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Societe Generale: More Bears in Sight for U.S. Gas Markets

The U.S. natural gas supply situation remained bearish at the end of March, despite "historic lows" in Canadian imports and the dry gas Haynesville Shale continuing to lose popularity among exploration and production (E&P) players, according to a review by Societe Generale's Laurent Key and Stephanie Aymes.

The energy analysts gave their take on U.S. gas trends in a note to clients last week. Based on a review of the gas data at key trading points, there appears to have been a "slight pullback from the end-of-March production highs," and while Canadian gas imports were increasing in seasonally adjusted levels, they remained low when compared with the width of AECO basis. Liquefied natural gas imports remained at contracted levels.

"The adjustment of supply to low U.S. natural gas prices has so far only been observed in the import sector," said the duo. "Canadian imports adjusted for U.S. demand variability have remained 1.2 Bcf/d below normal on average since the start of February. However, March drilling data show that E&P's intentions to produce less natural gas have finally materialized. Surprisingly, the same drilling data on the oil and liquids side also seems to point to a slowdown in activity."

Since the beginning of this year, domestic gas output "from dry plays or associated to liquids plays has remained solidly anchored around 63.5 Bcf/d," wrote Key and Aymes.

The regional breakdown of production receipts indicated that the current stable levels of Lower 48 gas output resulted from declining production from dry gas plays, including the Haynesville and Fayetteville shales; and rising volumes from the Marcellus Shale, both dry and wet gas areas, as well as big liquids-rich areas of the country.

"The growth in oil-oriented drilling has offset the decline in the gas rig count and resulted in sustained levels of total U.S. dry as output," said the analysts.

The "previous, current and future key production regions" were the primary regions reviewed to determine the drilled well count, as well as the number of active, undrilled wells that are permitted. According to the review, the main E&P regions that the analysts focused on were:

A well count "evolution" also has taken place, along with a backlog of undrilled permits in the four regions, which indicate several things.

Notably, Marcellus drilling activity on the dry gas side has dropped for the second month in a row, noted the analysts.

"New pipeline capacity needs to come online to further expand Marcellus drilling. The strong decline rate of shale well production may not lead to a halt of Marcellus production growth until we see more declines in drilling activity. By that time, new pipelines will be completed to decongest the region."

In addition, they wrote, the inventory of active, undrilled Marcellus well permits is growing. "The cost of opportunity of drilling shale gas is growing because experienced drilling crews are becoming scarce and expensive, amid the shale oil boom. Still, the profitability of Marcellus wells makes it likely that the inventory of undrilled wells will be reduced after a market rebound. The market only needs to rebound to $3.00/Mcf for these wells to be drilled."

In Texas, both oil and natural gas well drilling activity also has declined for two months in a row and the inventory of undrilled wells has risen, they said. "What is happening in Texas on the liquids side is kind of similar to what is happening on the Marcellus Shale for dry gas. The lack of continuity in drilling activity is likely the result of rising production costs and a lack of processing capacity for liquids."

Even with all of the producers moving to gain a foothold in the Utica Shale, the "inventory of undrilled active permits is growing" in Ohio as well, said the analysts.

"The play is a liquids-rich one and is close to premium-consuming eastern markets for its produced associated gas," they said. However, in March "some E&Ps had to reclassify wells from 'oil' to 'gas,' a reclassification that goes against companies' talks of migration away from natural gas, but it shows that the Ohio 'boom' will likely be a major bearish fundamental factor for the second half [of the year] of the U.S. natural gas market. More test wells will have to show good results before we put more likelihood to this scenario."

The Haynesville Shale no longer is the golden child of the gas age. "Louisiana drilling activity is slowly dying, despite a rebound in oil and gas wells drilling in March, likely due to lease holding," said the analysts. "The very bearish outlook on Louisiana basis prices does not suggest a rebound anytime soon. The inventory of active permits will continue to grow, but should not be tapped until the market eventually recovers to $5.00/Mcf by the middle of the decade."

It's too early to call for a "sharper drop" in gas production than what the analysts said they'd seen to date.

"The declines in drilling activity on the Marcellus shale are not enough to curb growth. Moreover, the growing activity in Ohio could lead to a new gas gluts in the East for the end of the year. However, the main concern seems to be the way producers will cope with cost escalation. Slowing drilling activity in Texas' liquids-rich plays is seen as a potential bullish factor for the 2013 U.S. natural gas market. Having said that, it needs to be confirmed in the later reports."

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