Seven Marcellus natural gas myths, or, you’re playing with fire, America

Sometimes a phenomenon comes along that captures the public’s attention in near totality, and we find ourselves losing our minds and joining the parade. The dot com boom was one example, a time when random new websites became worth billions despite the presence of any revenue. The US housing boom was another example. When people with no income, no jobs, and no assets suddenly started buying homes, a few fringe weirdos thought that that wasn’t right, but the mainstream line of thought was so captivated by the booming housing market that it paid no attention. Nothing seemed absurd at the time because almost everyone read the future the same way.

The energy business is not exempted from this phenomenon. In the natural gas world, an onslaught of publicity from shale gas producers, brokerage houses, trading firms, government agencies, and you name it have chimed in with one voice to declare that the US is now at the dawn of a century of cheap natural gas. Some commentators have heralded the rise of “just in time” natural gas, where storage is of decreasing value because of the inventory of thousands of drilled and uncompleted wells that can flood the market at any time that prices rise. The forward curves for natural gas prices reflect this mentality, and the viewpoint is as nearly universal as it can get. This view has been built largely on the massive reserves of the Marcellus and Utica region.

Courageous contrarians have however noticed a few attention-grabbing cracks in that wall of beliefs. Second hand analysis is one thing, but here is a startling admission from the horse’s mouth. On October 24^th 2018, Range Resources Ltd held its third quarter conference call. Reading a 15-page conference call transcript may not sound thrilling, but they can be invaluable. Recall that Range is one of the largest Marcellus shale producers with, according to their IR presentations, “thousands of top quality locations.” During the conference call, an analyst asked Jeff Ventura, Range’s CEO, about sweet spot exhaustion in the Marcellus, and whether it would occur in a 1-5 year time frame or a 6-10 year time frame. Here was Ventura’s response:

‘…you can take state-of-the-art technology and pump that in Centre County or you can pick the county of your choice and the wells still aren’t very good. So in fact they aren’t good at all. So it’s important where you are drilling…So the cores are limited, the cores are known, people have drilled a lot of wells in them. And I think within, you said in the, is it in the first 5 or years 6 through 10, I think it’s clearly within the first five you’ll see that core exhaustion and you’ll start seeing it with deteriorating capital efficiency.”

The importance of these comments should not be understated.

Consider them in the context of a few widely-held Marcellus gas beliefs upon which the US has staked its energy future:

1. The US has a hundred years of gas supply – this statement arrived early in the Marcellus’ development, when every new well and area was getting better than the previous. We now know that there are sweet spots, and a lot of not-so-sweet spots. The map below illustrates this perfectly, and it also corroborates Mr. Ventura’s comments:
2. Marcellus growth is limited by lack of pipelines – this was once the case several years ago. These days, there doesn’t appear to be anywhere near enough gas to meet takeaway capacity, as shown in the chart below:
3. Marcellus producers make adequate returns at sub $3 gas – this argument was based on the fact that Marcellus/Utica production kept rising through a low-price environment. What is missed by observers is that producers had to drill and increase production to meet upcoming take-or-pay requirements. In fact, Cabot Oil & Gas, another huge shale producer, in its most recent quarterly financials said that fully one-fifth of natural gas revenue was from selling gas acquired in the open market to meet sales obligations. This is a very clear sign that it may be cheaper to buy the gas than to drill for it.
4. Drilled but Uncompleted inventory (DUCs) is like readily available storage – this belief is possibly the one that has exposed the US to the most danger, if winter is colder than normal. If this statement was true, there would have been a huge drawdown in the number of DUCs as winter approached with storage at extremely low levels. However, the DUC inventory hardly budged, and no new rigs came running back either:
5. Longer lateral wells improve productivity- what they really do is simply chew up the reservoir faster. There are productivity gains in that a single well can extract more gas, but it’s not free, and it simply accelerates development of the field. See the above chart that shows drilling activity in the Marcellus. Consider that new horizontal wells are now up to 3 miles in lateral length. The top 5 producing counties are Susquehanna, Bradford, Lycoming, Washington and Greene. Together these 5 have an area of 4,676 square miles, and have a total of 5,609 producing wells (and a total of 7,110 wells drilled). As a gauge of dominance, in 2016 these 5 counties accounted for 82 percent of the value of Marcellus gas as reported in MarcellusGas.org. As Range said, the sweet spots are within sight of exhaustion, and subsequent locations will be of lower quality.
6. The stock market will support production growth – every single third quarter conference call for a major shale producer showed that this is categorically untrue. Analysts almost unanimously asked about capital efficiency, returns to shareholders, share buy backs, etc. No one wanted to hear about growth.
7. Solution gas will save the day – this view arises from the massive rise in natural gas output from the Permian basin in the US, and to a lesser extent Bakken solution gas. However, these gluts are localized, and will bleed off into regions other than the main US consuming areas. Permian gas is destined to head south or west, and won’t be of any help to the regions with real winters.

Almost everyone has been overwhelmed by highly speculative forecasts – ironically, exactly like the fears of climate change itself. People have been hammered with both messages for so long that doubting either is considered foolish to think otherwise.

We now therefore have entered winter with dangerously low inventories. The US is separated from a physical disaster, one that would make a hurricane look like a thunderstorm, by hopes for a mild winter and a bucket of dangerous misconceptions.

If you think that is hyperbole, consider what is happening in lower mainland of British Columbia. One of several pipelines that carries natural gas to the region is operating at 80 percent of capacity for the winter. Even with this relatively minor disruption, residents have been warned of potential gas shortages and to turn down furnaces, etc.

Now consider that Vancouver’s winter is tee shirt weather for a large swath of North America’s population. What do you suppose a natural gas shortage would look like in Chicago or Toronto at severely sub-zero temperatures? What would your neighbourhood look like if gas supplies were shut off in the dead of winter? Or even cut in half?

If the winter turns out warm, everyone can have a good laugh at the naysayers and doomsday fools. Let us hope that holds true. If winter is colder than average or a polar vortex returns, and storage is depleted, it is hard to describe what would happen, because I can’t really picture it. The Vancouver example, of a very minor shortage in a very temperate climate, gives an indication that the problem could be of unprecedented proportions.

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Read more insightful analysis from Terry Etam here. To reach Terry, click here