Natural Gas Producers Deal with ‘Perfect Storm’

Mild weather combined with lower consumption has resulted in declining demand and lower prices for natural gas.

The State Journal
13 September 2009
By Pam Kasey

A “perfect storm” of natural gas market conditions has brought about the lowest prices in seven years.

The U.S. average monthly wellhead price dropped to $3.14 per thousand cubic feet in August, as estimated by the U.S. Energy Information Administration. That is down from $3.43 in July and over $10 in July 2008.

It’s a boon for consumers but a hard market for producers.

Demand and Supply

Consumption is down because of both the economic downturn and because of relatively cool summer weather across much of the country.

“Demand is weak on a year-to-year basis,” said Dominion Exploration & Production President Ben Hardesty. “Total demand is down 2.8 billion cubic feet per day.”

That’s about 5 percent below last year’s average daily third-quarter demand, according to the EIA.

Industrial use has been dropping for at least a decade as heavy manufacturing has moved overseas.

But while the decline in industrial consumption has been offset over the same period by an increase in consumption for electric generation, this cool summer season — combined, possibly, with conservation, Hardesty pointed out — has made this a down year for electric generation as well.

So demand is down.

At the same time, production is up.

It’s not for lack of a pull-back by the industry.

Well Numbers

Drilling, for example, has declined. The number of drilling rigs in operation on Sept. 1 was just 701, Hardesty said — less than half the number just a year ago.

Dominion E&P, which Hardesty said is the leading driller in West Virginia and Pennsylvania, has scaled back its drilling some.

That is reflected in the number of well starts in the region: 245 in the two states in Aug. 2008, according to RigData, but just 143 in August this year.

Still, total production is high. More gas was produced nationwide from July 2008 through June 2009 than in the previous July-June, according to the EIA, despite the price plummet over the period.

Why do drilling and production continue this strong in such a down market?

In this region, and particularly in the Marcellus Shale, Hardesty said, “Part of it is that the major companies have moved rigs into the area and they have commitments to drill so they’re fulfilling their own commitments on leases or their own drilling programs.”

Because of this region’s proximity to big northeastern markets, he said, the economics are good here even with prices down.

And across the nation in general, “Keep in mind a lot of gas is sold on long-term contract or has been hedged at a higher price,” he said. “Because of that people can still continue to drill.”

Storage and Prices to Come

When gas is produced but not consumed, it goes to storage for later use.

And that’s getting pretty full.

Working gas in storage at the end of August was 3,323 bcf: the highest August inventory the EIA records in its database that goes back to 1993, and 85 percent of U.S. demonstrated working storage capacity.

When August storage figures came out, industry analysts told Bloomberg News that there’s not enough winter storage left for every producer’s volume and that, without an upturn in demand, that likely will put further downward pressure on prices.

The EIA doesn’t see demand turning around this year.

The agency projects total demand down 2.6 percent in 2009, then a slight, 0.5 percent rise in 2010. Hardesty said he takes a long view.

“Everyone expects gas demand to improve,” he said.

“Our company never overextended on leasing, drilling commitments or projects, so we’re in a position where we have sufficient capital,” he said, “and we believe that the markets will recover so we’re continuing to drill and produce.”