Natural Gas Prices and LNG's Dirty Little Secret

…While the drilling rig count, and especially the gas-directed rig count, are down sharply from last year and continue to fall, the key question remains when we will get an upturn in gas demand from recovering automobile and housing industries. Most gas industry CEOs and Wall Street analysts are confident that all that is needed for a sustained recovery in natural gas prices is an uptick in gas demand, but more importantly the fall in production due to the gasrig count downturn. Once gas prices recover, then drilling should resume, but due to the rapid production declines for most gas shale wells, the industry will be spending quite a bit of time trying to catch back up with falling supply in the face of rising demand thus sustaining higher natural gas prices.

The challenge for the oil service industry is to gauge the number of drilling rigs that will be needed once we enter the industry recovery phase. We have heard comments from various CEOs that there may be only 1,200 to 1,400 gas-directed rigs needed, which if one throws in another 250 oil-directed rigs, suggests a total of 1,450 -1,650 working rigs at the next industry peak. Since we recently peaked out at 2,031 rigs, according to the Baker Hughes (BHINYSE) rig count data, then the domestic contract drilling industry will have a significant surplus of rigs going forward. The simple math appears to be about 2,050 rigs plus about 300 rigs under construction that will enter the fleet boosting the domestic fleet to 2,350 rigs. Since we will need considerably fewer rigs (1,450- 1,650), the drilling industry will need to eliminate nearly 700-900 rigs in order to restore a relative balance between supply and demand that is needed to support reasonable pricing. (Investors should consider the stocks of companies manufacturing acetylene torches since so much steel will need to be cut up.)

With a peak drilling rig fleet on only 1,450-1,650 rigs, it would appear there is a shake-out coming among land drilling contractors. At this point we will not get into our views of the dynamics of the future drilling rig fleet and how the industry consolidation might shake out, but instead we want to focus on another gas industry issue that has not received much attention and that could have a significant impact on the land drilling business.

The conventional wisdom about the contract drilling business is that sometime later this year or early in 2010 the rig count will begin rising from the roughly 800 rigs that will be working at the industry trough to maybe 1,200 rigs. But that conventional wisdom is predicated on the domestic natural gas supply/demand balance being restored and crude oil prices remaining in the $50 a barrel range. Our question is what happens if the gas market doesn’t recover its balance? How might that happen? We suggest there is a “dirty little secret” about liquefied natural gas (LNG) that could disrupt the North American gas supply/demand balance and contribute to low gas prices for several more years. Can anyone spell “gas bubble?”

Rigzone