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Shale is Too Much of A Good Thing for Prices

For gas producers, nothing fails like success, it would seem, as prices continue to founder on the strength of robust production out of unconventional plays. With normal weather, the industry will face record inventories at the end of next October, warned Barclays Capital analysts in a note last Wednesday.

Barclays said weakness in the gas market will persist and prompt-month prices will average $6.36/MMBtu over the course of 2009. "[T]he seemingly unstoppable growth in U.S. supply has set the direction for prices and continues to drive our price outlook," the analysts wrote.

"Indeed, supply-demand balances are looking increasingly loose. As data now clearly show, domestic production is not just matching last year's growth, but exceeding it by a wide margin. During January-August, output was up a healthy 4.4 Bcf/d, compared with a 2.2 Bcf/d average yearly uptick in 2007."

Texas and the Rockies lead the production growth. Unconventional wells are offering record initial flow rates as well as slower second- and third-year declines than average conventional wells, Barclays noted. "Our estimates now point to domestic natural gas production growth of 3.14 Bcf/d in 2008," the analysts wrote.

The increased use of horizontal drilling has altered the relationship between rigs and production. At the beginning of 2000, horizontal drilling accounted for 6.5% of activity, but it has grown to account for 34% today, the analysts wrote. "The effect horizontal drilling can have on well performance is large, particularly if heavily stimulated: recently completed horizontal wells have yielded initial production rates of as much as 23 MMcf/d in the Haynesville and 6.5 MMcf/d in the Marcellus shales, compared with an average of 2.5 MMcf/d in the Barnett for 2007 and a 2.0-4.0 MMcf/d average for the U.S. Lower 48," the analysts wrote.

The industry is responding to the bounty of supply as well as to tighter credit markets. Producers are pulling back on spending plans for 2009, and Barclays said drilling will be slowed through 2010. With sustained prices below $7/MMBtu, they expect the rig count to fall below the level necessary to keep supply flat, the analysts wrote, "The natural gas industry has faced tight credit markets and lived with low prices before, but never so forcefully at the same time. As a result, the outlook for drilling and production in 2009 is uncertain in this new terrain."

And in a contracting economy outlets for robust production are reduced. "While even colder weather would boost heating demand, the weakened state of the economy means that dampened power and industrial consumption is likely to offset the increase in heating load," the analysts wrote.

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