Natural gas rigs dropped last week, partially reversing prior week’s rise

  • Natural gas rigs decreased last week from 431 to 418, following the prior week’s increase from 407 to 431.
  • Rig counts had been trending down-to-flattish after a long and steep downward slide given depressed natural gas prices. Despite declines in rig counts, natural gas production has been growing/flat over the same period.
  • A focus on the most productive wells, an increase in efficiency, and gas produced as a result of oil-targeted drilling, are all factors that have contributed to flush natural gas supply despite a cutback in rigs.

Baker Hughes, an oilfield services company, reported that rigs targeting natural gas decreased from 431 to 418 for the week ending March 22. This week’s decline followed a large increase in natural gas rigs last week, when rigs increased from 407 to 431. The prior week’s increase in natural gas rigs may have been a response to a month-long rally in natural gas prices. However, rigs specifically targeting natural gas are still down from YE2012, and had experienced a long and steep downward slide since October 2011 given sustained low natural gas prices.

2013.03.18 - Nat Gas Prices LTEnlarge Graph

Natural gas supply and prices are major drivers of valuation for natural gas producers such as Chesapeake Energy (CHK), Comstock Resources (CRK), Southwestern Energy (SWN), and EXCO Resources (XCO).

To provide some context, the number of rigs drilling for natural gas can be indicative of how companies feel about the economics of drilling for natural gas. More natural gas rigs drilling generally means companies feel bullish on the natural gas environment. Additionally, rigs drilling can also be indicative of future supply as more rigs drilling implies more production. Therefore, market participants monitor rig counts to get a sense of oil and gas producers’ sentiments, and as a rough indicator of future expected supply. This week’s increase in rigs may be a signal that producers are feeling bullish about the current price environment.

As mentioned, rig counts have largely been in decline since late 2011. With this decline in rigs throughout most of 2012, one would expect a drastic cutback in natural gas production, and therefore a bump in prices and natural gas producer valuations. Despite this, supply has remained flattish thus far, with prices rebounding somewhat since 2Q12 lows, but mostly from demand drivers rather than supply cutbacks. The below chart shows natural gas production in the U.S. over the past twelve months; note that supply has not fallen off significantly.

2013.03.18 - Nat Gas Production v2Enlarge Graph

There are a few major likely reasons why natural gas production has not yet followed the drop off in rig counts.

  1. The rigs targeting gas right now are likely targeting the most productive and economic wells, and the rigs that were put out of work were targeting more marginal wells. This has resulted in a large cut in rigs, without a proportionate cut in supply.
  2. Rigs that are classified as targeting oil are not included in the natural gas rig count, and oil wells produce both oil and natural gas (often called “associated gas” when it comes from an oil well). Oil prices have remained relatively robust, and the pace of oil drilling has remained frenzied, with the by-product being associated natural gas production.
  3. Producers have become more efficient at producing more gas with less rigs due to advancing technology and deeper knowledge about the areas in which they are drilling.

That is not to say that supply cuts will not be experienced at all. Note that in the above graph U.S. natural gas production goes only through December 2012 as that is the last period that the DOE has reported thus far. We have yet to see what the DOE will report for January and February. 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. This past week saw a decrease in rig counts, which can be construed two ways: (1) that producers are feeling more negative about natural gas drilling and possibly expect a decline in natural gas prices and (2) that a decrease in rigs could decrease natural gas supply which would be positive for natural gas prices.