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Arthur Berman

Arthur Berman

Arthur E. Berman is a petroleum geologist with 36 years of oil and gas industry experience. He is an expert on U.S. shale plays and…

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Natural Gas Prices To Crash Unless Rig Count Falls Fast

Natural Gas Prices To Crash Unless Rig Count Falls Fast

Spending cuts for oil-directed drilling have dominated first quarter 2015 energy news but rig counts for shale gas drilling are too high.

Investors should pay attention to this growing problem. Bank of America fears sub-$2 gas prices now that winter heating worries are over. Low natural gas prices affect the economics for gas-rich oil production in the Eagle Ford Shale and Permian basin plays as well as for the shale gas plays.

Meanwhile, an orgy of over-production is taking place in the Marcellus Shale. Well head prices are now below $1.50 per thousand cubic feet of gas because of limited take-away capacity and near-saturation of regional demand. Even companies in the Wyoming, Susquehanna, Allegheny and Washington County core areas of the Marcellus play are losing money at these prices.

The rig count for shale gas plays has decreased by only half as much as for the tight oil plays. The reason appears to be that most shale gas companies do not have significant positions in the tight oil plays and must continue to drill to maintain production levels.
Shale gas rig counts have dropped only 19% for horizontal rigs and 25% for all rigs from 2014 highs. The corresponding decrease for tight oil plays is 41% and 46%, respectively, as shown in the table below.


Rig count change table for tight oil vs. shale gas plays as of March 20, 2015. Source: Baker Hughes and 

Labyrinth Consulting Services, Inc.  (Click Image To Enlarge)

This has puzzled me because the shale gas plays are not commercial at less than about $6/mmBtu except in small parts of the Marcellus core areas where $4 prices break even. Natural gas prices have averaged less than $3/mmBtu for the first quarter of 2015 and are currently at their lowest levels in more than 2 years. Related: Oil Prices Will Recover: Market Fundamentals Are Working


Henry Hub daily and quarterly average natural gas prices. Source: EIA and Labyrinth Consulting Services, Inc.(Click Image To Enlarge)

Most shale gas producers either do not have positions in the tight oil plays or are strongly gas-weighted in their production mix. These companies must continue to drill in shale gas plays despite poor economics in order to avoid the consequences of falling production levels.

The only criterion that seems to matter to investors these days is production guidance. If production drops, stock value will fall even farther than it has already. This will trigger loan covenants if asset values fall below thresholds set out in the loan agreements. When that happens, the loans will be called unless the companies can come up with more cash. This might result in bankruptcy. So, the drilling must continue as long as there is capital.

The table below shows the companies that have overlapping positions in both tight oil and shale gas plays based on current drilling activity.


Current rig counts for companies with positions in both tight oil and shale gas plays. Source: DrillingInfo and Labyrinth Consulting Services, Inc. Rig counts may differ from Baker Hughes because the source is different.  (Click Image To Enlarge)

All companies in the table except Continental Resources are gas-weighted so maintaining gas production levels is important to them for the same reasons it is important to operators without tight oil exposure. Overall, the companies in the table operate only about one-third of all rigs in the shale gas plays. Shale gas is otherwise characterized by a different set of companies that feel they have no choice but to continue drilling and hope that investors don’t notice or care.


Shale gas rig count by operator. Source: DrillingInfo and Labyrinth Consulting Services, Inc. Rig counts may vary from Baker Hughes because the source is different.  (Click Image To Enlarge)

But don’t oil-weighted companies face the same concerns about production levels?
I compared the change in rig count from January to March 2015 by operators in the Eagle Ford Shale play to understand how rig counts are being reduced. I found that key operators were strategically reducing their activity to the best locations in core areas in order to affect production levels the least (see chart below).


Eagle Ford Shale rig count comparison by operator, January and March 2015. Source: DrillingInfo and Labyrinth Consulting Services, Inc.(Click Image To Enlarge)

The next most active class of operators are holding drilling fairly constant in this most productive of tight oil plays. Then, there are a small number of new entrants to the play that are more than balanced by operators exiting the play. My previous post on Eagle Ford well performance showed that there are ample locations in the most commercial parts of the core areas for well-positioned operators to optimize production with fewer new wells.

Related: Majors Could Be The Big Winners Of The Oil Price Crash

It is worth noting that the top group of operators in the Eagle Ford Shale play have reasonably good balance sheets (see the table in my previous post) and are not particularly vulnerable to loan covenant threshold triggers. This cannot be said for many of the top operators in the shale gas plays shown in the table below.


Summary table of 2014 year-end financial data for natural gas-weighted U.S. land-based E&P companies. All dollar amounts in millions of U.S. dollars. FCF=free cash flow; CF/CE=cash flow from operations/capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc. (Click Image To Enlarge)

The table shows financial data through year-end 2014. What it reveals is not pretty. 2014 negative cash flow reached $15.5 billion, an increase of $7.2 billion over 2013. Much of this increase involved Southwestern Energy’s puzzling acquisition of Chesapeake’s West Virginia Marcellus Shale position that increased that company’s negative cash flow by almost $5 billion over 2013.

On average, shale-gas companies earned only 68 cents for every dollar that they spent in 2014. Total debt increased almost $10 billion to $93.5 billion and average debt exceeded stated equity by 18% excluding companies with negative equity including the now-bankrupt Quicksilver Resources.

Shale gas plays are commercial failures. The misuse of capital to continue to increase production while destroying price and shareholder equity has gone on for too long. Investors should demand that shale gas companies cut rig counts at least as much as tight oil companies have.

Rig Count Summary for the Week Ending March 20, 2015

Rig counts are important today because they may indicate future trends for oil prices. Horizontal wells in the Bakken, Eagle Ford and Permian basin plays produced about 3.5 million barrels of crude oil per day in November 2014 (see table below). These are, therefore, the key plays to watch for rig count decreases.


U.S. key tight oil play production. Source: Drilling Info and Labyrinth Consulting Services, Inc. (Click Image To Enlarge)


The horizontal rig count for these key plays–Bakken-Eagle Ford-Permian HRZ-dropped 25 rigs this week (23 rigs last week) and was down 40% from the 2014 maximum. The horizontal rig count for tight oil plays overall dropped 22 rigs this week (32 last week) and is 41% lower than the 2014 maximum (see the first table above in this post). Rigs for all tight oil plays were down 31 this week (39 last week) and are 46% lower than 2014 maximum rig counts.


Summary of most changed rig counts by play. Source: Baker Hughes and Labyrinth Consulting Services, Inc.(Click Image To Enlarge)

The plays with the greatest change from their respective 2014 maximum rig counts may be viewed as the least commercially attractive to producers. This suggests that the Barnett, Granite Wash, and Permian All are the least attractive.

Related: Global Shale Revolution On Hold

It is interesting that the Bakken moved into this category this week. Well head prices in the Bakken have now fallen below $30 per barrel. The play is geologically solid but wells are expensive, the pay-out times are fairly long because relatively low decline rates for a shale play, and rail transport adds a lot to the cost of each barrel of oil.

The overall U.S. rig count for the week ending March 20, 2015 was 1,069 of which 1,030 were land rigs. Only about 25% of total land rigs and 11% of horizontal rigs are drilling outside of the major shale gas and tight oil plays. Detailed data for all of the plays are shown in the table below.


Summary table for all U.S. land rig counts. Source: Baker Hughes and Labyrinth Consulting Services, Inc. (Click Image To Enlarge)

This and other data continues to suggest decreasing U.S. tight oil production and increasing world demand. Rig count continues to fall for the critical oil-producing plays and that means that things are on track for an oil-price recovery sooner than later.

Investors should carefully examine why shale gas players have not reduced rig counts more. Continued drilling in the Marcellus will crush natural gas prices further. The fact that there are 34 rigs running in the Haynesville Shale is economically baffling. We may only speculate on why there are 51 rigs in the Woodford Shale and why some operators now call it the SCOOP play.

By Art Berman for Oilprice.com

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  • Lee James on March 23 2015 said:
    "Investors should carefully examine why shale gas players have not reduced rig counts more. Continued drilling in the Marcellus will crush natural gas prices further."

    The rush to produce Marcellus gas seems to be an instance of "Tragedy of the Commons"... individuals acting independently and rationally according to each's self-interest behave contrary to the best interests of the whole group by depleting some common resource." (http://en.wikipedia.org/wiki/Tragedy_of_the_commons)

    We know that the resource is limited and that the industry is already centered on core production areas. Some companies, like Cabot, had the good fortune of landing on the core early-on. We need to understand that Cabot is a poster child company in the Marcellus.

    Even with the rush to bring a limited resource to market, what drives uneconomic behavior in most areas of the Marcellus? Hoped for technological breakthroughs just bring more production, carrying with it storage and transport problems in a saturated local market. Shortfalls in local utilization drive export. "Someday," LNG will make it all work... if the economics of LNG and pipelines are there.

    So, what hope do we have for managing a finite resource that's scattered about, beneath farms, roads, forests lakes and towns? Again, from the Wiki article:

    "Elinor Ostrom, who was awarded 2009's Nobel Prize of Economics for her work on the issue, and her colleagues looked at how real-world communities manage communal resources, such as fisheries, land irrigation systems, and farmlands, and they identified a number of factors conducive to successful resource management. One factor is the resource itself; resources with definable boundaries (e.g., land) can be preserved much more easily. A second factor is resource dependence; there must be a perceptible threat of resource depletion, and it must be difficult to find substitutes. The third is the presence of a community; small and stable populations with a thick social network and social norms promoting conservation do better.[48] A final condition is that there be appropriate community-based rules and procedures in place with built-in incentives for responsible use and punishments for overuse."

    What to expect? I see the choices as: moderate, sustainable development; get-there-first development and damn the production cost; or Hail Mary and trust that LNG type solutions will work. I vote for the former. Included with sustainable development is protection of other natural wealth, such as fresh water.

    The full cost of doing fossil duel business must be reflected in the fossil fuel price tag that consumers see. Short of this, we choose to have Tragedy of the Commons. Price carbon and other externalities now!
  • M Scruggs on March 23 2015 said:
    Mr. Berman paints an interesting picture. He clearly explains why producers are continuing to drill even though prices are signaling to stop. Even astute investors and businessmen often fail to understand the classic dynamic of 'boom and bust' cycles that continue to drive the oil and gas industry. Mr. Berman describes for us the drivers. Yes, Lee James, there seems a madness to it, but these companies are interested economic self-preservation. If they can just last long enough for the cycle to turn so high prices return.

    While the siren song that Lee James talks about sounds inviting, and even touts a Noble Prize winner nonetheless. The song sounds strangely like 'government managing everything'. In other words some governmental body mandating who can drill, where they can drill, and even prices that can charge. THAT is a recipe for disaster. Haven't we seen that proverbial movie? It sounds great until you realize that the US is not a small country (310 million and growing), that the US does not make world energy policy (In fact, we haven't even made a US energy policy...ever). New taxes that never go away is not the answer. Our federal government needs less power not more.

    My counter point to government managing everything is that I am fairly certain that the oil and gas industry would not be nearly as advanced as it is today without free market economics. High oil prices, not government mandates, drove innovation. Innovative uses of new technologies such as seismic mapping, fracking, horizontal drilling, and operating in high pressure, deep sea environments was not invested by governmental-driven economic systems such as Russia, China, Iran, India or you name it. They were put to use mainly by for-profit companies using lots of good-ole technical know-how born in the USA. The shale boom started in the US. Yes, we did it. Not the government. Not a bunch of foreign investors. The main reason these US companies want to get the oil and hydrocarbon is to make money, the good ole American way.

    There is a good ending to the story that Mr. Berman is telling. He just did us a favor and didn't spill the beans. But I will give you a hint. Low prices cure low prices. Price discipline will return, after some blood letting. Yes, that means that high prices will return.

    If we still had fully regulated natural gas markets in the US, then we would be importing expensive natural gas, looking for jobs, and wearing Jimmy Carter-looking sweaters. Thank goodness for R Reagan.
  • Steven on March 24 2015 said:
    If you go back in time when Natural Gas peaked say around June of 2008, you can see that the natural gas price plunge started there. It kept plunging and bottomed out in 2009 and has been bouncing between 4-6.00 range. Interesting all the natural gas players were claiming that they "had to have" $4 or $5 to keep drilling, yet even when prices went below that they kept drilling.

    The real truth was that the absolutely out did themselves and over drilled to the max with the expectation that prices were going to come back up. Some gas industry folks have said that they over drilled 50-60%.
    Since 2009 the companies have been pulling natural gas out of the ground at the lower prices , process it and pumping it into various storage locations such as salt caverns all over. Ones in SW Wyoming and Central Utah come to mind not to mention what they called played out fields. Now they have those full. Again the expectation was the price would come back in 6 months, then next December, then the following February...always at some point in the future. But it never happened.
    With the price down the banks weren't as helpful loaning money to the industry as they had in the past. In fact at one point the various companies had gone crazy getting loans from the bank for speculation purposes. There were 100s of millions of dollars of loans if not billions with all the companies. Most of the companies were running on borrowed dollars. A few smart ones weren't

    Last year you had the various companies that have been selling various assets to cover loans and expenses. Now that the oil bust has hit, the banks have become real skittish about loaning any energy company natural gas or oil any kind of money unless they have a load of cash laying around. Not many have that. Then you have another price drop of natural gas.

    So now you have the natural gas companies cutting back and laying down rigs. Those companies that jumped over to the oil side of the equation last year and the year previous (pre bust) especially cutting back and laying off.

    Several major companies have been laying off hundreds if not thousands of workers in Wyoming. As one natural gas company person said, this should have been happening in late 2009 to 2012 as opposed to now but they were operating on the pipe dream that at some point in the close future the price would go back up and they would make a real killing.

    The question now is, how long can the energy industry sustain low prices? Some in the oil industry think it's going to come back in a few months. I really hope that is the case but the reality is that until the price comes up and stays up, it won't happen. We will probably see some spurts of activity. The Bakken's have 856 non completed holes that the companies are waiting on a deadline for a tax credit before they complete them. So flurry of activity in Bakken's, then the boom busts.
    Some of the big players, with cash are using this as an opportunity to buy low but that won't last forever especially if low prices hang around.

    It's really going to be interesting!!!
  • Lee James on March 24 2015 said:
    Hello, M

    You are right to question my message... I do not advocate business as usual. The cure for high oil prices are low prices. But it will be an endless cycle, with an overall trend of significantly rising oil prices.

    Yes, high prices are driving innovation. But innovation is not free. The U.S. unconventional industry set a new world-wide standard for oil prices, and the Middle East and Russia thought $100+ oil is just fine. Oil producing countries began setting their national budget in according with our new, "just fine" high price. Conveniently, the new oil price was way above their cost of production. That leaves a nice margin for Russia to increase its defense spending. The same can not be said for us. We must have the higher price or invoke miracle technology to reduce production cost.

    The trend of rising U.S. production cost, combined with mischief-making by petro-states, does not look good. I recommend an accurate price signal in our Western marketplace for what burning oil really costs us. For example, an aspect of the cost is national security. What is our total cost for conflict in the Middle East and holding the petroleum-funded states of Russia and Iran at bay?

    While we need to see the true cost of burning oil as consumers, that does not mean that U.S. citizens have to be done-in by a higher pump price. Pricing carbon can be revenue neutral, like what British Columbia is doing. Give all the carbon tax back to citizens annually. Let citizens make the spending decisions, not government -- just like what you advocate.

    A tax or a fee that is returned to citizens is revenue neutral. Carbon fees are used to offset existing taxes, or they can be returned to households each year.

    I am a big advocate for transitioning away from fossil fuel. The only issue in my mind is how we do it. The fossil fuel treadmill is not a healthy place to be.

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