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Credit Suisse Sees Faster Market Reset on Declining Conventional Gas

Sharp declines in onshore conventional natural gas activity and a more "permanent" shift to liquids plays may bring about a faster reset in the gas market than the futures strip implies, Credit Suisse analysts said Wednesday.

A return to conventional activity is "unlikely given shifting operator behavior," said the Credit Suisse team, led by Arun Jayaram.

"Given weak natural gas prices, conventional production began to soften in October 2011. Since that time the conventional natural gas rig count has tumbled by 194 rigs, or 56%, and a further 100-plus rig decline is anticipated," analysts said. "We believe a snapback in conventional production is not likely given what looks to be more permanent shifts in producer economics favoring lower cost gas shales (i.e., the Marcellus) and oil/liquids-rich unconventional plays."

The Credit Suisse analysts anticipate the "potential for meaningful declines," with 3.2 Bcf/d in 2013 and a 1.6 Bcf/d decline in 2014, partially offset by rising unconventional gas.

"While we share the market's near-term pessimism on gas given bloated inventories as well as limits on coal-to-gas switching this summer, we believe an underappreciated and under-analyzed part of the supply equation is the potential decline of conventional production, which is generally at the higher-end of the cost curve."

The "missing link" has been onshore conventional production, which accounted for 34 Bcf/d or 46% of production, based on 2011 data. "Conventional production is still a larger piece to the supply equation than unconventionals (18.4 Bcf/d, or 27%)," noted the analysts. Associated gas from liquids plays accounted for 10.3 Bcf/d or 15%; offshore output took another 5.1 Bcf/d or 7%; and net imports totaled 5.3 Bcf/d or 7%.

Analysts have used a database of more than 508,000 conventional wells since 1982 to model predictive production and to gauge productive capacity.

"Our model suggests conventional production peaked in 1Q2012 and is poised to move lower given weak gas prices and unfavorable drilling economics for conventional drilling," said the Credit Suisse team. Based on the current production rates, the "unremediated decline curve" for conventional gas is about 11.1%, or 4.1 Bcf/d, a year.

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