Is Natural Gas Staging a Comeback? (XOM, CHK, BP, ECA, COP, DVN, EOG, APC, UPL, STR, UNG)

It has been almost exactly two years since Exxon Mobil Corp. (NYSE: XOM) completed its $31 billion merger with XTO Energy to create the largest natural gas company in the US. Exxon’s shares traded at about $57, compared to about $82 today. The Henry Hub spot price for natural gas in June of 2010 was about $4.80/thousand cubic feet, compared with about $2.20 today. At its high point in 2008, natural gas sold for about $11.30/thousand cubic feet, still about a third below the all-time high of about $13.40 in October of 2005. The most recent low is $1.95 in April of this year.

The US Energy Information Administration (EIA) last published a list of the top producers ranked by “wet” gas reserves in 2009. Exxon/XTO is the biggest, of course, followed by Chesapeake Energy Corp. (NYSE: CHK), BP plc (NYSE: BP), Encana Corp. (NYSE: ECA), ConocoPhillips (NYSE: COP), Devon Energy Corp. (NYSE: DVN), EOG Resources Inc. (NYSE: EOG), Anadarko Petroleum Corp. (NYSE: APC), Ultra Petroleum Inc. (NYSE: UPL), and Questar Corp. (NYSE: STR). Both BP and Chesapeake have been shedding assets since this list was compiled, but they are not likely to have dropped out of the top ten.

Natural gas producers have stopped hoping that prices will rise and have begun reducing production in an effort to boost prices. Those cutbacks appeared to bear fruit yesterday following the EIA’s weekly storage report that showed a smaller than expected inventory build. But inventories remain about 30% above the top of the five-year range.

There are about 2.9 trillion cubic feet of natural gas in storage today, about 71% of maximum capacity of 4.1 trillion cubic feet. The EIA estimates that total gas in storage by November will be just short of that mark. And with marketed production estimated at nearly 68.5 billion cubic feet/day for 2012, keeping the amount of gas in storage within limits means that at least 460 billion cubic feet of production will have to be cut.

The good news for producers is that demand is growing at a slightly faster rate than production now. Production is up 3.4% over 2011, but demand is up by 4.1%, driven by fuel-switching at electricity generating plants.

More good news for gas producers came from last week’s data on drilling rigs. Baker Hughes data showed a gas rig count of just 565 last week, the lowest level in 13 years. While that’s good news, the produced gas associated with drilling for shale oil has increased as producers go after the higher priced liquids. Total production cuts so far are estimated to total about 1 billion cubic feet/day, not nearly enough to reduce supplies significantly.

The market’s reaction to yesterday’s storage report yielded the biggest one-day jump in natural gas prices in more than three years. The spot price is up another 0.5% today, likely anticipating another decrease in rig counts. The United States Natural Gas ETF (AMEX: UNG) is down about -1.8% today after rising about 15% yesterday. That’s probably due to some profit taking.

The short version of this story is that natural gas production needs to fall more rapidly and significantly in order to push the price up to around $3 or more. There really doesn’t appear to be any way for that to happen in the near term on any sort of permanent basis.

Paul Ausick