Natural gas rig counts have been flat or rising for the past three weeks
Baker Hughes, an oilfield services company, reported that rigs targeting natural gas remained flat last week, at 369 for the week ending July 26. From May 17 through July 5, the rig count had been range-bound between 349 to 354. However, rig counts rose for the two weeks prior to last, up 14 total. Before that, rigs had largely been trending downward or flat. However, if rig counts continue to rise, they might signal a reversal to the trend.
Despite rising natural gas prices earlier this year, natural gas rigs decreased
The rig count had largely been decreasing throughout early 2013, even as prices had experienced a strong rally from $3.15 per MMBtu (millions of British thermal units) in mid-February to ~$4.40 per MMBtu in mid-April. Natural gas currently trades around $3.60 per MMBtu. The drop in rig count from February through April could have signaled that despite the strong rally, natural gas prices of over ~$4.00 per MMBtu still aren’t high enough to incentivize producers to shift significantly more capital towards natural gas and that there’s no compelling reason to increase natural gas rig counts. Also, in the last two months, the number of natural gas rigs drilling has been relatively flat, staying within a narrow range near 350. This could perhaps signal a bottom—the bare minimum of natural gas drilling that the upstream sector is willing to fund in the present environment.
Natural gas rigs have fallen over the past few years also, due to low prices
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).
The number of rigs drilling can reflect producer sentiment
To provide some context, the number of rigs drilling for natural gas can indicate how companies feel about the economics of drilling for natural gas. More natural gas rigs drilling generally means companies feel bullish (positive) on the natural gas environment. Additionally, rigs drilling can also indicate future supply, as more rigs drilling implies more production. So market participants monitor rig counts to get a sense of oil and gas producers’ sentiment and as a rough indicator of future expected supply.
Despite falling rig counts (implying reduced drilling), natural gas supply has remained flat
As we’ve seen, rig counts had largely declined since late 2011. With this decline in rigs throughout most of 2012, you’d expect a drastic cutback in natural gas production, and therefore a bump in prices and natural gas producer valuations. Despite this expectation, supply has remained flattish so far, with prices rebounding somewhat since 2Q12 lows, but mostly from demand drivers rather than supply cutbacks. The chart below shows natural gas production in the United States over the past 12 months. You can see that supply hasn’t fallen off significantly relative to rig count declines.
There are a few major likely reasons why natural gas production hasn’t yet followed the drop-off in rig counts.
That isn’t to say that producers won’t experience supply cuts at all. Note that in the above graph, U.S. natural gas production goes only through April 2013, as that’s the last period that the DOE has reported so far. We have yet to see what the DOE will report for May and June. Additionally, companies plan their expenditures year by year, and it’s likely that given the continued low price of natural gas and continued support in the price of oil, companies have shifted their budgets towards drilling oil rather than gas.
But so far, the rig reductions haven’t significantly dented natural gas supply. So 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 (exchange-traded fund) designed to track Henry Hub natural gas prices, the major domestic benchmark for the commodity.
Is the outlook optimistic?
Natural gas rigs remained flat last week and increased slightly over the two weeks prior. If natural gas rigs drilling increases further, it may signal that companies are more optimistic about the natural gas price environment. However, the past few weeks of data points aren’t enough to draw a real trend. Note also that natural gas rigs had remained roughly flat for the past two months, despite some price volatility. This may also signal a bottom, or reflect the bare minimum of capex (capital expenditure) that upstream companies are willing to spend on drilling gas at the moment.
© 2013 Market Realist, Inc.
But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.