Click here or read below...
Natural gas prices after rallying on surprisingly strong labor market news have retreated in recent days as the prospect of full storage suggests the industry will be forced to curtail production unless demand picks up. At the end of July, natural gas in storage was almost 3.1 trillion cubic feet (Tcf), or about 25% above the 5-year average for volumes at this time of year. Estimates of full storage capacity range from 3.7 Tcf to 4.1 Tcf. At the date of this report from the Energy Information Administration (EIA), there were 10 weeks left to the storage injection season meaning that without a strong pick up in gas demand or a collapse in production, domestic gas producers are facing the eventuality of all having to curtail their production. When that happens, we should expect a meaningful drop in natural gas prices.
Chesapeake, you're not planning to do what?
This industry-wide predicament was highlighted by Aubrey McClendon, CEO of Chesapeake Energy (CHK-NYSE) on his company's earnings conference call. Mr. McClendon, the poster child for aggressive gas production management during periods of weak gas prices, announced his company was not planning to curtail production since it expected storage to max out and thus they, along with all
other producers, would be forced to shut in flowing gas volumes. For the first
time, Chesapeake was not about to exhibit discipline in supporting gas prices for the benefit of producers who did not curtail their production. Does this suggest that leaders of the natural gas industry are prepared to ignore production economics to demonstrate a point to their fellow producers?
The May 914 gas production was 62.84 billion cubic feet per day (Bcf/d), down from the revised April monthly data showing production of 63.35 Bcf/d. Many analysts, gas producing company executives and forecasters jumped on this decline as confirmation the long-anticipated gas production decline was underway. On closer examination, however, we can't be totally sure because there have been a number of other recent months when the initial monthly gas production estimate was revised lower. The initial May production estimate now is virtually identical to the revised December 2008 estimate.
The initial gas production estimate for April was revised down, but only from 63.37 Bcf/d to 63.35 Bcf/d. The revised April production estimate was down from the March revised figure by approximately 200 million cubic feet per day (MMcf/d), but it was essentially flat with the revised February production estimate of 63.58 Bcf/d. Can we take solace in the May production estimate decline? Is the recent monthly revision pattern being reduced a sign that when the May estimate is revised it too will show even lower production?
Since January 2005, there have been 52 revisions to the initial monthly production estimate. One revision showed no change. Of the remaining revisions, 33 were higher than the initial estimate and 18 were lower. Increased estimates were made nearly two-thirds of the time. Admittedly, there were stretches when the revisions were always up, just as there were stretches when they were all lower. At the moment, we appear to be in a period marked by mostly lower revisions, but we can't find
any rhyme or reason why historical patterns of revisions shifted from mostly up to down or vice a versa.
Given the data history showing such a strong bias in favor of increased monthly production estimate revisions, we remain skeptical in calling for a further reduction for May's initial estimate.
Do you love shale gas? Read the end of this paragraph and you'll love it even more!
One aspect of the drilling industry decline that has been of particular significance for the gas business has been the difference in the type of drilling rigs that were being laid down. This interest has gained significance by the emergence of the gas-shale plays. Data has shown that wells drilled horizontally in these gas-shales have tended to be more prolific than wells drilled vertically. The guiding principal behind the significant initial production volumes coming from gasshale wells has been the successful marriage of horizontal drilling technology with improved formation fracturing capability. Drillers have been able to rapidly drill long lateral well sections in the heart of many of the gas-rich formations. Well stimulation technology has enabled the development of multiple stage fracturing applications within the same well bore. Together these technologies have produced gas wells with initial production volumes multiples of conventionally drilled and completed gas well volumes.
Getting into the thick of things,
Given the growing importance to the nation's production of natural gas from wells drilled horizontally, we examined overall gas production figures versus measures of drilling rig activity. When gas production is paired with gas-oriented drilling rigs, one sees a dramatic fall-off in rigs since last fall with barely any movement in the Form 194 monthly gas production volumes so far this year, based on the initial monthly production estimate.
Check these three graphs out:
Gets very interesting, doesn't it? Some predicted months ago that natural gas may drop to $2 per MMbtu.