Natural gas prices appear likely to have bottomed, but any "significant" improvement in prices is unlikely over the coming year, Moody's Investors Service said in a revised outlook for the global exploration and production (E&P) sector.
"Our view is that natural gas prices have bottomed and are not likely to get worse from this point, absent a U.S. double-dip recession," said Senior Credit Officer Kenneth Austin, who wrote the rating agency's report. "Any significant recovery in natural gas prices is likely to be very slow unless North America experiences a severely cold winter, and any sustained improvement is not likely until 2012.
"Many producers are shifting their attention to oil and NGL [natural gas liquids] plays to enhance their margins and returns. In addition, joint ventures with larger international companies offer another source of capital to help E&Ps develop complicated but potentially lucrative shale plays while improving their returns."
Gas "demand may begin a very slow climb back as the U.S. economy improves, but this recovery is still a bit shaky and may take some time."
Even with the ongoing oversupply of gas, most independent E&Ps are maintaining a robust drilling pace, reducing the pressures associated with low gas prices by shifting their focus to crude and NGLs for margin relief.
"Some of this margin benefit will be offset by still-rising levels of drilling activity, which can keep raising oilfield services costs," said Austin. "But E&P companies can still capture margin benefits for some time, as long as oil prices remain strong -- as we expect them to do into 2011 -- and as long as NGL prices do not come under pressure from oversupply."
Moody's is assuming that oil prices will remain at about $80/bbl "in 2011 and beyond." However, gas price assumptions have been lowered to $4.50/MMBtu for 2011, which is down from a previous forecast of $5.00. After 2011 Moody's gas price assumption is $5.50/MMBtu.
"Very accessible capital markets and attention from large international companies have helped enhance the E&P sector's liquidity," Austin said. "This improved liquidity provides some cushion against any disappointment from early stage shale plays, weak gas prices or rising services costs."
The rise in shale gas output "complicates our near-term E&P outlook," he said. "Once largely untouched by E&Ps because of their technical difficulty and expense, shale plays have become easier to develop and E&Ps have grown increasingly interested in shale gas in recent years. But for many of the hot shale gas plays, current gas prices do not generate sufficient margins and returns, and in some cases do not even meet break-even costs."
For many E&Ps operating in the shale plays, "the decision to continue drilling is based less on economics than on establishing production on their properties in order to retain the leases. As production is established on most of the leases and the pressure to drill them eases, management teams will have more discretion and incentive to slow drilling activity until margins and returns have improved. But this may not happen until later in 2011."
Rising oilfield services costs also are adding to margin pressure, Austin said in the report. "Typically, when commodity prices decline, oilfield services costs move in the same direction. But even with very low natural gas prices today, services costs are rising, particularly for assistance with shale plays.
"For example, pressure pumping services, which are critical to the completion of shale gas wells, are running at nearly 100% capacity in many regions. This has translated into costs for that service rising by more than 30% over the first three quarters of 2010."
The report noted that in discussions with producers "suggest that we will not see any meaningful pull-back in activity, so these costs are likely to increase further -- or at least remain near current levels until early 2011, when new pressure pumping capacity is expected to come online."
Even though the offshore drilling moratorium has been lifted in the Gulf of Mexico (see related story), it's too early to determine whether the end of the ban will be "credit positive" for E&Ps with significant offshore interests, he said.
"Although the U.S. government has lifted its moratorium on deepwater drilling in the Gulf, we foresee a slow return to drilling activity there as the larger independent E&Ps continue to pursue international opportunities," said Austin.
The report, "Crude and NGL Prices Give Independent E&Ps Relief from Natural Gas Doldrums," is available at moodys.com.
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