The Biggest Reason Natural Gas Prices Could Surge

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Since mid-February, natural gas prices have risen by a whopping 30%, accelerating a trend of generally rising prices that began after April of last year.  

While much of this recent surge in prices reflects stronger-than-expected seasonal demand for gas, there's one huge reason prices could rise significantly over the longer term -- perhaps even triple over the next five years. Let's take a closer look.

U.S. natural gas market conditions
The recent increase in gas prices marks a departure from the weak pricing environment that has persisted over much of the past few years. As advances in drilling technologies allowed energy producers to coax massive quantities of natural gas from shale fields, an oversupply steadily built up, contributing to severely depressed prices for the fuel.

In response, virtually every major U.S. energy producer curtailed gas drilling in favor of producing oil and, to a lesser degree, natural gas liquids. For instance, Chesapeake Energy (NYSE: CHK  ) , the nation's second-largest natural gas producer, reduced its gas-directed rig count from over 100 rigs in early 2010 to around 10 by the third quarter of last year. Similarly, EXCO Resources (NYSE: XCO  ) slashed its gas rig count from 23 as of year-end 2011 to 7 as of the end of October last year.

But now, with gas prices above $4 per Mcf, some producers are either resuming or ramping up operations in gassier plays. For instance, Encana (NYSE: ECA  ) announced in February that it intends to increase its gas rig count in the Haynesville shale by three this year, citing the play's recently improved profitability.

Yet others -- including some of the lowest cost producers in the industry -- are waiting for prices to recover further before they rush back into gas drilling. For instance, Devon Energy (NYSE: DVN  ) , whose mainstay was once natural gas, said it doesn't plan on drilling for it at all this year. The company will instead be directing much of its capital budget toward drilling for liquids in the Permian Basin.

Not surprisingly, the number of rigs drilling for natural gas slipped to near a 14-year low last month. In fact, the current gas rig count is almost a fourth of what it was at its September 2008 peak.  

But give it another three to five years, and these companies may be flocking to gas fields in droves, eager to extract as much natural gas as possible. The reason? Sharply higher prices brought about by lower-than-expected supply and higher-than-anticipated demand for the clean-burning fuel.

Shale gas well decline rates
The reason future supply may turn out to be much lower than anticipated has to do with how quickly production from shale plays may taper off. According to Arthur Berman, a Houston-based petroleum geologist and prominent shale gas skeptic, U.S. shale gas wells have decline rates in the range of 30% to 40% per year, as compared with conventional wells that decline at rates between 20%-25%.

Berman has conducted exhaustive analyses of thousands of individual shale oil and gas wells and arrived at a shocking conclusion -- many shale plays have decline rates so staggeringly high that hundreds of new wells need to be brought online each year just to maintain a flat level of production.

In the Barnett shale, for instance, he calculates the yearly decline in total gas resources to be roughly 1.7 billion cubic feet per day. For net production in the play to increase, he estimates that Barnett producers would have to drill nearly 4,000 new wells each year.

High decline rates among shale gas wells may help explain why drilling is so abnormally sensitive to abrupt changes in gas prices. If wells continue to decline at the rates shale gas skeptics suggest they will, we could see a sharp increase in prices over coming years -- a response needed to give gas drillers incentive to produce more.  

Jeremy Grantham's view and final thoughts
Others outside the oil and gas industry have also suggested that natural gas prices could rise sharply in coming years. Investor Jeremy Grantham, co-founder and chief investment strategist at Boston-based investment firm GMO, suggests prices could triple over the next five years, as the current surplus gradually turns into a shortage.

Speaking at the Richard Ivey School of Business value investing conference in Toronto earlier this month, Grantham argued that the current level of US natural gas prices -- less than half what it is in Europe and about a quarter of the level in Japan -- is unsustainable.

This massive gap in global prices has lured a number of companies -- including petrochemical, steel, and fertilizer manufacturers -- back to the U.S., in hopes of capitalizing on cheap domestic energy. As these and other sources of demand grow, they will soon outpace supply and lead to a surge in prices, according to Grantham.

If prices do triple over the next five years, Chesapeake Energy, as the nation's second-largest gas producer, stands to benefit tremendously. Though the company has allocated the majority of its capital this year toward drilling in liquids-rich plays, natural gas still makes up more than three-quarters of the company's production mix. Will the company be able to ramp up oil production and survive until natural gas prices finally recover? Or will it languish under the weight of its heavy debt load? To answer that question and to learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy, and, as a bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.

Read/Post Comments (14) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 21, 2013, at 1:45 PM, koala11 wrote:

    As the article rather states - it's all about getting the prices up and after that happens they'll starting producing more again............figures doesn't it!

  • Report this Comment On April 21, 2013, at 2:17 PM, dontneedreason wrote:

    Reason !!!!!!!! who has to have one , if needed , make one up !!!!!!!!!!!!! not a problem

  • Report this Comment On April 21, 2013, at 2:47 PM, doneal5332 wrote:

    In other words, collusion, to manipulate the markets through monopolies to fleece customers.

  • Report this Comment On April 21, 2013, at 3:23 PM, dadx wrote:

    funny Feburary, it was being touted that natural gas prices were going to be the lowest fuel prices ever...

  • Report this Comment On April 21, 2013, at 3:24 PM, DiverMike wrote:

    Supposedly we have hundreds of years supply and prices are going to go up because we need to find new supplies? Sure.

  • Report this Comment On April 21, 2013, at 4:09 PM, ArchibaldBomwitz wrote:

    Big Gas knows what they can charge for gas! And they are not going to sell it for a fraction of a cent cheaper! But they will sell it for much higher!

  • Report this Comment On April 21, 2013, at 5:22 PM, gasblogger wrote:

    Natural gas will not go substatially above $5. Learn why. Natural gas references:

  • Report this Comment On April 21, 2013, at 5:40 PM, us54985312 wrote:

    I Feburary, it was being touted that natural gas prices were going to be the lowest fuel prices ever..Every storage facility for this propane was bulging at their seams and panic was setting in to sell it abroad. Now that the ships have all but dried up the glut here, we get the bill for any new drilling to create more while you sell what's already been being pulled out of the ground.

    There is a shortage alright and it's not of gas but minds running this country. I hope people wake up and vote for something other than a iconic money hoarder.

  • Report this Comment On April 21, 2013, at 6:14 PM, luckyagain wrote:

    As long as the US government is at the beck and call of the oil/gas/coal cartel, nothing will change. The wind and solar energy producers are the only other game in town and they have been demonize as being "subsidized" without anyone pointing out that oil/gas/coal have billions of dollars of subsidies. The US has spend trillions of dollars protecting Saudi Arabia so that the Saudis can ship oil to Asia and Europe. Americans are so foolish that nothing will change. The Chinese are taking over the wind and solar industries because they do not want to beholden to oil/gas/coal cartel. Smart Chinese, dump Americans.

  • Report this Comment On April 21, 2013, at 9:05 PM, danno228 wrote:

    Quite trying to scare the public into burning their

    front porch instead of maintaining their furnace. Your as bad as Obama with all his dumb programs to save the world. Go stick your head back in the sand.

  • Report this Comment On April 21, 2013, at 9:48 PM, emailnodata wrote:

    As a country we'd be smart to build out GSHP everywhere we can.

    Who fights that?? Big oil, big gas. Why?? Duh. GSHP can reduce overall energy use in a house by 80%.

    Notice every federal initiative to build out solar or wind is always met with derision and scorn?? It's because once in place, you can be looking at 20-30 years of diminished use of oil, coal or gas in that region.

    From an engineering standpoint, it makes sense to build GSHP, wind, and solar to the point where we never really have to worry about nat gas or oil reserves.

    However, as a nation, we don't have the will to do it.

  • Report this Comment On April 22, 2013, at 12:58 AM, 38psychnurse wrote:

    Strange...I have been reading Motley Fool and they have been recommending investing in drillers in the Bakken field. I have been looking for the best way to invest, but have not yet made a decision. Now, it looks like waiting might have been the best decision; especially in light of the comment in this article that shale producers are not going to be able to keep up production. What next? Invest in hyperbole would be my recommendation.

  • Report this Comment On April 22, 2013, at 3:43 PM, damilkman wrote:

    I think this article is very interesting. Do not understand the comments what this has to do with renewables. The reason why renewables are failing has nothing to do with governement polices or evil hydrocarbon cartel and more to do that they have problems. As someone who has looked into solar, fuel cell, geothermal, it is not viable unless I want to waste a lot of money. When the technology issues are resolved then renewables will have a chance. For those that accuse the oil industry of manipulating our energy options I would just point out nuclear. The French generate 80% of their electric power from nuclear and last I looked no one seems to glow in the dark.

  • Report this Comment On April 22, 2013, at 9:26 PM, skypilot2005 wrote:

    , damilkman wrote:

    "The French generate 80% of their electric power from nuclear and last I looked no one seems to glow in the dark."

    Yes but, you won't see nuclear grow here with the Democrats in the White House and controlling the Senate.

    The "Greens" have taken the party over. Remember Al Gore?

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