Monday, January 23, 2012

Flaring Contango

My inner energy futures trader is mesmerized by what is happening in the natural gas markets of late.  If you do not wake up at night wondering if natural gas will flip from contango to backwardation then I will make it simple..  the price of natural gas is plummeting faster than anyone predicted. 

A little over 3 years ago, right around when a lot of folks were signing a lot of their Marcellus Shale leases, the benchmark price for natural gas peaked at over $14 per million British thermal units. The benchmark is for the gas at the Henry Hub pricing point.   As of Friday that price had dropped to around $2.34. So for now a decline of 80+% from it's recent peak, but nobody seems to know where the trend ends. Some describe it as a 10 year low in natural gas prices, but that is in nominal prices.  Adjusted for inflation I wonder what prices would be described as?  I only know what I read, and it seems to me that industry folks, or at least the traders, are beginning to contemplate a near term future where there isn't enough storage capacity to hold the gas being produced.  Then what?

Remember the glow of steel mills along the rivers?  There may be a new glow forming across the Pennsylvania countryside.

But it means more than the potential artificial twilight that may be on the horizon.  Most landowners signed leases with upfront hand money as a bonus to entice signing development rights to one of the drillers out there, but also with guarantees of royalities against future production usually around 12.5% as per state law setting the minimum royalty payments, though many may have negotiated higher shares.

But not all minimums are a minimum.  Some may remember that the drillers won a court case against landowners that the royalty payment  was only due on the price NET of a cost to get gas to market.  How much that isI do not know, but if there are any folks out there in receipt of royalities it would be of interest (at least to me).  The only number in the record I see is from this old blog post which says Range Resources is deducting 72 cents or 80 cents, mer MMBtu, for dry and wet gas respectively.

So just for sake of argument, assume the selling price for gas is the benchmark price.  Yes, some may be getting more, but hold the thought and lets assume a dry gas example for moment.  If you net out 80 cents from the peak and current prices it works out to $13.28 back in 2008 and $1.62 on Friday, it then works out to a royalty decline of over 88%. 
Seems to me there are some latent stories out there of individual landowners seeing their royalty checks dropping precipitously?  Though I have no idea what the time lag is between production and check which may have a lot to do with it. The biggest drops in gas prices have been very recent, and certainly to recent to have been reflected in checks yet.

The bigger question is just where the stability returns to the market.  Are current price levels enough.  Some industry folks say clearly yes and tht profit can be made even as low as $2.50, likely because of the other 'wet' products in the gas here.  But we are not even at that level right now.


Anonymous The Wiz said...

Landowners indeed are feeling the impact of lower gas values. Royalties are usually paid 90- 120 days after the sale but it varies with the company. So royalty checks will be dropping soon. Especially bad as wells deplete rapidly leading to a drop in production, often half in the first year and again in half the second year. Thus royalties will be much lower than a year ago.

There is much chatter about this issue. Some believe that storage will be at capacity this summer and prices will fall below $2/MCF. Wells in the Bakken field are being flared off already as it is too expensive to transport the gas such a long distance and also because of a lack of pipeline capacity. Some wells in Texas are being flared also.

I saw one expert that stated that gas companies will continue to sell gas even at a buck fifty as they make a profit on the wet gas alone and any gas produced is basically free gas and will add to the profit. But in areas where the gas is mostly dry gas landowners may see wells shut in for some time.

Chesapeake just announced they are cutting their drilling rigs from 50 to 24 in dry gas zones. They also will curb production by a billion MCF/yr. But there will still be substantial drilling, keeping gas prices low for several years. All you who heat with gas should be very happy.

Only an increase in demand will bring prices back up. The main demand drivers will be electrical generation and soon as the export terminals come online in a couple of years. Gas prices in overseas are four or five times current US prices. Other demand drivers will be nat gas transportation (see Westport nat gas engines)and a resurgent plastics/chemical/pharma industry.

Monday, January 23, 2012 11:05:00 PM  
Anonymous Anonymous said...

For those banking on exports, I do wonder. The media has been rife with reports that Central Europe, Poland in particular, has very attractive large shale deposits. Not long ago, Chesapeake and Cheniere were banking on imports. Investment in those terminals are now sunk costs. Could all these companies be making export terminal investments just in time for the market to crash abroad as well? Can anyone say, "Tulips"?

Moreover, it is ironic, is it not, how the one thing that would really push a switch to NatGas for electrical generation and in transportation would be enforcement of EPA rules on carbon emissions opposed by all Republican candidates. Remember Tip O'Neill's rule when you go to the polls this year: all politics is local.

Tuesday, January 24, 2012 9:59:00 AM  
Anonymous MH said...

Is gas now bigger than coal here? I have no idea.

Tuesday, January 24, 2012 12:14:00 PM  
Blogger C. Briem said...

I know a smidge about international shipping actually.. LNG transportation issues are so much more complicated than most may presume.

Tuesday, January 24, 2012 1:00:00 PM  

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