One Hundred Years of Natural Gas? Not At These Prices

Posted in The Petroleum Truth Report on September 8, 2016

One hundred years of natural gas? Not at these prices.

U.S. gas production is declining and shale gas output is down almost 2.5 Bcf per day. Production is decreasing while consumption and exports are both increasing. EIA data indicates a supply deficit by the end of 2016.

Henry Hub spot prices have doubled since early March. Will companies show discipline to preserve higher prices?

Not a chance. They will drill more wells if investors continue to provide capital. This, however, will probably be too little too late to stop the decline in gas production that is already underway.

Real Gas Prices Have Never Been Lower

In February 2016, I wrote that an increase in natural gas prices was inevitable and in April, I wrote that prices would double. Now, spot prices have doubled from $1.49 on March 4 to $2.97 per mmBtu on August 29 (Figure 1).

Still, real natural gas prices (in July 2016 dollars) have never been lower. Average prices so far this year are just $2.20 per mmBtu. That’s the lowest annual price in since 2000 and it is lower than any monthly price except April 2012.

Real Natural Gas Prices Have Never Been Lower_STEO_NATURAL GAS MASTER

Figure 1. Real natural gas prices have never been lower than in 2016. Henry Hub natural gas prices are in CPI-Adjusted July 2016 dollars. Source: EIA, U.S. Bureau of Labor Statistics and Labyrinth Consulting Services.

Prices have increased because total dry gas production has declined 1.6 Bcf per day (Bcfd) from its peak of 75.29 Bcfd in February. Shale gas production has declined 2.4 Bcfd from its peak of 44.17 Bcfd (Figure 2).

Total natural gas and shale gas production have declined_STEO_NATURAL GAS MASTER

Figure 2. Total natural gas and shale gas production have declined since February 2016. Source: EIA August 2016 STEO, EIA Natural Gas Weekly Update and Labyrinth Consulting Services, Inc.

Conventional gas has been in terminal decline since 2008 and shale gas production growth has maintained and increased U.S. supply. Now, that shale gas production is also in decline (Figure 3), it is unlikely that production will increase much without higher prices.

Shale Gas_MASTER

Figure 3. Shale gas production has declined 2.4 billion cubic feet per day since February 2016. Source: EIA Natural Gas Weekly Update and Labyrinth Consulting Services, inc.

All shale gas plays have declined including the Marcellus which is down -0.64 Bcfd (Table 1). Even the relatively new Utica play has declined -0.12 Bcfd. The legacy plays have declined the most: Haynesville, -3.77 Bcfd; Barnett, -1.91 Bcfd; and Fayetteville, -0.92 Bcfd. No new horizontal wells have been drilled in either the Barnett or Fayetteville since early 2016.

Shale Gas_PLAY DECLINE TABLE

Table 1. Shale gas play declines from maximum production. Source: EIA Natural Gas Weekly Update and Labyrinth Consulting Services, Inc.

Shale gas plays were supposed to provide 100 years of supply but there never was 100 years of gas.

It was a story told to promote the erroneous idea that the U.S. had so much gas that it could afford to squander and export this valuable natural resource. It is true that some of the production decline from shale gas plays is because the plays are not commercial at current prices.

But whose fault is that? Conscious over-production reduced the price below the marginal cost so promoting increased consumption and export became the only ways to increase price.

The U.S. government has been a great ally of the shale gas companies. The SEC changed reserve reporting rules in 2010 making it easier for companies to book reserves and borrow against them. EPA air pollution regulations since 2011 have led to the closing of dozens of coal-fired power plants in favor of increased dependency on natural gas for electric power thus increasing demand. The U.S. Department of Energy has granted almost blanket approval to applications for LNG (liquefied natural gas) and pipeline export in recent years also increasing demand. And in 2011, the U.S. Department of State under Hillary Clinton created the Bureau of Energy Resources, a 63-person group to promote shale gas export and the spread of fracking technology around the world.

Meanwhile, E&P companies destroyed billions of dollars in shareholder value. They did this by knowingly producing gas into a non-commercial market and then, diluting shareholders by issuing more stock to fund more drilling and production.

Comparative Inventories Tell The Story

Natural gas storage is at near-record levels for this time of year. This surplus distracts from the likelihood of a supply deficit by the end of 2016 suggested by EIA STEO data (Figure 4).

STEO_NATURAL GAS BALANCE SEPT 2016

Figure 4. Natural gas supply should go into deficit by January 2017. Source: EIA September 2016 STEO and Labyrinth Consulting Services, Inc.

Periods of production growth led to lower prices and lower gas-directed rig counts. Flat production led to supply deficits that resulted in higher prices and more drilling. During the last deficit in 2013 and 2014, spot prices averaged $4.06 per mmBtu. The ensuing low prices have resulted in less drilling and flat production.

It is, therefore, reasonable that the increase in gas prices since March 2016 will result in more supply but how high might gas prices go before that happens?

Comparative inventories are the best indicators of price trends. Comparative inventory is the difference between current storage volumes and the 5-year average of storage levels for the same week. Figure 5 shows that there is an excellent negative correlation between comparative inventory and spot gas prices.

Comparative Inventories Are The Best Indicators of Price Trends

Figure 5. Comparative inventories are the best indicators of price trends. Source: EIA and Labyrinth Consulting Services, Inc.

That is because the U.S. gas market is a disequilibrium system in which production and consumption are never in balance. During the months of winter heating, consumption greatly exceeds production. Withdrawals from storage provide the portion of supply that remains unmet by production. Once winter is over, production exceeds consumption. Additions to storage restore that portion of supply needed for the next winter heating season.

Gas traders compare the current year’s evolving inventory level with that of previous years to determine if storage will be adequate to meet winter demand. If the rate of inventory buildup is judged to be ahead of expected winter demand, the price of futures contracts decreases. If that rate is deemed questionable to meet winter demand, the price of those contracts increases. Producer response to price signals is typically delayed until a price trend emerges to justify increased or decreased drilling. The potential for over-shoot and under-shoot is great.

Comparative inventory is, therefore, the best measure of the disequilibrium in the seasonal supply chain. It effectively removes the seasonal effects of energy use and plant maintenance that sometimes confuse the interpretation of absolute inventory levels.

Figure 6 shows that the fall in comparative inventories since May 2016 has been significant compared to both the 5-year average and to 2015 inventory levels.

Comparative Inventories Have Fallen Sharply Since May

Figure 6. Comparative Inventories (CI) have fallen sharply since May 2016. Source: EIA and Labyrinth Consulting Services, Inc.

Despite falling comparative inventory, prices commonly decrease in the late summer based on probable inventory levels needed to meet winter consumption. Although that may be happening now, I believe that higher prices will prevail by the end of 2016.

A simplified cross-plot of comparative inventory and spot prices suggests a range of likely year-end prices between $3.00 to $3.75 with a most-likely case of of approximately $3.35 per mmBtu (Figure 7).

2014-Present Comparative Inventories Suggest a $3.30 - $3.50 Price

Figure 7. Simplified 2014-present comparative inventory vs. spot price cross-plot suggests a $3.00 – $3.75 price range for year-end 2016. Source: EIA and Labyrinth Consulting Services, Inc.

Shale Gas Company Performance Is Weak

What will happen if gas prices increase to approximately $3.35 per mmBtu in the next several months? Operators with access to capital will probably add rigs and increase production. That is the correct response to market price signals in a market that believes company claims that they are making money at current gas prices.

Approximately 150 new wells are being completed each month in the currently active shale gas plays namely, the Marcellus, Utica, Haynesville and Woodford plays (Figure 8).

PA Marcellus-Utica-Haynesville-Woodford PROD-NUM WELLS 7 SEPT 2016

Figure 8. Number of new producing wells per month and gas production from the Pennsylvania Marcellus Shale, Utica Shale, Haynesville Shale and Woodford Shale plays. Source: Drilling Info and Labyrinth Consulting Services, Inc.

Unfortunately, most companies cannot make a profit at current gas prices despite their public statements. Today’s wellhead prices in the Marcellus Shale play have increased to $1.34 per mmBtu and Utica prices averaged $1.44 in the second quarter of 2016. A few well-hedged companies may break even on costs in the best parts of the Marcellus and Utica core areas but most do not.

Even so, breaking even does not meet the standards of serious investors who need at least a 10-15% discounted return once the cost of capital, and project and commodity risk are considered. Most Haynesville and Woodford wells need at least $6.00 per mcfe to break even.

All leading companies in the Marcellus and Utica plays reported net losses for the second quarter of 2016  summarized in Table 2. Antero, Cabot, Gulfport and Rice apparently had better access to equity capital than the rest based on share offerings in the first half of 2016.

marcellus-producers-net-losses-equity-offerings-table

Table 2. Marcellus-Utica key operator second quarter (Q2) 2016 gains and losses and first half (1H) 2016 equity offerings. Source: Company documents and Labyrinth Consulting Services, Inc.

The debt loads and debt-to-cash flow ratios of these companies is alarming. The average for the companies shown in Figure 9 was 9.4 in the first half of 2016. The current bank-risk threshold for debt-to-cash flow is about 4:1.

q2-2016-sampled-eps-debt-to-cash-flow

Figure 9. All leading Marcellus-Utica operators exceeded debt-yo-cash fow bank-risk threshold of 4:1 in the first half of 2016. Source: Google Finance and Labyrinth Consulting Services, Inc.

Nor do the stock prices of most of these companies provide a good proxy for the substantial increase in Henry Hub spot prices of 75% since March 2016. Although the increase in stock prices for all companies exceeded 10%, only Rice and Consol out-performed commodity price and UNG (Exchange-traded natural gas fund) gains (Figure 10).

marcellus-producers-stock-prices-august-2016

Figure 10. Most leading Marcellus-Utica Companies’ stock prices under-performed spot and ETF gains since March 2016. Source: Google Finance and Labyrinth Consulting Services, Inc.

100 Years of Gas? Not At These Prices

Despite their financial weakness, I expect that a small number of producers will continue to find favor among yield-hungry investors. I doubt, however, that increased drilling by those companies and a few like them in the Woodford play will be able to reverse declining shale gas production and, therefore, U.S. gas production.

In the early 2000s, the U.S. was running out of natural gas. Canadian imports supplied 17% of U.S. consumption by late 2005. The shale gas revolution was a singular phenomenon that occurred initially because gas prices from 2000 through mid-2008 averaged more than $7 per mmBtu in real 2016 dollars.

In late 2002 and early 2003, a few wells were horizontally drilled and hydraulically fracturing in the Barnett Shale. Initial production rates were more than three times higher than Mitchell Energy’s vertical wells that had been drilled as an experiment in the previous decade.  Devon Energy and other operators applied for permits to drill more than 180 additional horizontal wells by mid-2003 and the shale gas rush was on.

A few years later in 2005, Southwestern Energy began the exploration and development of the Fayetteville Shale in nearby Arkansas. The apparent early success of the Barnett and Fayetteville plays heightened the frenzy of mineral leasing as prices soared to over $10,000 per acre. By 2007, Chesapeake Energy Corporation emerged as the dominant player in shale gas with a position second only to Devon in the Barnett and the leading position in the emerging Haynesville Shale play in Louisiana and East Texas.

Initial production rates of more than 10 million cubic feet (mmcf) per day from Chesapeake’s first Haynesville wells lead to an unprecedented land grab reminiscent of gold rushes in the 19th and early 20th centuries. Plains Exploration and Production Company paid more than $30,000 per acre to form a joint venture with Chesapeake. Foreign oil and gas companies eagerly entered similar partnerships with the company in the Haynesville, Barnett and Marcellus plays while major oil companies like ExxonMobil and BP also entered the shale gas arena.

Range Resources tested the first horizontally drilled wells in the Marcellus Shale in Pennsylvania in 2005. Development in the Marcellus was somewhat slower than the other plays but it has now proven to be the most prolific among them.

The explosion of production resulted from the mass participation in the plays by thousands of companies. Gas prices collapsed beginning in July 2008 with the onset of The Financial Collapse. After that, easy-money policies kept the party going for a few more years.

Over-production pushed gas prices well below the marginal cost of the wells. Liquids-rich and later, tight oil plays then stole the spotlight from shale gas. Gas could not compete with oil for profit or investor capital and it was really gas associated with the newer tight oil plays that kept gas production strong.

Despite the flagging fortunes of the shale gas plays, the natural gas lobby concocted a story that said the United States had 100 years of natural gas supply. This was based largely on technically recoverable resource estimates by the Potential Gas Committee that had nothing to do with reserves or economics. By 2012, the idea of 100 years of gas found its way into President Obama’s State of the Union address.

The collapse of oil prices in 2014 was the turning point for U.S. gas supply. It does not seem likely that oil prices will break out of their current range boundaries of about $40 to $50 any time soon and so associated gas will continue to decline. Even adding 150 new wells per month in the 4 active shale gas plays has not arrested or even slowed the inexorable decline of shale gas production.

North American natural gas supply is largely a closed system. Even a weak economy cannot suppress the price of gas as supply becomes less secure. That is because gas use has been implicitly mandated by EPA regulations and its low price over the last  7 years has greatly limited the growth of renewable alternatives.

Those regulations and the foolish decision to allow increased exports were founded on the preposterous belief that U.S. gas supply was almost unlimited, that we had at least 100 years of gas. It was a classic case of thinking that the future would be just like the present and immediate past, and that gas production would continue to increase forever. A similar irrational belief underlaid the real estate bubble that ultimately led to the 2008 Financial Collapse.

People in the eastern U.S. are not really all that into gas drilling, fracking and pipelines. Environmental groups have learned that they can slow the permitting and construction of pipelines. This has kept wellhead prices low and development in check.

There never was 100 years of natural gas. The Barnett and Fayetteville plays that began a little more than a decade ago are dead at today’s prices. No horizontal wells have been drilled in either play since January of this year.

The Haynesville Shale was a great disappointment but has considerable volumes that can be developed commercially at $6 gas prices or higher.  There are 35 rigs working in the Woodford play where liquids contribute to the value stream but unhedged producers need about $6 prices there also.

The Marcellus is the jewel in the shale gas crown and is currently providing almost 25% of U.S. total supply. Even the Marcellus, however, needs $4 gas prices for unhedged operators to break even. Although production has peaked, it will continue to provide meaningful supply into the next decade but not forever.

The Utica Shale is still in a relatively early stage of development but has the potential for commercial production at $4 to $5 gas prices in its core. That area is poorly defined at present but is smaller than the Marcellus core areas. Utica counties outside the core need $6 gas prices to break even.

The U.S. is not running out of gas yet. It will, however, take much higher prices to develop the remaining decade or so of supply. We have squandered the best production into a losing market and committed additional volumes to long-term foreign contracts that never made sense in the first place.

Declining production, greater consumption and increased exports have combined to make natural gas one of the best commodity values around. If somewhat higher prices cannot rescue supply then, even higher prices will be needed.


18 comments on this entry


  1. The stupidity of crushing an industry (coal) and thinking shifting to another more “lower carbon footprint” source because it is plentiful and cheap would not result in neither for long should speak for itself. Such short sighted efforts are counter-productive and increase the cost of producing energy (which includes the cost of infrastructure as well.)

    And the decline rates suggest that at some point someone has to “ramp up” production again. We’ve had nary a rig running in the Fayetteville this year, but reportedly SEECO (SW energy) is calling some people back to work and a rig may be up as I speak. Hanging over that are stick DUCs…each months applications are mostly companies asking for a delay in plugging wells that they drilled in 2014 and 2015 and are loathe to complete. I think the commission should force the issue because I suspect most of these are marginal at best and used primarily to inflate reserves (PUD) or keep mineral owners from getting their mineral right back. Some owners were leased in 2005 and have been “HBP” but have yet to see any money or only a pittance…perhaps being “held” solely by less than 10% of the borehole, which might be holding four sections (units) with a single marginal well.


  2. Terrel,

    Whenever government gets involved picking energy winners and losers, the people lose.

    I am not arguing for or against coal, natural gas, oil, wind, solar or any other source of energy. Energy is complex and energy problems commonly have no obvious solutions. Politicians and bureaucrats lack the knowledge and patience to decide about energy.

    I do not believe that DUCs are the big, apocalyptic deal that many analysts think they are. You are correct that the rates and reserves of many DUCs hardly move the needle. In any case, they will never come on line simultaneously especially with the scarcity of frack crews.

    There was a lot of concern about shale gas DUCs after the 2008-2009 price and financial collapse. In the end, they were a non-issue. I’m not saying it will be the same this time but we need some perspective and context.

    If 150 new high-rate shale gas wells per month don’t affect the decline rate much, it is hard to imagine how some number of DUCs per month in addition will do much more. I may be wrong but that is how I think about it.

    All the best,

    Art


  3. Great analysis as usual….keep’em coming.


  4. Joe,

    Thanks for the comment.

    Art


  5. Real nat gas revolution: Dr. Moniz

    Dr. Moniz, United States Secretary of Energy

    Art, the video at the below link ties well to your article. Thank you for the exceptional work.

    http://video.cnbc.com/gallery/?video=3000496548&play=1


  6. Scott,

    Thanks for the link. Moniz is among the clearer-headed Energy Secretaries we have had but is a nuclear physicist with no experience in the fossil energy industry. Nuclear represents 4% of primary U.S. energy consumption; oil and gas is 56% and coal is another 30%. If I were selecting the country’s energy head, I would want someone with knowledge and experience in at least one of our largest sources of energy but what do I know?

    As he said, all the so-called experts got natural gas totally wrong less than a decade ago. That does not inspire confidence in the latest version of the truth that Moniz seems to believe.

    All the best,

    Art


  7. Art,

    Once again, thank you for your excellent commentary.

    I have often contemplated the location of the DUCs in relation to the various shale play sweet spots vis-a-vis the fringe edges of the play fairways. Industry always high grades acreage and prospects to drill a the best opportunities first. Even allowing for a lack of infrastructure, how productive or economic can these DUCs be since experience tells me they will probably be the worst performers.

    Even the build out of gathering systems to connect these DUCS might not be economic if even more wells aren’t drilled proximate to the DUCs.

    To quote another friend, it looks like a soup sandwich to me.


  8. John,

    As I wrote to Terrel, I would be surprised if the DUCs turn out to be a major factor that changes the supply balance. I do not dispute that there are lots of them but I think there were plenty when times were better and prices were high. I imagine there are more now than then but I am not worrying much about them.

    All the best,

    Art


  9. Hello Mr. Berman
    I’m from Argentina, I always read his articles and are incredibly based information and data.
    While I am an artist, I am a very curious person, and energy is a captivating theme.

    It is inconceivable as many media have created a “screen world” where technology can do everything. And it seems that it is very easy to have electric cars, solar energy and wind that can easily replace fossil fuels.

    But behind this “World Screen” there are physical realities, resources are finite, we all processes generate pollution, the laws of thermodynamics are inviolable, but there are two concepts I want to stress. The first concept is about the complex structures and dissipative system (Russian-Belgian physical chemist Ilya Prigogine).

    Believe me hardly know about these issues, but I know that show the wonder of life but also our limits and that economists should learn more about this.

    On the other hand the exponential growth is an issue that seems to be nonexistent in the economy, at least in the media economists, and I know that this growth is explosive if not taken into account.
    Thank you for enriching my poor knowledge
    Sorry for my basic English.
    Best Regards


  10. Hola Carlos,

    Ilya Prigogene era luminario verdadero. Su concepto de las estructuras disipativas describa nuestra sociedad actual. El crecimiento tiene sus limites y los alcanzamos.

    La realidad de la prensa, los politicos y los analistas “expertos” no refleja la de los datos.

    Gracias por sus comentarios desde el punto de vista artista.

    Art


  11. Art
    Your Spanish is good. Thanks for answering.

    Tell me if I’m wrong in the following.
     
    If we assume our global economic system as a complex structure dissipative, surely this oversimplifying but I can not put it another way, to stay active this “complex structure” needs an energy cost which has a limit, if energy costs more, for example, high oil prices are not fit to keep alive the “complex structure” and would lead to a collapse of the entire structure, which will not be very pleasant, I imagine rather brutal for all of us.

    It is something like this?

    (I give as an example because it is oil that moves the transport almost entirely, without economic transport not see the existence of a possible global economic system)

    And today this whole system is maintained due to the debt that continues to climb, a huge bubble that is now much, much, higher than the housing bubble that burst in 2009. (I take this Gail Tverberg)

    Sometimes I’m really confused, I think we’re close to something catastrophic, and rather near to far.

    If I say these things to my relatives I believe that many believe are ravings of my imagination and a few other crazy.

    I try to think, with all that this entails. Am I not overreacting?
    This I see why others do not see?

    I do not believe in conspiracies of evil oil companies that do not allow good and clean energy development, not think of a divine punishment pounces upon mankind.

    What I believe is that we humans have become very arrogant with respect to nature, and many believe that we can dominate and we are not aware of what the word “Limits”

    Someday I’d like to tell you about the philosophical thoughts and art, it’s interesting.

    best regards from Buenos Aires


  12. Carlos,

    You have a very clear picture of the state of the world. The artificial growth of the last 40 years was funded by debt. Now, there is no possible way to pay the debt and the only way the debt can be managed is by keeping interest rates super-low or even below zero. We have traded fake growth for fake affordability.

    An economic collapse is both inevitable and the only way out of this dilemma. It will, of course, be traumatic but the central banks of the world have become expert at extending the day of reckoning. They may be able to postpone it for 10 years or it may come much sooner depending on the extent to which things either get out-of-control or not.

    My first degree was in history before I became a geologist. Collapse is a fairly common occurrence in world history and extinctions are reasonably common in the geological record. So, for as gloomy as our discussion may appear, its subject is a recurring theme in human and earth history. We think that these catastrophes are the end of the world but they are not. The Earth does just fine without a few hundred species

    We are already in the first stages of collapse and the populist revolts from the Middle East to Brexit to Donald Trump are expressions of the reality that things are getting worse. When this has all played out, most people will have much less although things will generally be better than they were 100 years ago. I expect that there will be a lot fewer people also. Population is the underlying cause of most of the world’s current problems.

    If you haven’t read my post Oil Prices Lower Forever? Hard Times In A Failing Global Economy, it gives a reasonable history of how all of this happened from an energy and debt perspective.

    Saludos cordiales,

    Art


  13. Hi Art,

    Thanks for your great analysis as always. I have a question on conventional gas production. There was a nice tick up mid this year. Is that GOM production coming online or something else? How sustainable will that uptick be in your view (i.e. when can we expect the trend of declining production to overwhelm the new projects that presumably just came online).

    Thanks

    Alex


  14. Alex,

    It is an artifact of the data. The only way to determine conventional production is to subtract shale gas production (that EIA provides) from total dry gas production. If shale gas production declines as it has but EIA reports total dry gas production flat, conventional gas must increase. I don’t believe it but don’t know what to do about it.

    A few years ago, I downloaded all of the horizontal gas production from Drilling Info and subtracted it from total production. The process took days because each download was huge and the result was not hugely more satisfying.

    Thanks for your question,

    Art


  15. Hi Art,

    Thanks for your great analysis as always.

    I would like to ask about conventional supply as you see it over the next 12 months. Conventional is in decline overall, but it ticked up over the summer. Is that new project related (GOM?) or something else? How sustainable is this bump and when do you expect macro declines to reassert themselves again?

    Thanks

    Alex


  16. Alex,

    I answered your question yesterday. You must have missed it.

    Art


  17. […] is why we must take seriously the calculations of Texan energy specialist Arthur Berman; who has used SEC data to calculate the current US reserves of shale oil and gas.  According to […]


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