EIA Drilling Productivity Report Forecasts Declining Natural Gas Production

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Includes: CHK, COG, DVN, EOG, MCF, MRO, PQ, RRC, UNG
by: HiddenValueInvestor
Summary

The EIA Drilling Productivity Report forecasts natural gas production in the Marcellus, Bakken, Eagle Ford, Permian, Utica, Niobrara, and Haynesville Shale will decline by 221 million cubic feet/d.

Without an increase in the rig count natural gas production can be expected to decline month by month for the rest of the year.

The decline in natural gas production can be expected to be more than the Drilling Productivity Report suggests, because the report doesn't include all natural gas producing regions.

The latest EIA Drilling Productivity Report shows natural gas production in the seven basins followed by the report are forecasted to decline by 221 million cubic feet per day in July. This is a bigger decline than the forecasted 112 million cubic feet per day for June. The EIA has two different methods of forecasting production and that is explained here. The method used in the Drilling Productivity Report takes into consideration the rig count, the productivity per rig, and the legacy decline rate of each field.

Here is a look at the Eagle Ford region to illustrate how the report works. First the EIA shows an estimate of new well gas production per active rig:

Then the EIA estimates the legacy decline in production from all existing wells in the Eagle Ford region:

The EIA then combines the forecasts for new production with the forecasts for the legacy decline rate, which in July is forecasted to be a decline in the Eagle Ford region of 108 million cubic feet per day:

The EIA repeats this analysis for the seven regions it follows. Those regions are the Marcellus, Bakken, Eagle Ford, Niobrara, Haynesville, Permian, and Utica. Because the rig count has continued to decline in the last several weeks it can be safely assumed the EIA Drilling Productivity Report will continue to forecast a decline in production for the next several months.

But the potential monthly decline in natural gas production could currently be considerably larger than the EIA forecasts. That is because the EIA does not follow several large natural gas producing regions in its report. For example, according to the Baker Hughes Rig Report for June 5, the Barnett Shale had only 6 rigs operating versus 28 rigs a year ago. In January of 2015 there were still 25 rigs drilling in the Barnett Shale. According to the Texas Railroad Commission, the Barnett Shale was already in decline with almost 30 active rigs in 2014:

The Drilling Productivity Report was started in late 2013 to focus on rapidly growing oil production. Almost 95% of the oil produced in the lower 48 United States comes from one of the seven regions in the report. But only around 60% of the natural gas produced in the lower 48 comes from one of the seven regions in the report. However, at the time the report was started all of the growth in natural gas production was attributable to one of the seven basins followed in the report.

Other natural gas producing states like California and Utah are not followed by the Drilling Productivity Report. According to the Baker Hughes Rig Count, California currently has 11 rigs drilling in the state versus 48 rigs last year. Utah currently has 7 rigs drilling versus 27 rigs last year. Just like the Barnett Shale, there can be no doubt natural gas production is already declining in those states. The point is the decline profile for the areas that produce the 40% of natural gas not followed by the report is greater than for the areas followed by the report. The declines for the regions not followed by the report would be in addition to the 221 million cubic feet per day decline forecasted by the EIA for July.

Many investors in natural gas are bearish believing production will remain flat, or even grow slowly. But the EIA Drilling Productivity Report is painting a very different picture. The market may be surprised at the speed with which natural gas production declines in the second half of 2015. This may cause a significant rise in natural gas prices in the second half of 2015.

Investors have multiple ways to participate in a rise in natural gas prices. The most direct way is the United States Natural Gas Fund (NYSEARCA:UNG), which is tied to near-term NYMEX Natural Gas Futures. But perhaps a better way is to invest in Exploration and Production companies which get more than half of their production from natural gas.

Marcellus producers like Cabot Oil & Gas (NYSE:COG), Range Resources (NYSE:RRC), and Chesapeake Energy (NYSE:CHK) should see prices rise in their region. But the Marcellus is still pipeline constrained and production growth cannot exceed takeaway capacity.

So producers more tied to the Henry Hub and other regions should see the largest price increases to potentially encourage more dry gas production. Some of the companies with significant exposure to natural gas production outside of the Marcellus include EOG Resources (NYSE:EOG), Devon Energy (NYSE:DVN), Contango (NYSEMKT:MCF), Petroquest (NYSE:PQ), EXCO Resources (EXCO), and Marathon (NYSE:MRO).

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.