While prompt month pricing for oil has rallied 60% and natural gas has followed suit up nearly 20%, upstream investment continues to decline as producers work to mend balance sheets. As production declines and pipeline delays reduce the impact Marcellus and Utica producers can have on the overall market, the North American natural gas market is beginning to wonder where 2017 and 2018 supply will come from and at what cost as drilling activity plunges to unsustainable levels.
In December, we wrote our first piece highlighting the risk that $30 crude could lead to substantially higher natural gas prices if drilling activity continued to drop. It is no surprise to anyone following the oil patch that rig activity continues to decline and in BTU Analytics’ Upstream Outlook, we estimate that just 455 horizontal wells will be drilled in April and approximately 700 wells will be turned to sales during the month as producers consume the inventory of drilled and uncompleted wells (DUCS). In our December piece, we estimated that turning to sales just 750 wells per month through 2018 could leave the market short by as much as 12 Bcf/d by 2018 and now activity has dropped below even that threshold. Combining the declining activity with the inability for global producers to come to an agreement on how to balance global oil markets, our conviction that North American natural gas markets are on course to see stronger cash prices for natural gas than the current forward strip of $2.85/MMbtu in 2017 and $2.92/MMbtu in 2018 has solidified even further.
How much stronger will be determined by many factors, several of which will be addressed in our free upcoming webinar on April 21: DUCs, COBs, and the Ceiling on Marcellus Production, where we’ll outline our estimates on how the backlog of production and pipeline delays are factoring into the balance of natural gas over the next several years. In addition to the above and as a lead in to the webinar, we wanted to focus on the harder to quantify impacts: people and capital availability.
While we are constantly reminded of the reality of layoffs in the industry, the statistics indicate more are on the way if pricing and thus activity do not rebound soon. Utilizing data from the Bureau of Labor Statistics and Baker Hughes, we can see that employment (blue area below) peaked in 2014 at nearly 200,000 individuals involved in the extraction of oil and gas in the US and that the ratio of total employees per active rig averaged ~105 from 2012-2014. Today, that ratio has blown out to 377 employees per active rig, despite a reduction of more than 20,000 positions or 11% of the E&P workforce since 2014.
While some blow out in the ratio would be expected as not all personal are tied directly to new drilling activity, the indication would be that overall, the industry could have as many as 30,000 jobs to eliminate before employment levels coincide with our projected level of rig activity in 2018 of 843 rigs (estimate based on 175 employees per active rig, well above the historical average rate).
As the industry sheds more positions and for a longer period of time, the ability for US E&Ps to react to price volatility will diminish, creating longer periods of imbalance and sending the necessary price signals for producers and services companies alike to begin hiring. In addition to needing to maintain industry employment, producers will need to access significant pools of capital to fund drilling programs to meet increased natural gas demand and offset drilling declines.
Based on our estimates of supply and demand in the natural gas, natural gas liquids, and crude oil markets, BTU Analytics estimates that drilling and completion activity needs to rebound to over 10,000 horizontal wells drilled in 2017 from an estimated 6,600 horizontal wells in 2016 and by 2018, the fleet needs to be drilling closer to 13,500 horizontal wells to fuel the nation’s electricity grid, supply industrial projects in the gulf, and support exports to Mexico, Europe, and Asia . These kinds of rebounds in activity and capital expenditures (50% in 2017 and 35% in 2018) will not happen if crude languishes at $40/bbl and natural gas prices sit below $3/MMbtu. Thus, BTU Analytics remains resolute in our forecast of higher pricing than the current strip for both commodities…assuming normal weather, of course.