Unprofitable drilling, a global recession and dwindling access to capital could lead to a decline in U.S. natural gas production this year and next. The declines could finally set the stage for an increase in prices in 2021, according to two reports.
The frenzied pace of fracking in the U.S. over the last few years led to a supply glut even prior to the onset of the coronavirus. Associated gas in the Permian, along with record production in the Marcellus shale in Appalachia, crashed prices below $2/MMBtu at the start of 2020.
The bust in the gas sector brought production to a halt as even sub-$2.50 gas was largely unprofitable. Late last year, Chevron took an $11-billion write-down, and a big chunk of that was from its shale gas assets in the Marcellus. Pittsburgh-based EQT also announced a $1.8 billion write-down at the start of 2020.
Again, that occurred before the coronavirus brought major economies to a standstill.
Now, rigs, capital and people are abandoning the Permian. Production is widely expected to be at a peak and declines are just around the corner. A slowdown in drilling will translate into lower associated natural gas production.
The economy has also suffered a sudden stop. Goldman Sachs sees full-year U.S. GDP contracting by 3.8 percent. Much of the focus in the trade press looks at the fall in oil demand because of empty skies and quiet streets, but factories are also idling, blowing a hole in industrial and utility gas demand.
The surplus is large enough at this point that the U.S. is set to enter the winter of 2020-2021 with record levels of inventories, which will prevent a rally in prices. The drop in gas output from the Permian will arrive too late for 2020 prices.
But that sets the stage for a tighter market next year, as gas output continues to slide even as demand rebounds.
“[A]s we enter the 2020/21 winter, we expect production declines to be visible enough that gas prices will rally sharply in our view to help summer 2021 reach comfortable inventory levels,” Goldman Sachs wrote in a report on Tuesday.
“Under current forward prices, we believe this would lead US natural gas balances to a record-low level that summer, nearing only 2.2 Tcf,” Goldman analysts wrote. “This would be the result of an estimated 2.4 Bcf/d summer-on-summer decline in production matched up against a 5 Bcf/d expected increase in demand.”
“This exceptionally tight outlook suggests current forward prices are not sustainable,” the bank concluded. The bank sees $3.50/MMBtu gas by the winter of 2020-2021 and $3.25/MMBtu by the summer of 2021.
Nevertheless, in the short run, the investment bank still sees Nymex gas prices averaging $1.60/MMBtu in the second quarter, a level so low that few shale gas drillers can earn a profit. Meanwhile, across the globe, LNG prices in Asia (JKM) will hover at historically low levels of $2.50/MMBtu.
In a separate report, Bank of America Merrill Lynch is even more downbeat. Bank of America sees 2021 pricing at just $2.45/MMBtu – up substantially from this year, but notably short of the $3.25-$3.50 that Goldman sees.
Bank of America pointed out that Appalachia has been living off of drilled but uncompleted wells for several years, allowing production to continue to rise. That backlog is now depleted, which should lead to a decline in output. But the Permian still has a large backlog of DUCs, which means that production may not fall off of a cliff – by extension, associated gas output in the Permian may decline by less than might be expected.
Still, the sector is in distress and production is set to decline. “We have likely passed peak shale natural gas production for the next couple of years,” Bank of America said.
Just because prices begin to rise in 2021 does not mean that the shale business comes back in the same way. “[I]t will be difficult for producers to get back on the shale treadmill. Investor focus on ESG and poor historical equity and debt returns likely limit access to capital for the E&P sector,” Bank of America Merrill Lynch wrote in a note.
By Nick Cunningham of Oilprice.com
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