Depressed natural prices have caught the attention of the financial press with professional and amateur bloggers taking note. Some writers have observed the natural gas price charts and concluded the price must rise or spike sometime soon. It's said the cure for low prices is low prices. This mainstream commentary often misses the key ideas in the natural gas marketplace.
Bears point to the 100 years of natural gas supply, while flippantly commenting the natural gas glut is here to stay. This skips the most endearing feature of natural gas production for investors: high natural decline rates. New shale natural gas wells have flush initial production, followed by hyperbolic production declines on the order of 70-80% in the first year. Older production also declines to at a robust clip. If all U.S. drilling halted immediately, production would collapse by 32% in the next year. In the past, oversupply could always be corrected quickly. Not so going forward.
With the current natural gas price near $2 MMBTU, often overlooked is that prices since the shale gas revolution and financial crisis have been low. The oversupply has only further depressed natural gas pricing with this past winter having been warm. The warm winter is given the blame, but natural gas was in already in oversupply.
Unfortunately for producers, drilling is not stopping and continues for reasons other than economic return. Numerous shale natural gas joint ventures have gas drilling continuing so the producers can receive their drilling carries, such as Consol's (CNX) and Noble's (NBL) deal last year. As a consequence of the land leasing frenzy of last decade, most E&Ps are drilling to 'hold by production' their land. EOG Resources (EOG) loves to boast about being early to the oil production shift, yet it keeps quiet about its continuing natural gas drilling to HBP land. Additionally, publicly traded producers are loath to slow production growth for fear Wall Street will punish their share price.
Going forward the major problem for long term natural gas pricing will be natural gas production associated with oil drilling. Oil wells also produce natural gas. Associated natural gas from booming oil drilling is increasing robustly. Citi suggests the increase in natural gas production over the past year is due to the oil rig count increase. Pioneer (PXD) CEO Scott Sheffield thinks dry natural gas drilling has already collapsed, which mean there just are not many more natural gas directed rigs available to be dropped.
The natural gas oversupply and low prices are so great that entire industries are being dislocated. To burn off the oversupply, electrical utilities like Southern Company (SO) and American Electric (AEP) are incented by the low prices to switch from burning coal to natural gas, boosting their bottom line. Coincidentally, thermal coal producers such as Arch Coal (ACI) and Peabody Energy (BTU) are suffering as a result. Patriot Coal (PCX) has been especially hard hit, recently idling another coal mine. Even mighty Chesapeake Energy's (CHK) recent problems can be described as a function of the low price of natural gas.
To be clear, a doubling of natural gas prices to $4 would not constitute a price spike, except for futures speculators. For producers, a $4 price is still low and dry natural gas drilling would still be uneconomic with all-in costs included. With the uneconomic drilling set to continue in the form of associated gas, look for natural gas prices to toggle back and forth between depressed and low in the years ahead.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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