Natural gas

[MahOyster]

I think that natural gas companies resemble a lot with shipping companies. They have to invest a lot of money and then they need a breakeven daily rate (or long term fixed contracts) to stay afloat.

 

Gas companies are very shy in stating their breakeven gas price. Why is that, why are they shy? May breakeven be in the $7 range? Would providers of capital run away if the breakeven would be discussed openly by these companies?

 

I tend to believe Berman is knowledgeable and that $7 he suggests could be a realistic treshold.

 

I would be curious to see the IRR's per well/company for shale gas operators. CHK for instance consumes capital like donuts. What is the real value of their assets? (a bear (realistic) approach/analysis here: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/19220)

[petec]

I'd say there are two key differences.  1) After you stop spending capital, ships take longer to rust than gas supply takes to decline.  So overrsupply of gas will be addressed by falling supply but the same cannot be said of shipping.  2) Gas demand is price elastic, as we can see from power and transport switching etc.  Is shipping price elastic?  I think not - I think people ship when they need to ship, regardless of price, and don't when they don't need to.  So shipping is much more macro-driven.

 

I think this means gas cycles reset quicker, meaning gas prices come to the marginal cost of new production quicker, meaning low cost producers get to make >their cost of capital most of the time.

 

Not all companies are shy about breakevens: UPL and Peyto, which have been mentioned here and are the only two I follow, are but very clear about it.  But they are low cost, so no need to be shy ;)

 

As a UPL holder I will be delighted if Berman is right and $7 is breakeven, but I don't think he is.  That presentation was notably short on detail and I suspect $4-5 is the likely breakeven with $6 as a top bound.  But I'm guessing.

[bathtime]

Re: Berman. I was convinced he's off the mark after watching the Natural Gas presentation at the Milliken institute elsewhere on this board. There was consensus that his view is incorrect. The rep from BP Capital basically said, look, we've seen more data on production than just about anybody, that thesis is just not true.

[MahOyster]

There is so much enthusiasm about shale gas. ... capital availability for gas companies was not an issue with gas prices above $4. And the supply was/is acclaimed by the public as ever growing rather than diminishing. Berman details his view here: http://www.theoildrum.com/node/8212.

 

His voice sounds rational and probably that when the availability of capital drys out some carnage will occur  for all those companies whose breakeven is above market prices.

 

... unless gas prices go up sooner rather than later... which may renew the frenzy.

 

The BP Capital consensus view (just like Berman) may be wrong. Nevertheless, his study is convincing - his point is not made out of thin air but reasoned.

 

[txlaw]

Article on European fracking bans.

 

http://www.bloomberg.com/news/2012-05-23/european-fracking-bans-open-market-for-u-s-gas-exports-1-.html

[tyska]

Article on European fracking bans.

 

http://www.bloomberg.com/news/2012-05-23/european-fracking-bans-open-market-for-u-s-gas-exports-1-.html

 

One reads stuff like that and wonders if Europe has any hope of finding a way out of it's other messes. Just stick with what we are doing and expect a different outcome must be the motto.

[gokou3]

So, with no fanfare, US natural gas is up $1 / MCF from its bottom.... that's 50%.. although many producers are still losing money at this price.

[bmichaud]

Nat gas at $8 soon?

 

http://www.forbes.com/sites/richardfinger/2012/07/22/were-headed-to-8-00-natural-gas/

[ExpectedValue]

Nat gas at $8 soon?

 

http://www.forbes.com/sites/richardfinger/2012/07/22/were-headed-to-8-00-natural-gas/2/

 

The author of that post references the low gas rig counts which is likely a mistake. You have to differentiate between dry gas rigs and then also rigs in liquids rich and oily plays. Liquids rich plays will still produce a ton of gas, oily plays do as well -- and worst of all, the economics of the associated products make it so you can dump the gas at ultra low prices (say $0.50 per mcf in the Permian) and still earn your required rate of return from the well.

[bmichaud]

Nat gas at $8 soon?

 

http://www.forbes.com/sites/richardfinger/2012/07/22/were-headed-to-8-00-natural-gas/2/

 

The author of that post references the low gas rig counts which is likely a mistake. You have to differentiate between dry gas rigs and then also rigs in liquids rich and oily plays. Liquids rich plays will still produce a ton of gas, oily plays do as well -- and worst of all, the economics of the associated products make it so you can dump the gas at ultra low prices (say $0.50 per mcf in the Permian) and still earn your required rate of return from the well.

 

 

True, but the storage numbers are quite interesting:

 

After Thursday’s numbers were released inventories stood at 3.163 Trillion Cubic Feet or 19.2% above last year but only 17.5% above the five year average. A seemingly decent cushion until you consider as recently as May 10 stockpiles were 48.4% and 49.9% ahead of the previous year and the five year averages respectively.

[petec]

Associated gas is ~14% of production so I am not sure it is as significant as some say.  What's more important is that the number of wells drilled per rig has risen a lot as operators have gotten better rigs and figured out how to use them better.  Even so, I agree with the thrust of the article.

 

By thw way, does anyone know what this sentence refers to?  "A national fueling system is near completion with locations along the major interstate arteries."  I am aware that some locations have been built but this makes it sound like a major, co-ordinated effort.

[ExpectedValue]

Associated gas is ~14% of production so I am not sure it is as significant as some say. 

 

Do you have a citation for that?

 

I looked at this back in April and found that only 33% of production was coming from dry gas, with up to 40% coming from wet gas and the remainder from casinghead gas.

[twacowfca]

Associated gas is ~14% of production so I am not sure it is as significant as some say.  What's more important is that the number of wells drilled per rig has risen a lot as operators have gotten better rigs and figured out how to use them better.  Even so, I agree with the thrust of the article.

 

By thw way, does anyone know what this sentence refers to?  "A national fueling system is near completion with locations along the major interstate arteries."  I am aware that some locations have been built but this makes it sound like a major, co-ordinated effort.

 

No details, but it's a major investment of about $40,000 for a big truck to be able to burn natural gas. 

There are a few major long distance routes where there is development of nat gas fueling stations to make this economical for big trucking lines.

[txlaw]

By thw way, does anyone know what this sentence refers to?  "A national fueling system is near completion with locations along the major interstate arteries."  I am aware that some locations have been built but this makes it sound like a major, co-ordinated effort.

 

It sounds like the guy is referring to the Boone Pickens sponsored venture, Clean Energy Fuels. 

 

They're building out a network of nat gas fueling stations for big trucks.

See http://www.cleanenergyfuels.com/buildingamerica.html

[sculpin]

There definitely are increasingly positive signs for NG - the 2 most respected Calgary based I banks in Canada (First Energy & Peters & Co) are beginning to turn bullish on NG looking into 2013. NG has been in a long drawn out bear market for the last 4 years. I have written a report on a distressed NG stock that I own that has assets highly levered to a upturn in the NG price - will post this on the investments idea board when I get some more comments back from the Company & others with additional industry knowledge. Here are a couple of comments from both FE & Peters & co....

 

 

Quick summary of the FE report..

 

We provide an update of our tipping point estimate - the

U.S. gas rig count required to bring U.S. domestic gas supply

growth to a halt. At 520 gas rigs, we believe that this is

much lower than the figures implied by other Street analyses,

but that market is now much closer to seeing a more

negative natural gas supply picture begin to emerge for

the United States.

 

Key conclusions from this research note include:

 

• The market remains increasingly impatient for signs of a

downturn in U.S. domestic natural gas supply.

 

• We compute that the U.S. rig count is at or near the tipping

point of 520 dedicated natural gas rigs, which is that

rig count needed to bring U.S. domestic supply growth to

zero.

 

• Given our tipping point estimate, we expect that U.S.

domestic natural gas supply will begin to show flat to

negative year-over-year supply changes in the next few

months, setting the market up for a strong price rally

heading into 2013.

 

Text from a research piece from Peters & Co.

 

Continuing with our theme of late that you should be bullish on natural gas (my special email update calling for a “historic bottom” for TOU, CLT, PEY on April 25th looks pretty good right now…), you’ll see that the large storage surplus that we had at the beginning of the injection season continues to be worked off in a hurry. This is due in part to record power demand, fuel switching and decreased gas volumes (at least in Canada…US has been flattish but declines will take over). There continues to be next to no money spent on natural gas at the moment. In Alberta, there were 12 gas wells drilled in all of June and pipeline receipts have fallen by over 10% since January (a change of ~2 BCF/d). In my opinion we are looking at a market that is coming quickly into balance, and at this rate we will probably be looking at a YOY storage DEFICIT at some point this winter. As natural gas is a market that loves to overshoot in both directions, don’t be surprised to see prices recover much faster than you might think. Natural gas is a market that is littered with price spikes…and the next one is coming.

 

[petec]

Sculpin, shhhh!  All this positivity makes me bearish!

 

TariqAli, I can't remember the exact source - will try to dig it out - but it was a sell-side broker.  (Should I be shot for talking to them?  At least it wasn't Tilson...)

[sculpin]

RECORD NUMBER OF COAL-FIRED GENERATORS TO BE SHUT DOWN IN 2012

Daily Caller

 

Facing declining demand for electricity and stiff federal environmental regulations, coal plant operators are planning to retire 175 coal-fired generators, or 8.5 percent of the total coal-fired capacity in the United States, according to an analysis by the Energy Information Administration (EIA).

 

A record-high 57 generators will shut down in 2012, representing 9 gigawatts of electrical capacity, according to EIA. In 2015, nearly 10 gigawatts of capacity from 61 coal-fired generators will be retired.

 

While many of those coal plants are old and relatively inefficient, the scope of this new planned shutdown is unprecedented.

 

"The coal-fired capacity expected to be retired over the next five years is more than four times greater than retirements performed during the preceding five-year period," EIA noted in the analysis.

 

The generators that will be retired between 2012 and 2016 are "approximately 12% more efficient than the group of units, on average, that retired during 2009-2011," according to the EIA.

 

The low price of natural gas resulting from the shale boom has led to reduced coal consumption and made the shutdowns necessary, experts say.

But federal and state regulations have also damaged the industry and contributed to plant closures.

 

"The cost of compliance with anticipated and existing Federal environmental regulations such as the Mercury and Air Toxics Standards (MATS) is a factor," the EIA noted. "Particularly in the case of older, smaller units that are not used heavily, owners may conclude it is more cost efficient to retire plants rather than make additional investments."

 

Most of the coal-fired generator retirements will occur in the Mid-Atlantic, Ohio River Valley and the Southeast.

[kevin4u2]

I frequent this board and feel like I should contribute more given how much Parsad puts into this forum. 

 

Anyway, it looks like NG drilling has definitely bottomed.  Exploratory drilling for NG was zero for May and June in the US.  This is remarkable since exploratory drilling is has never been this low.  In fact only 14 exploratory wells have been drilled since March of this year.   

 

Development drilling for NG was 396 wells in June.  This is below the level many believe is needed to sustain current production.  It's also the lowest level in decades.  It really looks like the bottom for NG has to be near given that companies are realizing that low prices aren't going away unless they take action.

 

In comparison oil exploratory and development drilling are around 25 yr highs.  Oil production in the US lower 48 also hit a 23 year high in July.  So much for peak oil. 

 

I have attached graphs of each.

[Buddy0807]

The term "exploratory" as it relates to NAM shale gas is kind of confusing to me.  Nowadays, the extraction process is more like manufacturing.  You stick a horizontal drill in the ground (like anywhere these days) and boom you've got shale gas.  I tend to think of it like a faucet that producers can turn on and off with relative ease.  So while gas prices may indeed be close to a floor (or have already reached it earlier this year), I'm not sure it's as asymmetrically unballanced to the upside as many tend to think.  Basically, bc of the ease with which producers can ramp up production quickly if gas prices rebound, there also may a ceiling to prices. 

[kevin4u2]

The term "exploratory" as it relates to NAM shale gas is kind of confusing to me.  Nowadays, the extraction process is more like manufacturing.  You stick a horizontal drill in the ground (like anywhere these days) and boom you've got shale gas.  I tend to think of it like a faucet that producers can turn on and off with relative ease.  So while gas prices may indeed be close to a floor (or have already reached it earlier this year), I'm not sure it's as asymmetrically unballanced to the upside as many tend to think.  Basically, bc of the ease with which producers can ramp up production quickly if gas prices rebound, there also may a ceiling to prices.

 

Hi Buddy, you make a number of blanket statements that I hear quite a lot but perhaps I could make a few comments.

 

First, I think you are confusing exploratory with development drilling.  I presented both slides above.  Exploration has stopped while development continues albeit at decade low numbers.

 

Secondly, I agree much of the drilling is like manufacturing.  However up until this year many producers were only doing land retention drilling.  That means drill just to retain the land rights.  They didn’t care what the gas price was. 

 

Lastly, I agree more supply can be brought on but at what gas price and what cost.  It’s obviously higher than here given the drilling stats.  Many producers are losing money today. 

 

The best way to invest in this environment is to own the low cost operators.  And you won’t find out who that is from a corporate presentation.  Every CEO thinks they are the low cost operator.  I own the low cost operator in Canada and they are increasing their drilling right down because of the low service costs.  They are also profitable at these NG price levels.  Given the drilling response this is a firm bottom. 

[Buddy0807]

Sorry for the blanket statements...

 

Nope, not confusing exploration with development.  The lines are fairly blury onshore.  Just pointing out that onshore "exploration" is a substantially different process than offshore.  With onshore, you're just basically taking core samples and designing the appropriate fracturing cocktail.  I'm obviously being general...

 

Of course they care about the gas price.  To your point, there has been and still is acreage held by production (HBP) and therefore must be drilled to be retained.  But HBP drilling should be complete soon.  I've heard YE 2013 being thrown around.  Who knows for sure.  But the pig has moved pretty far through the python.  That'll clearly be a benefit gas price wise for those rigs force drilling dry gas wells, well assuming they stop... 

 

On your marginal cost comment, I'm personally not so sure.  Reasonable minds can disagree.  Two thoughts.  The first is associated gas.  I've heard recent estimates suggesting that onshore gas production can still grow at ~5% per year without drilling ANY gas wells.  And it's all because of associated gas produced from onshore oil drilling.  Second, low cost basins are driving the gas production growth.  The Marcellus (the gas portion) is meaningfully economic at $3.50/mcf.  The Eagle Ford dry gas makes around 10% IRRs in the ~$3s/mcf.  Service cost reductions have clearly helped with this but so have efficiency gains which are here to stay. 

 

One thing that's counter intuitively good for gas prices is there's very little incentive for producers to move their rigs back from onshore oil plays (well, assuming oil prices stay high).  The IRRs are so huge in onshore oil plays, much better than wet gas basins.  So it will take a serious rebound in gas prices to incent producers to reallocate rigs to dry gas basins (all things being equal and assuming sustained oil prices, lots of ifs). 

 

Sure, I agree that it's plausible that gas prices have hit a bottom.  I'm just saying that the upside to downside ratio might not be huge and possibly 1x1 as a result of several forces keeping a lid or ceiling on prices.  Basically, range bound. 

 

I agree that the low cost producers are the way to go if you want to play this thesis long-term.  I also personally like some of the more levered (as in financially levered) gas producer equities, sort of looking at them like options.

[Buddy0807]

Here's a summary of fairly interesting thoughts from a panel discussion on natural gas from a recent industry conference:

 

Upside to Current Strip:  The panelists believed there is limited upside to the forward strip through YE’13 but potential upside in ’14.  This is driven by an uptick in power generation demand in ’14 due to the construction of new gas power plants combined with a likely rolling over in gas production.  They were not surprised that gas production had not rolled over yet since there is a long lead time on pad drilling (6-9 months from initial drill dates to production and ultimately production decline) combined with associated gas growth and producers that are drilling their best dry gas wells to ensure economic returns. 

 

Gas Market Becomes Balanced at $4:  The panelists believe the gas market reaches balance at $4/Mcf.  When 12 month strip prices cross below this threshold, then producers reduce activity (witnessed during the fall of 2011).  At $5/Mcf, one panelist believed that conventional supply would come into the market.  As such, $5/Mcf is likely too high a price.

 

$5 Gas with a $3 Supply Cost is Equivalent to $100 Oil with a $60 Supply Cost:  Regarding the question of what gas price is necessary to redirect capital away from oil/liquids plays, one panelist stated that $5 gas with a $3 supply cost is equivalent to $100 oil with a $60 supply cost.  Therefore, at $5 it appears quite a bit of drilling activity will begin and significant gas supply can be unleashed.

 

Bullish on Demand:  The panelists were uniform in their enthusiasm for long term gas demand, specifically power generation driven by the construction of new gas plants combined with the future de-emphasis on coal-fired generation.  Regarding liquefaction, one panelist stated that they were not as optimistic given that politicians would prefer that the gas stayed domestic and at reduced prices to increase industrial employment.  Moreover, any argument regarding exporting gas would likely include an argument on the export of crude oil which would politically complicate the discussion and make securing export permits difficult.  The panelists were optimistic about long term industrial and transportation fuel demand—it will just take time to achieve robust gains in gas demand in these areas. 

 

Horizontal Gas Rig Count Should Move Lower:  One panelist expects the horizontal gas-directed rig count to decline by another 30-40 rigs and then flatten out.  The horizontal rig count declines will primarily be in the Granite Wash and the Eagle Ford.  This panelist expected the Barnett, Fayetteville and Haynesville rig count to flatten out from here and for the Marcellus rig count to have a slight upward bias next year.

 

New Liquids Plays Will Take Time:  The panelists are pursuing a number of new liquids plays and we specifically asked about the Tuscaloosa Marine Shale, Brown Dense, DJ and Montana Bakken plays.  For the TMS, the challenge remains to reduce well costs.  For the Brown Dense, one panelist stated that they are on the cusp of determining whether the play works or does not.  For the DJ and Montana Bakken, it is still early days and time will tell.

 

Lower Service Costs Ahead:  Both panelists expected lower service costs ahead in FY’13 (~10% lower across the board, fulcrum of the decline driven by frac).  The panelists expected E&P’s to have the upper hand on service costs for the next 2-3 quarters.  For FY’12, costs were expected to be down 12% in the Fayetteville and down 10% in the Marcellus.

 

Supply-Demand  Works:  One panelist reminded the audience that nothing cures low prices like low prices.  After having nearly 900 bcf of surplus gas in storage at the end of March ’12 relative to last year , this surplus has been cut in half and should fall further as lower gas prices stimulated much better than expected power generation demand.

 

Longer Term the Oil-Gas Spread Should Narrow:  Gas has too many benefits (cleaner burning, cheaper than coal and oil), as such the extreme spread between oil and natural gas should be reduced over time.  While the current spread of 35 to 1 is too high, 6 to 1 is likely not feasible either.  The panelists believed the right answer would be somewhere around 15 to 1.

 

[kevin4u2]

Thanks for the notes from the conference.  Much appreciated. 

 

[gaf63]

Thanks for posting the NG info from the conference, G

[txlaw]

Link to NERA report on US nat gas exports that was commissioned by EIA:

 

http://www.fossil.energy.gov/programs/gasregulation/reports/nera_lng_report.pdf