Natural Gas Drillers to Leave it in the Ground

http://www.chron.com/disp/story.mpl/headline/biz/6476969.html
By KRISTEN HAYS Copyright 2009 Houston Chronicle
June 13, 2009, 3:08AM
Natural gas producers have been idling rigs for six months, trying to reduce output and boost prices that fell sharply amid bloated inventories and recession-shrunken demand.

That sweet spot remains elusive, despite a 56 percent reduction in the number of rigs drilling for natural gas, to 700 from the September peak of more than 1,600.

“It’s a self-correcting mechanism,” said David Pursell, an analyst with Tudor, Pickering, Holt & Co. Securities in Houston. “Prices go low, the rig count follows, and voila, production falls and the market fixes itself.”

But natural gas prices have largely lingered below $4 per million British thermal units since March after falling 78  percent from a high of more than $13 last summer.

Pursell said this down cycle has been more severe than is typical because the recession-fueled fall in demand followed rapid supply growth last year thanks to a boom in producing gas from thick shale rock. And inventories keep rising as producers have yet to dial down production enough to decrease underground stockpiles. Natural gas in storage reached 2.443 trillion cubic feet for the week ending June 5, the U.S. Energy Information Administration reported Thursday, up from 2.337 trillion a week earlier and 1.875 trillion in early June last year.

The agency, an arm of the Department of Energy, also projected in its monthly short-term outlook that total natural gas consumption is projected to fall by 2.2 percent this year and then increase slightly in 2010.
Headed for a record

By October, the EIA expects gas in storage to reach 3.659 trillion cubic feet — 94  billion cubic feet above the previous record of 3.565  trillion cubic feet in October 2007. The nation’s total storage capacity is about 3.8 trillion cubic feet.

“We’re producing a ton of gas. It’s dropped off some, but we’re producing from wells already drilled,” said James Williams, head of WTRG Economics, an Arkansas-based energy consulting firm.

“Clearly, we have more supply than demand,” Williams said.
Likely won’t follow oil

The Energy Information Administration doesn’t expect natural gas prices to mimic crude’s recent uptick. Instead, the agency projects that natural gas prices will average $4.13 per million Btu this year and creep up to an average of $5.49 in 2010.Natural gas for July delivery closed at $3.86 per million Btu Friday on the New York Mercantile Exchange.

“There certainly has been no indication on the price side that the market thinks we’re digging out of that supply situation,” said Karr Ingham, head of Ingham Economic Reporting in Amarillo. “We’re relatively early into this contractionary period.”

Pursell said the shrunken rig count will result in less production, but not as quickly as the industry would like. Weak demand will linger as long as industrial usage falls, as it will when GM shutters factories for nine weeks this summer. Car manufacturing requires lots of natural gas to produce steel, rubber and plastic, he noted.

The Energy Information Administration expects industrial consumption to fall by 8 percent this year.
New factors

And the storage side of the issue has some new factors that didn’t exist in previous times of oversupply, Pursell said.

First, increased liquefied natural gas imports could add more to storage and keep prices low. LNG is natural gas chilled to liquid form so it can be shipped via tanker or truck when pipelines aren’t available.

More LNG has been expected to arrive in the U.S. this year because of weak demand elsewhere and increased capacity to liquefy natural gas at plants in other parts of the world, including Qatar, Algeria and Russia.

“There’s lots of LNG out there and uncertain global demand,” Pursell said.

Second, technological advances in shale gas production have created more prolific wells. A tried-and-true vertical well is drilled straight down. Now producers also drill horizontal wells, where the bit dives vertically and then turns to drill sideways through a formation, gaining access to more gas than a vertical well. More access means more production per well.
Best wells drilled first

And while the overall natural gas rig count has plummeted, producers are ditching more rigs that drill vertically than ones drilling horizontally. Pursell said the horizontal rig count is down 40 percent, while the vertical rig count is down 64 percent.

“When times are tough, cash matters, and you’re trying to survive, you tend to keep drilling your best wells and you tend to try not to drill your worst wells. In simple terms, you drill your best stuff first,” he said.

Ingham said the pullback in drilling lays the foundation for prices to spike when demand recovers with the economy, storage thins out and production is slow to restart.

“We go through these very defined cycles and over the course of the contraction, we sideline so much production capacity that we generally get caught a little flat-footed. There’s an ugly intersection between strengthening demand and falling supply,” he said.

kristen.hays@chron.com