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Natural gas production is growing while rig counts are slipping

Ingrid Pan, CFA

Must-know: US oil rigs increased while natural gas rigs decreased (Part 3 of 3)

(Continued from Part 2)

Natural gas rigs continued to slide, and were down 18% compared to the same period of 2013

Baker Hughes, an oilfield services company, reported that rigs targeting natural gas dropped last week, from 372 to 357 for the week ended January 10, 2014.

Through 2013, natural gas rigs have fallen from 439 to 372, a drop of 15%. Natural gas rigs fell most in the Marcellus Shale (-11), the Granite Wash (-19), the Barnett Shale (-12), and the Fayetteville Shale (-4). Natural gas rigs rose most in the Mississippian (+8) and the Utica Shale (+15).

Background: Natural gas rigs have fallen sharply over the past few years, 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). Falling gas prices can spur producers to stop drilling for natural gas.

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). If prices rally significantly or producers can significantly lower cost curves even further, that could be an impetus for natural gas rigs and natural gas drilling to increase. However, current depressed prices remain a major factor to slowing natural gas targeted drilling.

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

As we discussed above, natural gas rigs have been falling since mid-2011. However, natural gas production has climbed since then. This trend has been due to a combination of several factors. Firstly, 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 to contribute to natural gas production. Another factor contributing to growing natural gas 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 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 these wells profitable.

Natural gas rigs didn’t decline as much as forecasted in 4Q13

On Baker Hughes’ (BHI) 3Q13 earnings call, management noted that it expects natural gas rigs in 4Q13 to average 340, 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. Natural gas rigs drilling actually averaged 370, compared to the forecast of 340 and 3Q13 average natural gas rig counts of 380. One factor that may have helped support natural gas rig counts is that natural gas prices had a strong rally over 4Q13, rising from ~$3.50 per MMBtu in late September to current prices of ~4.05 per MMBtu. For more on natural gas prices, see Why natural gas prices fell 6% last week.

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