Sunday, January 19, 2014

IHS: Natural Gas Price to Remain $4-5/MMBtu for Next 20 Years; What's the Implication for the Haynesville?

Research analytics company IHS released a report Thursday concluding that natural gas prices will remain in the $4-5/MMBtu range, inflation adjusted, through 2035.  That's not great news for fans of the Haynesville Shale who are focused on $4.50 as the magic gas price that will bring a higher level of drilling activity to the region.

Before getting too worked up, we should all keep in mind that this is a 20 year estimate of a commodity price and there are many unforeseen circumstances awaiting on the sidelines that will undoubtedly impact this projection.  People were sitting around reading the book The Black Swan but nobody saw the shale gas phenomenon on the horizon six or seven years ago.  The IHS prediction seems largely based on the assumption that natural gas supply will meet any new demand increases through increased production and limit any ability to command a higher price.

But one underlying positive implication is that outside of normal seasonal and event-driven fluctuations, the volatility of natural gas prices should be low for the decade or so.  While commodity traders hate low volatility, gas consumers love it because it allows them to more safely project costs.  The silver lining of this report is that the fairly low price of gas and the lack of volatility will drive greater consumption from new users and customers switching from other fuels, ranging from industrial and manufacturing users to homeowners that now depend on fuel oil.  This will help build an even larger base of consumers that is not there right now.

Blah, blah, blah.  If you're reading this far, your big question probably is, to what extent will this impact the Haynesville shale and when will activity in the Haynesville pick up?  In the past six months, we've seen some producers that have let their rig counts go drop to one or zero return with a flurry of activity.  This usually lasts a few months and then fades, just long enough to get a handful of wells into production, probably to satisfy contractual obligations to midstream providers or customers.  Good but not permanent.

Over the next several years, as large industrial and gas export projects are built along the Louisiana/Texas Gulf Coast, expect production from the Haynesville Shale to pick up somewhat.  I think you will see drilling activity increase, but will it be enough to bring dormant Haynesville drillers like Questar, EP Energy, J-W Operating and the like back to the play?  Probably not right away.  I think the increased demand will lead to drilling surges but not necessarily consistently increased activity.

Ultimately, I think greater activity in the Haynesville is dependent on two factors.  First is the ability of producers to continue to lower the cost of drilling Haynesville wells to improve their economics.  Years of trial and error have optimized the shale drilling process (EP Energy's recent investor materials cite a 47% internal rate of return for their Haynesville wells - although they are not drilling them right now).  It's been a gradual process, and now that the demand to drill the Haynesville formation has slaked, producers may have the upper hand in negotiations with suppliers.

Second, and way outside of anyone's control, is the attractiveness (or lack thereof) of alternative plays.  Over the past several years, independent E&Ps have entered into a period of austerity where shareholders are not letting them significantly outspend operating cash flow and investors are forcing a laser like focus on oil and liquids, which currently provide a higher return.  Because there is only so much cash to allocate and a lot of the big liquids plays are now being prospected, dry gas projects tend to go unfunded.  But in a few years, the producers that now are trying to re-balance their portfolios between oil and gas will approach a happier medium.  At that point, assuming good economics, dry gas will become more attractive, maybe even a growth opportunity.

The big question is, when will that happen?  Unfortunately it's not likely to be this year or the next.  But fear not, at least some increase in Haynesville activity will happen over the next year or two.  It just likely will come from the current cast of characters rather than all of the old participants.

2 comments:

Anonymous said...

Robert,
The date on your Hanesville ticker is incorrect.

Robert Hutchinson said...

Thanks for the catch.

RH