GAS_AND_POWER_KALEIDOSCOPE：HIDE_AND_SEEK-2013-01-09.ppt

commodities research north american natural gas and power 8 january 2013 gas and power kaleidoscope hide and seek biliana pehlivanova +1 212 526 1170 shiyang wang +1 212 526 7464 while headline us gas production continues to grow, signs of declines in parts of the country are emerging. we single out four areas of production growth, which are concealing declines elsewhere. we estimate that gas production in the marcellus, fayetteville, and gas from oil wells in texas and north dakota added 3,150 mmcf/d through september in 2012. outside of these four regions, lower-48 dry gas production dropped 2,850 mmcf/d in the first nine months of 2012, in line with gas-directed drilling trends. without a meaningful uptick in gas-directed drilling outside of the marcellus and fayetteville, we expect these declines to accelerate. producers are well hedged for 2013, but at lower prices than last year. while some uptick in gas-directed drilling is possible in 2013, gains should be limited. we reiterate our expectation for aggregate us lower-48 production to tip into declines in the second half of 2013. revisions to historical production data caused our y/y production growth estimate to inch slightly higher. we expect 2013 dry gas production to average 64.95 bcf/d, up 180 mmcf/d versus 2012. chart of the week: lower-48 dry gas production, bcf/d 70 65 60 55 50 45 40,jan-08,oct-08,jul-09,may-10,feb-11,nov-11,aug-12,other lower-48,tx associated,nd,fayetteville,marcellus,source: eia, north dakota industrial commission, arkansas oil and gas commission, bentek, barclays research please see analyst certifications and important disclosures starting after page 17,growing,1,2,barclays | gas and power kaleidoscope,gains in the marcellus, fayetteville, and associated gas output in texas and north dakota have outpaced declines in the rest of the country so far gas produced from oil wells is gains in gas from oil wells are highly concentrated in texas and north dakota,headline us dry gas production continues to grow, despite the sharp pull-back in gas-directed drilling (figure 1). but signs are emerging that in many parts of the country output is in a steep decline. seeking to understand the magnitude of dry gas production declines outside of the major growth areas, we single out four regions with growing gas output: gas produced from oil wells in texas and north dakota, and the marcellus and fayetteville shale formations (chart of the week), and compare that with aggregate lower-48 output. we find that outside of these four regions, lower-48 dry gas production dropped 2,850 mmcf/d in the first nine months of 2012, in line with gas-directed drilling trends (figure 2). we reiterate our expectation for aggregate us lower-48 production to tip into declines in the second half of 2013. revisions to historical production data caused our y/y production growth estimate to inch slightly higher. we expect 2013 dry gas production to average 64.95 bcf/d, up 180 mmcf/d versus 2012. associated gas an increasing amount of gas is produced from oil wells and it is clear that oil-directed drilling is having a meaningful effect on us natural gas production trends. what is less obvious is the magnitude of associated production gains, as data lag significantly and are plagued by reporting inconsistencies. note that the industry does not have a standard definition for what is considered an oil well. eia data on associated gas production aggregate data reported by the states. but each state has its own rules on classifying wells as an “oil well” or a “gas well”. as a result, the ratio of gas production for each unit of oil output can vary greatly from state to state. moreover, data for some states (oklahoma for instance) appear inconsistent from year to year, further clouding the production landscape. thus, reported us associated gas data may not be an accurate reflection of the trends. to the extent that the data are consistent over time within a state, however, they can be helpful in understanding the underlying developments in associated gas. in particular, we focus on associated output in texas, and north dakota, where the eagle ford and bakken shales are leading the way in the development of shale oil. texas: texas is the largest associated gas producing state, with gas production from oil wells1 averaging 2,900 mmcf/d in 2011, up 610 mmcf/d from 2010 (eia). associated gas has ramped up consistently with the growth in oil output, and we use oil production data to extrapolate the trend for associated gas in 2012 (figure 3). this approach suggests that gas produced from oil wells in texas could have increased by 1,200 mmcf/d in 2012, barring,figure 1 lower-48 dry gas production and gas-directed drilling,figure 2 lower-48 dry gas production, excluding marcellus, fayetteville and associated gas in texas and north dakota,70,000 65,000 60,000,1,800 1,600 1,400 1,200,54 52 50,1,600 1,400 1,200 1,000,55,000 50,000 45,000,1,000 800 600 400 200,48 46 44 jan-08,jan-09,jan-10,jan-11,jan-12,800 600 400 200 -,40,000 - jan-08 oct-08 aug-09 jun-10 apr-11 feb-12 nov-12 lower-48 dry gas (mmcf/d) gas rig count (rhs) source: eia, smithbits, barclays research,lower-48 dry gas production, ex fayetteville, marcellus, nd, and tx associated gas gas rigs ex fayetteville and marcellus (rhs) source: eia, north dakota industrial commission, arkansas oil and gas,commission, bentek, barclays research texas classifies a well as “oil well” if it produces less than 100,000 cubic feet of gas per one barrel of oil. 8 january 2013,in 2013,2013,0,3,p d d s ld,barclays | gas and power kaleidoscope infrastructure constraints. a similar extrapolation for 2011 produced results within 1% of reported associated output.,infrastructure additions and increasing oil output will pace texas associated gas growth north dakota gas output could repeat last years growth in,the largest sources of associated gas production in texas are the permian basin and the eagle ford. while the permian carries the greater portion of overall associated gas output, it is the eagle ford that has driven the majority of the growth. anecdotal evidence points to significant flaring of associated gas in the eagle ford, due to gathering infrastructure and processing capacity constraints. thus, in 2013, the states associated gas production will be paced by the increase in oil output, as well as by pipeline and processing capacity additions that debottleneck latent or flared supply. pipeline capacity in the eagle ford is set to add 600 mmcf/d in q1 13, and a further 500 mmcf/d in q3 13. this compares with about 200 mmcf/d of pipeline capacity added in 2012. processing capacity in the play grew by 1.65 bcf/d in 2012, and this year is expected to see a further 1.65 bcf/d come on stream. north dakota: gas production in north dakota comes overwhelmingly from bakken shale oil wells, and is constrained by available gas processing and pipeline infrastructure. reports from the state of north dakota show the states production at 796 mmcf/d in october 2012, and volumes sold at 524 mmcf/d (figure 4). the difference, about 270 mmcf/d, or 34% of the states gas output, is flared. north dakotas gas output grew by only 50 mmcf/d in 2011, but is adding 180 mmcf/d on average in 2012 through october. further growth this year will be paced by oil production increases, as well as pipeline and gas processing capacity additions. two new processing plants started operation in late 2012, with a combined capacity of 135 mmcf/d, and three others are scheduled to come online this year, adding a further 300 mmcf/d. the infrastructure expansions suggest that the 2012 growth in gas production in north dakota can be matched and exceeded in 2013, even if drilling moderates slightly. other oil/liquids shale plays, such as the granite wash, niobrara, mississippi lime, and cana woodford, among others, will add to gas production growth. the analysis of production trends in these areas is complicated by the lack of contemporary production data. in addition, it is unclear whether rigs targeting liquids wells are classified as gas- or oil-directed in the drilling statistics. while gas production gains could be significant in relative terms for each shale play, their combined volumes are still relatively small and unlikely to have an overriding effect on overall us production.,figure 3 texas associated gas output, mmcf/d (2012 estimates) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 jan-05 jan-06 jan-07 jan-08 jan-09 jan-10 jan-11 jan-12,figure 4 north dakota gas output, mmcf/d 900 800 700 600 500 400 300 200 100,oil (kb/d),gas from oil wells (mmcf/d),jan-08,jan-09,jan-10,jan-11,jan-12,source: eia, barclays research 8 january 2013,source: north dakota industrial commission, barclays research,4,barclays | gas and power kaleidoscope our oil team expects oil-directed drilling to remain broadly unchanged from current levels in 2013, and oil production to continue growing, albeit at a somewhat slower pace (780 kb/d in 2013, versus 580 kb/d in 2012). while this would suggest that associated gas production growth should maintain its pace or decelerate, debottlenecking of some pent up volumes is likely to propel associated gas output higher than oil output growth alone would indicate. marcellus and fayetteville,marcellus production growth can be repeated in 2013, despite the pull-back in drilling fayetteville gas output should tip into declines in 2013,marcellus stellar performance is single-handedly overwhelming the bulk of dry gas production declines. the plays output has soared from 2.8 bcf/d at the end of 2010, to over 8.6 bcf/d in december 2012 (figure 5). on a yearly average basis, gas production rose a staggering 3.2 bcf/d in 2012, based on pipeline flow reports. even at todays muted forward curve prices, the marcellus offers attractive returns as economics are boosted by high liquids content. processing infrastructure has not kept pace with gas production growth, and a significant amount of ethane is being rejected into the gas stream, effectively adding to dry gas production. drilling activity in the play has slowed as a result of moderating prices last year, but the pull- back has been modest, compared with the drops elsewhere in the country (figure 5). in addition, a large inventory of drilled but uncompleted wells and upcoming infrastructure expansions that will debottleneck latent supply promise to keep production growing in 2013. pipeline infrastructure in the marcellus is poised to add 550 mmcf/d in q3 and 2,500 mmcf/d in q4 of this year. this compares with 460 mmcf/d of pipeline capacity added in h1 12 and 2,760 mmcf/d starting operations in h2 12. debottlenecking and a reduction in drilled by uncompleted wells will support marcellus production this year, and we believe that, despite the moderation in drilling, the play is likely to repeat last years growth. fayetteville gas production averaged 2,800 mmcf/d in 2012 through september, up 250 mmcf/d from the prior year. drilling in the play has slowed, and while efficiency gains are offsetting some of the negative effect, the rate of production growth in 2012 was half of its 2011 levels (figure 6). southwestern energy, which produces over 80% of fayettevilles gas, plans to complete 385-390 wells this year, compared with 482 wells completed in 2012, and expects production to decline 1.5% (at guidance mid-point) y/y (see southwestern energy (swn) - 2013 guidance largely in line, august 18, 2012). rig count data show that other drillers in the area have cut their rigs in half in the last two months of 2012 versus 2011. thus, fayettevilles output should tip into declines in 2013.,figure 5 marcellus natural gas production and drilling,figure 6 fayetteville natural gas production and drilling,10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0,85 80 75 70 65 60 55 50,3,500 3,000 2,500 2,000 1,500 1,000 500 0,80 70 60 50 40 30 20 10 0,jan-08,jan-09,jan-10,jan-11,jan-12,jan-08,oct-08 aug-09 jun-10 apr-11 feb-12 nov-12,gas production (mmcf/d),rig count (rhs),gas production (mmcf/d),rig count (rhs),source: bentek, smithbits, barclays research 8 january 2013,source: arkansas oil and gas commission, barclays research,txoilwellgas,marcellus,fayetteville,lower-48,nd,other,txoilwellgas,marcellus,fayetteville,lower-48,nd,other,5,barclays | gas and power kaleidoscope other lower-48 production,production outside of the four growth areas examined is in a steep decline we expect declines in “other” lower-48 output to accelerate producers have hedged 36% of 2013 output, at an average price of $4.48 per mmbtu,in aggregate, we estimate that the four areas discussed above have contributed 3,200 mmcf/d of y/y production growth in 2011 and 4,800 mmcf/d y/y through september in 2012. given overall dry gas output, this implies that excluding these areas, “other” lower-48 production grew by 1,200 mmcf/d y/y in 2011, but declined by 1,100 mmcf/d y/y in the first nine months of 2012 (figure 7). note that as defined above, “other” lower-48 gas output includes production from the haynesville, barnett, and gas-well gas from the eagle ford shale play, among others. in contrast to aggregate natural gas production, the trajectory of “other” lower-48 output, as defined, above mirrors drilling trends (figure 2). by september 2012, “other” lower-48 production was down 2,900 mmcf/d from january 2012. since tipping into declines at the end of 2011, “other” lower-48 output has dropped, on average, 375 mmcf/d each month. if this pace of declines persists throughout this year, “other” lower-48 output will fall by over 3,900 mmcf/d in 2013. in this scenario, a repeat of last years strong growth of marcellus and associated gas in texas and north dakota, coupled with a modest drop in fayetteville production, would result in aggregate lower-48 output growing about 400 mmcf/d y/y, on average, in 2013. however, we believe that as of september (the last month for which data in all examined regions are available), “other” lower-48 production had not yet reflected the full effect of last years pullback in gas-directed drilling, as the gas rig count averaged 639 in h1 12, and 442 in h2 12. while some production areas have been in a decline throughout 2012, others are only now tipping into sequential losses. if gas-directed drilling remains at current levels throughout 2013, on average, drilling activity would be down 20% y/y. without a meaningful rebound of gas-directed drilling outside of the marcellus and fayetteville shale plays, we believe the declines in “other” lower-48 are poised to persist and accelerate. producers are well hedged, but at lower price levels than last year analysis on hedging by our colleagues in credit research shows that companies have hedged 36% of expected natural gas production for the current year, and 23% for 2014 (see hy research: high yield e&p 2013-14 hedging overview, december 21, 2012). while the level of hedging for 2013 is similar to that of last year, producers have locked in significantly lower,figure 7 y/y change of gas production* average january september 2012, mmcf/d,figure 8 change of gas production, january september, mmcf/d,4,000 3,000 2,000,4,000 3,000 2,000 1,000,2010,2011,2012 (jan-sep),1,000 0 -1,000 -2,000 source: eia, north dakota industrial commission, arkansas oil and gas commission, bentek, barclays research 8 january 2013,0 -1,000 -2,000 -3,000 -4,000 source: eia, north dakota industrial commission, arkansas oil and gas commission, bentek, barclays research,6,barclays | gas and power kaleidoscope prices (figures 9 and 10). in effect, the y/y drop in revenues from hedged production (-$1.04 per mmbtu) will offset any gains from a recovery in prices (+$0.87 based on our price forecast of $3.70 average for 2013). while some uptick in gas-directed drilling is possible in 2013, gains should be limited, as long as prices stay below $4.004.50 per mmbtu. we expect the rig count to hover around 450 this year a level at which we believe production declines accelerate. we reiterate our expectation for aggregate us lower-48 production to tip into declines in the second half of 2013.,we expect dry gas production to average 64.95 bcf/d in 2013,while our headline production forecast has not changed, revisions to historical production data caused our y/y production growth estimate to inch slightly higher. we expect 2013 dry gas production to average 64.95 bcf/d, up 180 mmcf/d versus 2012.,figure 9 hedged natural gas production, current year, %,figure 10 average price of natural gas production hedges, current year, $/mmbtu,60%,$7.00,$6.29,50%,49%,$6.00,$5.52,40%,37%,36%,$5.00,$4.48,30% 20% 10% 0%,$4.00 $3.00 $2.00 $1.00 $0.00,2011,2012,2013,2011,2012,2013,source: barclays research figure 11 hedged natural gas production, next year, %,source: barclays research figure 12 average price of natural gas production hedges, next year, $/mmbtu,25% 20%,22%,18%,23%,$7.00 $6.00 $5.00,$6.04,$5.67,$4.48,15% 10% 5% 0%,$4.00 $3.00 $2.00 $1.00 $0.00,2012,2013,2014,2012,2013,2014,source: barclays research 8 january 2013,source: barclays research,7,barclays | gas and power kaleidoscope commentary on weekly data prices,prices suffered further correction on the week the storage withdrawal was in line with expectations the eia revised lower-48 dry gas production lower for 2010, 2011, and 2012, on average industrial demand was revised higher, and october data show exceptionally robust growth the strength of industrial consumption is trumped by weak weather-related demand,natural gas prices could not recover despite encountering some colder-than-normal weather at the end of december of last year. with the market pricing in the warm weather forecast for the next 15-day period, as well as the warmer-than-normal weather that we have had so far