Must-know: Natural gas rigs likely to keep falling off in 4Q13

Market Realist

Why rig counts will trend lower in 4Q13 (Part 3 of 3)

(Continued from Part 2)

Natural gas rig counts increased slightly last week

Baker Hughes, an oilfield services company, reported that rigs targeting natural gas increased slightly last week, to 372 from 369 for the week ending October 18. Natural gas rigs drilling are up 5% since lows in early July, but are down 15% from the beginning of 2013.

Despite rising natural gas prices earlier this year, natural gas rigs had decreased

The rig count had largely been decreasing throughout early 2013, even as prices had experienced a strong rally from $3.15 per MMBtu in mid-February to ~$4.40 per MMBtu in mid-April. Natural gas currently trades around $3.60 per MMBtu. The drop in rig count from February through April could have signaled that despite the strong rally, natural gas prices of over ~$4.00 per MMBtu still aren’t high enough to incentivize producers to shift significantly more capital towards natural gas and that there’s no compelling reason to increase natural gas rig counts.

However, natural gas rig counts had risen ~5% since early July despite relatively weak prices of between $3.30 per MMBtu and $3.80 per MMBtu during that period. This could perhaps signal that companies expect natural gas demand to pick up, or have more capital to spend on natural gas drilling, or possibly that natural gas rigs have become cheaper to contract out and therefore more are being used right now.

Natural gas rigs likely will decline in 4Q13

Altogether, though, with natural gas currently trading around ~$3.60 per MMBtu, there isn’t much of a catalyst for natural gas activity to pick up significantly from current levels. Plus, on Baker Hughes’ (BHI) 3Q13 earnings call, management noted that it expects natural gas rigs in 4Q13 to average 340, about 9% lower than current levels, with the drop in rigs due both to normal seasonality in winter months and increased efficiency allowing upstream names to produce more with fewer rigs.

Background: Natural gas rigs have fallen sharply over the past few years, also due to low prices

From a longer-term perspective, natural gas rigs have been largely falling or flat since October 2011 in response to sustained low natural gas prices (see the natural gas price graph below).

Natural gas rigs drilling can indicate the sentiment of major natural gas producers such as Chesapeake Energy (CHK), Comstock Resources (CRK), Southwestern Energy (SWN), and Range Resources (RRC).

Natural gas rigs increased slightly last week, but they’re down ~15% since the beginning of 2013

Given current gas prices, there doesn’t seem to be a strong incentive to increase natural gas drilling activity. However, note also that natural gas rigs had remained roughly flat for most of May and June, despite some price volatility. This may also signal a bottom, or reflect the bare minimum of capex that upstream companies are willing to spend on drilling gas at the moment.

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