Mike Sumrow
Drilling Editor
HOUSTON, Apr. 29 -- Natural gas prices in the US will recover sharply this year. Next year promises to be a very good year for the number of drilling rigs working and for the use of coiled tubing services. Oil and gas supply and demand fundamentals in 2003 should yield replacement-cost pricing for rigs. These are all early signs of a long-term recovery beginning for the oil and gas industry.
That was the message delivered by J. Marshall Adkins, managing director of energy research and senior oil field service equity analyst for Raymond James & Associates Inc. (RJA), St. Petersburg, Fla., at the Society of Petroleum Engineers and International Coiled Tubing Association's coiled-tubing conference last week and earlier in the month at IADC's (International Association of Drilling Contractors) 2002 Land Contractors Day in Houston.
Adkins said, "The past 8 weeks have seen a huge change in the fundamentals for oil and gas."
Referring to natural gas, Adkins said, "The weather has cleaned up the storage overhang that we were worried about a few months ago."
He also noted that production cuts by the Organization of Petroleum Exporting Countries have shown up in the markets, causing inventories to fall dramatically and thus fundamentally supporting higher oil prices.
Secular trend
Adkins reported that the oil and gas industry, beginning in 1995-96, has entered a secular upward trend that should last for 10-15 years. He said the outlook is very bullish.
"We're still going to have cycles within the secular move, but the upward trend is still very much there," he said.
This cyclic history has led investors to undervalue oil industry stocks. Adkins explained that many in the investment community value oil field service stocks in light of their relative poor performance during the past 20 years. Investors often apply the more recent analogy of the latest downturn in 1998.
He makes the point, however, that the industry's current situation is closely related to its position in the early 1970s. During 1972-74, the oil field service stock index behaved almost exactly as it has from 1999 through today. The trends are similar. The sharp oil price increase of the 1970s triggered an economic recession, which is the same that happened in 1999 when oil, natural gas, and electricity prices increased sharply at the same time.
Adkins said, "Energy has a much greater effect on the economy than people think." For the entire 1970s, oil industry stocks did extremely well at the expense of the rest of the economy. He thinks the same trend might occur over the next 10 years.
He predicted that within the next 5 years, there would be a substantial increase in the rig census, like what the industry saw in the late 1970s.
Technology's impact
In Adkins's view, enhanced technology will yield higher exploration and development success rates.
New technologies, notablyadvances in horizontal and directional drilling, have gained a substantial share of the market. In addition, improved technology has allowed the industry to open access to new areas, such as deep water.
Adkins said, however, all of this has had a tangible impact on finding oil and gas, but on the other hand, average well depth has increased 40% in the past 20 years, making the wells more expensive to drill.
Considering the sharp rate of decline in field size for new discoveries, Adkins said, most people don't realize the commodity is finite. Putting more rigs to work doesn't necessarily mean industry is going to add a lot of production.
In the 1970s, the industry tripled the number of rigs drilling for oil, but production still declined by 35%. Because natural gas depletes faster than oi, even steeper declines will occur for natural gas, according to Adkins.
Adkins said, "I don't think there are enough rigs out there that we can throw at this problem to meaningfully change the declines that we're seeing in natural gas production right now."
Natural gas
"We think that production is going to fall this year 1.5%/quarter, which is about 5-6% on a year-to-year basis," said Adkins, commenting that the decline rate was the most severe that the industry has observed. He added, "I think this is going to be the biggest shock to the market going forward."
In RJA's survey of the 30 largest E&P firms, the companies reported an average production decline of 1.8% from fourth quarter 2001 to the first quarter of this year.
He added that the sequential decline was a huge number, and often the actual decline is more than the companies initially estimate. The actual decline could be 2% or more.
Canada supplied the US with a lot of gas production in mid-2001, which was a function of the drilling they did in the winter of 2000-2001. Adkins said he didn't think that Canada would provide the boost that it had during the past year.
Adkins said it is amazing that gas prices are at $3.50/Mcf today, after the warmest winter on record. The unusually warm winter weather reduced demand by 7-8 bcfd. The US would have had a huge problem if the winter weather had been closer to normal.
Adkins predicted that increased demand from an improving economy, reduced supply rate due to decline, and a return to more normal and colder winter weather would cause excessive withdrawals from natural gas storage.
Gas prices could spike to as high as $10/Mcf and certainly to more than $5/Mcf, in response.
Oil fundamentals
Adkins said that the historical relationship between inventories and oil prices justifies a current price floor of $23-24/bbl. He said that, considering the inventory forecast going forward, the second half of the year should see oil prices in the high $20s.
The consensus on Wall Street cites a $7-8/bbl premium for Middle East turmoil and the US-led war on terrorism, but Adkins does not think it should be that much. He noted that there are wild cards for oil markets, with the question of whether Russia will continue ramping up production, which did not appear to be an issue at this stage. However, current Middle East problems should command only a $2-3/bbl premium, he said.
Adkins contends that economists dismiss the impact that lower energy costs have on the US economy. Lower energy costs have given the economy a $1 billion/day benefit, which is a huge stimulus package.
He added that it dwarfs the combined stimulus from tax cuts, mortgage refinancing, and lower interest rates, and even the proposed stimulus package, concluding that "we have to believe that oil demand will come back over the next year."
