Bull Case for Natural Gas..

Got an email when I was on vacation from a reader in the natural gas industry (UNG). He asked to remain anonymous due to his position (of course I oblige) and I received permission to repost his comments. Being long UNG, I found his commentary backs my bullish stance on the commodity.

The reader says…

…..read the XTO and EOG and RRC and FST and CHK conference calls.. Those guys are some of the best in the business and I haven’t seen them this bullish in years. There are good discussions about why nat gas production is about to fall off the cliff in Q4 and that all the focus on the storage numbers each week is irrelevant.

EIA published its last production report and it showed a 0.8% DECLINE in production in May even though production in Louisiana and Oklahoma grew. It is called the EIA-914 monthly natural gas report. Big decline curves in Texas combined with the drop in rigs is finally showing up in the numbers. But I have been in this business 25 years and know”it doesn’t matter until it matters”.. And since 90% of “investors” are really just day/swing traders, none of those guys are paying any attention to what is really going on..

Things you will hear on the calls..

EOG is completely UNHEDGED for 2010.

CHK took OFF hedges for the back half of 2010.

XTO is 40% hedged at $10 mcfe and waiting to put more on.

FST is seeing production declines in the Rockies.

EOG and CHK have internal models that are predicting 2-5 BCF declines by next year.

ECA and CHK are starting to shut in production.

Basically it comes down to big decline curves in Texas more than offsetting the ramp in production in the Marcellus and Haynesville and the hurricane damaged production in the Gulf versus the weather (el nino) versus industrial production usage returning..

Here is the report he references:
EIA-914_ Monthly Natural Gas Production Report

From the EOG earnings call:

Our view of the North American gas and oil markets is consistent with our previous earnings call, except that we’ve become more bullish regarding 2010 and 2011 gas prices. We still expect North American gas prices to remain quite low through year-end. As you know, we’ve historically devoted a lot of work to developing domestic gas supply models and we think our
current model is the most granular and best we’ve ever built. It’s telling us that December 2009 domestic production will be 4.8 Bcf a day lower than year-end 2008 and this deficit will deepen further throughout 2010.

When added to the Canadian supply drop of at least 0.8 Bcf a day, we expect the gas market to turn sometime early in 2010 almost regardless of what happens to LNG imports. Everybody seems to be focusing on the supply growths from new horizontal plays, but the 800 pound gorilla in the
room is Texas vertical gas production. This represents the largest single block of production in the U.S. 16.3 Bcf a day in December ’08, and the rig count here has fallen from 450 rigs in January 2008 to 145 rigs today.

Our model shows production from this large segment of domestic production will fall from 16.3 Bcf a day at year-end ’08 to 13.2 Bcf a day by year-end ’09 and then 11.6 Bcf a day by year-end 2010 down 4.7 Bcf a day over two years. In my opinion, this is the most important well population that people should be focusing on if they want to understand what’s going to happen to gas supply over the next 24 months.

From the XTO call:

If we just take a little look at U.S. gas production for a moment, we from the very beginning have said you would not see U.S. gas production drop until May. Looking at the EA 914, you’re down about half a B a day from April to May, which is what we anticipated.

If you were to maintain that same fall for the next seven months of the year, you could potentially be down four Bs a day in U.S. natural gas productions. We’ll wait to see but that’s not an unreasonable number. If we look at EA 914 and break it down to onshore only, we’ve actually been down five in the last seven months and we’re off 1.7B a day just in U.S. gas production onshore.

What’s made the difference is onshore has been coming back on because of the hurricanes and is up 1.1B today and that’s the real difference in what you’re seeing. So I think you are seeing the decline that we’ve all talked about with U.S. natural gas recount dropping from 1600 to 675, and you will continue to see that, which should set you up for rebound in natural gas prices going forward.

If you’re over supplied 3 or 4Bs a day that would indicate you should be balanced by the end of the year. Obviously, there’s a lot of the year left to go. We do have the next 90 days will be very interesting as storage is relatively full at this point in comparison in history, and you may have some gas on gas competition as you get into the September and October timeframe. But I think we are setup as we’ve all talked about for a rebound in natural gas prices in ’10.

From the CHK call:

I would point out, though, that with the rig count having dropped, for natural gas, to well below 700, and kind of leveled out in the 675 or so rig count range, that really sets the stage for natural gas prices to decline materially into the back half of this year and the first half of next year.

We have seen a slow steady climb in gas production from 2005 through March of 2009. And it’s leveled off to a very slow sequential decline through the summer, but that should pick up dramatically and we can see production decline on a year-over-year basis, of perhaps as much as 2.5 to 3 Bcf per day by the end of the year, approaching 5 Bcf a day down year-over-year by late spring early summer next year.