Drilling Boom Deemed Unlikely Despite Natural Gas Price Surge
(Copyright © 2003 Energy Intelligence Group, Inc.)
Natural Gas Week Monday, March 3, 2003
The steady rise in winter gas prices -- punctuated by last week's record-breaking spike at the New York Mercantile Exchange -- harkens back to the 2000-01 heating season when US markets saw similar volatility. But there is a critical, and troubling, difference: Many producers this time appear unwilling to step up to the plate and significantly boost drilling efforts to add to production.
In fact, while Gulf Coast and Texas spot prices were surging to the $15-$20/MMBtu range, drilling fell last week by 20 gas rigs, according to Baker Hughes. Analysts expect this demonstration of caution from producers to continue through 2003.
In part this reflects a paucity of decent well prospects as conventional US gas plays mature. But it is also a matter of prudence, as drillers have learned their lesson from the last drilling boom.
"The producers ran out in 2000 and 2001, chasing the price and drilled a bunch of really bad wells," said David Pursell, upstream analysts at Houston-based Simmons & Co. "It's like going to Mardi Gras. You have a really a great time, then wake up in the morning and all you have left is a hangover, no memory, and a promise never to do that again."
The hangover, he said, is "high [finding and development] costs, high lifting costs, horrible reserve replacement, and no production growth."
As a result, the exploration and production (E&P) sector's new mantra is fiscal discipline. By and large added cash flow from higher gas prices is going to repay debt or buy back stock, and is not being plowed back into capital budgets.
Not coincidentally, this is what Wall Street wants to hear.
"If these guys had gone out and really come in with a decent return on capital [during the drilling boom], I think the markets would open to them," Pursell said. "They were not rewarded for their efforts."
"If you were to ask E&P executives, most would be disappointed in their share price given current commodity prices," he added.
The belt-tightening in capital budgets is reflected in a so-far sluggish response to surging gas prices.
The number of rigs drilling for gas in the US stands at 747, which is only slightly higher than drilling levels last September, according to Baker Hughes. It is also well short of the period from May to August of 2001 when the US gas-directed rig count remained above 1,000 (see chart).
There normally is a time lag before producers can fully ramp up to respond to higher prices, so the rig count likely has more room to rise. But the short-term response so far has been notably less impressive than during the 2000-01 winter.
Two years ago gas prices saw a "step change" from $4/MMBtu to the $5 level over a three-month period, from August through October 2000, and producers responded over this time by putting roughly 100 more rigs to work, to more than 850 active gas rigs. This winter gas prices have undergone an even more dramatic rise over a similar three-month period, from $4 at the start of December to a current $6 level. Yet the gas rig count has risen by only about 50 over this period.
"I think people are hesitant just to open their pocketbooks and go to town, even though I think there's strong evidence that we have a very tight gas market." Johnson Rice analyst Ken Beer said.
Beer believes the gas rig count could pick up to a level of 850-900 later this year, but says E&P companies will want to see evidence of prices holding steady at higher levels before committing to drill more wells.
Exxon Mobil Chief Executive Lee Raymond says the lukewarm response to recent high gas prices is easily explained by the lack of big prospects left to drill in most of the US. "The prospectivity is gradually eroding, simply because it's so mature," he told the recent Cambridge Energy Research Associates conference in Houston.
Michael LaMotte, an oilfield services analyst with JP Morgan, said that while gas prices and the rig count were closely correlated in the past, the link had broken down since 2001 as the major oil companies scaled back their activity in the US.
Diminishing reserve targets led the majors away from the US onshore and the shallow waters of the Gulf of Mexico as they focused instead on the deepwater Gulf and overseas operations.
"It is the reserve size, not the price of the commodity, that plays the biggest part in the decision to commit capital. Onshore and shallow Gulf reserves are quite simply not there in sufficient scale," LaMotte said.
Rising costs as companies drill deeper wells in pursuit of more elusive reserve targets are also a potential deterrent.
Lamotte's analysis of companies' capital spending and drilling plans leads him to conclude that the US gas rig count will average 760 in 2003, up from 691 last year but well short of the average of 939 recorded in 2001.
Lehman Brothers analyst Thomas Driscoll says companies can drill all they like but that it will not prevent a further decline in US gas production in the coming years.
"We do not believe that the industry can drill its way out of this situation of declining production," he wrote in a recent report.
Driscoll calculates that an average of 426 rigs drilling in 1994 added 11.9 Bcf/d of gas to supplies or 27.9 MMcf/d per rig. In the boom year of 2001 more than twice as many rigs were running, but they contributed only half as much gas per rig.
Driscoll expects an average gas price of $5/MMBtu for 2003 with high prices leading to a permanent loss of some demand in industrial sectors such as chemicals, fertilizers, and metals and thus helping to keep the market balanced (see story,p20). On the supply side he expects a steady rise in LNG imports in the coming years.
--Andrew Kelly, Andrew Ware
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If the gas rig count doesn't start with an "8" by April Fool's Day and the OSX is still at similar levels as it is presently this sucker's gonna start shorting some drilling stocks. |
