An American Gas Story
November 2016
The collapse in oil prices has finally brought an end to the US shale gas boom, with active shale gas rigs falling below 100 in 2016 from 936 in 2011. The upheaval of the US gas market began ten years ago with the shale gas revolution, but this was only the start of the revolution for natural gas trade. The lifting of the US LNG export ban and first LNG export from Cheniere’s Sabine Pass have opened the way for another 15 LNG projects in development, representing up to 0.65Bcmpd of new gas demand.

The Turning Tide

The change in gas trade flow was the result of an unprecedented switch in the drivers of the US gas market. Less than five years ago the Lower 48 States were expected to become one of the largest gas importing regions in the world. Export facilities were virtually non-existent and there was no demand or incentive to construct them. However, the tide turned for the gas market on the back of booming shale gas production.

In the past ten years, the adoption of new and cheaper cost technologies for horizontal drilling and the perfection of hydraulic fracture stimulation techniques has allowed producers to access gas trapped in parts of the U.S. previously considered inaccessible. Drilling for natural gas took off in shale plays across the US, with horizontal drilling rig counts growing at the expense of vertical rigs. As more companies tapped into unconventional plays, from 2010 to 2012 US natural gas production rose over 200%, to 1.2Bcmpd.

From the early 2010’s there was a rush by companies to secure drilling leases, but this came with an obligation to drill or be forced to relinquish the lease. The low interest rate environment that proceeded the global financial crisis (2007-2008) provided incentive for external investors to continue pumping money into US gas companies which bolstered supply growth, even in the face of challenging economics.

With gas production reaching record highs, in large part due to the massive contributions from booming shale-gas fields and weak demand as a result of reduced consumption during milder US winters and summers, downward pressure was put on gas prices. In October 2011 gas prices were impacted by further downward pressure as US gas storage facilities reach capacity at around 110Bcm. With no storage remaining, gas prices plummeted to the cash costs of many operations, forcing producers to shut in well.

Oil and gas companies reacted dramatically. The number of rigs drilling for natural gas peaked at 936 in the last two weeks of October 2011, but with plummeting gas prices, the efforts of independent operators moved towards the use of their gas drilling techniques and learnings to drill for liquids. As natural gas was no longer profitable and price differentials between liquid hydrocarbons and gas reached record highs, the production focus shifted and accelerated from gas to liquids.

West Texas Intermediate v Henry Hub Price Difference

Source: AME

A New Dynamic

The laws of economics can work surprisingly well. Prices did recover slowly after 2012 to above US$4/MBtu, however this was still below many shale gas producers’ breakeven price. At the same time, low prices led to an increase in demand from power companies, new export facilities and chemical companies which all took advantage of the opportunity to purchase cheaper natural gas.

On the supply side, low prices for natural gas stalled production of dry natural gas. The retreat from natural gas drilling was rapid, as reflected in the rate of decrease in rig count; in October 2011 there were 936 rigs drilling for natural gas, but a year later this was down to about 350 rigs.

However, as the domestic Henry Hub price remained depressed, growth in emerging markets and the so-called “commodity super-cycle” was pushing demand and prices of oil and natural gas liquids to new highs.

At the time, with oil priced at above US$100 per barrel, a second surge in shale drilling activity was triggered, this time largely for oil and associated gas as many shale wells that produce oil also produce significant volumes of gas and condensates.

A new price dynamic developed, perhaps unique to US markets; high oil prices induced low gas prices. In most countries oil-price links and fuel competition means that oil and gas price swings have a positive correlation.

US Natural Gas Rig Fleet v Dry Shale Gas Production

Source: AME, EIA

Beginning of the End

Gas production would have fallen further since it became uneconomic to drill for gas, but the growth in shale oil drilling and the associated gas it produced, more than compensated for the loss of production from solely natural gas projects. As a consequence, natural gas production increased further, and continues to test new gas price depths for the commodity.

While US shale gas remained resilient through several years of low gas prices, the more recent collapse in oil prices is finally putting an end to the gas boom. Combined shale oil and gas rig count closely track the price of oil and gas with a time lag. In 2016, four years after 350 active shale gas rigs were reported in October 2012, less than 100 gas rigs are actively drilling.

Currently, US gas prices are remarkably low compared to the rest of the world. This disparity cannot last forever — it will be filled by rising new demand from chemical companies and manufacturers building new plants to take advantage of the comparatively low natural gas prices.

Another massive source of natural gas demand growth will be US LNG exports. Currently the US has one approved export terminal the Cheniere Energy Sabine Pass LNG Terminal, Louisiana which began service in February 2016. Fifteen other projects are working through the approval process or are currently under construction. If all are approved and constructed, US LNG will represent 0.65Bcmpd of new gas demand and represent a huge longer-term source of demand.

A further source of growth is from US power generation utilities that are seeking to replace high emission coal fired power generators with lower emission natural gas plants which are cheaper to manufacture and operate.

Rig Count – US Lower 48 States

Source: AME / Baker Hughes