The collapse in oil prices gets most of the headlines. But the corresponding collapse in natural gas prices may be the more important story for both the short- and long-term interests of the U.S.

On July 1, natural gas futures peaked at $13.51. On July 14, crude oil futures peaked at $145.16 per barrel. Today, the spot price for natural gas is about $5.67 and the spot price for oil is about $46. And those prices may go lower still. On November 24, Jen Snynder, the head of North American gas research for the energy consulting firm Wood Mackenzie, released a report which she claimed that the U.S. gas market should expect to see natural gas prices “in the range of $5 to $6” for the next five years.

While many analysts have discounted Snyder’s prediction, the potential for a long-term slowdown in natural gas drilling in the U.S. could have devastating effects on the drillers and oilfield service companies. The number of rigs drilling for gas usually outnumber those looking for oil by more than 3 to 1. But now that the U.S. is awash in gas, a drastic slowdown in drilling has begun. That can be seen by looking at the latest rig count numbers from Baker Hughes. And Texas, the biggest natural gas producer in the country, provides a good barometer for the trend. In September, an average of 946 rigs were working in the Lone Star State. By the first week in December, the number of active rigs in Texas had fallen to 852.

The bear market in gas will be exacerbated by recent announcements. Yesterday, Houston-based Petrohawk Energy announced that three of its new wells in the Haynesville Shale in Louisiana were each producing more than 20 million cubic feet of gas per day. Those are the biggest wells ever recorded in Petrohawk’s history. Also yesterday, Dallas-based Exco Resources announced its own Haynesville well, which was also flowing gas at more than 20 MMcf/d.

Those are sizable wells by any measure. Keep in mind that the U.S. produces about 19.2 billion cubic feet of gas per day from more than 448,000 wells. That means that the average U.S. gas well produces about 43,000 cubic feet per day. These new Haynesville wells are showing initial production rates that are three orders of magnitude larger than that. And those new wells are coming online at the same time that some gas producers in Oklahoma have shut in their wells rather than sell their gas at current prices. Furthermore, some 2 billion cubic feet of daily gas production in the Gulf of Mexico continues to be shut in due to lingering damage from this summer’s hurricanes.

The new reality for the gas industry is one of enormous available resources, with much of that availability coming from the new shale plays like the Haynesville, Fayetteville, and Marcellus. In July, a study done by Navigant Consulting estimated that America’s potential gas resources may total 2,200 trillion cubic feet. That’s 50 percent more gas than the current proven reserves of Russia and twice as much as the proven reserves in Iran. Put into oil terms, that 2,200 Tcf of gas is the equivalent of one-and-a-half Saudi Arabias. A more recent study, published in mid-November by consulting firm ICF International, estimated U.S. gas resources at 1,830 trillion cubic feet. In petroleum terms, that’s the oil equivalent of 329 billion barrels of oil or about three Kuwaits.

On November 11, during a meeting of the Independent Petroleum Association of America held in Houston, Mark Papa, the chairman and CEO of EOG Resources said the U.S. gas industry was in the midst of a “total sea change unlike anything we’ve seen in our careers. Don’t underestimate the power of that sea change.” Papa said that the Haynesville Shale, which may contain 50 trillion cubic feet of gas, the equivalent of about 9 billion barrels of oil, is one of “the biggest fields found in the entire world over the last decade.” At that size, the Haynesville field would be bigger than the massive offshore Tupi discovery in Brazil that was announced by Petrobras in 2007. Papa said that the shale gas deposits provide a “huge amount of gas that can be mined. And I use the term ‘mined’ because the geologic risk has been minimized.”

Although the geologic risk has been minimized, other risks have come to the fore. Fifteen years ago, natural gas was “hard to find and easy to produce,” says David Pursell, a managing director at Tudor, Pickering, Holt & Co., a Houston-based investment banking firm. With these new shale plays, gas is “easy to find and hard to produce…. You have traded one risk for another.” In the past, the U.S. gas business was focused on geology and geophysics. Now, says Pursell, “It’s a much more of a completion and engineering game.”

Indeed, the ability of natural gas producers to get big production numbers from their shale wells requires them to employ multiple hydraulic fractures in a single well. The Exco well announced yesterday had a nine stage fracture on a horizontal lateral that was 4,481 feet long.

Pete Stark, the vice president of industry relations at IHS, a Denver-based data and consulting firm says these new shale plays are “an incredible plus for U.S. energy security.” But he adds that the negative for the gas companies and gas drillers is that this “huge supply growth is coming onstream at the same time that demand is falling out of bed. So it’s a killer for the industry going forward.”

Thus, the problem for the gas industry is a familiar one: profits. During their discussion at the IPAA meeting in Houston, Papa of EOG Resources and Jeff Wojahn of EnCana said that their companies needed natural gas prices to be in the $7 to $8 range for their shale drilling programs to be profitable. Obviously, given current prices, all of the gas-focused independent companies are scaling back their drilling programs by as much as 50 percent. And it’s not yet apparent how many drilling rigs will be idled in the coming months as more and more companies slash their capital expenditure budgets.

H.G. “Buddy” Kleemeier, the president and CEO of Tulsa-based Kaiser-Francis Oil Company, says that the gas industry must adapt to this new paradigm: huge available resources, minimized geologic risk, increased engineering risks, and ongoing price risk. In the past, the oil and gas industry was largely regulated by either government restrictions on production (prorationing that was administered by the Texas Railroad Commission) or restrictions on how gas could be used (like the Powerplant and Industrial Fuel Use Act of 1978) or by pricing regimes imposed by regulators.

Today, the natural gas industry operates in a largely deregulated environment. Given that fact, Kleemeier, (who is also the current chairman of the IPAA) expects the gas industry to be governed by what he calls “prorationing by price.” When prices fall, drilling rigs will be idled. And those rigs will remain idle until prices recover.

Obviously, the U.S. will need to keep drilling lots of new wells as these shale gas wells have steep decline curves. But it will take many months, or perhaps several years, before the U.S. gas industry understands the optimal rate of drilling. The hard truth about the current gas glut is that the U.S. gas industry has been victimized by its own success. The amazing technological breakthroughs in extracting natural gas from shale has led to a surfeit of gas. At the IPAA meeting last month, Porter Bennett, the president and CEO of Bentek Energy, an Evergreen, Colorado-based consulting firm, said “We have more gas that we know what to do with.” That’s good news for consumers. It’s good news for the environment, as increased natural gas use should result in cleaner air. And more natural gas use in the truck and car fleet could help reduce U.S. oil consumption.

The irony is that the current excess of domestic natural gas is bad news for the very industry that made the gas glut possible. And now, the gas industry must look to the new Obama administration for some type of legislation that could help spur natural gas demand and therefore raise prices. That legislation could come in the form of a tax on carbon or more restrictions on coal-fired power plants. For Stark, the policy path should be obvious: “If the Obama administration is at all clever, they will capitalize on this increased gas production and use it to solve quite a few clean energy objectives for the country.”

Original text here: http://www.energytribune.com/articles.cfm?aid=1055