Natural Gas’ Historic Reversal of Fortune: Oversupply to Drastically Short in Months?

The world as we know it has flipped on its head over the past 30 days.  The US went from full employment to 17 million Americans filing for unemployment. The White House has discussed how the US might participate in joint action with OPEC+. Oil producers who were searching for every way to cut G&A by $0.25 per barrel are now inquiring about the ability to dispose of oil down disposal wells when crude storage fills.  But what hasn’t received enough attention is the impact of this new world on natural gas markets. The stage is being set for what could be a historic swing in fortune in natural gas markets over the coming months.

To say that US natural gas producers have had a rough couple of years is an understatement.  Equity valuations have cratered as investors soured on uneconomic growth for growth’s sake.  Associated gas from crude oil development has been growing at nearly the same pace as demand, and renewables are gaining market share in the power sector that many had earmarked for gas-fired generation.

Most of the large publicly traded gas producers have taken meaningful steps to appease investors, focusing on returns rather than growth and moving to pay down substantial debt burdens. However, gas pricing hasn’t provided any favors, as mild weather has capped natural gas prices below $2/MMbtu for most of 2020.

But the one-two punch of COVID-19 and an OPEC+ price war are changing everything.  We highlighted three weeks ago in our commentary that US producers were on a collision course with shut-ins as storage nears capacity.  As the latest US weekly data showed last week, US oil stocks are soaring.  Very soon crude will have no place to go.  It appears highly likely that millions of barrels of US oil will soon be shut in as the US crude system potentially reaches its physical limits.

Activity in the field has been cut along with capital budgets, but more cuts are on the way.  After all, it will be hard to make a case for bringing new wells online when wells that are already producing will need to be shut-in.

Lowering completion activity and shutting in wells will be a part of the solution to re-balancing oil markets.  But those same shut-ins compounded with lower levels of activity in oil plays could cause massive impacts to the balance of the natural gas market as well.  A few basic charts can demonstrate this impact at a high level.

Setting aside 2020 crude shut-ins for a moment (and clients, don’t set this aside, read the alert and supplemental analysis we sent you this morning) to focus on the impact of lower levels of activity, the chart below is a comparison of US oil production projection based on rig counts prior to the COVID and oil price war to a projection of production from existing wells (PDP) if no new wells were turned to sales in addition to a case where activity from earlier this year is cut in half.  Again, neither of these cases include any impact for shut-ins or represent BTU’s actual forecasts as those forecasts including shut-ins are made available exclusively to BTU clients.

These scenarios show crude oil production 2.7 MMb/d lower in 2021 for the 50% reduction in activity case or 5.4 MMb/d in the PDP case.  Now we don’t expect US producers to complete zero new wells through the end of 2021.  But 2020 capex spending and activity will set the stage for 2021 production, and the outlook for that spending and activity continues to be revised lower, even before significant shut-ins begin.  What does 2.7- 5.4 MMb/d of lower activity mean to the natural gas market?  The answer depends on the gas-to-oil ratios for the wells impacted.  While BTU models shut-ins and activity cuts at a basin level using specific GORs, to keep things simple for this energy market commentary we can use a generic  assumption of 3 GOR.  The chart below translates the oil activity cuts highlighted in the former chart into gas volumes.

Using a generic 3.0 GOR assumption implies 8.1 to 16.2 Bcf/d of impact.  For comparison, Q1’20 LNG Exports were just over 8 Bcf/d.  And while this simple analysis doesn’t consider changes to demand from COVID or what producers in gas-focused plays might do, it also doesn’t include shut-ins in 2020, the impact of seasonality or transmission constraints.  Gas production was once capable of growing quickly.  But analysts expecting Appalachian gas producers or even Haynesville producers to solve this problem haven’t dug into the details.

The good news is that BTU Analytics is making real time changes to both S/D, storage and pricing models and has views on oil shut-ins, gas production impacts, pricing, and fundamentals.  Clients can call in and speak to our team of analysts anytime.  If you aren’t a client, you should ask how well your data and research provider serves you when it counts.  Email info@btuanalytics.com to learn more about BTU Analytics’ natural gas market coverage.

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Kathryn Downey Miller is President of BTU Analytics where she leads the firm’s consulting and analytics groups in delivering market advisory services to clients across all sectors of the industry. Additionally, Kathryn oversees strategic planning, financial budgeting and analyst development for the company. Prior to founding BTU Analytics, Kathryn built market expertise in a diverse set of prior industry roles, including buyside investment research at an energy focused hedge fund, energy market fundamentals consulting at Bentek Energy, investor relations strategy consulting for E&P companies and investment banking at Citigroup. She speaks frequently at industry events on North American energy markets and is a CFA charterholder.

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