Musings: Natural Gas Prices and LNG's Dirty Little Secret

Optimism about the ending of the U.S. recession and its impact on future demand for natural gas coupled with positive comments from large domestic gas suppliers about the trend in gas supplies has ignited a rally in natural gas futures prices during the past week. Natural gas prices jumped from a low of $3.25 per thousand cubic feet (Mcf) on April 27th to a recent high of $4.31 per Mcf last Friday. A near 33% rise in gas prices in such a short time-period reflects a severely oversold market. The dramatic price run-up may have more to do with commodity short-sellers than people buying into the view of a sustainable and healthy recovery for the market.


There were several very positive statements made by the CEOs of major natural gas producers about the changing supply/demand dynamics of the business on their company earnings conference calls with analysts. Mark Papa, CEO of EOG Resources, Inc. (EOGNYSE), said he expects the impact from the decline in gas-oriented drilling will result in natural gas production falling by 4.5 billion cubic feet per day (Bcf/d) by the end of the year. He believes the resulting North American natural gas production declines could be reversed by early in 2010 if $7 per Mcf gas prices return or the gas-directed rig count falls below 650. This view compares with that of the Petroleum Industry Research Association (PIRA) that believes gas production will be 3 Bcf/d lower at year end. Equally bullish was Aubrey McClendon, CEO of Chesapeake Energy (CHK-NYSE), who sees gas storage being full by October and that gas production would be 10% lower at year-end compared to 2008. That implies natural gas production should fall by 4 Bcf/d. Should these estimates prove accurate, the supply drops would go most of, if not all, the way to wiping out the perceived supply/demand imbalance in the domestic gas market of about 5 Bcf/d due to the falloff in industrial and commercial consumption related to the economic recession and credit crisis.

While the drilling rig count, and especially the gas-directed rig count, are down sharply from last year and continue to fall, the key question remains when we will get an upturn in gas demand from recovering automobile and housing industries. Most gas industry CEOs and Wall Street analysts are confident that all that is needed for a sustained recovery in natural gas prices is an uptick in gas demand, but more importantly the fall in production due to the gasrig count downturn. Once gas prices recover, then drilling should resume, but due to the rapid production declines for most gas shale wells, the industry will be spending quite a bit of time trying to catch back up with falling supply in the face of rising demand thus sustaining higher natural gas prices.

The challenge for the oil service industry is to gauge the number of drilling rigs that will be needed once we enter the industry recovery phase. We have heard comments from various CEOs that there may be only 1,200 to 1,400 gas-directed rigs needed, which if one throws in another 250 oil-directed rigs, suggests a total of 1,450 -1,650 working rigs at the next industry peak. Since we recently peaked out at 2,031 rigs, according to the Baker Hughes (BHINYSE) rig count data, then the domestic contract drilling industry will have a significant surplus of rigs going forward. The simple math appears to be about 2,050 rigs plus about 300 rigs under construction that will enter the fleet boosting the domestic fleet to 2,350 rigs. Since we will need considerably fewer rigs (1,450- 1,650), the drilling industry will need to eliminate nearly 700-900 rigs in order to restore a relative balance between supply and demand that is needed to support reasonable pricing. (Investors should consider the stocks of companies manufacturing acetylene torches since so much steel will need to be cut up.)

With a peak drilling rig fleet on only 1,450-1,650 rigs, it would appear there is a shake-out coming among land drilling contractors. At this point we will not get into our views of the dynamics of the future drilling rig fleet and how the industry consolidation might shake out, but instead we want to focus on another gas industry issue that has not received much attention and that could have a significant impact on the land drilling business.

The conventional wisdom about the contract drilling business is that sometime later this year or early in 2010 the rig count will begin rising from the roughly 800 rigs that will be working at the industry trough to maybe 1,200 rigs. But that conventional wisdom is predicated on the domestic natural gas supply/demand balance being restored and crude oil prices remaining in the $50 a barrel range. Our question is what happens if the gas market doesn't recover its balance? How might that happen? We suggest there is a "dirty little secret" about liquefied natural gas (LNG) that could disrupt the North American gas supply/demand balance and contribute to low gas prices for several more years. Can anyone spell "gas bubble?"


We recently spoke at a conference where another of the speakers was an old acquaintance, Jim Jensen, a leading U.S. consultant on LNG. Mr. Jensen and I had time to talk about the LNG market. We were looking forward to getting educated on LNG market trends given this fuel's growing importance on the outlook for the domestic natural gas industry. We will not go through his talk's conclusions, but he also shared with us another, more detailed LNG talk he made earlier this year. His bottom line is that the LNG market is going through another upheaval that is likely to impact the North American natural gas market. This upheaval could last through 2011, but the future for the North American natural gas market after that date remains uncertain because the future will depend on decisions LNG players make about new investments in the current period.

Since there are so many new LNG facilities coming on stream, many after delays, there is a surge in LNG supply coming. Its arrival coincides with the decline in gas demand, and the question mark about when gas demand will resume its traditional growth. To understand the magnitude of the LNG supply issue, Mr., Jensen calculated that for the 14 year span of 1997-2011 including the completion of the LNG facilities currently under construction, LNG supply will have grown at an 8.4% annual growth rate. For the prior 14-year period, the supply growth was only 4.7%. Today, Qatar has replaced Indonesia as the world's largest supplier of LNG, which is where the "dirty little secret" comes in.


Conventional wisdom suggests that LNG cargos come to the United States because it has the largest available storage capacity, which is true. However, people believe that when gas prices get very low, below $3 per Mcf, LNG sellers will look for other international markets with better prices. Many of these foreign markets have linked their LNG pricing to crude oil prices, which was partially the reason why we heard of LNG cargos going for $18-$20 per million Btus (roughly per Mcf). Why would LNG sellers want to dump their gas into the U.S. if gas prices are so low? Well, what if you make so much money from the sale of the natural gas liquids (NGLs) contained in the gas streams utilized to produce the LNG that the gas actually has a negative value?

According to Mr. Jensen's data, Qatar gas contains 48 barrels of NGLs per Mcf. Qatar can realize enough income from selling those NGLs to cover the cost of liquefaction, transportation and regasification of the LNG, and still have profit left over. In that case, Qatar would find no natural gas price too low to stop sending LNG cargos to the United States. In Mr. Jensen's March speech at MIT, at a time when the domestic natural gas price was around $4.50 per Mcf, he posed the question of who would blink first between shale gas producers and LNG exporters. But the question becomes, who blinks at $3, or $2 or $1 per Mcf gas prices? If Qatar could actually pay someone to take their LNG, then shale gas producers, no matter how low a finding and development cost they have, will be have a hard time convincing Wall Street analysts on the value of their production and reserves. The dirty little secret becomes more significant when one realizes that most of the LNG gas streams have even higher NGL content than Qatar's gas distorting the economic decision about exporting LNG volumes.

Assuming the shale gas producers are the ones that blink, what happens to drilling and oilfield service activity in the United States? Our guess is that there would be little recovery in the drilling rig count until this imbalance with LNG is resolved. So could the domestic oil service industry be looking at a rig count averaging in the 800s for several years? That would certainly change the outlook for oil service company earnings and the attractiveness of their stocks. That would also magnify the challenges of restructuring the domestic oilfield service industry. We will be revisiting this scenario in future Musings.

While we always talk about the natural gas business being primarily a regional industry, the globalization of the LNG business may radically alter the U.S. natural gas industry. We could, however, be entering a period much like the domestic gas business was forced to deal with in the late 1980s and early 1990s when $1/Mcf gas was a reality. We are not forecasting such a dire outlook since there are many factors at work in this scenario. However, we are certainly going to be monitoring these factors to attempt to assess their possible impact on future natural gas prices and the outlook for U.S. oilfield service industry activity. But not considering the impact of an extended "L-shaped" pattern for the domestic rig count could be a mistake, whether one agrees with our LNG concerns or not.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.


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john oneill | May. 21, 2009
We can simply export the natural gas... get it for $1 and sell it for $2

Zephrine Millard | May. 17, 2009
This doesn't make sense to me.

The LNG markets are becoming more fluid by the day with spot trades and swaps being a reality with the case in point being the variety of destinations that LNG cargo from Trinidad has even been diverted and shipped as far as Japan.

Domestic consumption of natural gas in the US is significantly assisted by LNG gas supplies up to about 25% [from my last eyeball of the figures]. However, if demand in the US were to fall, I don't see how any responsible LNG trader will send gas from even Qatar to the US market if the net back price is not sufficient.

Even if NGLs were to be so significant and lucrative a hydrocarbon that producing and liquefaction of gas isn't currently as viable, then reinjection is the obvious real option available to the producer.

It may be possible for a sort of GAS BUBBLE to occur if the rig count goes down and stays down with high rig costs, price is at just above profitable enough to send LNG cargo from the myriad of international trains to come on stream and perceived oversupply turns into become a fit for the gap in domestic supply but too many things must happen simultaneously for such a situation to occur.

In my humble opinion, the situation isn't dire. The industry has seen many downturns before and will see more in the future. It's the cyclic nature of price in the business. What businesses must remember is the old biblical fable where you build infrastructure and save your grain in the seven years of plenty to use in those seven years of drought.


When gas prices return to around $6 per MBTU [I'll speak in MSCFD another day], I expect the situation to normalize to a point where the supply optimized and balanced to support domestic shale gas production and perhaps an increasing amount of LNG in the market. I doubt the market will ever be as fluid as crude was, but great things are in store for a highly uncertain future of LNG.

M.E. Lynch | May. 15, 2009
Look for old Jersey to come out with a Q squared Max and "the Shell that hit Germany hardest" to be right behind with a Q cubed Max or something like that. A new Guerre du Petrole is coming along fast. Guess who will win? The usual suspects. XOM, RDS, CVX, TOT, BP.

Greg Veitch | May. 14, 2009
What a load of hoo-ha.

I have worked in LNG for 20 years & have never known any producer to do anything more than try to sell at the highest available netback price. To suggest that there is some sort of conspiracy to damage the rig industry in the USA is over the top.

Qataris are reknowned for being very hard nosed business people. They negotiated for 6 years on a long term price for 4Mtpa LNG into Chubu Electric!!! They have consistently sought oil parity prices for LNG delivered into Asia. (What is HH at the moment - half of oil parity?).

Qatar will have excess LNG over the next 3 years or so, and they will play the market. It may mean in the short term that excess LNG is sent to the USA (and Europe). Qatar will take whatever price those markets give to them. But I would expect that they would look to optimising deliveries on a seasonal basis and to diversions to higher paying markets as they become available.

As Asia comes out of recession they will be buying at higher prices than in the USA, and that is where Qatar will focus their attention. LNG deliveries into the USA will rise and fall on basic supply/demand market principles.

The USA is in an excellent position to manage its own supply of NG. UCG producers have done a great job in developing a new resource. This short period of world LNG over-supply will provide a test to see if the UCG industry can continue to reduce costs and compete in the world NG market place.

R. G. Hunter | May. 14, 2009
Very interesting especially given the explosion of planned & being-built LNG plants in this part of the world!!!

RP | May. 14, 2009
It's a crazy world. Half the time in the US it isn't profitable to strip NGLs out of the gas stream. It has to be done so gas will meet pipeline specs. Many times I'd take the BTUs full wellstream and leave the plant to fight the NGL market. I'm kind of surprised the NGLs are being compared to crude since the C2-C4 market may be in a deeper rut then USnatgas. There are definitely a lot of dynamics here, but reinjecting the gas to make more liquids (if it is such a rich reservoir) may make a lot more sense the spending money to liquify and ship for nothing. I for one do not believe the new LNG people are going to be doing this for gratis very long. They will however elbow themselves a share of the market.

Gavin Longmuir | May. 13, 2009
Are we talking about NGLs (very light liquids knocked out at low temperature) or condensates (oil-like liquids which drop out at normal temperatures)? I would guess that gas from places like Qatars North Field contains both.

There have been a number of very large gas cycling schemes in the world, where gas was reinjected into the field to maximize the recovery of valuable condensate. If countries find themselves selling LNG for something close to $0/MCF, they will probably look very hard at the economics of re-injecting that gas instead of liquifying it. The glut of LNG may not materialize.

Donald Trullis | May. 13, 2009
Surely the economics of gas and liquids should be based on the energy content. If a realistic pricing system was to be used for all hydrocarbon (and other energy sources) based on the energy available then more efficient use would be the end result - this would probably assist in the climate change issues that are becoming more prominent as the years go by. How can any national economy give energy away to another? This is what is being suggested.

Michael McKee | May. 13, 2009
The key point in the article seems to be that a thousand cubic feet of produced NG contains 48 barrels of NGL and that the NGL production actually provides a negative cost for the natural gas. If that were truly the case then I would characterize this field as a condensate field that produces associated natural gas. IMO someone should verify the numbers in the article. A typical oil field that produces light crude will produce several hundred to several thousand cubic feet of associated natural gas per barrel of oil.

RESPONSE: I will have to double check the data. The point about profitability of the NFLs in LNG streams has been confirmed by several sources so the point about a zero cost for the gas is correct. The idea is that a lot of the LNG coming to the US has essentially a zero cost, which will compete with domestic gas and put downward pressure on prices and on the pace and magnitude of the industry recovery.

Allen Brooks
Eric Johnson | May. 13, 2009
Great article, highlighting an issue that many gas people have been talking about more and more over the last several months. I would like to see a follow up article that covered information related to infrastructure issues. IE: Can the current infrastructure handle increased amounts of LNG, convert it to gas, and insert it into the lines at a rate that will be able to supply a large amount of gas to the pipeline system. In other words, are there constraints to getting LNG into the overall gas system.

Again, great article.

Bill Simpson in Slidell | May. 13, 2009
Fantastic article! Domestic businesses now have to consider how Washington will react to their business decisions, as well as the overall competitive environment. Add the question of how will cap & trade laws affect the price of alternate fuels, and the uncertainty is magnified. Personally, I think that the growth of oil and gas demand from China will absorb the excess hydrocarbon demand a lot faster than is currently projected. And if the price of oil escalates as the world economy improves, natural gas might gain market share as a transportation fuel. I'm glad that I don't have to make any drilling decisions with the NGL factor to consider.

Bert Golden | May. 13, 2009
This makes holding natural gas acreage a lost cause. We have 100,000 acres in the Cook inlet and some deep gas in Lavaca County Texas. Guess we will stick to oil and hope the economy of the world grows at a faster rate. A dumping tax on LNG would not necessarily be approved by the current leaders.

JL | May. 13, 2009
Excellent analysis; this is a sing of market complexity and that there are opportunities to make profits. But midterm should give new factors coming in to take important roles, as environmental regulations and new gas discoveries in USA. If this country plans and executes important projects to replace carbon and heavy fuels for power generation and transportation, many of these new gas reserves will be developed and this scale can provide important cost reductions in drilling and infrastructure (T&D), so this could give a new equilibrium in natural gas pricing.

John Costley | May. 13, 2009
The day The Chicago Board of Trade began speculating in futures, that was the day that changed the business forever. Speculators have only one goal, and it is always short term. The given dew point of the condensate and how it is managed will continue to have a huge impact on the shale oil / gas future. Grand Junction, CO is a prime example of untapped reserves and speculators crashing like marbles.

Kevin Henson | May. 13, 2009
India and China will absorb all the cheap surplus gas they can find, also the countries that suffered at the Russian gas blockades will look to getting their gas elsewhere, these market conditions will keep the price buoyant. Stop the panic.

M Foster | May. 12, 2009
I never thought that I would say this but given the fact that Western Colorado is already in trouble from shale gas production in Appalachia, Texas and Louisiana we will be 100% wiped out if LNG enters the market as well.

The benefits to state and local economies from domestic oil and gas production can't be ignored. Doesn't the "free" transportation cost of LNG amount to dumping? What about a tax on imported LNG and oil from non NAFTA countries?

Jim Doyle | May. 12, 2009
Won't most NGLs be knocked out of the gas stream and separated from the gas prior to liquification? This would allow Qatar to sell the NGLs separately - though you make a good argument that it may be beneficial to them to keep the two combined. Would love to hear how much LNG Europe might soak up in light of a desire to diversify from Russian supplies.

Mike | May. 12, 2009
I think the move in NG has to be short covering and speculators....

As cheap as it was in the low 3s it should probably be cheaper in the mid 2s with the HUGE build up and lack of demand....

But we saw how SPECULATORS not DEMAND drove oil prices to about 150 bucks so who knows what happens short term... speculators make the market a circus

David | May. 12, 2009
What is the incentive for Qatar to liquefy and ship the gas at a loss? Why not just flare it for free (after NGL liquid removal)?

Nick G | May. 12, 2009
I run a UK Business Energy website, and analysis like this is very valuable, as the connection between Henry Hub and UK NBP gas prices grows stronger every day. LNG is like a giant worldwide chess game price wise. I'm familiar with Jim Jensen from way back too, good to see him still around. I think he's right about Qatar Gas (the UK terminal was finally opened today). Five years or so ago during the planning stage, I heard from a high UK gov source that Qatar/Exxon expected to still make a profit from a gas price as little as 3 UK pence per therm, about 50 cents MMBTU.

But I wander: What I really, really, really want to know is: When does shale gas technology come out from North America? If coal and oil is planet wide, there must be huge amounts of nat gas everywhere else as well. Why are we worrying about an energy crisis at all with numbers like this? Any info on European or other world shale gas potential very welcome!

Craig | May. 12, 2009
Surely there is a mistake in your NGL content - 48 barrels per Mcf? That would be 2,106 gal/mcf or 2106 gpm in gas processor lingo. That is unheard of - there must be a mistake. Perhaps you meant 48 barrels per MMcf? That would be 2.1 gpm, which certainly is believable. If that is the case and all that NGL is being separated from the natural gas prior to liquefaction, and the NGL price was equivalent to crude, then the NGL value could be $2.50 per mcf. I think your "dirty little secret" is still a interesting point, as long as the LNG could be sold at a price sufficient to cover the liquefaction and transportation cost. Otherwise, Quatar would be better off economically to flare the natural gas after removing the NGLs.

Aaron Trigo | May. 12, 2009
I am a drilling consultant. Is it going to pick up soon, or do we have to worry that rig counts are going to drop more? We are hurting out here. Back then we had 40$ oil and everybody was drilling. What's going on?


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