Understanding the natural gas market is not for the faint hearted. Natural gas production recently returned to record levels last seen before prices fell through the floor. How could that happen in the face of record storage levels? It’s all par for the course - in a world where the threat of a major Hurricane no longer impacts the price of natural gas (NYMEX Natural gas closed down 4 cents at $2.614 yesterday). Today we will look at buoyant natural gas production levels.
Yesterday our friends at Bentek reported that last week’s average US gas production was 64.5 Bcf/d - close to the all time high of 64.7 Bcf/d set in November 2011. Natural gas in storage continued to set records. Last week the Energy Information Administration (EIA) reported a 47 Bcf storage injection - leaving total storage at 3.308 TCF - 400 BCF above last year’s level at this time. During August NYMEX natural gas prices have retreated again to $2.614/MMbtu after rallying over $3.00/MMbtu in July. Prices have fallen 13 percent year to date.
Why is gas production at record levels even though storage is higher than ever and prices are weak? Didn’t all the drilling switch to wet gas plays? Gas production should be in retreat until prices get back to $5.00/MMbtu right? As is so often the case in the world of shale gas these days, what is actually happening is not what you would expect to be happening. Take gas production for instance. The data shows (see chart above) that US residual or dry gas production has been growing steadily since the start of the shale gas revolution in 2005. The rate of increase in production took off in 2010 and continued through 2011 - only retreating in the first quarter of 2012 as prices fell below $3.00/MMbtu in January and then below $2.00 in early April. If ever there was a time to put the brakes on and stop producing more gas – that was the time.
However, seemingly in defiance of common sense - production has picked right back up again since then and returned close to record levels. The chart below shows a close up of this year’s production (Bentek numbers) using a 30-day average to smooth out the noise. You can see that production has risen since the start of July, appeared to stall in mid-August and then increased again in the past two weeks. These step-like increases in production likely reflect infrastructure (gathering systems) coming online to provide new takeaway capacity.
You might be forgiven for thinking that all of this new production is wet gas and “associated gas” from crude oil plays. Drilling rigs have certainly migrated to both liquid rich and crude oil plays, although some of that associated gas (for example in the Bakken) is being flared in the absence of infrastructure. Actually however – a lot of the new production coming online is from dry gas basins – especially the dry (Northeast Pennsylvania)Marcellus - where drilling continues as pipeline and fracing crew infrastructures free up a backlog of wells waiting to produce. Marcellus production this month (August 2012) is averaging over 5.9 Bcf/d, 80 percent higher than a year ago. As new infrastructure is completed more wells are fraced and put into production as soon as the gas can be delivered to market. Bentek reports another 0.5 Bcf/d of Marcellus production will be brought online in September after gathering line expansions are completed.
It is true that the number of rigs drilling for natural gas has declined since 2010. The chart below shows the Baker Hughes drilling rig counts for natural gas (red line) and crude (blue line) since 2005. After gas prices started to fall following the recession (in 2009) and as crude oil prices stayed higher, the return on investment for liquids targeted drilling became far more attractive. As a result, the crude oil rig count has increased from 200 in mid-2009 to 1,408 today. After peaking at 1000 in 2010, the gas drilling rig count has fallen back to 486. However dramatic improvements in drilling rig productivity have sustained increases in gas production in spite of the lower rig count (see “Natural Gas Rig Count – Production and Productivity”).
The challenge with continued high gas production is going to be finding the demand to consume the extra gas. Natural gas demand did pick up in 2012 – in particular the roughly 4.8 Bcf/d of increased power burn as gas prices fell below coal encouraging coal to gas generation switching. Seasonal power burn increases will likely taper off in September as temperatures fall and peak generation declines. This year’s increased power burn does appear to have allowed gas storage to dodge the “full to capacity” bullet this season at least. Analysts seem to agree that total working gas in storage is now unlikely to hit 4 Tcf by the end of October or early November.
Natural gas power burn will continue to be a growing source of new gas demand. New demand will come at the expense of coal plant retirements over the next four years. Plant owners and operators reported to EIA in July that they plan to retire almost 27 gigawatts (GW) of coal fired generation capacity between 2012 and 2016. That amounts to 8.5 percent of total 2011 coal-fired capacity. The coal plants are being retired to avoid the cost of retrofitting them to meet new emissions standards. The retired coal plants will either be replaced by new natural gas combined cycle gas turbine (CCGT) plants or by increased use of existing CCGT plants.
US production will also continue to push out Canadian imports as we have discussed here before (see “Border Wars – Will Bakken Producers Muscle Out Canadian Gas”). Another avenue for new demand is pipeline gas exports to Mexico already at 1.8 Bcf/d and growing fast. An increase in industrial demand for natural gas is also expected to result from new refining, petrochemical and processing infrastructure being built to handle increased natural gas, natural gas liquids and crude oil production in the US. In the longer term the greatest hope for new demand (if the regulators play ball) lies with planned liquefied natural gas (LNG) terminals set to start coming online in 2016 (see “Export Boom or Import Echo – Do US LNG Export Schemes Make Sense?”).
So until storage levels hit capacity or prices fall to levels where producers are forced to abandon their drilling programs – you can expect to see production continue at record levels. Although increased power burn, industrial consumption and exports to Mexico will increase demand the market is likely to remain in a precarious supply/demand balance over the next few years. Of course there will be occasional disruptions – such as hurricanes shutting in Gulf of Mexico production or a freezing spell shutting down gathering systems. However, if this week’s evidence is anything to go by, the market will feel comfortable that supplies are sufficient to cushion such blows. After all if a Hurricane bearing down on the coast of Louisiana can’t raise the price of natural gas, you have to wonder what can?
