Why near-term natural gas rigs won’t increase at current prices

Market Realist

Natural gas rig counts were relatively unchanged last week

Baker Hughes, an oilfield services company, reported that rigs targeting natural gas increased very slightly last week, to 378 from 376 for the week ending October 4. Natural gas rigs drilling are up 6% since lows in late June and early July, but they’re down 14% from the beginning of 2013.

(Read more: Chesapeake Energy and its former CEO suggest huge Utica potential)

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 (millions of British thermal units) in mid-February to ~$4.40 per MMBtu in mid-April. Natural gas currently trades around $3.70 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 ~6% 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.

Altogether, though, with natural gas currently trading around ~$3.70 per MMBtu, there’s little incentive for producers to significantly increase natural gas drilling activity.

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).

(Read more: Introduction [PART 1])

Natural gas supply and prices are major drivers of valuation for natural gas producers such as Chesapeake Energy (CHK), Comstock Resources (CRK), Southwestern Energy (SWN), and Range Resources (RRC).

The number of rigs drilling can reflect producer sentiment

The number of rigs drilling for natural gas can indicate how companies feel about the economics of drilling for natural gas. More natural gas rigs drilling generally means companies feel bullish on the natural gas environment. Plus, rigs drilling can also show future supply, as more rigs drilling implies more production. So market participants monitor rig counts to get a sense of oil and gas producers’ sentiment and as a rough indicator of future expected supply.

Oilfield service companies aren’t overly bullish on US rig counts for the rest of 2013

Most major oilfield service companies commented that they expect US rig counts (including both oil and gas) to remain flattish for the balance of the year. Companies such as Halliburton (HAL) noted that the driver of this trend is a switch to pad drilling (drilling more than one well on a single well site), which requires fewer rigs running to drill the same number of wells. However, this doesn’t translate into weak activity or a negative signal necessarily.

Halliburton noted, “In spite of a relatively flat sequential U.S. rig count, drilling efficiencies in the trend towards multi-well pads are driving a more robust well count.” Producers are still eager to drill wells, and even if rig counts are flat, other services such as well completion are still needed, providing revenue to oilfield service names in the situation of higher well counts. See Higher well count and stage count helping US fracking market for more background. In recognition of this need, as a service, Baker Hughes has begun to report well counts alongside rig counts.

Natural gas rigs were relatively unchanged last week, and they’re down ~14% 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.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part II))

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