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Why are 2014 natural gas rig counts down 15% year-to-date?

Ingrid Pan, CFA

Strong oil activity continues to drive higher US oil rig counts (Part 2 of 3)

(Continued from Part 1)

Natural gas rigs drilling continued to decline last week

Baker Hughes, an oilfield services company, reported that rigs targeting natural gas continued to decline, falling from 326 to 318 for the week ended March 28, 2014.

Natural gas rigs are down 54 since the beginning of the year, a decrease of ~15%. Note that Baker Hughes stated on its last quarterly earnings call that it anticipated that 2014 would exit with U.S. natural gas rigs drilling totaling ~360, above current levels. Most of the decline in gas rigs was from the Cana Woodford (-11), the Eagle Ford (-11), the Marcellus (-9), the Permian (-6), and areas that Baker Hughes classifies as “Other” (-18). Meanwhile, drilling rigs targeting gas increased by 6 in the Granite Wash.

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

Through 2014, natural gas rigs fell from 372 to 318, a drop of 15%, and natural gas rigs declined throughout 2013 as well, from 439 to 374. From a long-term perspective, natural gas rigs have been largely falling or remained flat since October 2011 in response to 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.

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 (see Why natural gas prices rose 4% on the week), prices remain relatively low from a long-term historical context. Oilfield service company Halliburton noted, “Continued strength in natural gas prices could provide some upside potential, but we are not optimistic there will be a meaningful uptick in gas activities in the near-term.” However, if prices remain elevated or rally further, it’s possible that upstream energy names could be spurred to increase natural gas drilling activity.

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. 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 to 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, and natural gas prices remain relatively low (despite a recent rally), there doesn’t seem to be a very strong catalyst for natural gas rig activity to increase.

Continue to Part 3

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