Baker Hughes, an oilfield services company, reported that rigs targeting natural gas remained unchanged at 354 for the week ending June 7th. Though for the past three weeks natural gas rigs remained unchanged, the rig count has largely been decreasing week over week during 2013, even as prices experienced a strong rally from $3.15/MMBtu in mid-February to ~$4.40/MMBtu in mid-April. Natural gas currently trades around $3.83/MMBtu. This could have signaled that despite the strong rally, natural gas prices of over ~$4.00/MMBtu still are not high enough to incentivize producers to shift significantly more capital towards natural gas.
From a longer-term perspective, natural gas rigs have been largely falling or flat since October 2011 in response to sustained low natural gas prices (see natural gas price graph below).
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 Range Resources (RRC).
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.
As mentioned, 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. The below chart shows natural gas production in the U.S. over the past twelve months; one can see that supply has not fallen off significantly relative to rig count declines.
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, U.S. natural gas production goes only through March 2013, as that is the last period that the DOE has reported thus far. One has yet to see what the DOE will report for April and May. 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 U.S. Natural Gas Fund (UNG), an ETF designed to track Henry Hub natural gas prices, the major domestic benchmark for the commodity. Despite last week’s flat data point, natural gas rig counts have declined significantly both over the medium and long-term, which could signal that producers still wish to shift capital away from natural gas at current price points.
© 2013 Market Realist, Inc.