Between now and the end of the year, the United States should drop 130, or 40%, of the rigs drilling in dry natural gas plays, according to Raymond James and Associates Inc. Meanwhile, Societe Generale said the lag that separates drilling cutbacks to actual production declines “will keep the market waiting for a true supply response.”
In a note last week Raymond James analysts J. Marshall Adkins, Collin Gerry and Lenny Bianco said “even the ‘perma-bulls’ have to dial back assumptions sometimes…Lower natural gas prices are going to have an effect on the rig count.”
Several U.S. gas producers have announced plans to reduce their drilling programs in 2012. Some, including Chesapeake Energy Corp., the No. 2 gas driller in the country, are cutting dry gas spending and dropping gas rigs. Others, like No. 1 producer ExxonMobil Corp., are moving the gas rigs to more liquids-rich fields (see related story).
According to a data report by Baker Hughes Inc. , the U.S. gas-directed rig count fell by 32 rigs from the week before to 745 total rigs; oil rigs were up by 20 to end the week at 1,245 rigs. The Canadian rig count climbed by 28 total rigs to 710.
“The rig count can be divided into three main buckets: oil, wet gas and dry gas,” said Adkins and his team. “Obviously, the rigs most at risk in today’s sub $3.00/Mcf gas world are the dry gas rigs (think areas such as Haynesville, Marcellus, Fayetteville). Two years ago, these emerging dry gas areas were a big deal, representing over 30% of all active rigs in the U.S. and responsible for an even greater percentage of the overall growth.”
By the end of this year, “we think the dry gas rig count will fall from 315 rigs today to less than 190 rigs (a 40% decrease) followed by another 20%-plus decrease in 2013. For wet gas rigs, which currently total 490 rigs, we think activity will stay resilient but will bleed modestly lower in 2012. Specifically, we think the wet gas count will fall from 490 rigs active today down to about 470 active rigs by the end of 2012.”
Roughly 180 new oil rigs are predicted to begin drilling by the end of 2012, which would be a gain of 15%. Based on the loss of gas rigs and gain of oil rigs, the net result would be a gain of about 30 rigs between now and year’s end, which would represent a “very flat 2% growth.”
Based on Raymond James calculations, the 2012 average rig count is expected to hit 2,031, 8% above 2011’s average rig count of 1,879. The updated 2012 rig count forecast is 7% lower than Raymond James’ previous forecast of 2,172 average rigs for the year. Using current strip pricing for commodity prices layered, “we could see a reacceleration in operator cash flows as a result of accelerating production declines” in 2013, indicating 6% rig count growth over 2012.
Returns on U.S. oil wells are “outstanding at today’s oil prices,” but lower gas prices would “clearly have a negative impact on the industry’s cash flow available to drill more oil wells…The biggest takeaway to us is that the two-year trend of significant cash flow growth appears to be leveling off largely because of the fall in natural gas prices.”
Last year natural gas still comprised roughly one-third of U.S. exploration and production (E&P) cash flow, noted Adkins and his team. “Thus, a 25%-plus decline in gas prices (moving from $4.00/Mcf in 2011 to below $3.00/Mcf) in 2012 will have a negative effect on overall industry cash flow.”
The bigger driver obviously is going to be oil prices, they noted. If current strip oil prices are around $100/bbl West Texas Intermediate, “E&P cash flows should drift modestly higher in 2012, thereby allowing the oil-directed activity increase to more than offset a dry gas decrease.” If oil prices this year fall closer to around $90, domestic E&P cash flows “could be down 10-15% in 2012 before picking back up in 2013.”
The trio acknowledged that only reviewing E&P cash flow is simplistic because E&Ps routinely outspend their cash flow. In addition the industry is “wily” in finding capital to fund oil and gas well returns by using royalty trusts and joint venture (JV) partnerships, for example.
“We expect the overall U.S. gas rig count to fall about 150 rigs (or 19%) from current levels,” said the analysts. “From a bigger picture perspective, our gut tells us the gas count must and will fall more in 2012 but, when we look at it on a basin-by-basin level, JV programs, leasehold drilling and specific high-return areas seem likely to limit the magnitude of the gas rig decline in 2012.”
Beyond 2013, “the crystal ball gets murkier. We think that the trend in operator cash flows is a significant determinant of longer-term drilling activity. Given the huge production growth we’re seeing, even if oil prices stay flat and gas prices stay weak, we expect modest growth in cash flows can continue to drive 5-8% rig count growth.”
Societe Generale’s Laurent Key warned in a note that unless more U.S. gas rigs are taken down in the next month or so, “the market in spring is bound to fluctuate between $1.80 and $2.20/MMBtu to force shut-ins” (see related story). “On top of that, the two-month lag that will separate cutbacks from actual production declines will keep the market waiting for a true supply response. The risk to our floor price forecast of $1.80/MMBtu is thus on the bearish side.”
The decline in the gas rig count over the past three months hasn’t spurred any decline in total U.S dry gas output because oil rigs continue to be added and “we witnessed continued well productivity increases,” Key noted. The “likelihood of production declines in the short term remains low at current natural gas curve prices.”
Recent data on new, active undrilled permits and drilled permits point “more to increased gas output than to drilling cutbacks,” Key said. In Texas, for instance, “more than 2,100 undrilled active drilling permits for dry gas wells have been stacked up for the last 12 months…the number of dry gas well permits since February is lagging behind the active permit count by 200 wells.
“The fact that the inventory of new active undrilled dry gas permits is higher than the number of drilled wells could be seen as an indicator of slowing interest for gas drilling in the Lone Star State, but the reality is actually the opposite: it seems that, while not picking up steam, the number of new drilled dry gas well has remained fairly stable at 210 new wells each month since November 2011.”
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