The last three months of 2006 resulted in a 6.3% upward move in U.S. natural gas production from publicly traded companies, mirroring the upward trend from 3Q2006, but essentially all of the output rise came from the rebound following the hurricane-related production deferrals in late 2005, Raymond James & Associates energy analysts reported.
"If we try to remove the hurricane impact, it appears that U.S. gas production would have actually been down by 3.2%," said a team of Raymond James analysts led by J. Marshall Adkins. "This substantial, albeit imprecise, decline appears to mark the resumption of the organic declines that have characterized U.S. gas production from 2002-2005."
More important, the analysts noted, "all these declines have come amid virtually 100% utilization of onshore gas rigs, along with significant gains in rig counts and drilling efficiencies over the past four years" -- something that Patterson-UTI Chairman Mark Siegel noted earlier this month (see Daily GPI, March 21).
According to the Minerals Management Service (MMS), about 364 Bcf of offshore production was taken off-line in 4Q2005 (an average of 4.0 Bcf/d). Raymond James noted that it is not possible to know the exact percentage of these deferrals attributable to companies in its survey, "but given that the majority of offshore production is operated by relatively large, publicly traded companies, we estimate this figure at no less than 60%."
Using 65% as the base, the analysts "added back" 2.6 Bcf/d to the survey's reported 4Q2005 production. With the adjustment, the analysts estimated the underlying (ex-hurricane) year-over-year decline rate was actually 3.2% in 4Q2006. This compares to a decline of 0.3% in 3Q2006, which followed growth of 1.4% in 2Q2006 and 0.5% in 1Q2006.
"Given the resumption of the production declines previously observed in our surveys spanning from 2002 through mid-2005, it would appear that the modest gains posted in late 2005 and early 2006 may have come to an end," said the analysts. "In fact, we would point out that the 3.2% decline is the steepest decline our surveys have shown since 3Q2004."
The Raymond James analysts said producers' exploration and production capital budgets suggest that drilling activity may not slow down as much as some investors think, but the "huge" drilling growth rates of 2005 and 2006 are unlikely to be repeated this year. They also said gains in efficiencies should be slow, and field declines rates will continue to trend higher as overall prospect quality continues to diminish.
"All-in, we believe these factors will cause the U.S. gas supply picture to remain quite constrained for years to come," the analysts said.
Raymond James expects gas prices to remain at "depressed levels" relative to crude oil in the short term, but "our long-term bullish North American energy thesis remains fully intact. Today's gas story is much like the 1970s oil story, when U.S. oil production continued to stagnate despite greater and greater numbers of active drilling rigs. Accordingly, we expect domestic gas production levels to remain relatively flat (or even trend downward) over the foreseeable future."
In the second half of 2007, with the storage overhang "likely" dissipated, the analysts said they expect U.S. gas prices to rebound back to "at least 7:1 parity with crude oil, and potentially 6:1 or higher, depending on the weather. While the short-term gas prices and oil/gas price ratios will continue to be volatile, if oil prices remain near the $60/bbl level, this would imply fair value for gas of $9+/Mcf."
The survey also underscores "an even more astonishing reality," said the analysts: "the independents are driving drilling activity increases, with only modest production response from the group to show for it. Specifically, the public independents have been responsible for putting an additional 68 gas rigs to work (a 15% increase) over the past year (December 2006 versus December 2005), while their gas production in 4Q2006 rose 9.7% year-over-year -- and that's with the year-ago quarter's production being artificially low due to the hurricanes.
"Ex-hurricanes, we would estimate the growth rate at only 0% to 3%," the analysts said of the survey group. "Even though these results may seem mediocre compared to the massive level of investment, it is important to note that even at current gas prices, these companies are making strong returns on almost every prospect they drill. As a group, however, they are barely able to 'move the needle' on U.S. gas supply."
The Raymond James survey covers about 55% of total U.S. gas output, and the results are not necessarily reflective of the other 45%, which mostly consists of smaller, privately held companies. Raymond James' figures contrast with the Energy Information Administration (EIA), whose data indicates 4Q2006 output was up 1.6% sequentially. Raymond James said the discrepancy can be attributed to several factors, including that EIA data "often includes gas consumed in field operations and plants, which could cause a meaningful variance from the volumes reported in our survey."
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