Why 2014 natural gas prices are higher but rig counts remain down

Market Realist

Why rig counts are 1 key way to gauge oil and gas activity (Part 2 of 3)

(Continued from Part 1)

Natural gas rigs were flat last week but have dropped significantly year-to-date

On May 9, Baker Hughes reported that natural gas rig counts remained flat week-over-week at 323—the second week in a row that natural gas rig counts were flat. Natural gas prices throughout 2014 are up significantly from last year, with 1Q14 prices averaging $4.72 per MMBtu compared to the 2013 average price of $3.73 per MMBtu (using the front month contract for Henry Hub natural gas).

Currently, natural gas is trading at around ~$4.40 per MMBtu. However, natural gas rigs have decreased throughout 2014. At the beginning of this year, natural gas rigs drilling totaled 372. The current natural gas rig count of 323 represents a drop of 49, or 13%. Most of the decline in natural gas rigs came from the Cana Woodford (-13), the Eagle Ford (-16), and other areas outside of the major classified plays (-16).

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

The drop in natural gas rigs year-to-date represents a continuation of a trend that has been ongoing since late-2011 when natural gas rigs topped 900. The drop has been driven by sustained low natural gas prices (see the natural gas price graph below). Low natural gas prices can spur producers to stop drilling for natural gas, as the economics of drilling natural gas wells become less and less attractive with lower natural gas prices.

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). Many of these names are also part of energy ETFs such as the S&P Oil & Gas Exploration & Production ETF (XOP). Despite the recent rally in natural gas prices, prices remain relatively low from a long-term historical context.

Regarding the U.S. natural gas, Baker Hughes commented on its 1Q14 earnings call, “Taking a look at natural gas, U.S. working gas in storage is currently 1 trillion cubic feet below the five-year average. Getting storage levels back to average before next winter’s drawdown, would require an addition of another 3 trillion cubic feet of gas. And that sort of addition would require injection levels to approach record levels every week between now and then. With gas storage at this level, prices are higher than many would have guessed only a few months ago. When coupled with favorable oil prices, this environment fares well for our customers’ cash flow and spending capacity.”

Background: Why natural gas rigs keep falling, but production continues to climb

As we discussed earlier, natural gas rigs have been falling since mid-2011. However, natural gas production has climbed since then. The EIA reported that for February 2014, natural gas production totaled 67.7 billions of cubic feet per day (bcf per day), up from 65.1 billions bcf per day. For reference, throughout 2011, natural gas production averaged around 62 bcf per day.

This trend has been due to a combination of several factors. First, while rigs targeting natural gas have declined, oil drilling has remained active. While companies have targeted oil, most oil wells also have significant natural gas production. So the increase in oil-targeted drilling has helped contribute to natural gas production.

Another factor contributing to the increase is the development of super-prolific areas such as the Marcellus Shale. Wells in the best areas of the Marcellus Shale have extremely high natural gas production rates, which have contributed to the supply by being so prolific and have also encouraged more drilling, as the cost per unit of production for such wells is very low and has made drilling them profitable. Given that natural gas production continues to climb despite declining-to-flat natural gas–targeted activity, natural gas rig counts will likely remain around current lows.

Continue on to the next part of this series to read about oil rig counts.

Continue to Part 3

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