The U.S. natural gas-directed rig count this year has fallen even more than in 2009, but production continues to grow, throwing into question its future trajectory "perhaps greater than ever before," according to Barclays Capital.
Analysts Biliana Pehlivanova and Shiyang Wang reviewed this year's domestic rig count and output in a recent report and found that a lot of things stand in the way of gas prices moving higher for the near-term.
To begin with, oil and natural gas liquids wells are "yielding a large, and increasing, amount of associated gas production," they noted. The Energy Information Administration "puts gas production from oil wells in the Lower 48 at 8.0 Bcf/d in 2010. Associated gas output grew by 445 MMcf/d in 2009 and by 790 MMcf/d in 2010 year/year, while the oil-directed rig count averaged 275 and 588," the analysts said.
Meanwhile, a "massive backlog of drilled-but-uncompleted wells" exists, created in part from a lack of gas pipeline infrastructure. "The second half of this year saw 1.7 Bcf/d of pipeline capacity additions, and another 1.6 Bcf/d is scheduled to come onstream this month. In 2013, capacity additions are largest in the second half of 2013, with 1 Bcf/d approved, proposed or under construction for 3Q2013, and 2.5 Bcf/d for 4Q2013.
"The exact amount of gas the newly constructed capacity will be debottlenecking is difficult to estimate. Anecdotal evidence suggests that the Marcellus backlog of drilled-but-uncompleted wells is over 1,000. For the Eagle Ford, pipeline additions will not only help work off drilled but uncompleted inventory, but also reduce the amount of flaring, which some estimate to amount to over 1 Bcf/d."
The issues that contributed to higher dry gas output this year will continue into next year, said the duo. The higher gas production will materialize even though Barclays analyst James West expects North American producers are likely to keep spending relatively flat (see related story).
Drilling is in producers' DNA, said Pehlivanova and Wang. "Producers, more than ever, are committed to spending within cash flow, but they were born to drill and the markets continue to reward growth of production. Every dollar of increased revenues yielded by an uptick in gas prices and a co-incident drop of costs will provide room for drilling to grow."
Mirroring recent reports by other analysts, as well as comments by executives at big U.S. gas firms, Barclays' team believes it's going to be difficult to pry drillers out of the oil and liquids patches because of the higher-than-dry-gas returns. Chesapeake Energy Corp. CEO Aubrey McClendon, among others, believes this to be the case (see NGI, Sept. 10).
"While not all wells were created equal and some of the best dry gas wells still offer better returns than marginal oil or liquids ones, on average oil and liquids-directed drilling is likely to attract capital before any meaningful uptick in dry gas drilling takes place," said the Barclays analysts. "Given our price forecast for calendar 2013 to average $3.70/MMBtu, we expect gas-directed drilling to be broadly range-bound and remain below the 500 mark. This would represent a marked slowdown from 2012, as gas-directed drilling averaged 570 rigs so far this year."
The new year's gas production in the Lower 48 should start in a "growth mode, carried on the wings of debottlenecking and strong associated production, but tip into declines in the second half of next year. On average in 2013, we expect Lower 48 dry gas production to moderate slightly and average 64.7 Bcf/d, 0.1 Bcf/d below 2012 levels."
An analysis of natural gas market and gas patch dynamics by analysts at Standard & Poor's Ratings Services (S&P) yields little reason to be excited about dry gas production and ongoing low prices won't be much of a catalyst for opportunistic mergers and acquisitions (M&A), an S&P credit analyst said Wednesday.
North American gas production is expected to hold flat or be down slightly over the next 12 months, S&P said, adding that there are "few catalysts for a pick-up in demand." Gas prices are likely to remain below $4.00/Mcf in 2013 unless the supply-demand dynamic changes significantly.
Barclays analysts also noted that forward prices currently are "notably stronger" than the average cash prices in 2012 and where the 2013 price strip-traded for most of this year. They believe prices would need to recover "above the $4.00-4.50/MMBtu range in order to see a meaningful uptick in gas-directed drilling."
During a conference call last week, S&P credit analyst Ben Tsocanos also noted that gas prices had been a victim of the onshore drilling successes. While the gas market has delivered some volatility this year, the ground gained by natural gas prices isn't enough to draw drillers back to the dry gas plays, and to bring drillers back, prices around $4.50/Mcf are generally needed, he said.
Even with the drop in dry gas drilling, November production in the United States was the highest of the year, thanks largely to improvements in drilling and completion technologies and practices, Tsocanos noted. One might think low gas prices would stimulate some activity on the M&A front, but he doesn't think it's likely. "I don't know that a prolonged period of lowish gas prices is going to spark an M&A wave except to the extent that companies are distressed."
Putting North American gas prices in a global context, S&P credit analyst Andrew Wong said in a report that the gulf has widened between Henry Hub and the rest of the world, particularly Asian markets. "The divergence reflects underlying regional market fundamentals, such as excess gas supply in North America, rapid growth in gas demand in Asia at a pace faster than the global average, and constrained gas supply in Asia from maturing fields...Standard & Poor's believes that natural gas consumption is likely to continue to grow, particularly in Asia. At the same time, domestic gas supplies will remain constrained and the use of imported gas, namely LNG [liquefied natural gas], will increase."
For the short term, LNG producers should benefit, but they face risks just a few years out, Wong said. For one thing, Australia is growing LNG export capability, and the United States is right behind it, both with an eye to serving markets where domestic supplies could develop in coming years from shales and coalbed methane (see related story). "We expect liquefied natural gas producers to maintain favorable pricing power for the next few years, given tight LNG supplies and the forecast for demand outpacing new liquefaction capacity until at least 2014."
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