Last week the Energy Information Administration released their ‘EIA-914’ report on natural gas production in the U.S. for the month of July. Production decreased 0.7 bcf/day from the previous month—a relatively bullish report. It was the fifth month in a row that production declined, reflecting the fact that the U.S. natural gas drilling rig count has fallen by over half from the highs last fall.
Canadian rig counts are also down by over half from year ago levels. After over twenty-four months of volumes slowly moving upward the ‘trend’ in natural gas production the last five months has reversed and turned downward.
The lack of natural gas drilling activity should cause production to fall further as we head into winter, a period when heating demands increase demand for natural gas by nearly fifty percent. Historically, when we have seen natural gas production trend downward it takes nearly eighteen months – a year and a half – for the trend to reverse after drilling activity recovers. Natural gas drilling activity has stabilized but shows no sign of recovering. The production trend is clearly downward for the foreseeable future.
Natural Gas Market - Tudor Pickering Holt, an energy consulting group out of Houston, made the following comments on their recent natural gas supply study and on the recent EIA-914 report:
. . . we have gotten bullish on 2010 gas following our US Natural Gas Supply Study published in late August. With our neck out on the limb, we are watching the data points and anecdotes quite closely (understatement of the century).
Bottom line: Production should be falling. It is. Decline should be fairly steep. It is. Month-to-month and week-to-week datapoints will wear you out but they are generally confirming our thesis. Our conviction level is higher today than it was [a couple of months ago] . . . [this data] raises our conviction level on 2010 gas market tightness and $7.50/mcf price forecast . . . [note the current natural gas price is roughly $4.45/mcf]
Ben Dell of Sanford C. Bernstein & Co. made a case on Bloomberg last month that we are in the first stage of a multiyear upswing for energy prices—for many of the reasons we have been noting for the last couple of years (increasing global demand, supply issues, lack of spare production capacity, depletion, lack of investment due to the economic crisis, etc.) His analysis has been summarized as follows:
In a July 30 report, [Mr. Dell] estimates natural gas production declines will start happening now – in the summer of 2009. He presents his math which suggests that December production will fall 10% from 2008-2009, going from 63 bcf/d to 57 bcf/d.
Dell and his team also shows overall decline [well depletion] rates increasing from 15% in 1992 to 25% in 2000 and 29% in 2008, and this higher decline rate will help lower production. First year production declines were much sharper - 62% for horizontals, and 45% for non-horizontals [vertical wells] . . .
These opinions are by no means universal. Most energy analysts are still focusing on the fact that we have one month left of injection season and natural gas storage facilities are nearly full. They expect natural gas prices to fall to $3/mcf or less – and expect prices to remain weak for some time. While they may be correct short term, the longer term production trend in our opinion has turned bullish.
Crude Oil Market - Goldman Sachs released a report last month forecasting crude oil prices at $85 a barrel by year end (crude oil is trading at roughly $68 a barrel). Next year they expect crude oil prices to average $90 per barrel.
From global crude oil demand of 84.7 million barrels per day in 2009 they expect demand to increase to 86.4 million barrels per day next year—an increase of 1.7 million barrels per day—which will exceed the 86.3 million barrels per day of demand seen in 2008. They note economies in Asia continue to expand, along with the demand for energy. Auto sales in China this year will exceed those in the U.S. for the first
time in history. The International Energy Agency also increased their 2010 global demand estimates last month.
As with natural gas, this bullish opinion is not universal. Many analysts see weakness in crude oil prices into 2010 due to high inventory levels and lagging demand due to economic weakness. Again, short term the bears may be correct, but in our opinion longer term the trends are overwhelmingly bullish.
If the optimistic analyst forecasts are correct these developments should be positive for an energy overweight portfolio of attractive firms in the sector.
Joseph R. Dancy, is manager of the LSGI Technology Venture Fund LP, a private mutual fund for SEC accredited investors formed to focus on the most inefficient part of the equity market. The goal of the LSGI Fund is to utilize applied financial theory to substantially outperform all the major market indexes over time.
He is a Trustee on the Michigan Tech Foundation and is on the Finance Committee which oversees the management of that institution's endowment funds. He is also employed as an Adjunct Professor of Law by Southern Methodist University School of Law in Dallas, Texas, teaching Oil & Gas Law, Oil & Gas Environmental Law, and Environmental Law, and coaches ice hockey in the Junior Dallas Stars organization.
He has a B.S. in Metallurgical Engineering from Michigan Technological University, a MBA from the University of Michigan, and a J.D. from Oklahoma City University School of Law. Oklahoma City University named him and his wife as Distinguished Alumni.
Joseph R. Dancy | Adjunct Professor Oil & Gas Law, SMU School of Law | LSGI Advisors, Inc.
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