Natural Gas Production Up in the USA

By KRISTEN HAYS
Copyright 2008 Houston Chronicle News Services
Dec. 25, 2008, 6:25PM
Natural gas prices have fallen dramatically this year much like crude prices, but shrinking demand is only one culprit. The other is a gas glut from a boom in U.S. production.
"The industry is suffering from its own success in some respects," said Karr Ingham, head of Ingham Economic Reporting in Amarillo. "We’ve added a lot of natural gas production in Texas and elsewhere just because of high prices."
Those prices, which surpassed $13 per million British thermal units last summer, have fallen below $6 as U.S. production grew while demand decreased amid the recession in the second half of the year.
Producers are slashing capital budgets and idling rigs so they can drill within their means amid the credit crunch as well as reduce output.
But so far, production hasn’t slowed enough to compensate for oversupply. Output is on track to exceed 60 billion cubic feet per day next year — the highest in 35 years, Merrill Lynch analyst Francisco Blanch said in a note to investors.
"We have too much gas, exacerbated by the potential for sustained demand weakness," said David Pursell, an analyst with Tudor, Pickering, Holt & Co. Securities in Houston. "We know we have demand weakness now. The question is, how long will it be soft?"
This year’s boom doubled gas drilling activity from what it was 10 years ago, largely because of technological advances that allowed producers to pull more gas from thick shale rock. The Energy Department this week said the amount of gas in storage in the week ending Dec. 19 dropped 147 billion cubic feet to 3.02 trillion cubic feet, from 3.008 trillion cubic feet a year ago.
Pursell said the current pace of drilling combined with soft demand suggests the market is oversupplied by about 4 billion cubic feet of gas per day despite Gulf of Mexico production interruptions because of hurricanes Gustav and Ike.
Rig count drops
According to Baker Hughes, which has tracked North American rig activity since 1944, the nation’s rig count — which includes both oil and gas rigs, though most drill for gas — has dropped to 1,764 from its September peak of 2,031, as of the Dec. 19 count.
But Pursell said Tudor, Pickering is projecting production in excess of the nation’s operational storage capacity of 3.85 trillion cubic feet next year even if 400 rigs are idled to flatten production while industrial demand drops 2.5 percent and electricity demand remains flat. That outlook suggests more than 400 rigs need to stop drilling or the industry could face having to shut in production in August through October, he said.
Simmons & Company International said in a report this month that if 700 gas rigs stop drilling, production should start declining in May and set the stage for large withdrawals of stored gas for the 2009-2010 winter. Then prices would rise, and give drillers incentive to bring rigs back on.
So Pursell said a bitter cold winter alone won’t be enough to bring supply back in sync with demand.
"In a world where people are in hunker-down mode — and I would argue that most people are in hunker-down mode in this economy — you probably see people turn the thermostat down a little bit," Pursell said.
Richard Mason, publisher of the Land Rig Newsletter in Lubbock, said this year’s drilling boom stemmed from rising prices that encouraged more activity, particularly in hot natural gas shale plays like the Barnett around Forth Worth and others in Arkansas, Oklahoma and Colorado. Potential reserves in emerging shale plays also gained attention, including the Haynesville in East Texas and Louisiana and the Marcellus in the Northeast.

When natural gas hit $8, then $9, and then double digits, companies leased more land — or jumped in the shale game — and hired more rigs.
Also, in February, cold weather prompted robust draws from stored gas, further stimulating production.
"We saw a response in the April and May rig count that began one of the most dynamic rises in the modern era," Mason said. "It was incredible to see."
He said much of the current pullback is seasonal as drilling budgets run their annual course, particularly for independents—companies with exploration and production, but no refining — and smaller, privately owned players.
Comparable to May
Mason noted the current rig count is comparable to levels in May and is still high compared to 2006 and 2007. Some analysts say a 400-rig pullback like that projected by Tudor, Pickering could lower production enough to bring supply in line with demand.
Others have called for more dramatic pullbacks of 800 to 1,000 rigs, to half or less than half of those currently pumping.
"The challenge is, there is so much uncertainty in the general economy right now, it’s hard to apply rationality to how severe the pullback in drilling activity is going to be," Mason said. "Operators are acting like consumers. They’re just shutting down spending and waiting to see how things are going to work out."
Oklahoma City-based Chesapeake Energy’s about-face to its aggressive drilling expansion earlier this year exemplifies the pullback, though it is far from the only company to idle rigs and slash spending. In November, Chesapeake said it would cut its drilling budget through 2010 by 31 percent, or nearly $3 billion, and cut its acquisition budget by $2.2 billion, or 78 percent. This month the company updated those figures, noting that since July, it has cut its drilling and acquisition budgets in 2009 and 2010 by $9.8 billion, or 58 percent.

In addition, Chesapeake is cutting operating rigs from a peak of 158 in August to 110 to 115 in the first quarter of next year. The company said the moves would ensure it will operate within its cash flow and eliminate its dependence on asset sales to fund its operations.

El Paso Corp., Exco Resources, Williams Cos. and Canada’s EnCana are among other companies that have announced capital spending cuts that include idling natural gas rigs.

"This happened so quickly that it has been very difficult for the industry, particularly the service industry, to grasp the magnitude of what happened before our very eyes," Mason said.

More room to contract But analysts say production still needs to contract further.
Blanch, the Merrill analyst, said the raft of announcements from producers to cut spending on drilling and leases doesn’t mean the cutbacks will be big or immediate. He said rigs will likely decline in the Rocky Mountains or the Midwest, but not necessarily in more highly producing areas like the Barnett.
"We expect more drilling announcements from producers," Blanch said.
Mason said this year’s gradual dropoff of rigs likely will burst into a "big unwind" in the first quarter of 2009, with rigs dropping by the dozens. However, a lot of that will be rig contracts at high-cost wells winding down with operators unwilling to re-sign them in the current price and economic climate.
But not all companies will react the same way, he said. The oil majors’ operations are consistent in any price environment. Independents, particularly those like Chesapeake that outspent their cash flow during the boom, are scaling back. But the small, private operators that fluctuate with seasons and price are expected to bolt in droves, Mason said.

"In early 2009, those privately held guys will give up the ghost and precipitate the cascade," he said. Harder to power back up

However, Ingham said too much contraction as prices fall would bring about a dramatic spike if supply trails demand amid an economic recovery.
"When prices drop as far as quickly as they have, we tend to react to that fairly quickly — idle rigs quickly, and essentially power down the industry," he said.
"Then when economics change, or we have a cold winter and we’re not prepared for that on the supply side, we see price spikes again. We can power down the industry a lot faster than we can power it up again."
kristen.hays@chron.com