09/12/2010 Star Telegram

2011 looks just as grim for gas firms

By Jack Z. Smith
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*Natural gas production has exceeded market demand, resulting in suppressed prices.

A year ago, optimistic natural gas producers were poised for a substantial rebound in prices in 2010. But prices have remained weak this year. Even worse, 2011 isn't looking any better.

The problem is "too much supply, pure and simple," said Marshall Adkins, managing director of energy research for Raymond James & Associates in Houston. In the still-weak U.S. economy, natural gas production has exceeded market demand, resulting in ample supplies in storage and suppressed prices.

Nevertheless, the number of rigs drilling for natural gas in both the U.S. and North Texas' Barnett Shale is up sharply from a year ago.

Nationwide, 977 rigs were drilling for gas in the first week of September, 39 percent more than the 701 active rigs a year earlier, according to Houston-based oilfield services firm Baker Hughes.

In the Barnett Shale, 94 rigs were drilling, up 28 rigs, or 42 percent, from 66 a year earlier, according to RigData.

Mark Caffey, CEO and owner of The Caffey Group in Fort Worth, said a substantial amount of Barnett rig activity is being driven by gas producers' need to drill wells to prevent expiration of leases for which they paid hefty prices back in 2007 and 2008, when gas prices were much higher.

Lease bonuses soared as high as $30,000 an acre in 2008, but bonuses in the range of $2,500 to $5,000 are now "pretty much the standard" in Tarrant County, said Caffey, who is involved in leasing, drilling and production in the Barnett.

In regard to gas prices, "I've got to tell you, I'm worried," Caffey said. "I'm worried that prices will stay at this level through 2011."

Gas prices soared above $13.50 per million British thermal units in July 2008 but soon began plunging. Since then, they have generally remained modest. Prices recently have been below $4, which producers say is too low to sustain robust drilling activity. Some producers say they would be content with a steady price of $6 to $7.

Pessimistic forecast
Raymond James, a financial services and investment banking firm, is "looking at a gas price hovering in the $3.75 to $4.25 range for the rest of this year," Adkins said. Prices will probably wind up averaging about $4.50 for all of 2010, but 2011 prices are likely to average only about $4.25, he said.
"We expect supply to continue to outpace demand through 2011," he said.

Technological advances in horizontal drilling and multi-stage hydraulic fracturing of wells in so-called unconventional shale gas, tight sands and coalbed methane plays have dramatically boosted U.S. gas production, Adkins said. The oil and gas industry "is continuing to expand into more shales," he said.

The quest for 'liquids'
Gas production has also increased because of heightened drilling in areas with an opportunity to recover "liquids" - higher-priced oil, condensate (essentially a light oil) and natural gas liquids that yield valuable ethane, propane and butane, Adkins said. As examples, he cited drilling in the Eagle Ford Shale in South Texas and the Granite Wash in the Texas Panhandle and Oklahoma, two plays that offer both natural gas and liquids production.

Scott Richardson, a principal of RRC Richardson Barr, a firm that assists in oil and gas acquisitions, said at a recent Dallas energy conference that "we really see companies focusing on liquids," a trend he said could go on "for the next several years." Producers "are pivoting toward oil ... either through acquisitions or through the drill bit," he said.

Oklahoma City-based Chesapeake Energy, a gas producer with a large Barnett Shale operation in Fort Worth, has said it plans to make a major shift toward greater oil production because crude prices are much more attractive than gas prices.

In the first week of September, 665 rigs were drilling for oil in the U.S., more than double the 295 active rigs a year earlier, according to Baker Hughes. In recent weeks, the U.S. oil rig count has been at its highest in more than 20 years.

Joint ventures
Despite low gas prices, U.S. shale-gas drilling also has been boosted by joint ventures of large foreign energy companies pursuing long-term goals with U.S. gas producers offering shale experience. Examples of such Barnett Shale matchups include French oil giant Total hooking up with Chesapeake Energy, and Italian oil firm Eni pairing with Fort Worth-based Quicksilver Resources. The foreign firms are providing huge cash infusions in exchange for stakes in Barnett operations and the chance to gain expertise in shale-gas drilling that they can apply elsewhere in the world.

Hedging factor
Some U.S. producers have continued drilling substantial numbers of gas wells because they previously hedged a sizable portion of their 2010 production. That allowed them to receive appreciably higher prices for their gas than today's market offers.

However, with gas prices remaining low this year and the pessimistic outlook for 2011, the prices that can be secured through new hedges are sharply lower. As older hedging contracts expire and producers have to settle for lower prices, the result is likely to be a significant decline in drilling, some analysts say.

Gas production apparently is already falling in the Barnett Shale. Preliminary data from the Texas Railroad Commission show that Barnett output totaled 871 billion cubic feet in the first six months of 2010, a decline from 906 billion cubic feet in the first half of 2009. The Barnett was the largest gas-producing area in the nation in 2009, outstripping the San Juan Basin of New Mexico and Colorado.

Ripple effect
Sustained low gas prices could dramatically affect other major energy operations, including coal-fired and nuclear power generation plants, some analysts say. Natural gas is a major fuel source for electricity generation in Texas and the U.S.; the lower gas prices are, the more attractive gas-fired power generation becomes.

John Rowe, the CEO of nuclear-plant operator Exelon Corp., said Thursday that he expects natural gas prices to remain low, potentially delaying construction of new U.S. nuclear plants by a "decade, maybe two," according to Bloomberg News.

Advocates of "clean coal" technology also have expressed concern that its development could be thwarted by inexpensive gas.

"We think natural gas will stay cheap for a very long time," Rowe told Bloomberg. "As long as natural gas is anywhere near current price forecasts, you can't economically build a merchant nuclear plant."

Merchant plants sell their power on wholesale markets without the assurance of adequate profit margins that some regulated electric utilities enjoy, and hence must compete with all other generators in their market.

Jack Z. Smith,
817-390-7724