Thursday, December 4, 2008

Why Natural Gas will not go below $4 MCF.

1) Natural gas supply from Canada is falling and will continue to fall for the next few years. Until the BC shale play gets pipe, it will fall a bcf or more in 2009. Look at the past several years and you can see the decline WITH a great natty price. In the meantime, Alberta has significantly increased taxes, the overall price has fallen and costs have skyrocketed. According to market analyst Martin King of FirstEnergy
Capital, "at current prices, little in the way of new natural gas
production is economic in Western Canada." As a result every player is reducing cap ex by 30-50%. This will decrease production by a significant amount (10%?)

2006 2007 2008 2009
Oct 17.21....16.71....16.18 15.?

2) If the price is low, LNG will continue to be low. Several simple cost addition show you need a price well above $5 for LNG to be economic. In other words, the cost of transporting and getting the LNG to natty costs about $4+. With a price below $5, it does not pay anyone to ship the gas.

3) For some reason electric generation has been killed this fall. This is giving many a signal that the natty market is oversupplied. But a decrease in demand for natty from generation is likely to be temporary. All signs point towards more electricity being used in transportation and other energy sources. Coal will be 'killed' by new co2 regulations at the very time electric demand will increase. Thus, to argue that electric demand is going to continue to be lower than normal is risky.

4) Demand is a concern in a recession. Fertilizer and other products that use natural gas are clearly decreasing output. As a result the demand for natty is going to be down YOY ignoring weather. Thus, the price of natty will be down from lower demand.

5) THE BIG ONE: Supply from the new shales. Everyone agrees that the new technologies have increased production from unconventional sources. But several important factors limit the amount of production increase in 2009:
a) Pipelines- EOG's Papa has argued strongly that pipeline capacity is going to limit production increases. You have to have pipelines to deliver the gas to markets. When you are talking about a bcf a day, that requires a lot of pipe. Many have ignored the huge constraint in production of pipelines.
b) Credit: With out credit, many shale producers are scaling back ALL capital expenditures. Look at CHK's dramatic decrease in cap ex. The leasing prices have fallen through the floor. Once the current leases get developed, production levels will fall. But even more important to the short run projection is the lack of credit to drill all the current leases. In order to drill all the wells, significant capital must be in place (local pipelines, processing equipment etc). The net call on cash will be too great for all but the largest operators.
c) Why produce a well now at <$6 mcf, when you can wait and produce it later? With a clear economic signal that we have enough natural gas, many producers will delay drilling for better prices. Many leases are held by production or are so expensive, it may pay to drop or re-lease.
d) Permits and other government approvals will be more difficult. With the new administration, any permits not granted by Jan 20, will be at the least delayed and at the extreme rejected. Colorado is going to see a large decrease in drilling because of permits. Even if you have all of the previous comments covered, you have to have a permit. That is not going to be easy after Jan. 20th.

From all of these factors, drilling after the 20th of January is going to drop significantly from prior years levels. I would not be surprised to see 750+ less rigs drilling for natural gas than last year. At that rate, depletion of 15%+ will have an impact on production.

Of course, if we get a very warm winter, then prices can go below $4. But with a reasonable winter, prices will not be less than $4.

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