Just how much natural gas is available in the U.S. market is a subject of intense analysis and controversial debate.  In December, the prestigious scientific journal, Nature published an article, Natural gas: The fracking fallacy. The gist of the article was that The United States is banking on decades of abundant natural gas to power its economic resurgence. That may be wishful thinking. 

From our perspective, this may be a solid  trading opportunity as natural gas is trading at the lowest price in 15 years and several factors may be converging to reverse this secular decline in price when most pundits are least expecting it. Natural gas prices and the companies involved in the production, storage and transportation of it are not just a product of producers and end users  but  speculators also play a large role in price discovery.   Sentiment change can have a big impact as the recent remarks from the Saudi’s oil minister about not making the expected cuts on OPEC production to stabilize the price of oil.

The long-term growth profile in natural gas production is the subject of the Nature article and they make some startling assertions.

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As you can see the University of Texas and Nature magazine study contrasts sharply with industry and EIA consensus.

The results are “bad news”, says Tad Patzek, head of the University of Texas at Austin’s department of petroleum and geosystems engineering, and a member of the team that is conducting the in-depth analyses. With companies trying to extract shale gas as fast as possible and export significant quantities, he argues, “we’re setting ourselves up for a major fiasco”.

But what really peaks my interest is the short-term direction of natural gas and how the dramatic drop in the price of oil will impact the production of natural gas in the U.S.

In researching this contrarian view, it’s important to explore all the relevant data to see how well it holds up.

The price of natural gas moved steadily higher in the U.S. during the years 2002-2008.  In the summer of 2003, former Federal Reserve Chairman Alan Greenspan appeared before a congressional committee to share his thoughts about the U.S. natural-gas market.  Recent price spikes, Mr. Greenspan said, were the result of increased demand chasing limited U.S. supplies. Natural gas heats about half of U.S. homes and generates 20% of the nation’s electricity.

To stabilize the market, Mr. Greenspan said, the U.S. needed to become a major importer of liquefied natural gas, or LNG. Moreover, he added, “Access to world natural-gas supplies will require a major expansion of LNG terminal import capacity.” New facilities would have to be built in the U.S. to handle the expected surge in imports.

The Wall Street Journal in February of 2009 wrote, “Mr. Greenspan and the industry experts who shared this view — and there were many — couldn’t have been more wrong. But within a year of his testimony, there were plans for 40 new or expanded LNG terminals under consideration in North America, according to a tally by the Federal Energy Regulatory Commission. By March 2005, the list had grown to 55.

Greenspan and the LNG investors couldn’t have been more wrong. Instead of rising prices, the exact opposite happened.  Gas prices plunged. The price of natural gas plunged in the United States  from a peak of  $13.42 per million Btu in October of 2005 to a low of $3.43 in October of 2010. From there it has hovered at this price until recently breaking down below $3 correlated with the much publicized collapse in crude oil.


Henry Hub Pricing
Henry Hub Pricing

The collapse in the price of natural gas  to around $4 was the result of  a supply demand imbalance caused by increased supply from new extraction technology such as 3D seismograph, horizontal drilling, and fracking that made previously inaccessible deposits of gas available. Today only six of these LNG terminals have been built, and most of those sit idle.

Forecasts can swing abruptly when it comes to figuring out where natural gas is needed and how much. Expectations of future supply can change quickly, too.  A few years ago, most people looked at U.S. natural-gas production and saw it entering a slow, terminal decline. But in fact, the opposite has happened. Rising prices and easy financing encouraged a horde of companies to develop “unconventional” gas fields such as the Barnett and Haynesville shales, located, respectively, in north Texas and along the Texas-Louisiana border. These shale wells, once thought to be too costly and difficult to exploit, succeeded beyond everyone’s expectations.

This surge of new gas has lowered domestic prices and reduced the need for imports. Meanwhile, companies that bought into the earlier vision of soaring imports and strings of new terminals went from being Wall Street darlings to also rans.   Companies that invested heavily in future natural gas output paid a steep price epitomized by the $41 billion dollar purchase of XTO Energy.

Rex W. Tillerson, the chief executive of Exxon Mobil,  spent $41 billion to buy XTO Energy, a giant natural gas company, in 2010, when gas prices were almost double what they are today.  Tillers minced no words about the industry’s plight during an appearance in New York during the summer of 2012. He was quoted in the NY Times Oct 20, 2012,

“We are all losing our shirts today,” Mr. Tillerson said. “We’re making no money. It’s all in the red.”


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If  a smart man, like the CEO of Exxon can’t make any money producing natural gas, why is there more production today at prices near $3 per million Btu than there was when natural gas was at $3.28, the time the CEO of Exxon made these comments.  Does losing your shirt producing something, mean you make more of it? That’s certainly what the chart suggests.

Even more perplexing is the EIA’s forecast of past and expected demand. Dry gas production is expected to continue to rise well into 2016 while demand is relatively static.  Even the forecast for increased LNG exports starts to double and triple in 2015 to 2016 but is still an immaterial amount of supply taken off the market.

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EIA projects that U.S. total natural gas consumption will increase to an average of 73.8 Bcf/d in 2015 and 74.8 Bcf/d in 2016, compared with an estimated 73.6 Bcf/d in 2014.  That’s about 4Bcf/d more supply than demand adding weight to the bearish sentiment.

So that really adds even more curiosity to the Tillerson dilemma.  Why are we producing more and more natural gas at an uneconomic price in the face of obvious over-supply?

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But if you look closely at the rig count in the chart above, we are not adding more drilling rigs.  In fact the number of rigs drilling for gas has declined precipitously since Mr. Tillerson’s quote in October of 2012.  Therefore there an only be two explanations to account for the increase in production of natural gas.

  1. The wells drilled are getting more efficient and existing wells are producing more, or
  2. Dry gas produced is a byproduct of drilling for crude oil.

The EIA DPR data in March 2014 show that each drilling rig in the Eagle Ford Shale will contribute over 400 barrels of oil per day (bbl/d) more in April 2014 than it would have in the same formation in January 2007. At the same time, the DPR also shows that a Marcellus Shale well completed by a rig in April 2014 can be expected to yield over 6 million cubic feet of natural gas per day (Mcf/d) more than a well completed by that rig in that formation in 2007. A backlog of drilled but uncompleted wells will continue to support production growth as new pipeline infrastructure comes online in the Northeast.

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n 2011 and 2012, more than 50% of new wells produced both oil and natural gas according to the EIA.  .A Business Week article April 2012, stated, “Gas pumped as a byproduct of oil and other liquids will represent 75 percent of the increase in natural gas production this year and as much as 90 percent next year, according to Barclays (BCS) research in 2012. Such byproducted output, as it is called, will probably keep rising as long as oil remains above $75 a barrel, the bank says.”  Then it only stands to reason that all else being equal, a drop in the exploration of crude oil will result in a reduction of supply of domestic natural gas. 

There is little doubt that the number of rigs drilling for oil in this country is begging a sharp decline. The total U.S. rotary rig count decreased by 74 units to 1,676 rigs for the week ending January 16, according to data from Baker Hughes Inc. The natural gas rig count fell by 19 units to 310, while oil rigs decreased by 55 units to 1,366. This is the largest week-on-week decline in the oil rig count recorded in this particular Baker Hughes data set, which extends back to 1987.

According the the Financial Times, The world’s biggest energy companies are preparing to cut billions of dollars from capital spending as they set out plans this week to respond to the drastic slide in oil prices. Investment in the exploration and development of oil and gasfields could fall by 20 per cent, or $28bn, by 2017 from last year, according to analysts at Morgan Stanley, as the industry protects dividend payouts as cash flows are squeezed…The effects of the collapse will be more acute for smaller, independent producers. Across the industry, and including nationally owned groups, Wood Mackenzie estimates companies will need to cut overall costs by $170bn, or 37 per cent, to maintain net debt at last year’s levels, assuming a price of $60 a barrel for internationally traded Brent crude.

This decline in active drilling rigs is happening with a backdrop of the beginning of exports of US natural gas for the first time in the lower 48.  On an otherwise barren strip of the Louisiana coast, a crew of more than 4,000 workers has spent the past two years building what will be the largest supercooling facility for natural gas in the U.S. When it’s finished late 2015, Cheniere Energy’s Sabine Pass liquefaction terminal will begin chilling natural gas to -260F so it can be loaded onto tankers and sold to customers in Europe and Asia. It will be the first facility to export natural gas from the contiguous U.S.

The first phase of the Sabine Pass project will cost more than $12 billion and seemed unlikely after Cheniere bet the wrong way on the U.S. natural gas market. In 2008 it spent $2 billion to build an import terminal that quickly became useless when abundant natural gas in the U.S. ended demand for imports, cutting the price from $13 per million BTUs to less than $3 in the U.S.

Cheniere says it will be the largest buyer of U.S. natural gas by 2020. Its liquefaction plant in Louisiana and another planned for Texas will allow it to ship about 6 percent of all the gas produced in the U.S. It’s locked buyers into 20-year contracts based on the cost of natural gas within the U.S., which averaged $4.47 per million BTUs for the first nine months of 2014.

The real question then is will efficiency in drilling for natural gas outstrip the loss of the byproduct of gas from the reduction in drilling for crude.  If the contrarian view is correct, at some point in the next six months,  the EIA stats will show both a decrease in natural gas production and storage.  Expect a very big rally then in the underlying commodity as well as the beaten down nat gas producers such as Rex Energy, Southwestern, Chesapeake, Range Resources, and many others.

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