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Published: October 30, 2009
With natural gas hovering at about the breakeven
point for new field development -- and with a glut continuing to
weigh down prices in the U.S. market -- this would hardly seem to
be the place to look for investment opportunities.
During the next six months, however, these circumstances will
begin to change. And with those changes will come one of the
biggest new opportunities in the U.S. energy sector.
There will be two key factors to this shift:
- First, gas demand is returning. And that increased demand will
be accompanied by a renewed interest in drilling. Residential
use is now matching volumes seen prior to last year’s financial
shock and power production is actually above pre-crisis levels.
It is industrial demand that languishes, continuing to reflect
the sluggish recovery as a whole. Yet even here are signs that
demand is awakening. Demand had experienced a year-over-year
decline of -11% in August. By the end of October, however, that
decline will have narrowed to -6% or less.
- Second, production from conventional (or freestanding) gas
fields in both the United States and Canada is declining. That
means domestic volume will turn to unconventional sources. And
leading the list is shale gas. Until about 10 years ago, it was
too expensive to extract. But a technology that moves large
volumes of water under high pressure -- called a “frac” -- and
horizontal drilling have made shale the up-and-coming domestic
gas source.
The Massive Marcellus
While there are several U.S. shale plays now producing -- most
noticeably the Barnett Shale Field surrounding Fort Worth, Texas
-- attention is already fixed on The Marcellus. Forming a huge
“C” beginning in south central New York, extending across
central and western Pennsylvania and ending in West Virginia,
this may be the mother lode. The operating companies think so
and have been moving in for more than a year. About 60% of the
production is probably coming from Pennsylvania.
Fewer than 350 wells have been drilled, but pay zones tend to be
larger, pressure higher and recoverable volume greater than
projected. That means the initial estimate of 50 trillion cubic
feet (cf) of recoverable gas (out of the more than 500 trillion
thought to be there) could well be low. My current estimate is
closer to a 17% extractability level or about 85 trillion cubic
feet.
To put it another way: That volume would meet all U.S. demand
for almost five years -- or Pennsylvania’s needs for the next
113. On another matter of interest, there have been no “dry
holes” from any of the wells spud to date. That’s right -- a 100%
success rate! Currently, New York Mercantile
Exchange natural gas prices are
around $5 per 1,000 cubic feet and
that continues to depress drilling
nationwide. However, Marcellus wells
can generally remain profitable at a
level of between $3.60 and $6, and
Pennsylvania permits for new wells
are rising. I believe prices will be
about $5.40 by the end of this year
and will then rise to $7 by
mid-summer of 2010 -- reaching
$10-$12 by 2011.
Clearly, as we move into the New
Year, the Marcellus will be on
everybody’s radar.
Price-Increase Catalysts
Prices are headed higher for three
key reasons.
First, we will have a colder winter
this year than last, meaning the
drawdown from storage will be
greater. With 3.7 trillion cubic
feet set aside at the moment, a
historic high, there will be more
taken out than last year’s 1.2
trillion.
Second, we still have more than 40%
of the rigs off line nationwide,
resulting in a significant cut in
production in the face of rising
demand.
Third, demand on both the industrial
and power generation fronts will
continue to rise. I expect gas usage
for electricity production this year
to increase by +1.5% to +2% over 2008,
a significant result when we
consider the horrendous energy
picture earlier this year. On the
industrial side, the five leading
indicators directly related to
production are poised to begin
moving into positive territory.
A rise in energy use always precedes
such an upward movement, and natural
gas is the principal fuel to benefit
most directly from increasing
production. The location of the
Marcellus also positions its
production well for efficient supply
to an industrial sector needing the
energy -- especially in Pennsylvania,
where an expiring electricity price
cap threatens an already vulnerable
employment base.
With production moving to shale
nationwide, the Marcellus has a
decided pricing advantage over other
plays. While it will take a contract
price of $8 per 1,000 cubic feet to
make most Fayetteville fields
profitable, word has it that almost
50% of remaining Barnett volume may
well require a contract price in
excess of $10.
More than 50 operating companies
have already moved into the
Marcellus. Among them, the companies
to watch include:
- Range Resources Corp. (NYSE: RRC),
the first driller in the Marcellus.
- Chesapeake Energy Corp. (NYSE: CHK),
flush off a joint venture with
Norwegian StatoilHydro ASA (NYSE:
STO) and holder of the most lease
territory.
- Independents Anadarko Petroleum
Corp. (NYSE: APC), EOG Resources
Inc. (NYSE: EOG) and Ultra Petroleum
Corp. (NYSE: UPL). These three have
positioned themselves well to phase
in major drilling programs.
- Sources are also telling me that
Russian giant Gazprom OAO (OTC:
OGZPY) -- which recently signaled its
North American interest by opening
an office in Houston -- has been in
preliminary discussions about joint
venturing in the Marcellus.
But I am saving the most significant
Marcellus development for last.
After a fierce, 101-day political
battle, the Pennsylvania state
budget finally passed on Oct. 9. It
contains no taxes on Marcellus land
available for drilling leases. The
profitability of operating in the
Marcellus just got even better.
-- Kent Moors, Ph.D.
Contributing Editor
Money
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