Natural gas may need epic price collapse

April 3, 2012 04:33 AM
The Natural Gas Rout

There is no doubt in anyone’s mind that the natural gas market has taken a beating. But is the rout almost over or has it just begun? In what could turn out to be a historic swoon, it is clear that at some point something has got to give. The natural gas market is running out of space to put supply and the system will soon get clogged so it is becoming more obvious that the only thing that can fix this market is perhaps an epic price collapse. We have to get gas out of the system and based upon current production rates, it is clear that producers are not getting the message. Some producers of course do not care as the price of oil makes it possible to get rid of the gas for nothing. Yet wondering where this market will be in a few weeks just boggles the imagination.

The glut comes as the fracking revolution just continues to exceed supply expectations. The AP reports that, “Natural gas wells using the drilling method known as hydraulic fracturing are producing at a much higher rate than traditional wells, according to the first look at production figures from nine active wells in the Utica Shale formation in eastern Ohio. Figures reported Monday by Oklahoma City-based Chesapeake Energy Corp. show five wells in eastern Ohio producing 2.6 billion cubic feet of natural gas in 2011. The other four wells produced hundreds of barrels of oil but are not in natural gas production yet, according to Chesapeake. The report, which Chesapeake provided to the Ohio Department of Natural Resources, shows one well in Harrison County producing 1.5 billion cubic feet of natural gas, or 2% of the state's entire natural gas production. Put another way, that well has 300 times more in daily production than the average well drilled vertically into the ground," said Rick Simmers, chief of ODNR's Division of Oil and Gas Resources Management.”

Reuters reported that Baker Hughes data on Friday showed the gas-directed rig count rose by six to 658 after hitting a 10-year low of 652 the prior week. It was the first gain in the gas rig count in 12 weeks. The steady drop in dry gas drilling this year, the gas count is still down nearly 30% since peaking at 936 in mid-October, had stirred expectations that low gas prices would finally force producers to curb gas output and tighten supplies. But the drop has yet to be reflected in pipeline flows, which are still estimated to be at or near record high levels, primarily due to rising output from shale. U.S. Energy Information Administration production data last week offered little hope for the bulls, with January gross gas output climbing to a record of 72.85 billion cubic feet per day, eclipsing the previous peak of 72.68 bcfd in November. The slight drop the agency reported for December, the first measurable decline since well freeze offs curbed output in January and February 2011, had raised expectations that producers might finally be curtailing output.

Even if you were thinking that new EPA rules on fracking would give the market a chance to rally you had better think again. The Wall Street Journal reported that, "The Environmental Protection Agency postponed its first rules aimed at reducing air pollution from oil and natural-gas wells drilled by hydraulic fracturing, following a last-minute push by energy companies to weigh in on the new standards. The EPA said in a statement Monday it is postponing the rules by two weeks to April 17. The EPA said it needs more time to digest more than 150,000 comments submitted on the rule."

Now the big problem is where to store the gas. According to the Vancouver Sun, "storage capacity in the United States is already at 60%, with injections into storage being recorded in March for the first time since 1977. Analysts expect U.S. storage will start the traditional injection season April 1 with levels approximately 850 bcf higher than 2011 at 2,460 bcf, eclipsing a previous record set in 2006.The early start to injection season will have serious implications for U.S. natural-gas working capacity, which will be tested in the coming months, said oil and gas analysts Bentek Energy. "Assuming natural gas injections mimic last summer, the trajectory would imply inventories of 4,698 bcf by November, which is 220 bcf higher than total U.S. design capacity," Bentek said in a report this week.”

The bottom line is that this market needs a price shock to the downside to fix what can be a disaster for the storage and pipeline system. One way to approach this market is to buy puts as this sell off could stun us.

The Wall Street Journal reports that Encana Corp. is seeking partners to speed the development of more profitable oil and liquids-rich gas properties in North America, its latest shift as it struggles with low natural-gas prices. The Calgary-based gas producer — Canada's largest and North America's second-biggest by volume after Exxon Mobil Corp. — said it is shopping minority stakes to potential partners to help it develop some 1.6 million acres in five oil and liquids plays.  The fields are in Mississippi, Louisiana, Michigan, Texas, Oklahoma and Kansas and the Canadian province Alberta.  The company said, "It's premature to speculate on the size or value of any potential transaction." In January, Oklahoma City-based Devon Energy Corp. disclosed a similar joint-venture effort, selling minority interests in five oil-rich fields to China Petrochemical Corp. for $2.5 billion.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.