The problem becomes when we look deeper into the production estimates, we see that the volume decline was due to sharply lower Alaskan and Gulf of Mexico production. These volume changes can be large, but often are the result of specific events in these two markets. Natural gas price bulls have been counting on falling production for the Lower 48 land market, which is heavily influenced by shale drilling. The thesis for higher natural gas prices is based on the meaningful shift in producer focus from dry natural gas prospects in favor of shale oil and liquids-rich gas prospects. This race from dry gas to liquids has been underway for a while and actually accelerated during this year. In Exhibit 13 we have presented the oil and gas rig counts as reported by Baker Hughes (BHI-NYSE) since the last week in December 2011. During the eight months of 2012, the oil rig count has increased by 226, or 18.9%, while the gas rig count fell by 336, or 41.5%. Since these rigs are primarily located in the Lower 48 land region, one would have expected a greater impact on gas production.
So why hasn't gas production in the Lower 48 land region declined in pace with the fall in gas-oriented drilling rigs? The primary reasons reflect the large amount of gas associated with shale oil production, the focus on liquids-rich gas prospects that also produce larger than anticipated gas volumes, and the completion of previously drilled but uncompleted wells. This latter category of wells has always been an overhang for the natural gas market. These uncompleted wells were drilled during the rush to drill leases in order to hold them, but wells weren't completed as producers focused their limited capital on more economic wells and wells that proved up new producing areas. Now that much of the effort on defining the productive areas of shale basins is over, producers are going back to complete these previously drilled wells. Unless gas prices soar and stimulate producers to shift their drilling back to dry gas prospects, we expect gas production in the Lower 48 land market to drop in coming months. The questions will remain: how much and when?
Eoin Treacy's view As the evolution of the unconventional oil
& gas industry accelerates, the structure of the respective futures markets
are changing. However the point at which supplies become economic is a hard
fact appreciated by those exploiting various resources. When prices drop below
$3 a number of producers have a strong incentive to shutter production. This
should help to put a medium-term floor under the market and potentially cap
advances for as long as it takes new sources of demand to emerge.
Natural gas bottomed near $1.90 in April and has held a progression of higher reaction lows since. It bounced impressively this week from the region of the 200-day MA and a sustained move below S2.60 would be required to question medium-term scope for additional upside. (Also see Comment of the Day on July 23rd).
A number of natural gas explorers have fallen into financial difficulties as a result of paying too much for assets and not factoring lower prices into their budgets. Anadarko Petroleum (0.49%), Rexx Energy, EOG Resources (0.58%), Gulfport Energy, Noble Energy (0.93%), Southwestern Energy, Encana (3.52%), Apache (0.71%), Canadian Natural Resources (1.22%), Devon Energy (1.26%) and Chesapeake Energy (1.75%) all posted steep declines but found support earlier this year. They have mostly paused over the last month but broke upwards last week and have improved on that performance this week. Clear downward dynamics would be required to question potential for additional upside.
Enerplus Corp halved its dividend in July but still yields 6.62%. It has now rallied for 12 consecutive weeks and almost completely unwound its oversold condition relative to the 200-day MA in the process. A sustained move below $15 would be required to question potential for additional upside.