The Fuse

The Shale Gas Revolution Is Not Over, It’s Just on Hold

by Nick Cunningham | September 24, 2015

New sources of demand and improved drilling efficiency will mitigate damage to the industry in the medium term, but for now, the shale gas industry appears to be experiencing a painful adjustment.

U.S. oil production has received a lot of attention lately for stalling out and beginning to decline, but the U.S. shale gas revolution also appears to have slowed down, at least for now. It’s far from over: New sources of demand and improved drilling efficiency will mitigate damage to the industry in the medium term, but for now, the shale gas industry appears to be experiencing a painful adjustment that is impacting both company balance sheets as well as U.S. production as a whole.

Years before the boom in shale oil production, drillers were extracting massive volumes of natural gas by fracturing shale. As a result, U.S. natural gas production surged by more than 40 percent between 2006 and 2015, making the country the world’s largest producer.

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The dramatic rise in shale gas production caused prices to crash. Henry Hub spot prices for natural gas routinely traded above $6 per million Btu (MMBtu) in the years preceding the shale boom, but since early 2010, natural gas prices have remained below $5/MMBtu and are now trading at just $2.5/MMBtu.

The flood of shale gas has been a huge boon for consumers, contributing to a petrochemical and manufacturing revival, but the resulting price drop has been bad for gas drillers. The rig count began falling in 2011, and continues to this day.

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Conventional wisdom was that the precipitous fall in the number of gas rigs in operation would lead to a decline in natural gas production. But the opposite occurred in shale regions around the country: Production kept on climbing.

Conventional wisdom was that the precipitous fall in the number of gas rigs in operation would lead to a decline in natural gas production. But the opposite occurred in shale regions around the country: Production kept on climbing.

For example, in the Marcellus Shale—which stretches across Pennsylvania, Ohio, and West Virginia—natural gas production jumped from less than 4 billion cubic feet per day (bcf/d) in early 2011 to more than 16 bcf/d in 2015, a fourfold increase at a time of falling prices and a falling rig count.

How did this happen? One important reason is increased drilling efficiency. As producers gained experience, they tweaked their drilling practices, adding more wells per wellpad, extending laterals, using more sand per frack job, and a number of other ways to extract more gas with each given rig. As such, the amount of gas produced from an average rig steadily climbed over the years. Many are viewing this phenomenon as evidence that U.S. tight oil production can thrive even in the face of falling rig counts and low prices.

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But another reason that natural gas production continued to rise even as rig counts fell is that natural gas is often produced in conjunction with oil. After natural gas prices crashed, there was an exodus from the “gassier” regions, but instead of leaving the market altogether, drillers focused on extracting liquids. This was a logical development: Natural gas prices had cratered, but oil prices were routinely trading above $100 per barrel between 2011 and 2014. Shale drillers managed to ratchet up oil production at an impressive clip, putting U.S. oil production on par with Saudi Arabia and Russia for the first time in decades. In the meantime, even as drillers were targeting liquids, they often simultaneously pulled up natural gas—one of the reasons U.S. gas production remained so robust.

Oil decline hurts natural gas

But the party could be over. The historic collapse in oil prices could put an end to the shale gas boom in a way that the collapse in natural gas prices could not. As oil drillers back off, oil production is starting to fall, and now so is gas production.

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The Energy Information Administration (EIA) reported in its September Drilling Productivity Report that it expects natural gas production to decline in the major U.S. shale basins by a combined 208 million cubic feet per day (MMcf/d) from September to October, led by losses from the Eagle Ford (-117 MMcf/d) and the Marcellus (-82 MMcf/d). In fact, gross withdrawals of U.S. natural gas might have peaked in the spring of 2015 at 91 bcf/d, having fallen in consecutives months since then.

New sources of demand

Natural gas producers could be rescued by new pockets of demand. Cheap gas has sparked a flood of investment in petrochemicals, a major source of demand for natural gas.

Natural gas producers could be rescued by new pockets of demand, however. Cheap gas has sparked a flood of investment in petrochemicals, a major source of demand for natural gas. According to the American Chemistry Council, there are an estimated 226 petrochemical projects related to shale gas currently underway, accounting for at least $138 billion in capital investment. As new facilities producing plastics, fertilizers, and other industrial products come online, more natural gas will be consumed. The EIA projects that natural gas consumption in the industrial sector will rise by 6.4 percent in 2016 as a backlog of petrochemical and industrial projects are completed.

Natural gas is also increasingly stealing market share away from coal in the electric power sector. Utilities are taking advantage of cheap gas while also seeking to comply with more stringent environmental regulations on power plant emissions. That is forcing a wave of coal plant closures, with new natural gas plants springing up to take their place. The EIA says that natural gas consumption in the electric power sector will rise by 14.4 percent in 2015.

Another source of demand for U.S. natural gas is from overseas markets. Cheniere Energy is slated to bring its Sabine Pass liquefaction facility online by the end of this year, the first LNG export terminal in the Lower 48. The inauguration of Sabine Pass will mark the dawn of a new era in which the U.S. becomes a significant gas exporter.

In the short-term, however, LNG will only leave a small mark on the demand side. In 2016, the U.S. could see an average of 0.79 bcf/d in LNG exports, which will add only about 1 percent to demand. But with a few other export facilities under construction and a huge list of other projects on the drawing board, LNG exports could rise in the years ahead. To be sure, though, the fall of LNG spot prices around the world might keep many of these proposed projects from moving forward. Nevertheless, new export facilities will open up new markets for American gas producers, which could help prop up production in the years ahead.

Natural gas not a bust after all

Natural gas production might have peaked for now, but efficiency gains and improved drilling techniques allows producers to profitably extract gas even when prices are remarkably low. Meanwhile, demand is resilient, likely preventing prices from dropping further.

While the shale gas revolution may be tempered for now, fundamentals suggest the sector has plenty of room to grow.

A new report from Raymond James concludes that production cutbacks could be limited, leveling off in 2015 and 2016. As the bank sees it, oil producers will head back to drilling following an expected rebound in crude prices, and natural gas will see a corresponding increase in production. So while the shale gas revolution may be tempered for now, fundamentals suggest the sector has plenty of room to grow.