Natural Gas Prices Rise to Highest Levels in Over Two Years

December 2013 saw the highest spot price for natural gas in over two years, as a cold weather returns to many parts of the East and Midwest. Weekly data from the Energy Information Administration (EIA) showed that Henry Hub prices hit $4.44 per million Btu (MMBtu) in mid-December, the highest level since July 2011.

The “Shale Gas Revolution” over the last few years has led to rock-bottom prices as a record amount of volume has come online. Prices dropped precipitously from their double-digit highs in 2008. Yet, the low prices of 2012 were likely unsustainable – the December 2013 price of $4.44/MMBtu was more than twice as high as the price in the spring of 2012, which dropped below $2/MMBtu. At those levels, many wells became unprofitable to drill, and producers shifted their focus from dry natural gas to wet gas and increasingly into unconventional oil production. In other words, with prices so low, the frenzied pace of drilling had to slow down. That trend is reflected in EIA data, which shows a steady drop in rig counts since the summer of 2011 – the last time prices were as high as they are now.

To be sure, horizontal drilling is much more productive than vertical drilling on a per-well basis, so declining rig counts do not mean production would drop accordingly. And it hasn’t – natural gas production has remained flat for almost two years. As horizontal drilling has replaced vertical drilling as the norm, fewer rigs were needed to produce the same amount of gas. This explains some of the drop in rig counts over the last two years. On top of that, the EIA concluded in an October report that over the last year or so, drillers have made further efficiency gains, squeezing out even more gas and oil per new well than before.

Higher productivity reduces the need to throw more rigs at the problem, but even so, prices were unsustainably low throughout much of the last few years. Many producers wouldn’t have been able to breakeven at the 2012 prices of $2/MMBtu. While breakeven prices depend on a whole host of variables – geology, presence of natural gas liquids, proprietary drilling costs – one estimate from Rice University’s Baker Institute Center for Energy Studies puts the median breakeven price at $4.85/MMBtu. Low prices made some wells uneconomical, but with the latest spot prices heading back up, a lot more drillers will now find it profitable to return to drilling.

On the other hand, prices may be going up, but the industry also faces significant obstacles. Thousands of wells have already been drilled and the most productive wells were drilled first. The next round of wells may not be as productive. Perhaps more importantly, the proliferation of drilling has bumped up against local resistance in many places. Voters in the cities of Fort Collins and Lafayette in Colorado recently passed bans on fracking. And on December 20, the Pennsylvania Supreme Court shot down a state law that prevented local zoning authorities from restricting hydraulic fracturing. The decision injected a lot of uncertainty about the trajectory of the industry in Pennsylvania, as many cities and towns may try to pass local fracking bans.

How all of this shakes out is unclear, but the latest run up in prices will likely push natural gas companies towards more drilling.

By. Nicholas Cunningham of Oilprice.com