Musings: Growing Gas Storage Fails to Slow Drilling

Natural gas production continues to grow while demand remains stagnant.  As a result, the amount of natural gas flowing into storage continues to grow and generally at a faster pace than most commodity experts and petroleum analysts have been expecting.  The latest weekly storage injection of 83 billion cubic feet (Bcf) exceeded analyst estimates by 3 Bcf.  For the week ending April 30th, total gas in storage was 1.995 trillion cubic feet (Tcf), which was 5.1% ahead of the volume in storage at this time last year and 18.8% above the five-year average. 

The latest weekly storage injection of 83 billion cubic feet (Bcf) exceeded analyst estimates by 3 Bcf

As shown by the chart below, after falling back into the middle of the five-year average range of storage volumes beginning in January, storage volumes are now at or above the top end of the five-year range.  April is the start of the shoulder season for natural gas demand.  That means demand is low because winter is over and the air conditioning load from hot summer weather has yet to arrive.  Industrial and commercial gas demand remains weak as the economic recovery is advancing at a slower than desired pace.  But the bigger problem is the continued high level of gas-related drilling, especially in the gas shale basins. 

The bigger problem is the continued high level of gas-related drilling, especially in the gas shale basins

There are many pressures on oil and gas companies to drill their gas shale leases even in the face of weak natural gas prices.  The need to hold the leases for which many of the companies have spent large sums of money is one pressure.  Another is to use the money raised on Wall Street or through joint ventures and/or creative financing ventures.  Lastly, the companies have pledged to investors that they will grow their production volumes at above-industry growth rates.  As a result, when we examine the pattern of changes in rigs drilling

Exhibit3"

for natural gas and rigs drilling horizontal wells compared to the trend in natural gas futures prices, we see why the industry seems reluctant to slow down its drilling.

Exhibit4"

So far in 2010, there has been only one week in which the number of rigs drilling for natural gas fell.  The drop was 17 rigs, but the following week two of those rigs went back to work.  Admittedly there have been several weeks when the additions to gas-oriented drilling were only one or two rigs, but on balance there has been little slowdown in gas drilling despite low gas prices.  In fact, over the first four months of this year, there have been 199 additional gas-focused drilling rigs put to work, or a 26% increase in activity.

Over the first four months of this year, there have been 199 additional gas-focused drilling rigs put to work, or a 26% increase in activity

The science for successful gas shale development marries the technologies of horizontal drilling with multiple fracturing intervals in each well, all designed to maximize the amount of the formation exposed and crushed to release its trapped gas.  If we look at the change in horizontal rigs working we get a partial picture of what is happening in the gas shales, but the advent of increased horizontal drilling for crude oil has muddied the comparison.  As the chart below shows, there have been two weeks in 2010 with declines in the number of horizontal rigs working – one week with a five-rig decline and another with a one-rig drop.  Between the start of 2010 and the end of April, the horizontal rig count increased 194, or a 34% increase.

Exhibit5"

As long as natural gas producers believe their finding and development costs for gas shale reserves are below $4 per Mcf, the current futures price, they will continue to drill.  One begins to question whether E&P executives are addicted to drilling and will need an "intervention" by their shareholders in order to break their habit.

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

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