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How the shale revolution has affected natural gas and natural gas producers

2013.01.27 - NG vs CHK vs XCOEnlarge GraphNatural gas production in the US has grown tremendously over the past few years, mainly due to the “shale revolution.” This term generally refers to a combination of the development of new drilling methods (such as horizontal drilling and hydraulic fracturing or “fracking”) and the usage of these drilling methods to target shale formations, many of which were previously uneconomical to develop prior to technological advancements. The large increase in the supply of natural gas has caused prices to drop and forced many producers of natural gas to gear their portfolio towards more oil producing assets, cutting back on natural gas drilling.

The below chart shows US natural gas production from December 2008 through October 2012, during which production grew by 18%. For the decade prior to the “shale revolution,” which began accelerating in the mid 2000’s, US natural gas production had been flattish at 50-55 billion cubic feet per day. Therefore, this recent growth supply represents a paradigm shift for US natural gas.

Enlarge Graph In fact, so much gas has come online that natural gas prices are quite low in a historical context (see below graph). Natural gas currently trades in the mid $3.00 per MMBtu (millions of British thermal units) range, as compared to some peaks of over $10.00 reached during the past decade.

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Because of the prolonged low prices, many producers have announced that they would cut back natural gas drilling. The Baker Hughes Natural Gas rig count, a figure reported weekly by oilfield services company Baker Hughes, has shown that rigs targeted towards natural gas have fallen off significantly. For more on the Baker Hughes rig count, see the article titled “Why natural gas supply hasn’t fallen off with rig counts, and how it affects prices and producers.”

Companies that had dry natural gas shale production as a large part of their portfolio saw valuation come under pressure during the past few years given the low gas price environment. For example, Chesapeake Energy (CHK) and EXCO Resources (XCO) were two of the most gas levered names during this period. The below table shows the percentage of production from natural gas over the past several years.

Percent Production from Natural Gas      
  FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 (Guidance)
CHK 91% 92% 92% 92% 89% 84% 80%
XCO 89% 92% 91% 93% 96% 98% 96%

 

As might be expected, because of the companies’ high percentage of gas production, valuations of the companies fell with natural gas prices. The below graph shows the stock prices of CHK and XCO against natural gas on a percentage change basis from January 2007 to present. CHK and XCO were two of the most gas levered names during this period.

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The shale revolution has given upstream energy companies access to a promising new asset base. However, the rush to develop these assets has caused a deluge of supply in domestic natural gas which has depressed natural gas prices, and therefore lowered the valuations of companies weighted towards domestic natural gas. This has most affected small/mid cap natural gas heavy companies such as Chesapeake Energy (CHK), EXCO Resources (XCO), Quicksilver Resources (KWK), Comstock Resources (CRK), and the United States Natural Gas Fund (UNG), an ETF designed to track the price of domestic natural gas. A further article will discuss what actions natural gas weighted producers have taken in response to low gas prices.