Is Natural Gas Too Cheap to Drill? – By Matthew Philips

No Comments » April 17th, 2012 posted by // Categories: Energy Development Project




Is Natural Gas Too Cheap to Drill?

By  on April 17, 201

The price of natural gas is right around $2 and even traded below that level for the first time in a decade on April 11. Since peaking at $10 per 1,000 cubic feet in June 2008, natural gas prices have steadily declined as new horizontal fracking techniques have unlocked massive amounts of shale gas. As prices have declined, so has the number of operating gas rigs. There were only 624 operating in the U.S. as of April 13, the fewest since April 2002, according to Baker Hughes (BHI), a Houston oil- and gas-services company. Gas rigs have been disappearing particularly fast since late October, the last time prices were above $4.

Essentially, gas is so cheap that it’s no longer profitable to drill.

“Producers typically need $5 [per 1,000 cubic feet] to break even,” says David Greely, an energy analyst atGoldman Sachs (GS). The industry hasn’t seen prices consistently over $5 since September 2010, back when there were nearly 1,000 rigs operating in the U.S. The number of gas rigs peaked near 1,600 in mid-2008, when prices peaked at $10. (The boom was effectively confirmed in June 2009, when a Colorado School of Mines report showed that U.S. natural gas reserves were 35 percent higher than previously estimated.)

Other analysts say $5 is too high and that the average gas producer can still make money with the price between $3 and $4, depending on the well because different types of wells have different cost structures. Newer, high-production wells can turn a profit even with prices below $2, while older wells that are just trickling out gas need much higher prices to make money. That’s probably why there’s been stronger demand for horizontal rigs that specialize in fracking. Even those numbers have started to diminish in the last couple weeks.

Still, a fair amount of activity persists in the field. Low borrowing costs have helped spur a healthy appetite to invest in gas drilling despite low prices, with a lot of funding coming from equity markets and in the form of joint ventures. According to Greely, producers have continued drilling, despite low prices, in an effort to expand volume and hold on to leases, which require that they continue drilling.

With weather unseasonably warm this winter across most of the nation, demand for natural gas fell off precipitously, leading to a huge rise in surplus storage—from less than 100 billion cubic feet in December to nearly 900 bcf last week. “The primary driver of low prices right now is the lack of winter and lack of demand,” says Craig Shere, a natural gas and utility analyst at New York-based energy research firm Tuohy Brothers.

While many analysts believe natural gas prices will remain depressed through the rest of the year, Shere feels that the market is overly bearish about the price of gas, discounting in particular the longer-term production declines from falling industry capital expenditures, as well as increased demand from power plants that are switching from coal to gas. The U.S. Energy Information Administration (EIA) expects demand for natural gas from the power sector to increase by 9 percent this year.

“We’re seeing switching levels that no one imagined,” says Shere. As a result, gas will supply more of the electricity generated during the hot summer months than its customary 25 percent. Couple that with expected lower production rates in the coming months, and Shere believes supplies will tighten before the end of the year. “We will eat off this excess storage and prices will rise as a result.”

Philips is an associate editor for Bloomberg Businessweek.
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