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Drillers cut natural gas production as prices drop to about $2.50

Posted: February 13, 2012 - 12:00am

PITTSBURGH — As natural gas prices continue to drop, the recent nationwide boom in drilling is slowing. Drillers don’t make money if prices go too low — and drilling wells isn’t cheap.

“It is safe to say that there will be fewer natural gas wells drilled in 2012,” said Kathryn Klaber, president of the Marcellus Shale Coalition, an industry group based in Pennsylvania.

In recent weeks, several companies have announced plans to cut gas production around the nation, but experts say the low prices are also opening up new markets.

When the shale drilling boom was starting in 2008 the average price for a unit of gas was about $8. Two years ago it was down to $5.50, and now it’s dropped to about $2.50. Part of the reason is that the shale gas formations became productive more rapidly than expected, as thousands of new wells have been drilled nationwide.

Industry reports note that the national count of active new gas drilling rigs fell to 775 in early February, down from about 1,500 in 2008.

Yet Klaber said that the low prices create opportunities for more people and industries to use the product. For example, some drilling companies are focusing more on the so-called “wet gas” that sells for a higher price because it can be transformed by refineries into consumer products such as plastics and fertilizer.

Last month, Chesapeake Energy of Oklahoma City said it is reducing the number of new dry gas drilling rigs from 47 to 24 this year. In addition, it immediately cut existing production by about 500 million cubic feet per day, adding that if low prices persist, it may double the cut, to 1 billion cubic feet per day.

The company said that about 85 percent of its nationwide drilling expenditures this year will be toward the more profitable wet gas.

A spokesman for Chesapeake didn’t respond to a request for comment.

Experts say the companies have ways to cushion the low prices. It’s called hedging, and business people have used such tools for hundreds if not thousands of years, said Sara Moeller, a professor of business at the University of Pittsburgh.

“When you put a hedge on, you’re locking in one of your prices, because you’re happy with that price,” said Moeller, who has also worked as a commodities trader.

For example, Houston-based Cabot Oil & Gas Corp. said last month that it received $5.17 per thousand cubic feet of natural gas on some hedged deliveries in the final quarter of 2011. Yet the market price at the time was $3.18 per thousand cubic feet.

Moeller said such deals are possible because large consumers of commodities also want to reduce price swings, such as utility companies. Locking in prices limits their exposure to sudden jumps.

It’s done by a simple, registered trade on stock exchanges. People essentially buy and sell the hedges, setting varying prices for different points in the future.

Klaber said the record-low prices have “caused every company to evaluate their business model. A well that may have been profitable to drill last year, this year won’t be profitable.”

A government report issued last week predicted that at the end of March, the amount of natural gas that companies are storing is expected to be the highest since 1983. Those unsold reserves could push prices even further down.

But she noted that the drilling companies are just one part of the industry.

“What may be tighter times for the producers becomes incredibly positive for all the other people in the supply chain,” she said.

She said that means a big piece of the puzzle on long-term trends is how quickly consumers, power plants and refineries increase their use of natural gas.

And while oil and gas companies know how to use hedging to smooth price drops, that tool doesn’t work forever, noted Jay Apt, a professor of technology at Carnegie Mellon.

“It doesn’t necessarily fix your cost” over the long term, he noted, but gives a range of price options. If the boom in natural gas supply collides with a surge in demand, perhaps from power plants looking to take advantage of the low prices of the cleaner-burning fuel, he said price volatility could return.

“Then we could be in for a wild ride,” Apt said, because the higher prices might encourage companies to increase drilling again.

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