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Another Grim Forecast Issued for U.S. Gas Rigs

The U.S. natural gas rig count has peaked and is now in the early weeks of a downward correction that is likely to extend through all of 2009 and perhaps most of 2010, an energy analyst said last week.

"The total U.S. rig count is likely to decline by 25-30% before a new supply/demand equilibrium is established," said Stephen Smith Energy Associates in its Monthly Energy Outlook. The Natchez, MS-based energy team said the rig count rose because of two factors: high oil prices and the strong performance from the emerging gas shales.

The Smith analysts' rig forecast is similar to that of Raymond James & Associates Inc., which last month said it anticipates that the rig count will fall by more than 10% year/year in 2009 (see NGI, Oct. 27). The forecast also was substantiated by Chesapeake Corp. CEO Aubrey McClendon during a conference call Friday (see related story).

"The overhyped oil prices have retreated for now, and most likely for the next two to three years due to the global credit crisis and recession," wrote the Smith team. "Excluding hurricane effects and other weather extremes, Henry Hub prices in the $6-7.00/MMBtu range are likely to be the new norm if West Texas Intermediate (WTI) crude settles out near $70/bbl as we expect. Until more is known about the scale of the financial crisis, these are very rough guesses at best."

Both U.S. gas prices and world oil prices began their precipitous slide beginning last July, the analysts noted. "The 'oil price bubble of 2008' was one of two major drivers of U.S. gas price behavior in the year past. The oil bubble began with the legitimate concern of tightening global supply/demand over the next five-10 years."

However, "all financial markets are prone to excess," said the Smith analysts. "Oil prices were driven to levels which could not be sustained, in or of themselves, but particularly in light of the simultaneous global financial crisis, which was driven by a decade of other excesses."

The second driver of U.S. gas prices relates to the "coming of age" for major new North American gas resources, the analysts wrote. "The Barnett Shale is a prime example of an entire class of new shale plays, which are likely to be economic at prices well below the double-digit gas prices of last summer..."

Many of the new North American shale plays are economic at $5.50-7.00/MMBtu gas prices, according to the Smith team. However, many of the conventional gas plays are not, they said. "As rig counts decline in conventional gas plays, we will continue to see strong activity in the Barnett Shale and strong growth in the Haynesville and the Marcellus shale plays."

The Smith analysts said the shale gas plays are "not the modern-day equivalent of the East Texas oilfield discovery of the early 1930s, which drove oil prices down from a pre-discovery level of $1/bbl to a low of 10 cents/bbl." Most of the larger shale gas plays "require $5.50-7.50/MMBtu sustained to yield an adequate return. Gas prices below this range would reduce supply growth very quickly given the strong first-year production, which is typical of shale gas wells. Even prices in this range will reduce gas drilling in mature conventional gas regions and some shale gas plays."

The analysts based their outlook for U.S. gas using an average WTI crude price of $70/bbl for 2009, "but current market momentum suggests that a temporary decline into the $40s or $50s is possible. North American gas supply will exceed demand in 2009, but some movement toward market balance should be visible by late in the year."

The "daily oscillations" of oil prices are still plus or minus 5-10%, but the "best guess is that when the chaos clears, the Saudis will attempt to defend about $70/bbl," wrote the analysts. "We think this will translate to a Henry Hub price generally in the $6.00-7.50/MMBtu [range] in 2009."

Going forward, global financial markets and the global economy are "now in uncharted waters,"said the analysts. "Equities could get uglier before they get better...We remain positive on the long-term prospects for oil and gas prices and the long-term prospects" for exploration and production companies, "but in the short term, we are more pessimistic."

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