While many energy traders have taken the view that the heat wave that baked the nation over the last week has been responsible for the 51 billion cubic feet (bcf) injection of natural gas into storage this week, I think there is something much larger going on. Supply is falling. There should be little doubt. I know, I know… Some big Wall Street firm, the EIA or some boutique consulting agency kept saying that natural gas supplies are going to grow this year. How could they be wrong? Simple. They are all deeply involved in Model Worship. Model Worship is simply the practice of blindly believing that if X wells are drilled in a year, production will increase Y percent. I am sorry but the world does not work that way. It didn’t work that way for the banks that marked their portfolios to imaginary values and it won’t work for the oil and gas industry. Let’s get specific, shall we?
According to the Texas Railroad Commission, Texas production in April 2010 was 86 bcf lower than April 2009. Texas produces about a third of all gas in the US and has the most drilling rigs actively exploring for oil and gas of any state. Production is also falling in New Mexico, Colorado, Utah, Wyoming, Oklahoma and the Gulf of Mexico. However, a smart Wall Street analyst might supply the rebuttal of “But production is growing in Louisiana and Pennsylvania!” True. Now let’s get really specific.
According to the Pennsylvania Department of Conservation and Mineral Resources, (the agency that is responsible for reporting production data), the State’s production was less than 500 million cubic feet per day (mmcf/d) in 2007, the last year of available data. While production in the Marcellus has grown in the past three years, it has not grown nearly as much as most might assume. For example, the largest operator in the Marcellus, Range Resources, anticipates exiting 2010 at only 200 mmcf/d despite having spent several years and several billion dollars on the play to date. What about the second largest operator, Chesapeake Energy?
According to the most recent presentation available on their website, the company produced only 100 mmcf/d from the Marcellus as of May 3rd. I could go on but I think you see the trend. While the Marcellus certainly has significant potential, a major ramp up in production is going to take time. Therefore, while current data from the state of Pennsylvania is difficult to come by, it would be hard to see how current gas production from State is materially over 1 billion cubic feet per day (bcf/d). This amounts to less than 2% of total US production and only 5% of the current production from Texas. It is hard to see how Pennsylvania does much to offset the nearly 3 bcf/d of decline in Texas alone.
While there is little doubt that the Haynesville in Louisiana will grow this year, production has already begun to flatten out at approximately 2 bcf/d. More importantly, other producing areas in Louisiana have seen falling production as operators favor the Haynesville over plays such as the Travis Peak and Pettit. Without stable production from plays outside of the Haynesville, it will be very difficult for total Louisiana production to grow much above its current level of approximately 5.25 bcf/d.
While I would like to think that the majority of energy analysts would have learned the limits of models after the recent banking crisis, it appears they have not. This has created a tremendous opportunity for contrarians to purchase natural gas levered investments such as the UNG or long-term options on the UNG at great prices. I hold both of these securities.
Disclosure: Author long UNG and UNG $20 January 2012 calls
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