Nymex natural gas prices have fallen below the all-in costs of finding, developing and producing gas, says Carin Dehne Kiley, E&P analyst for Calyon Securities (USA) Inc.

This should reduce incremental gas-drilling investments and, along with other factors, should bring the market back into balance, she says. In early September, spot gas prices were below $6 per million Btu, driven down by high storage levels, liquefied natural gas (LNG) imports and increased production.

Besides milder-than-normal weather, contributing to higher gas storage is the continued loss of industrial demand along the Gulf Coast due to the destruction of business by hurricanes Katrina and Rita in 2005.







Also, "expectations for both an active hurricane season and extreme summer heat kept gas prices high, helping to attract record LNG imports to the U.S. during spring," which pushed more gas into storage, she adds. At the same time, gas prices fell in Europe during its warm winter, causing the U.S. to become more attractive a destination for spot LNG shipments, which increased some 55% year over year.

Previously high gas prices encouraged investment in drilling that has led to onshore production growth (some from unconventional shale plays), further increasing storage.

However, gas prices are expected to rise soon, as early as the end of the year, and bring the market back into balance, she adds. Several factors will initiate the price improvement, including fuel switching, gas-liquids stripping, higher LNG demand in Japan, reduction in drilling investment, and reservoir decline.

A Calyon sample group of gas operators' all-in finding, development and production costs, when adding a 10% rate of return, requires a Henry Hub price of $7 to $7.65.

"With the exception of one week in August, gas prices have been below $7 since last June, and a few operators have already announced voluntary production curtailments or deferred hookups of recently drilled wells," Kiley says. "We suspect that other operators, particularly the smaller, private companies that account for about a third of total gas production, are acting similarly, although there will not likely be any public announcements regarding their gas well shut-ins."

Falling natural gas prices overshadowed E&P companies' good second-quarter results and second-half plans, and made investors a little wary at EnerCom Inc.'s annual The Oil & Gas Conference in Denver recently.

E&P executives said there will not be any appreciable slowdown in the U.S. rig count unless the 12-month forward strip price on Nymex goes below $6 per million Btu. During the conference, the near-month price fell to about $5.85.

Many executives explained why the plays they are in would still be economic if prices were to remain below $6. "With $6 gas on Nymex, we can do real well," said Chip Johnson, chief executive officer of Carrizo Oil & Gas Co. "Drilling costs are flat and we've been adding reserves at lower costs."

Rodney Waller, senior vice president, Range Resources Corp., said, "Anybody can grow production, and many do, but the real question is, at what cost? With $6 gas, people start worrying about their projects, but ours work at a lower price." Range is one of the lowest-cost producers in its peer group, with reported 2006 costs of about $1.40 per thousand cubic feet equivalent (Mcfe).

There is still disturbing cost creep, Waller said. "Our F&D costs are up 74 cents per Mcfe, versus our peer group, which is up $1.56, per a Bank of America analysis."

The company just reported its 18th consecutive quarter of production growth and has a lot of built-in growth to come from its huge acreage position in low-risk plays such as Devonian shales, coalbed methane and other Appalachian opportunities. The company is also very active in the Barnett shale in Texas.

At the conference, Calyon's Kiley said high oil prices and the market's tendency to self-correct to the norm could bring gas back up to maintain a more typical oil-gas price ratio. As long as oil is still above $60 per barrel, gas prices should not collapse further, she said.

She expects a 2% annual increase in the U.S. gas rig count and a 1% uptick in onshore production, but producers continue to fight a 35% average annual decline in production, with the popular unconventional gas plays declining by as much as 60% in the first year.

Comments