)

By David Parkinson

Don't focus too much on what the seasonal trends in natural gas demand are telling you. The technology trends are trumping them - and they're changing the entire nature of the North American gas market, contends Patricia Mohr.

"New 'game-changing technology' - improvements in horizontal drilling and multi-fracturing of unconventional gas - has dramatically changed the dynamics of the North American natural gas market in the past year and a half," the veteran Bank of Nova Scotia economist and commodities specialist said in a report Monday.

She noted that horizontal rigs made up 46% of active drilling rigs in North America last month - almost double their share of drilling activity in January 2008.

The rapid adoption of horizontal-drilling advancements has triggered an explosion of new unconventional shale-based gas output that features both lower production costs and improved well productivity. As a result, production volumes have remained strong in the past year, despite the fact that slumping prices have discouraged drilling activity.

"While U.S. gas-targeted drilling activity plunged by 42% from January through July 2009, [energy research firm] IHS Herold estimates only a 1.5% [quarter-over-quarter] decline in U.S.. natural gas production in [the third quarter]," Ms. Mohr wrote.

"The apparent disconnect between drilling activity and production reflects much greater individual well productivity with horizontal, multi-fractured drilling, and considerably greater initial flow rates from shale developments than conventional vertical wells," she said. "While active drilling rigs have plunged and higher-cost gas wells have been shut in this year, producers continue to drill higher-quality shale prospects with high initial flow rates."

The quantum shift in North American gas production techniques goes a long way to explaining the ballooning gas supply levels that sent gas prices to seven-year lows this summer - and have continued even as seasonal expectations for rising demand have helped turn prices upward in recent weeks.

Illustrative of just how acute the glut of natural gas - not just in North America, but around the world - has become, Bloomberg News reported Monday that liquefied natural gas from overseas producers is afloat in tankers around the world's oceans, with no ports' buyers prepared to accept them.

Traditionally, the United States has been the default home for gas looking for a home, thanks to Americans' seemingly insatiable energy demand. But right now, there's no room at the inn: North American storage facilities are crammed to the hilt awaiting the anticipated demand surge when the winter home-heating season kicks in.

While seasonal demand should help alleviate the pressure (and give prices support) in the near term, Ms. Mohr argues that the North American gas market has undergone a longer-term fundamental shift - back to one of plentiful supplies, much like it enjoyed a couple of decades ago, and away from the tight-supply conditions traders got used to over much of the past decade.

"In my view, the North American natural gas industry needs to take steps to bolster demand," she argued.

She suggested the industry needs to push natural gas as a lower-emission fuel alternative to other petroleum products - to power vehicles and more electrical generation - as well as develop more LNG facilities to ship North American gas to fast-growing emerging markets.

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