Deer, Elk at risk from drilling

[MarvB]

Just read an interesting comentary that beats around the supply/demand/etc. debate going on and where prices may go-
I'll post a couple of the excerpts below:
IF ANYONE CAN RESIZE THIS IT WOULD BE APPRECIATED!!! |oo

February 13, 2006
Supply – Demand Commentary

As reported by the National Climatic Data Center, January 2006 was the warmest on record. With data back to 1895, January’s outcome represents a 1 in 110 year event – almost 3 standard deviations from the mean (assuming weather is normally distributed). As well, the 3-month period ending January 2006 represents the 3rd warmest since 1895. It is no wonder we are in the throes of a significant price retracement even with 1.5 Bcfd of Gulf Coast gas still shut in.

Market action following hurricane Katrina demonstrated that US natural gas demand can respond to price. The almost 50% increase in price immediately following Katrina allowed US storage to be filled as demand was sufficiently reduced freeing up capacity for storage injection. The market worked. Those that value gas most were able to bid up the price to ensure sufficient supply was available to meet their needs. And given the limited financial exposure Investor Owned Utilities (LDC's) have to the price of natural gas, there literally was no price that wouldn’t have worked. This coupled with their obligation to serve left little doubt that the IOUs value gas most and are willing to pay to ensure sufficient supply to meet demand. The thing is, and this is worth remembering, we had to go to $15/MMBtu to impact demand sufficiently. That is, demand remains resilient in spite of higher prices. In a lower price environment, it is easy to argue demand inelasticity to price - an important element in my belief that we are near a bottom.

There are 2 more fundamental elements which support my expectation of a near term (and significant) price bottom and the long-dated nature of the bull market in commodities. Both are supply related. The first recognizes that the North American natural gas market is effectively a closed system that is largely characterized by producing basins in permanent decline. The second element recognizes the long-dated timeframe to add new, significant sources of supply. Anecdotally, significant efforts to conserve will also mark the end of the bull market in commodities. The question is when?

Regarding the North American market, there are currently 4 LNG terminals in operation with combined capacity of about 4 Bcfd. That they operate at something less than a 50% capacity factor in spite of relatively high and sustained prices is one problem. However, in a US market that consumes 62 Bcfd on average, 2 Bcfd of incremental supply is not significant. And it will be years before sufficient global LNG capacity exists to provide the potential of substantial incremental supplies to the US. And that presumes the US will overcome permitting and environmental concerns and build sufficient re-gas capacity.

The other potential significant sources of new supply are in the McKenzie Delta and Alaska. My eight year old will graduate from college before we see that gas in the lower 48.

Given the above, I would characterize the North American market as effectively closed. What we got, is what we got. And it’s in decline.
To illustrate that point let’s look at the heroic efforts of producers. They have been busy…drilling…per figure 1.

But the results have been less than stellar per figure 2.

Figure 2 summarizes US drilling and production data back to 1988. I’ve attempted to illustrate the diminishing returns from drilling in the US, identifying 4 distinct periods. As is evident, the production response to each period of heightened drilling activity is smaller as one progresses to the right on the plot. Most worrying is the latest period in which we had the largest increase in drilling activity but no increase in production. Yet, strangely enough, there are analysts arguing that the US has realized increased production from its drilling efforts in recent years. I think we need to increase the legal drinking age.

It is also worth noting that, in the US, we have drilled 1/3rd of all the gas wells ever drilled since January 2000 yet production is down.
As well, the correlation of drilling activity to price is 93% (linear) with a 4-6 month lag and 50% of production is derived from wells drilled in the last 3 years. Given this, expect rig activity to begin falling in May in response to January’s lower prices. And then expect production to fall. And then expect prices to rise. There is a feedback system at work.

To summarize, we have a closed system characterized by falling supply, relatively inelastic demand and a long-dated timeframe to develop incremental supply. That is a recipe for a bull market. Regarding demand, it is strongly and linearly correlated to weather in the near term and population in the long term. As such, a warm winter or mild summer provides price relieve. That respite should be viewed as an opportunity and, in the context of active risk management, should result in some hedging activity for those that are inherently short.

 

[BigHornRam]

Hard to read Marv until it gets resized, but from what I could see, it's a little beyond what I learned in econ 101. Thanks.

 

[Nemont]

February 13, 2006
Supply – Demand Commentary

As reported by the National Climatic Data Center, January 2006 was the warmest on record. With data back to 1895, January’s outcome represents a 1 in 110 year event – almost 3 standard deviations from the mean (assuming weather is normally distributed). As well, the 3-month period ending January 2006 represents the 3rd warmest since 1895. It is no wonder we are in the throes of a significant price retracement even with 1.5 Bcfd of Gulf Coast gas still shut in.

Market action following hurricane Katrina demonstrated that US natural gas demand can respond to price. The almost 50% increase in price immediately following Katrina allowed US storage to be filled as demand was sufficiently reduced freeing up capacity for storage injection. The market worked. Those that value gas most were able to bid up the price to ensure sufficient supply was available to meet their needs. And given the limited financial exposure Investor Owned Utilities (LDC's) have to the price of natural gas, there literally was no price that wouldn’t have worked. This coupled with their obligation to serve left little doubt that the IOUs value gas most and are willing to pay to ensure sufficient supply to meet demand. The thing is, and this is worth remembering, we had to go to $15/MMBtu to impact demand sufficiently. That is, demand remains resilient in spite of higher prices. In a lower price environment, it is easy to argue demand inelasticity to price - an important element in my belief that we are near a bottom.

There are 2 more fundamental elements which support my expectation of a near term (and significant) price bottom and the long-dated nature of the bull market in commodities. Both are supply related. The first recognizes that the North American natural gas market is effectively a closed system that is largely characterized by producing basins in permanent decline. The second element recognizes the long-dated timeframe to add new, significant sources of supply. Anecdotally, significant efforts to conserve will also mark the end of the bull market in commodities. The question is when?

Regarding the North American market, there are currently 4 LNG terminals in operation with combined capacity of about 4 Bcfd. That they operate at something less than a 50% capacity factor in spite of relatively high and sustained prices is one problem. However, in a US market that consumes 62 Bcfd on average, 2 Bcfd of incremental supply is not significant. And it will be years before sufficient global LNG capacity exists to provide the potential of substantial incremental supplies to the US. And that presumes the US will overcome permitting and environmental concerns and build sufficient re-gas capacity.

The other potential significant sources of new supply are in the McKenzie Delta and Alaska. My eight year old will graduate from college before we see that gas in the lower 48.

Given the above, I would characterize the North American market as effectively closed. What we got, is what we got. And it’s in decline.
To illustrate that point let’s look at the heroic efforts of producers. They have been busy…drilling…per figure 1.

But the results have been less than stellar per figure 2.

Figure 2 summarizes US drilling and production data back to 1988. I’ve attempted to illustrate the diminishing returns from drilling in the US, identifying 4 distinct periods. As is evident, the production response to each period of heightened drilling activity is smaller as one progresses to the right on the plot. Most worrying is the latest period in which we had the largest increase in drilling activity but no increase in production. Yet, strangely enough, there are analysts arguing that the US has realized increased production from its drilling efforts in recent years. I think we need to increase the legal drinking age.

It is also worth noting that, in the US, we have drilled 1/3rd of all the gas wells ever drilled since January 2000 yet production is down.
As well, the correlation of drilling activity to price is 93% (linear) with a 4-6 month lag and 50% of production is derived from wells drilled in the last 3 years. Given this, expect rig activity to begin falling in May in response to January’s lower prices. And then expect production to fall. And then expect prices to rise. There is a feedback system at work.

To summarize, we have a closed system characterized by falling supply, relatively inelastic demand and a long-dated timeframe to develop incremental supply. That is a recipe for a bull market. Regarding demand, it is strongly and linearly correlated to weather in the near term and population in the long term. As such, a warm winter or mild summer provides price relieve. That respite should be viewed as an opportunity and, in the context of active risk management, should result in some hedging activity for those that are inherently short

 

[BigHornRam]

"Yet, strangely enough, there are analysts arguing that the US has realized increased production from its drilling efforts in recent years. I think we need to increase the legal drinking age."

Was this line directed towards Buzz?

 

[BigHornRam]

"The other potential significant sources of new supply are in the McKenzie Delta and Alaska. My eight year old will graduate from college before we see that gas in the lower 48."

What do you think about this statement Marv? Does it have merit?

 

[MarvB]

Thanks for the help Jeff! Size does matter

Paul- I think it's a BIG problem (decreasing supply PER drill start) that is going/does have a huge impact on wildlife. It's akin to Moosie getting his choco shake at the local frosty freeze....all is good in the beginning, then you've got to start moving the straw around the edges to get the last bit.
Full storage (as we have now) has very little to do with a long-term gas supply. Plus they compare storage to a prior five-year average...if those five years were "lean" your current storage projections are infact over-inflated.

Regarding drilling, the way these companies are infilling on their patches is going IMHO to have long term enviro impacts- plus it seems to be too easily approved...kind of the "hey, we're already drilling there so what's a few more wells?" theory. Problem is, as stated in the commentary, it really is a fairly closed system with few places to turn to and LARGE alternatives too slow in coming. Our Resources Dept. keeps beating the LNG drum but I see that impact as too little, too slow, too costly, and with its own enviro problems.

We are going to, on a smaller scale, more green power right now- have jsut about inked a small biomass project (about 10Mw) and are in the midst of our wind project that should go live by summer. AK and McKenzie I don't think will happen anytime soon- I would look for us to lean heavier on the sands and shale projects in Alberta before than happens...just my guess?

 

[MarvB]

Additonal in regards to supply...from Raymond James Financial today:

Adjusting for the hurricane-related production deferrals last fall, 4Q2005 U.S. natural gas production would have been up for the first time in years, Raymond James' analysts said in the latest "Stat of the Week." However, a lack of rigs, higher decline rates and a slowing in efficiencies likely will constrain the supply picture for years to come.

Analysts J. Marshall Adkins, Wayne Andrews and Pavel Molchanov noted the final quarter of 2005 saw a huge 5.9% drop in U.S. gas production from publicly traded companies. However, most of the decline followed the deferrals from hurricanes Katrina and Rita. "If we try to remove the hurricane impact, it appears that U.S. gas production would have been up for the first time in years," to around 1.2%.

However, moving toward a gas-production positive at the end of 2005 took immense effort from the industry, the report noted.

"The industry is now at virtually 100% utilization of onshore gas rigs, and gains in rig counts and drilling efficiencies have also been significant over the past three years. Going forward, constraints in rig availability are likely to become more pronounced, and gains in efficiencies should slow at the same time that higher decline rates begin to kick in, and prospect quality continues to fade. This means that the U.S. gas supply picture remains quite constrained for years go come."

Raymond James' long-term bullish North American energy thesis remains intact. "Much like in the 1970s, when oil production continued to stagnate, regardless of how many rigs were drilling, we think we are at a similar crossroads in the U.S. gas supply picture." As the storage surplus recedes moving into 2007, "we would expect U.S. gas prices to rebound back to the traditional 6:1 BTU parity with crude oil, and potentially even higher, depending on the weather. While short-term gas prices and oil/gas price ratios will continue to be volatile, if oil prices remain near the $60/bbl level, this would imply fair value for gas around $10/Mcf."