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North American E&Ps See Natural Gas Output Falling

A group of North American exploration and production (E&P) companies, which traditionally have mirrored the overall U.S. natural gas output trajectory directionally, is guiding toward an output decline this year, with the large caps forecasting the biggest drop, according to a review by Barclays Capital.

An "increasing number of producers" now expect domestic gas output to decline this year, and some are intrigued as to why the declines didn't appear in 2012, noted analysts Biliana Pehlivanova and Shiyang Wang.

"They point to a near-halt of industry spending on dry gas targets, and consequent production declines evident in some of the largest producing areas of the country, including the Haynesville and the Rockies. Others question whether growth of associated gas and the Marcellus can overwhelm production declines elsewhere in 2013, as it did in 2012. While some producers still expect production to grow on an average annual basis, our impression is that there is a broad consensus for a significant slowdown in output, with most producer estimates centered on aggregate U.S. production averaging roughly the same in 2013 as in 2012."

Earlier this year the analysts examined the historical production guidance for 20 of the leading North American E&Ps and found that in aggregate, the total output for the group "routinely" met guidance. Last year, the 20 E&Ps reported a 1.9% jump in gas output year/year, which exceeded their aggregate guidance by 0.4%. Those same operators now are "guiding toward a 4% drop in natural gas output in 2013."

The duo recently conducted a larger sample of 52 producers and their guidance, which also found a trend toward production declines this year, at a smaller 0.4% magnitude year/year. This group's past performance has followed overall domestic output, but the "magnitude" of output have varied.

This year may be the first in "at least" three years that E&Ps overall are guiding toward a "significant production decline," said the Barclays duo. "In aggregate, our sample group of producers expects their production to lower 4.1% from 2012 levels, or 0.82 Bcf/d. While some of the expected production losses are due to asset divestitures, the largest drops are projected by large cap producers that are seeing organic production declines stemming from minimal investment in dry gas assets."

Barclays sample of E&Ps was "heavily geared" toward larger natural gas-intensive producers "and that perhaps skews the results compared with the overall trend for the country."

The production decline of 0.4% year/year in 2013 follows a 3.8% increase in 2012, the analysts said. The group also was responsible for 45.4 Bcf/d gross output in 2012 (36.3 Bcf/d net of royalties), about 70% of domestic gas output.

The large caps are forecasting the biggest decline in gas production, with an overall guidance toward a decline of 425 MMcf/d, or 2.2% lower than in 2012, according to the analysis. Production from the large cap E&Ps accounted for more than half (54%) of total output in the Barclays sample for 2012. Mid-cap E&Ps, however, which accounted for 14% of the sample group's production in 2012, expect to see higher output year/year -- up 1.4% after jumping 8.5% in 2012 from 2011.

"The majors in this sample group saw natural gas production declining 2.7% last year and are expected to lose a further 3.3% in 2013," said Pehlivanova and Wang. "The six producers included in this sample, but not covered by Barclays Equity Research, have been growing production strongly for several years, and are guiding toward 27% growth this year, following a 21% increase in 2012." This group, adjusted for acquisitions and divestitures, accounted for 6% of the production sample in 2012.

The December 2012 data report from the U.S. Energy Information Administration (EIA) showed a sequential drop in gas output "sooner than we anticipated," they said (see Shale Daily, March 1). However, the data was skewed by the big impact from well freeze-offs during the month, which rendered the data "unreliable" for underlying trends. EIA's December report indicated month/month declines across all reporting areas except for Alaska. "Notably, output dropped in 'Other States,' which include Colorado and Utah where freeze-offs took place, but is also a reflection of Pennsylvania's growing Marcellus production. Pipeline flow data point to continued growth of Marcellus output in the past three months."

The well freeze-offs have distorted production data for the past two winters, noted the Barclays duo.

"The exact amount of production affected by freeze-offs is difficult to estimate. Unfortunately, with freeze-offs also occurring in January, February and March this year, underlying production trends will be obscured in the next three monthly data releases. While pipeline flow reports provide a more contemporary perspective on current production dynamics, data revisions are not uncommon, and have in the past included a reversal of decline and growth trends. We highlight the uncertainty that freeze-offs pose to reported production data in the near-term."

Tudor, Pickering, Holt & Co. Inc. (TPH) analysts said the U.S. oil and rig count for the week ending March 15 proved to be another frustrating data point, with conflicting numbers from RigData (minus 19 rigs week/week); Baker Hughes (19 rigs added, including 24 gas rigs, and a loss of two oil rigs); and Smith Bits, which reported the loss of one rig week/week and down 21 rigs over the past four weeks.

The "choppiness of third-party data" isn't helping to determine where the domestic rig count is headed, as "underlying activity" is "masked by rig mobilizations, transitory weather impacts, etc.," said TPH analysts. "We believe 1Q2013 activity is playing out as land drillers themselves generally telegraphed on Q42012 earnings calls, with the U.S. land rig count having troughed early/mid-January, bounced a touch in late-January/early-February but flattish ever since."

Based on their review, the 1Q2013 rig count should fall 3-4% in 1Q2013 from the final three months of 2012, "given that there are only two weeks left in the month." The count could go higher because the bias is "directionally higher versus the current level given continued healthy crude oil prices and the natural gas-oriented rig count having finally bottomed..."

The "key issue" remains one of timing and the magnitude of the U.S. rig count recovery.

TPH analysts said they've not seen nor heard evidence that warrants changing their view that the domestic rig count may start to trend higher in April through June. Analysts are modeling a gain of 40 rigs, or a 2% rise quarter/quarter from 1Q2013. However, for the year, they still expect a 60-rig decline from 2012, or down about 3% year/year.

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