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North American Rig Count Hasn't Bottomed Yet

The bloodbath in the U.S. natural gas market isn't over, and an unprecedented 800-1,000 Bcf will need to be shut in this summer to stop what is sure to be a continuing decline in gas prices, Raymond James & Associates Inc. energy analysts said last week. Some analysts, including Barclays Capital and SunTrust Robinson Humphrey (STRH) think the rig count will fall below 800 before it hits bottom.

According to Baker Hughes Inc.'s data published on Friday, the U.S. gas. rig count for Feb. 27 was 970, which was down 48 from the previous week and down 448 compared with Feb. 29, 2008. For February the total U.S. oil and gas rig count was 1,243, which was down 57 from the previous week and down 520 from February 29, 2008.

Texas lost the most rigs in February from a year ago, according to Baker Hughes data. The state had 538 oil and gas rigs operating on Feb. 27, down 26 from the previous week but off 321 from the same period of 2008.

Colorado's rig count totaled 62 at the end of February, which was down 48 from a year ago. In Wyoming, there were 49 rigs operating at the end of February, down 23 from a year earlier. Oklahoma's rig count fell to 120 at the end of last month, down by 80 from a year ago. New Mexico had 39 rigs operating at the end of last month, down 29 compared with the end of February 2008.

Louisiana, which has seen a boom in gas drilling over the past year, had 144 rigs operating at the end of February, which is down seven from Feb. 20. However, the rig count is unchanged from the same period of 2008.

Raymond James analysts J. Marshall Adkins and Collin Gerry said last week the rig count has further to fall and gas prices "must fall below $2.50/Mcf" this summer to begin to rebalance the market. The comments mirrored some made by Adkins at an energy conference last month (see NGI, March 2). "A string of bearish inventory numbers over the past few weeks suggests the market is now oversupplied by over 7 Bcf/d relative to last year," they wrote in a note to clients. "The combination of surging U.S. gas supply and falling gas demand has driven an unprecedented bearish shift in U.S. gas supply/demand fundamentals."

The Raymond James team, which late last year cut its 2009 average natural gas price forecast to $5/Mcf, now has slashed the forecast to $3.75/Mcf. The analysts forecast that gas prices will average $2.50/Mcf by 3Q2009.

"Over the past year, we have been concerned over the surge in shale-related gas supplies," said Adkins and Gerry. "Now we also have a demand problem. The combination of falling industrial, gas-fired electric and residential demand adds up to year-over-year demand destruction of around 2-3 Bcf/d (or about 4%). If we assume some fuel switching away from coal and to gas, net gas demand in 2009 (defined as Nov. 1 through Oct. 31) should fall by about 2 Bcf/d."

Theoretically, said the duo, the U.S. gas market could end the summer with 4.6 Tcf in summer-ending gas storage. "Since the U.S. has nowhere near that much gas storage, we believe the market will need to shut in 800 to 1,000 Bcf of natural gas this summer. To ensure such shut-ins, summer gas prices will need to fall to $2.50/Mcf, and perhaps even lower." Even with a relatively cold winter and several supply interruptions, the Raymond James duo now expects gas storage to end the withdrawal season "with roughly 1,700 Bcf in storage," which is more than 450 Bcf above last year.

The Barclays team, led by Jim Crandall, Biliana Pehlivanova and Michael Zenker, said last week that the "spellbinding decline in gas rigs has already brought the count well below 1,100, and we think it has much further to go before bottoming. Thus, we posit that after this supply peak, supply will trend lower, catching up with, and eventually outdoing, the recent weakness in demand."

Given the current market environment, Barclays analysts expect the rig count to continue to fall and "overshoot substantially to the downside. As a base-case scenario, we assume that the rig count will stand near 750 by year-end -- a number that would imply a year/year (y/y) production decline. Still, this level could be surpassed..."

STRH analysts also expect to see "meaningful sequential onshore supply deterioration" by summer, and they anticipate the gas rig count "should decline to 775 rigs (850 average 2009 gas rig count) versus our prior expectation of 800 rigs. A 40%-plus decline in gas-directed drilling in conjunction with our expectation for a further 35% increase in well/rig productivity this year suggests U.S. gas production should decline 4 Bcf/d y/y (7%)" in the second half of 2009 and by 7 Bcf/d y/y (12%) in 4Q2009.

In related news, Helmerich & Payne Inc. (H&P), whose drilling business is concentrated in the U.S. onshore, said 23 rig contracts were terminated early in just the past month. Of H&P's 196 rigs, 132 are currently contracted, including 102 under long-term contracts. Customers have terminated early about 9% of the remaining contracted revenue days. A total of 48 U.S. onshore H&P rigs previously in the spot market were idle as of last Friday. H&P expects around 20 more rigs to be idled by the end of March.

"We've had a real firestorm just after a great ramp-up in the business," CEO Hans Helmerich said late last month. "Rigs across the board...continue to become quickly idle. The next stage will entail a sorting process focused on capturing efficiencies. It is too early to call at this stage when that sorting process will occur."

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