If natural gas prices were to fall to $1, that wouldn’t be such a bad thing, according to EnerVest Ltd. CEO John Walker. In fact, low prices may be the industry’s “greatest savior,” he said last week at Bentek Energy’s Benposium in Houston.
The former Wall Street energy analyst, who 20 years ago created EnerVest and later EV Energy Partners LP, knows of what he speaks. Onshore operator EnerVest, which is 70% weighted to gas, today operates in 12 states across 4.1 million acres; its 20,000 wells produce 525 MMcfe/d. But the writing has been on the wall for half a decade, he told the audience.
The natural gas industry has been “backed into a corner,” said Walker. “All the factors that helped producers to profit no longer exist. The equity markets no longer reward dry gas production growth, dissuade dry gas production and producers can’t hedge. We have caught up with the supply and demand realities of natural gas. If we can conspire to constrain supply growth, it will allow demand to catch up in the 2014 to 2017 period…
“The pain of today will result in a much better environment for producers in 2014 to 2017…My objective is to try and really look at why $1 gas prices analytically will lead to much higher prices.”
In terms of “industry facts,” the oil and gas industry truly has been able to use high tech to outdo itself production-wise, he noted. By taking 60-year-old drilling and fracturing techniques and retooling the technology, unconventional formations have been unlocked and oil and gas has flowed faster and more plentifully than ever thought possible, he noted.
However, “despite leading the world” in technology, exploration and production companies have a history of single-digit rates of return (ROR), Walker said. Producers are more focused on the “volume of growth of production and reserves. Spending within cash flow has been a secondary focus.” Earning a “meaningful” ROR “is 20% or better on capital employed. Most companies don’t measure or acknowledge the all-in costs,” including geology, seismic, drilling, etc. So, when all signs pointed to domestic gas supplies growing at a fast clip, “companies kept drilling for gas in 2007, 2008, when it was apparent supply was leaping and demand was lagging.”
Gas demand “was just enough to keep prices in the $3 to $4 range but supply was too great for $4-plus prices,” Walker said. At the same time three years ago, operators that were benefiting from joint ventures that lowered drilling costs “argued that worst-case scenario for business. Prices were just high enough for undisciplined companies to keep drilling.”
And then the winter of 2010-2011 came along, the warmest winter in history, which “reconciled markets with supply and demand and the realities of the gas market.” To observers, the gas price struggle continues on a level not seen since May 1997, Walker noted. “Companies growing dry gas production are getting pummeled in the equity markets. And we may be below $2 in the shoulder months of September and October…
“Frankly, we’ve seen this in the Rocky Mountains in recent years,” the EnerVest chief noted (see NGI, April 20, 2009). “You can’t eat gas. Some dramatic things have to happen for that not to occur in September and October again. What we’ll see will be voluntary shut-ins, forced shut-ins, pipeline curtailments…Hopefully, we’ll get an early and cold winter…”
One of Walker’s concerns for gas prices has been all of the talk about coal-to-gas switching, which he noted had mostly been in the “Southeast but has been spreading to other states that use Appalachian coal. That’s a wildcard…The greatest savior for low natural gas prices is low natural gas prices. It sets the stage for $4-plus prices in 2014 and $5 beyond” (see related story).
Bentek Energy is forecasting that U.S. gas prices will average around $3.50/Mcf for the next five years, and be rangebound at $3-5 for the foreseeable future.
Giving a nod to the Bentek forecast, Walker said, “that’s what horse races are made of.”
Walker said he’s been negative about the gas supply/demand fundamentals since the middle of 2007. “As we dove into the irrational exuberance of 2008, with prices pulled up by oil prices as supply and demand fundamentals continued to deteriorate, we requested an extension from our institutions to hedge five years instead of two years,” and that has paid off, with Enervest realizing $250 million in hedging proceeds as of 1Q2012, with $80 million remaining. “Good analytical work is valuable, but acting creates real value.”
Walker believes “surging” growth demand in five sectors should tighten the demand balance and lead to higher gas prices:
“The process to remove NGLs is slightly increasing but the amount of gas is going up, so production is remaining more steady than you think,” Walker noted. “Drilling for oil instead of natural gas is attractive, but so many areas are dedicated to liquids-focused that by 2014, it’s going to be hard to reactivate dry gas drilling in many basins for a one, two or three-year period because of a lack of drilling and services. And we’re going to earn a higher rate of return in oil areas.
“Even at $4 gas prices, we’re going to choose to drill in oil areas. It’s going to dampen gas drilling, in my opinion,” said Walker. “I think oil drilling will remain more attractive.” Chesapeake Energy Corp. CEO Aubrey McClendon and other gas executives have made similar statements — once drillers move to oil from gas, it will be difficult to go back to gas, which makes a lower ROR than oil.
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