COMMENT U.S. GAS PRODUCERS HAVE LITTLE CHOICE BUT TO SELL

Vinod K. Dar
Dar & Co.
Washington

The first days of January bode ill for February U.S. natural gas prices.

The winter continues, at best, to be seasonal. Storage has gone from a small cloud on the horizon to a grey pall across the natural gas landscape. Industrial gas demand remains weak because of a pedestrian economy. Tax induced deliverability continues to expand vigorously.

Consequently, the price for Gulf Coast gas could dip below $1.30/MMBTU in February, which would be the lowest February price in the memory of the current generation of gas marketing managers.

Unless U.S. weather takes a prolonged turn for the miserable rather soon, the 1991-92 heating season is over for the gas industry.

Naturally, these prices will lead to bankruptcies, liquidations, and a massive sale of assets. just as naturally, producer executives who could lose their status and paychecks want the production industry to limit supplies so prices will stop sinking.

LIMITING SUPPLIES

Any attempt to limit supplies will have only a transient impact in 1992 for seven reasons peculiar to the industry and to the U.S.

The exploration and production segment is fragmented.
Some producers are doing very well drilling for coal seam and tight sands credits and can prosper even if wellhead prices fall another 30%. Other producers are consolidating their assets into just a few basins and will produce from and sell nonstrategic assets regardless of price.
Several larger producers are abandoning onshore Lower 48 basins where they have no technological edge and, therefore, will produce to liquidate. Yet other producers have such strict debt service requirements that any cash flow above lifting costs is too precious to forsake even if it means wiping out owners' equity.
It is virtually impossible for asset owners with such diverse interests to agree on any scheme to limit supply and, if they agree, to abide by it. Cartels never work for long.
The heating season is almost over. So even a substantial concerted effort to limit production in the next few weeks will founder on the unforgiving shoals of falling seasonal demand.
Heavy fuel oil prices seem to be sauntering toward $12-14/bbl by spring. So cheap fuel oil will rapidly replace withheld gas and put a ceiling on gas prices anyway in second and third quarters 1992.
Producers who process significant amounts of third party gas are making an abnormal processing profit and have relatively little desire to see gas production curtailed or gas prices capture more of the processing margin.
Small, low cost, new entrants in the E&P segment have an inherently lower breakeven price than established players or those who entered via acquisitions during 1984-89. These new, nimble players can make a good return on equity even at $1.25/MMBTU for their gas because their reserves often cost them 45-55/MMBTU vs. 85 to $1.20/MMBTU for many established producers or fund companies.
Finding and production costs for gas continue to fall, on the margin, as better exploration techniques are combined with superior production technologies. The owners of these advanced technologies have no motive to prop up their less innovative or less fortunate brethren by voluntarily limiting production.
Many government agencies looking for severance taxes, or royalty owners counting on their monthly checks, or shareholders or limited partners who want their gas assets converted to cash as swiftly as possible probably will sue managements of companies that attempt to form a Lower 48 gas production cartel and shut in significant amounts of production in 1992.

Moreover, Wall Street may take a dim view of companies that concede that other than forming a cartel to limit production their managements have run out of ideas for adding value to corporate assets.

IMPRACTICAL NOTION

In any other era, in any other country, limiting production or enforcing prorationing of natural gas production probably would have worked for a few years.

But a huge, fragmented, competitive market for gas as exists in the U.S. E&P sector, composition of the U.S. E&P industry, availability of cheap imported energy, and the litigious nature of our society make joint action to limit supply and hence boost prices an impractical notion.

Besides, how many producers would tolerate:

A consumer cartel, i.e. natural gas price controls.
An attempt by drilling contractors to "cooperatively" raise day rates.
An attempt by interstate pipelines to increase transportation charges as pipeline executives gather to "discuss survival."
A plan by commercial banks to raise interest rates on loans to E&P companies while banking executives confer on "irresponsible credit pricing."
A concerted attempt, no matter how visible, by energy lawyers to stem the erosion in their billing rates and hours as they collectively chant "We are a profession not a commodity"?