With natural gas prices as low as they are, one would think there is no good reason to drill for the stuff. Actually, there are several reasons to pursue gas; but they’re pretty much going away, according an analysis by Standard & Poor’s (S&P).

Producers that still have gas-directed drillbits in the ground tend to have a portion of their production hedged — 45% this year, dropping to 30% next year and 12% in 2013, according to S&P analyst Carin Dehne-Kiley, who noted that the hedges are rolling off.

Drilling to hold acreage is another reason, particularly in the Haynesville Shale of North Louisiana and East Texas. But that phenomenon is coming to an end, too. Then there are the deep pockets of joint venture (JV) partners that allow gas-directed drilling to continue. But that kind of money will increasingly be going to oil and liquids in the future.

Getting into a dry gas play early can give a company the super-low costs it needs to make money in today’s environment. “Southwestern [Energy] comes to mind in the Fayetteville Shale, for example,” Dehne-Kiley said.

Other producers believe they can drive their costs down to about $3/Mcf and make money today, she said. Some are still in the dry gas for the learning experience, and then others are keeping the faith that gas prices will be going up, she said.

S&P estimates costs for the companies in its universe to be about $4.45/Mcfe. With a spot price of about $3.10/Mcf, “companies aren’t really covering their costs by drilling for gas on an unhedged basis,” Dehne-Kiley said.

“We think cash flows for the natural gas producers are more likely to drop than rise in 2012. First, we have our price deck of $3.75/MMBtu compared to an average price of about $4.10/MMBtu in 2011. Hedges are rolling off for most of the producers…As well as service cost inflation, which is being driven by the ramp-up in activity in the oil/liquids plays. All of these three things should combine for lower cash flows next year.

“Every company we’ve spoken to…is shifting their capital from natural gas plays to oil plays and liquids-rich plays. We’re concerned that the shift in the growth of production from oil and natural gas liquids may take longer and might cost more than anticipated and might not be the quick fix to generating higher returns.”

How long companies can stick it out with low prices depends a lot on debt leverage, liquidity, the amount of production they have hedged and the amount that’s oil as opposed to gas, she said. “We’re definitely watching those things carefully in the companies that we cover.

“The conclusion that we have that natural gas drilling is not economic is supported by recent trends in drilling activity. The gas rig count is down almost 50% from its peak in mid-2008. Whereas on the oil side the rig count has nearly tripled to nearly 1,100 rigs today, which is not surprising because as of today oil is trading at about 32 times the price of natural gas and on a strip basis about 26 times.”

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