Fundamental differences between global crude markets and the domestic natural gas market are unlikely to return to the historic 7:1 ratio price-wise until U.S. shale gas reserves are depleted, gas demand infrastructure is enhanced or more domestic liquefied natural gas (LNG) export capacity is added, energy analysts with Raymond James & Associates Inc. said Monday.

In the latest Stat of the Week, J. Marshall Adkins, James M. Rollyson and John Fitzgerald analyzed whether now is the time for investors to buy natural gas because it is “cheap” relative to crude. When the U.S. gas and global crude markets were considered balanced, basically from 1997 to 2006, the crude-to-gas ratio averaged out at around 7:1.

However, abundant shale supplies and a changing domestic landscape have forever changed the gas market, wrote the Raymond James trio.

“Our view is that the oil-to-gas ratio is largely irrelevant when the gas market is oversupplied since natural gas is not a truly global commodity (i.e., it isn’t easily imported/exported), and consumers have already switched to using as much gas as possible,” said Adkins and his colleagues.

New technology has rapidly advanced domestic gas supplies from unconventional — and conventional — plays, which in turn has created a “technology-driven natural gas supply bubble,” said the analysts. “If the shale reserve estimates are close to what is being advertised, the readily available gas supply will continue to pose a problem for gas pricing. In other words, this could be another gas ‘bubble’ that could drive gas prices lower relative to crude for an extended period of time.”

With time, gas prices should move toward the cost of increasing production to keep up with demand, said the Raymond James analysts. “Every time natural gas prices move high enough to grow production, excess supply should push prices back down.”

Domestic gas output, the analysts noted, was growing at 6 Bcf/d year/year when the “worst” performing wells (from around 1,600 gas rigs) were economic at around $8/Mcf. Since the gas rig count peaked last fall, more than half of the active rigs that were drilling have been laid down.

“As the ‘high-grading’ of gas wells has progressed, the marginal prospect has likely moved from the $8/Mcf range to below $6/Mcf,” said Adkins and his team. “In addition, service costs have dropped 30-40% over the past nine months. If the least economical prospect being drilled today (at $6/Mcf hurdle rate) sees a 40% cost reduction, then that well now makes sense in the mid $3/Mcf range, roughly today’s price.”

With only 700 gas rigs in operation, the question is whether the U.S. gas supply will continue to grow.

“Time will tell,” wrote the trio. “Even if we need over 1,000 gas rigs running to grow supply, our guess is the marginal cost of the worst well will still make sense with gas prices in the $5-6/Mcf range. This analysis excludes any impact from restrictive legislation that could be passed with regard to drilling and completion activities.”

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