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Natural gas production not likely to curb soon, bearish for dry nat gas companies

2013.01.27 - NG ProductionEnlarge GraphIn recent years, natural gas prices have declined sharply, mostly as a result of the “shale revolution”. This term describes both technological advances (ex: hydraulic fracturing and horizontal drilling) that have made previously uneconomic hydrocarbon resources viable to drill, along with the discovery of several such resources, many of which are in shale rock. The shale revolution caused many oil and gas companies to rapidly lease and drill land containing natural gas, resulting in a surge of natural gas supply on the market without enough increase in demand to support prices. The below chart displays historic natural gas prices.

2013.02.12 - Nat Gas PricesEnlarge Graph

Despite the decrease in prices, natural gas production has not slowed down in response, which is bearish for companies that have a portfolio consisting mostly of dry gas production. Such companies include Southwestern Energy (SWN), EXCO Resources (XCO), Quicksilver Resources (KWK), and Comstock Resources (CRK). The below chart shows historic US natural gas production.

2013.01.27 - NG ProductionEnlarge Graph

One of the main reasons is because of a highly prolific region called the Marcellus Shale. The Marcellus is a hydrocarbon resource that spans across Appalachia that has seen a rapid increase in drilling over the past several years. The Marcellus is mostly natural gas, however, certain portions hold more natural gas liquids (NGLs), which on an energy equivalent basis fetch more revenue than natural gas. That is, one MMBtu (millions of British thermal units) of an average barrel of NGLs (which is actually a mixture of several hydrocarbons) is worth more than one MMBtu of natural gas. Certain companies with prime Marcellus acreage in the wet gas window are not planning to stop drilling, given still positive economics in this area because of the liquids portion.

For instance Range Resources (RRC) noted in a recent slide that in its southwest Marcellus acreage, even at natural gas prices of $3.00/MMBtu, the company still makes an over 50% rate of return on an average well drilled there. The areas hydrocarbon resources appear to be so prolific and economic that there isn’t a huge incentive to stop drilling right now. So, while natural gas is low, there are still large amounts of natural gas being produced from the Marcellus region.

Another reason why natural gas production has not declined is because natural gas is often found in wells targeting crude oil (often called “associated gas”). Currently crude oil prices are at relative highs, and US upstream names are making healthy returns on crude oil wells. Natural gas is a byproduct of these crude oil wells, and a significant amount of production is coming from associated gas.

Therefore, despite current low natural gas prices, because of liquids-rich, prolific areas such as the Marcellus and current high crude prices, many market participants do not expect natural gas production to drop in the near future. Consequently, general sentiment is that natural gas prices will remain relatively depressed for some time which is a negative for companies with primarily dry gas assets such as Southwestern Energy (SWN), Chesapeake Energy (CHK), EXCO Resources (XCO), and Comstock Resources (CRK).

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