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Low natural gas prices: good news for everyone?

February 2016

  • Natural gas consumption is increasing because of low prices and other favourable demand-side conditions.
  • In contrast, suppliers have been under pressure from the prolonged period of low natural gas and crude oil prices.
  • Reduced cash flow from lower gas and oil prices is having wide-spread impact.

North American natural gas has traded this winter at low prices not experienced since the 1990s. Unlike the last 2 winters, weather this year has not placed any strain on storage or pipeline capacity. Consumers have benefitted significantly in this environment, not only from the low prices but also from the relative lack of volatility.

Natural gas consumption is increasing, in part because of low prices and in part because the manufacturing and electricity generation sectors are relying more on natural gas as an input. The planned augmentation of existing pipeline networks and construction of liquefied natural gas export terminals will start to open even more markets to producers later this decade.

In contrast to the favourable demand conditions, suppliers have been under pressure from the prolonged period of low natural gas and crude oil prices. Recent earnings reports show producers suffering losses, cutting jobs, dividends and capital spending. The effects of this bearish environment can be seen in the decline in rig drilling activity (Fig. 1). There are early signs that reduced drilling activity may be starting to impact natural gas production (Fig. 2).

Figure1

Figure 2

During the shale gas boom that emerged in 2007, monthly growth in daily production had been persistent. Onshore rig operators used increasingly efficient techniques to extract natural gas to maximize revenue in an environment of prices trading in a range between $3 and $5 / MMBtu. However starting in 2015, production growth ceased with a critical mass of rigs left idle in the face of even lower asking prices. Technical innovations alone have been insufficient to increase yields at the remaining rigs.

Aggregate output from 7 key production areas (Bakken, Eagle Ford, Haynesville, Marcellus, Niobrara, Permian, Utica) is forecast to continue declining – indicative of the reduced drilling activity.

This development reflects decisions by large and small participants in the industry. For example, Cabot Oil & Gas Corp. which drills in Pennsylvania’s Marcellus shale gas deposit, set its capital budget for 2016 at $325 million US or 58% of its budget a year ago. In January, Southwestern Energy announced that it would lay off 600 employees involved in the Fayetteville shale gas deposit in Arkansas. For comparison, the company’s operations at Fayetteville employed 1,500 workers a year ago.

Reduced cash flow from lower oil and gas prices has wide-spread impact. Royal Dutch Shell announced at the start of February that it was delaying its decision to continue work on its LNG Canada export project. Prior to the announcement, Shell had been expected to make a decision on the LNG export project at the start of the year.

It is premature to speak of a contraction in output sufficient to spark a rally in natural gas prices. Certainly the forward price curve remains benign with prices under $4 as far as the eye can see. However the recent stabilizing of natural gas production indicates that the constant decline in rig drilling activity and prices are starting to bite.

Do prices for crude oil drive natural gas prices? Read more »