This opinion piece presents the opinions of the author.
When domestic natural gas output grew like a phoenix from the ashes of an industry projected to be completely dependent on Canadian and liquefied natural gas (LNG) imports to meet future demand, the gas shale revolution was hailed for its role. Gas executives, analysts and investors were amazed by the volumes of gas being unlocked by shale wells as a result of the technical success of marrying horizontal drilling with hydraulic fracturing. The gas industry’s phoenix-like recovery, however, was halted by the global financial crisis in 2008. But prior to that time-out, it appeared the gas industry was going to enjoy an unusual era of high natural gas prices coupled with strong oilfield activity, i.e., substantial production volumes and high drilling rig counts. That view even led some industry participants to begin imagining a world in which gas demand might never be constrained by inadequate supply.
The siren song of unlimited, cheap natural gas unleashed by the shale revolution created a boom for land leasing and drilling activity. Demand for drilling and completion services was so strong that it outstripped supply, boosting service prices and attracting huge capital inflows. This boom, which some refer to as the gas shale traveling road show, drove players to scour the landscape in hopes of finding the next most promising shale and swooping in to establish a large land position cheaply before the rest of the industry caught on. What many of these promoters failed to anticipate was how the prolific gas supply being unleashed by this boom would negatively impact gas prices, and in turn the profitability of gas shale plays.
Students of the gas shale revolution are quite familiar with the chart in Exhibit 1 (page 2) that shows the recent history of U.S. gross natural gas production and U.S. land gas output component compared to the rig count for those targeting natural gas prospects since 2005. From the early 2000s until the summer of 2008 when the financial crisis exploded, there was a steady increase in gas-oriented drilling along with a steady rise in land gas output. Overall, U.S. gas output did not climb as steadily as the land gas output component since production trends offshore in the Gulf of Mexico and in Alaska often rose and fell due to local situational events.
The dramatic decline in the rig count as a fallout from the financial crisis can be clearly seen in the chart, but notice also that land gas output declined. Total domestic gas output also fell, but it declined at a faster rate than the land output suggesting that Gulf of Mexico output also suffered from the financial crisis fallout. The important trends to observe are what happened to output and gas-oriented drilling as the nation struggled to extricate itself from the 2009 recession, which undercut economic activity, energy demand in general, and natural gas output in particular.
Starting just about a year after the 2008 peak in gas output, production turned up, both for land output and overall U.S. gas supply. That production rise continued until the fall of last year when it appears that both total gas output and land gas production reached peaks. Shortly before the gas production upturn in late 2009, gas-oriented drilling began to recover. The rig count upturn lasted just about a year before flattening out and then declining until early fall of 2011, at which point the rig count began a steep slide that has only recently moderated.
To understand how the gas industry became convinced it had entered a new era of unprecedented prosperity, one needs only to look at the price of natural gas during 2005-2013 as shown in Exhibit 2 (page 3). In broad terms, the history can be divided into pre- and post-financial crisis periods. With the exception of two significant spikes in natural gas prices between 2005 and 2009, gas prices essentially traded in the $7-$8 per thousand cubic foot (Mcf) range, a very healthy price. As the financial crisis and resulting recession trimmed domestic energy and natural gas consumption, while at the same time gas output was growing, gas prices slid until they bottomed in early 2011 in the $3/Mcf range, or less than half what prices had averaged in the pre-crisis era. While natural gas futures prices have recently rebounded above $4/Mcf, they are now trading in the mid-$3/Mcf range. The average price for the post-financial crisis era appears to be in the $3-$4 range, which is about half the average price for gas before the crisis. What appeared so promising and profitable for the gas business at mid-decade now looks to be a distressingly difficult challenge.
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G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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