Baker Hughes, an oil services company, reported that rigs targeting natural gas fell from 434 to 428 for the week ending February 1. As seen in the chart below, last week’s figures are a continuation of a longer term trend of less natural gas rigs working. With this sharp drop off in natural gas rigs, one would expect a drastic cutback in natural gas production, and therefore a bump in prices and natural gas producer valuations. However, supply has remained flattish thus far, with prices rebounding somewhat, but mostly from demand drivers rather than supply cutbacks. The continued flush supply of natural gas is negative for prices and therefore negative for natural gas producers such as Chesapeake Energy (CHK), Comstock Resources (CRK), Southwestern Energy (SWN), and EXCO Resources (XCO).
To provide some context, there have been a decreasing number of rigs targeting natural gas over the past year due to prices being near historic lows. The below graph shows natural gas prices from January 2005 to the present. Though natural gas prices have rebounded somewhat in recent months off lows of $2.00/MMBtu (or millions of British thermal units), they are nowhere close to the highs of over $10.00/MMBtu reached in the past decade. The extended price depression has caused producers to cut back on natural gas drilling and shift capital from natural gas to oil.
One would expect that given the drastic cut in natural gas rigs, a proportionate supply cut would follow. However, according to figures from the US Department of Energy, domestic natural gas production hasn’t been trending downwards and is relatively flat if anything. The below chart shows US natural gas production from November 2011 through November 2012, which is coincident with the sharp drop off in natural gas rigs.
There are a few major likely reasons why natural gas production has not yet followed the drop off in rig counts.
That is not to say that supply cuts will not be experienced at all. Note that in the above graph US natural gas production goes only through November 2012, as that is the last period that the DOE has reported thus far. One has yet to see what the DOE will report for December and January. Additionally, companies plan their expenditures year by year, and it is likely that given the continued low price of natural gas and continued support in the price of oil, that companies will further shift capital away from natural gas and towards oil in their 2013 drilling budgets.
However, thus far the rig reductions have not put a significant dent in natural gas supply. Therefore, natural gas prices have remained relatively low which has muted the margins and valuation of domestic natural gas weighted producers such as Chesapeake Energy (CHK), Comstock Resources (CRK), Southwestern Energy (SWN), and EXCO Resources (XCO). Additionally, natural gas prices affect the US Natural Gas Fund (UNG), an ETF designed to track Henry Hub natural gas prices, the major domestic benchmark for the commodity.
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