The US natural gas industry will be hammered by low commodity prices this winter because of a recession that some producers believe is worse than the government will admit.
But even with the near-term slump, the gas industry nevertheless faces serious supply constraints through 2007, two executives with top US independent producers told the annual meeting of the International Association of Drilling Contractors in New Orleans late last month.
Recession's effects
At the moment, the US gas market is oversupplied as a result of a 1 bcfd supply growth and 3 bcfd demand loss, said Mark Papa, chairman and CEO of EOG Resources Inc., Houston.
"What we're in today is clearly the most severe industrial recession we've seen in the last 20 years," said Papa.
"It is a lot more severe, in my opinion, than the government is letting on," he said. "If you look at total demand for gas in the US, 40% of the demand is in the industrial segment, and that's where we get clobbered right now."
The problem can be tracked in the rapid fall of gas futures prices on the New York Mercantile Exchange this summer, John Schiller, executive vice-president, operations, for Ocean Energy Inc., Houston, said at that same meeting.
"We weren't supplying that much more gas, and prices were falling anyway, due to lower demand from the industrial sector," he said.
With virtually every gas well at full production in the US and Canada, Papa said, "Storage is getting jam-packed. During October, it will get worse, and we expect gas prices to get worse."
The solution is for producers to start operating "like a business," he said. "We're going to reduce our rigs. Cur- rently, we're running about 45 rigs, and by yearend, we're likely to drop 10 rigs."
Papa predicted, "Rig activity will fall to yearend. We [producers] will drop another 200 rigs, with the Gulf of Mexico shelf proportionately hard hit compared with land rig activity. In our opinion, the remaining prospects on the gulf shelf absolutely do not work [at prices] below $3.25/Mcf."
Reducing drilling activity will accelerate current production declines. Then when industrial production rebounds, there will likely be a step change in gas prices from $2/Mcf to $3/Mcf, instead of smaller, incremental increases, Papa said.
Meanwhile, EOG Resources plans not to push its gas production so hard in the fall and spring shoulder months. "We don't see any reason to hurry and hook up recently completed wells so we can sell for current prices of $1/ Mcf in the Rocky Mountains, particularly if we think the price will go up in 6 months," Papa said.
Long-term outlook
US demand for gas as the preferred fuel for future power generation is real, Papa contends.
"The biggest growth area for natural gas over the next 10 years will be for power generation," he said. "Our guess is that the long-term stabilized gas price will be $3.25-3.50/Mcf. Anything above $4/Mcf destroys too much industrial demand. Prices at $2.25/Mcf will cause production supply to fall 1.5-2%/year, which is not going to work either."
With smaller discoveries and rapid production declines, Papa and Schiller said, the US gas market will be supply-constrained until a pipeline is built to bring gas from Alaska's North Slope to the Lower 48 in about 2007.
Until then, any new incremental supplies of gas will have to come from the Gulf of Mexico, South Texas, and western Canada.
Production decline rates in virtually all of those areas are getting steeper every year because of new and imaginative well completion technology developed during the past decade that allows the industry to produce reserves quicker, said Papa.
As a result, Schiller said, "The wells we're drilling today are not going to be here 12 months from now."
Texas, which produces 26% of US gas, saw its drilling activity increase by 57% from January 1999 through Sep- tember 2001. Yet its gas deliverability declined 1% this year, even before the recent rig count reductions, said Papa.
Oklahoma, onshore Louisiana, and New Mexico all show the same trend. The only US bright spot is Wyoming. Producing about 8% of US gas, it's the only state where deliverability has increased, up 13% with a 51% jump in drilling activity, Papa said.
"We're not going to solve the problem on the supply side," Schiller said. "In the Gulf of Mexico, we're down to the 5 bcf prospects. We can no longer find wells with 25 bcf reserves that flat-line at 40 MMcfd after they're drilled. Everything we're drilling now is tight gas."
He said the only long-term solution is to open new areas to exploration, such as government lands in the Rocky Mountains, the eastern Gulf of Mexico, and Arctic National Wildlife Refuge coastal plain in Alaska.