Thursday, August 14, 2008

The Big Story vs. The Big Picture

The two stories of natural gas oversupply and recently efficiencies leading to lower energy demand are getting lots of traction in the media, from newspapers to blogs. The recent price declines in natural gas (Henry Hub spot price was $8.10 at yesterday's close) and oil (about $114 right now) are certainly help drive the stories. But it is important when reading The Big Story to keep in mind The Big Picture.

I'm no prognosticator, but it's interesting to see the stories evolve as various media outlets pick them up and then beat them to death. I think there is a lot of overreaction going on here. As I've noted before, there is speculation that LNG imports will pick up again this year (although prices in Europe are significantly higher than in the US, thus making Europe a more attractive market) and smash gas prices in the US. There is also discussion that current exports to Mexico and Canada are artificially supporting the consumption (and therefore the price) of natural gas. There are many other ingredients suggesting depressed gas prices.

With all of the sudden doom and gloom, it's easy to overlook the long term situation: domestic natural gas is relatively clean (certainly in comparison to coal), relatively cheap (especially compared to oil) and absolutely NOT FROM THE MIDDLE EAST OR RUSSIA. Short term price changes are largely created by traders who profit from changing prices, either up or down. Traders do not change the ultimate fundamentals of a commodity, which in my opinion remain strong. Big decisions are being made today and in the near future that will lead to multi-billion dollar investments (building power plants, investing in natural gas technology for cars (maybe), etc.) that will drive the long term demand for gas. While recently plummeting gas prices are depressing to those who are involved in the Haynesville Play, it is important to keep in mind that the long term fundamentals remain strong.

Updated Petrohawk Presetation

Petrohawk (HK) recently came out with an updated investor presentation. There is nothing particularly earth shattering - it was at its core a "Rah Rah!" document aimed at enhancing the company's share price, especially in light of its recent decline and the sale of an additional 25 million shares to support growth - but it does affirm the company's devotion to the Haynesville Play.

The most interesting piece of information was the map (above) showing where the company has drilled, where it is currently drilling and where it will be drilling for the second half of 2008. HK is definitely focusing its efforts along the path of the Red River and the Bossier/Caddo/Red River Parish borders.

Some highlights:
  • HK has leased 300,000 net acres, up from the 150,000 it had in May, obtained at an average cost of $5,000. Obviously that cost per acre has gone up, but the company has already tied up most of the large chunks of acreage it has targeted.
  • HK has ten rigs in the area and anticipates having 20 by year end 2009. At that point, HK expects to have drilled 140 horizontal wells. The company's current Haynesville Play capital budget is $218 million.
  • The company remains open to deals and joint ventures. While things are still settling out, I would expect more sales of lease rights or joint ventures for producing among the various participants or prospective market entrants.

Tuesday, August 12, 2008

Second Petrohawk Well

New verse, same as the first.

There was a good recap of Petrohawk's recent operating activities in Oil Voice last week. Among the very interesting pieces of information relative to the Haynesville Shale was the report of results from the company's second well in the play, the Hutchinson 9-5, which came in as promising as Petrohawk's first Haynesville well. Quoting Oil Voice:

The well is "located in Section 9 / Township 15 North / Range 12 West, Caddo Parish, Louisiana. The well was completed on July 29 and tested at a rate of 16.7 Mmcfe/d on a 22/64" choke with 7,325 pounds per square inch of flowing casing pressure. Pilot hole data revealed approximately 151 feet of net Haynesville Shale at a true vertical depth of 11,222 feet. The well was completed with a nine stage fracture stimulation, including approximately 2.5 million pounds of sand."

Note the flow rate of 16.7 Mmcfe/day, which is about the same as the initial flow of the company's first well, Elm Grove Plantation #63. After a month of production, the flow rate at EGP has decreased to 13.7 Mmcfe/day, which isn't bad. The results from the well indicate that there may be approximately 170 Bcf of gas in place in the section in which it was drilled.

While I've noted a few things that interest me, there is much more in the article, which is a pretty good read.

Tuesday, August 5, 2008

Recent Declines in Natural Gas Prices

I’ve been watching natural gas prices with clenched teeth lately. Since peaking over $12.50 three weeks ago, the natural gas spot price (Henry Hub) has been declining steadily. Yesterday it closed at 9.18 (up 1.7%), but it’s down nearly 30% since reaching its recent peak (although it is nearly 50% higher than this time last year). The price of crude oil has also dropped over this same time period. Publicly traded gas exploration companies are feeling a similar hit, as their stock prices have dropped precipitously over the past three weeks (Goodrich Petroleum -50%; Chesapeake -39%; Petrohawk -46%; XTO -40%, etc.).

Much of the decline started when the government reported in mid-July that natural gas supplies are currently higher than anticipated, which bodes well for the gas heat dependent residents of the Northeast going into winter. I thought this would lead only to a short term disruption of prices, but they kept going down. Upon further investigation, I found there is much more afoot, especially in the global arena.

Energy pricing usually boils down to supply and demand. When one is askew, prices follow. The energy story for the past year has been demand, both internationally and at home. As prices have increased, energy users have found ways to cut back, which has lessened demand, which has in turn lessened upward pressure on price. Some of these changes may be short term in nature, but they have impacted the market nevertheless.

On the supply side of the equation, there are two big issues. The first is international consumption of liquefied natural gas (LNG), especially in Europe. Because Europe has little natural gas supply of its own, prices there can be 50-100% higher than in the US. These high prices have lured LNG purveyors to export higher quantities to Europe rather than the US. In 2007, US LNG imports were down 60% from the previous year. With new international fields ramping up in Qatar, Russia, Nigeria, Indonesia and Yemen, analysts expect international LNG production to increase approximately 34% next year. It is expected that increased quantities of LNG will arrive on US shores, especially as new LNG ports are constructed.

The second supply issue is the projected increase in domestic supplies over the coming years. This is driven in large part by increased access to unconventional plays like the Haynesville Shale. Some analysts suggest that domestic supply will outstrip demand this year and next. This information certainly validates recent chatter by Chesapeake CEO Aubrey McClendon of exporting US natural gas to international markets.

Bottom line: commodity prices are determined in a market environment. A good is priced based on what someone is willing to pay for it. As a result, pricing is not firm and perception and anticipation have a large role in setting prices. Clearly the perception of market participants has changed recently and prices are headed in a negative direction. The news might be different tomorrow if, say, Toyota announces plans for a new natural gas powered car, but at this point it does not look like sustained prices over $10/MMBtu are realistic for the next couple of years.

One piece of good news for the publicly traded companies would be if they were able to hedge large quantities of their future sales when the prices were in the $12+ range. That news should come out in the next few months.

Monday, August 4, 2008

Chesapeake Earnings Call: We're #1

Chesapeake announced its quarterly earnings last week as all public companies do (shareholder presentation and press release). The big news from Chesapeake's side, however, was not that the company beat analyst projections of revenue and income but that Chesapeake is now the #1 producer of natural gas in the US. Given the company's obsessive list of things in which they are #1, one can tell that it was a central part of the company's internal strategy to become the #1 gas producer in the US (rather than #3). If they had to buy, sell and deal their way into it, it was absolutely going to happen.

In discussing the Haynesville Play, Chesapeake noted that they have 450,000 net acres under lease (remember that they have deals where they share acreage, most notably with Plains Exploration, that reduce the “net” acreage) and are continuing to lease. They have 11 horizontal wells in place that are producing 45 MMcfe/day gross and expect to be generating 75 MMcfe/day by the end of the year.

Chesapeake’s latest well, Milton Crow 27-1H, is producing 14 MMcfe/day at 5,800 psi on a 24/64 choke. Chesapeake now has 8 rigs working the area, but they anticipate having 12 by the end of the year, which should allow the company to complete a well every five days. As they continue to add rigs (targeting up to 60) in the future, they should be completing at least one well a day in a few years.

There is no question that Chesapeake is all over the Haynesville Play.

Sunday, August 3, 2008

China/Chesapeake Shale Venture?

As reported by Bloomberg last week, an article appeared in the South China Morning Post (Hong Kong), that said that the China National Petroleum Corporation is entertaining a minority investment in Chesapeake Energy's Fayetteville and Marcellus shale ventures. Anonymous sources said the talks valued Chesapeake's assets in these two plays at around $15 million.

It's interesting that Aubrey "Swift Boat" McClendon would partner with the national oil company of China, but money is money and the Chinese are known for making small minority investments in US companies at huge valuations. The net effect is that the Chinese put up lots of money for a small ownership share of a company (before the Blackstone Group IPO last year, the Chinese government, through an investment entity, invested $3 billion for about 10% (non-voting) ownership of the company).

More cash at a good price provides the fuel that the Chesapeake machine needs to attack the various shale plays in which Chesapeake is making its name. It also might play into McClendon's long term strategy to export US natural gas to foreign countries.

American Clean Skies Foundation Report

The American Clean Skies Foundation (http://www.cleanskies.org/) released a report last week that states that the US has total recoverable supplies of natural gas of 2,247 trillion cubic feet, or 118 years of supply at current production and consumption levels (Reuters article; link to report). The report was completed by consulting firm Navigant Consulting, Inc.

American Clean Skies was founded and is chaired by Chesapeake Energy CEO Aubrey McClendon. Chesapeake is not shy about using its cash to promote both the company and the natural gas industry (see shale.tv).

The report isn't really ground breaking - it was really a survey of various sources of information, including exploration companies, government entities, journals, media reports, etc. The main point of the report is that previous estimates of natural gas supplies did not include unconventional gas plays like shale.

Many see the organization and this report as self-serving (it's hard to admit that it's not), but it did earn McClendon an opportunity to tout natural gas to the House Select Energy Independence and Global Warming Committee and the numerous mentions on national TV that accompany such testimony.