Natural Gas Rigs Shutting Means Prices May Double

By Reg Curren

March 16 (Bloomberg) -- Natural gas drillers from Devon Energy Corp. to XTO Energy Inc. are idling rigs at the fastest pace since 2002, setting the stage for this year’s worst commodity to almost double as supplies drop faster than demand.

About 45 percent of U.S. rigs have been shut since September, which means fourth-quarter gas production will tumble 5.2 percent, faster than the 1.9 percent decline in use, the Energy Department forecast. Prices will rise to $7 per million British thermal units by January from $3.897 today on the New York Mercantile Exchange, according to a Bloomberg News survey of 20 analysts. The gain would be the largest since the first half of 2008.

The last time drillers stopped rigs at this pace was seven years ago, when futures advanced 86 percent. The world’s biggest hedge funds have already started to close bets on a drop in prices, government data show. Natural gas tumbled 30 percent this year, the worst start since 2006, as sales weakened with the recession.

“When the recession ends and the economy starts booming, we’re going to have less natural gas than we do today and prices are going to spike back up,” said Larry Nichols, chief executive officer of Devon Energy Corp., the largest independent oil and gas producer.

Devon and Chesapeake Energy Corp., both based in Oklahoma City, slashed 2009 drilling budgets as gas prices tumbled more than 70 percent from a July high. The companies lost a combined $7.68 billion in the fourth quarter, mostly from writing down the value of gas and oil properties to reflect falling prices.

‘Steep’ Decline

“The drop in supply will be so steep, it could easily catch up to where demand has dropped to before the recession ends,” said Nichols, who declined to give a price forecast.

Devon declined 62 percent in New York trading to $45.17 on March 13 since the fuel set a 2008 high of $13.694 on July 2. Chesapeake tumbled 78 percent to $15.46 and XTO lost 55 percent to $29.70.

The number of exploration rigs in the U.S. has fallen to 884 from a record 1,606 in September, according to Baker Hughes Inc., the third-largest oilfield-services provider, based on data through March 13.

XTO of Fort Worth plans to cut rigs to 60 by the end of this month, from 73 in the fourth quarter, and keep it at that level for the rest of 2009, the company said Feb. 19.

Companies are idling rigs just as President Barack Obama spends $787 billion to revive the economy by improving roads, bridges and related public works. The effort will kick in later this year and accelerate in 2010, Michael Moran, chief economist at Daiwa Securities America Inc. said March 12.

Declining Demand

Demand from industrial users, which accounted for 29 percent of U.S. consumption last year, declined 5 percent in the fourth quarter from a year earlier as the recession deepened, according to the Energy Department. The decline would be the largest since 2005 should it last through the year.

By the fourth quarter, analysts expect the economy to expand. Gross domestic product will grow 1.6 percent in the final three months of 2009 and 1.8 percent in 2010, according to the median estimate of 61 analysts surveyed by Bloomberg.

“The next big move for gas is obviously going to be up,” said Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania, an energy markets consultant. “If we are higher, I’d expect to see us at $7 by the start of next winter.”

Speculators’ Positions

Speculators, who anticipated lower prices more than two years ago by increasing short positions, are signaling the worst may be past. A speculative short is a bet that prices will decline. Large speculators trimmed their net short positions in gas by 11 percent to 114,064 futures in the week ended March 10, the smallest total since July, Commodity Futures Trading Commission data show.

Any recovery depends on a rebound in the U.S. economy, which may not happen until next year, said Tom Orr, research director at Weeden & Co., a brokerage in Greenwich, Connecticut.

“A lot of the stimulus spending is going to be on the construction side, but that’s going to take a while to feed back into the main economy,” said Orr. “The market is operating on a show-me first basis, and you need a ton of things to work to lift prices.”

Weeden forecast in January that natural gas would average $5 per million British thermal units in the fourth quarter and into 2010, with a supply glut weighing on the commodity. Total marketed U.S. production soared 7.2 percent to 21.5 trillion cubic feet in 2008, while consumption gained 0.8 percent, according to the Energy Department.

OPEC Cuts

The decisions to reduce gas production are similar to steps by the Organization of Petroleum Exporting Countries to end a flood of crude. OPEC reduced output three times, and crude oil gained 37 percent from a December low to $46.25 a barrel on March 13. Gasoline futures rallied 34 percent this year to $1.3529 a gallon, leading commodities tracked by the S&P GSCI Index.

OPEC agreed at a meeting yesterday in Vienna to keep production quotas unchanged, deciding against a further cut that risked damaging the ailing global economy. The group will aim to complete last year’s reductions and meet again on May 28 to review the policy. The decision led oil futures to plunge as much as 5.2 percent to $43.85 a barrel in New York and the April contract was trading at $44.52 at 10:12 a.m. in Singapore.

Natural gas futures for delivery in January 2010 are trading at a 48 percent premium to the April contract, indicating speculators, industrial consumers and utilities anticipate higher prices. A year ago, the January 2009 contract traded at a 12 percent premium to the April 2008 futures.

“We’re starting to see a downward production trend” for natural gas, said Martin King, an analyst at FirstEnergy Capital Corp., a Calgary-based brokerage.

Price Rebound

Lower supplies coupled with a rebound in demand will push natural gas to an average of $7.75 in 2010, he said. Gas fell to $3.759 per million British thermal units on March 12, the lowest in more than six years. Natural gas for April delivery was trading at $3.897 per million Btu, down 0.9 percent, at 9:51 a.m. in Singapore.

Should the number of rigs drop more and stay there, production by the end of 2009 may be as much as 4 billion cubic feet a day less than a year earlier, King said.

Spending on U.S. exploration and production will drop an estimated 40 percent to $22.5 billion this year, Theresa Gusman, the head of equity research for Deutsche Bank AG’s DB Advisors unit, said in New York.

“These dramatic cutbacks in capital expenditures are going to lead to shortages as we move through this recession and come out the other end,” she said.

To contact the reporter on this story: Reg Curren in Calgary at rcurren@bloomberg.net.