The industry continues to lower natural-gas supply costs from major supply basins burgeoning with activity, research by Morgan Stanley & Co. Inc. suggests. However, the firm cautions that cost inflation "remains a key risk to E&Ps as increased activity levels in unconventional resource plays is contributing to acute service tightness."

According to an Aug. 16 research note, the firm has revised its survey of per-well economics across major supply basins, also affirming that an overhang of weaker gas prices and a negative outlook for the commodity due to abundant supplies will continue to affect the relative performance of E&Ps in the near term.

"While not wholly representative of domestic supply cost," the analysts concede, trends indicate that per-well economics are making headway with higher recoveries and improved efficiencies in such leading unconventional plays as the Eagle Ford, Marcellus and Granite Wash.

Based on its revision, Morgan Stanley estimates the breakeven prices for gas and condensate in the South Texas Eagle Ford play at $4.00 per Mcf and $3.40 per Mcf, respectively. In the Marcellus, the wet and dry (core) breakeven prices are tagged at $2.80 per Mcf and $3 per Mcf, respectively, and the dry (tier 2) price is marked $3.90 per Mcf. For the liquids-rich Granite Wash play, the firm estimates $3.10 per Mcf per horizontal well.

Considering only variable costs, Morgan Stanley reports that higher activity levels in these key domestic basins, where the lowest cost plays are prevalent, will likely be sustainable at the current forward curve.

The analysts note that in spite of enhanced disclosures from producers now including liquids yields and a breakdown of fixed versus variable operating costs, "the results suggest that the continued downward pressure of industry supply cost is well founded and likely to continue."

In Morgan Stanley's view, it is the supply side of the natural-gas equation that has prompted a nearly 17% reduction in the five-year strip year to date (YTD).

"While recent industry trends have suggested drilling and completion cost inflation is real, producer disclosure has yet to reflect this reality," the firm points out.

Meanwhile, the current gas pricing environment continues to weigh on the market and has led to recent downward revision in the commodity's near- and long-term price. A lower 2011 spot price around $5 per thousand cubic feet is "below levels where we believe hedging is accretive to margins for many major producers," the firm notes.

Morgan Stanley researchers add that "while the 'closing' of this hedging opportunity in 2011 is a potential positive…downward pressure (is likely) to remain, particularly with the reduction of seasonal demand patterns expected in the coming weeks."