Baker Hughes, an oilfield services company, reported that rigs targeting natural gas decreased from 418 to 389 for the week ending March 28. This was the largest weekly decrease in natural gas rigs drilling since February 2012, which was somewhat surprising as natural gas has recently had a strong rally. As recently as mid-February, natural gas was trading at $3.15/MMBtu, but since then prices rose to over $4.00/MMBtu.
Last week saw a significant drop off in natural gas rigs, continuing a trend that began in October 2011 as rigs specifically targeting natural gas saw declines given sustained low natural gas prices (see natural gas price graph below).
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’ sentiment 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 aforementioned, rig counts had 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.
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 December 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 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 an decrease in rig counts, which can be construed two ways (1) that producers are feeling less positive about natural gas drilling given the rise in prices and (2) that a decrease in rigs could decrease natural gas supply which would create positive price pressure.
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