Since the natural gas rig count peaked in early October 2011, we have had roughly seven and a half months of lower gas drilling. We acknowledge that the shift from rigs focused on drilling for dry natural gas in favor of drilling liquids-rich gas plays can actually lead to more gas production. But it is important to understand that at the time the gas rig count peaked, natural gas prices were in the $3.50-$3.70 per thousand cubic feet (Mcf) range, down from about $4 only a few months earlier. The lack of gas demand due to the weak economic recovery and growing gas shale production was signaling lower future natural gas prices. What actually happened was that the nation experienced one of the warmest winters in years that erased any hope for a surge in natural gas consumption. With reduced winter storage withdrawals, in contrast to the normal pattern, natural gas prices have collapsed.
We and others argued that it was going to take a serious reduction in rigs drilling for natural gas – both dry and liquids-rich – to curtail the growth in gas production. For months, the analysts and industry professionals have been watching the monthly gas production data reported by the Energy Information Administration (EIA) based on its Form 914 survey of producers. The data arrives with about a two month delay.
Last week the Form 914 production figures for the month of March were released. The data showed that total natural gas production in the United States was 81.76 billion cubic feet per day (Bcf/d), down from 82.38 Bcf/d in February and the January peak of 83.16 Bcf/d. The national total obscures the fact that gas production in the Gulf of Mexico was up to 4.69 Bcf/d from 4.56 Bcf/d in February and that Alaskan production fell to 9.99 Bcf/d from 10.04 Bcf/d. When you subtract Gulf of Mexico and Alaskan production from the national total, you get the production for the onshore Lower 48 States. That production was down to 67.07 Bcf/d from 67.78 Bcf/d the prior month and 68.19 Bcf/d in January, a two-month decline of over 1.5 percent.
A plot of Lower 48 onshore gas production versus the Baker Hughes count of drilling rigs targeting natural gas shows how the relationship between drilling and production has tracked over the past few years since the gas shale revolution developed. Because of the lag in reporting production data, we have the advantage of two additional months of drilling rig data to project the likely trend in future reported gas output. As shown in Exhibit 7 (above), the number of gas drilling rigs has continued its decline suggesting that Lower 48 gas production has continued to fall. We will only know whether that assumption is correct in the beginning of August. Part of the explanation for the production decline, however, may be selective curtailments by producers such as Chesapeake Energy and Encana, among others. What we don't fully know is exactly how much output has been voluntarily restricted by producers. In the same vein, we don't know how much output from older gas shale wells has fallen as their production matures. This phenomenon will set up the treadmill need of producers to accelerate gas well drilling at some point in order to sustain and grow gas production.
Analytical work by Art Berman and Lynn Pittinger shows that gas production from the Haynesville field, one of the major sources of output growth over the past few years, has peaked and is beginning to decline. Since this is a dry gas basin, low natural gas prices are limiting the industry's effort to drill in the region to offset declining production. A similar situation is developing in the Barnett formation in North Texas. Without an aggressive drilling effort, it will be a challenge for the industry to boost production. If demand for gas does pick up due to greater use for power generation, more industrial consumption or even an exceptionally hot summer and an early cold winter, the E & P industry could be looking at gas prices in the $4-plus range by December. Wouldn't that be a pleasant surprise?
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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