Despite weak prices, there is “significant upside optionality” to natural gas, according to a Credit Suisse analyst.
The “trend is your friend” because the gas supply “inventory overhang is not as bad as was feared,” said analyst Arun Jayaram. “Production from unconventional plays is starting to soften…and conventional production could drop significantly in 2013,” he said during a conference call.
Jayaram, who is in charge of Credit Suisse’s U.S. exploration and production (E&P) coverage, joined other analysts with the firm on Monday to discuss North American oil and gas markets in the near term.
Lower prices have led many producers to reduce their drilling, but “the 800-pound gorilla of the gas market,” Chesapeake Energy Corp., has had a huge impact, he said. Chesapeake began reining in its capital spending during the second quarter and dropping drilling rigs, and as the No. 2 U.S. gas producer, the cuts have dominoed across the industry. For instance, the producer shut in an estimated 60% of its output in the Haynesville Shale, and it is the biggest player there.
Now there are “cracks in the lowest-cost plays,” and a “sharp retrenchment in gas prices is beginning to impact liquids-rich drilling,” Jayaram said. “The bear case is when gas prices rebound, there is a mountain of gas waiting to come back, but returns do not support this view.”
Winter weather, “as always, is the key,” he said.
Natural gas continues to have “powerful demand trends” from the chemical industry and because of coal switching for power demand. In addition, gas “appears to be on the ‘right side’ of the upcoming policy debate.”
However, a “near-term pause is likely given price-sensitive power demand and flat production,” said the analyst. Is it time for a contrarian call? It’s getting close, he said. “Gas futures have plummeted, and the market has now discounted weak gas prices. The question shifts to the timing of the recovery.”
The analyst acknowledged that the consensus isn’t constructive on gas prices, which are “below the marginal coast of production in nearly every basin” in the U.S. onshore. A “minority of gas bulls are citing the imminent collapse in Haynesville and Barnett” shale production. An inflection point is coming next year.
“Efficiencies will elongate the timing of the gas reset,” said the Credit Suisse analyst. “Advances in stimulation and horizontal drilling have massively compressed cycle time.”
According to Credit Suisse, it took nine years for the Barnett Shale to reach 5 Bcf/d, while the Haynesville completed the same feat in less than three years. The Marcellus and Fayetteville shales are “set to top 3 Bcf/d in the next few months.” The Marcellus play has yet to hit an “efficiency zone” because of two things: infrastructure bottlenecks and E&Ps are motivated to “earn” acreage.
“A flood of Marcellus production is likely in coming quarters given hundreds of wells behind the pipe, which will keep a lid on gas prices, despite activity curtailments.”
Jan Stuart, who is head of global commodity energy research, said there is “terrific uncertainty” in the oil forecast. The only place where oil production is growing worldwide, he said, is in North America.
“There’s terrific growth, all oil, biofuels, but also light liquids, core crude oil and condensate,” he said. “I’m quite optimistic about North America…” However, U.S. oil demand is “on track to decline again,” with stronger growth in China.
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