Horizontal Drilling Increasing Per Well Production; Brace for more Cuts in Exploration Budgets as Low Prices Continue



Horizontal Drilling Increasing Average Well Production in Canadian Natural Gas

A very bullish sign for natural gas prices is the fact that initial production (IP) rates on natural gas wells in western Canada have dropped by almost two thirds from 1997-2007, to just over 350 thousand cubic feet per day (mcf/d). When you convert that to oil at the industry standard ratio of 6:1, it equals just under 60 barrels of oil per day (bop/d)– compared to just over 150 bopd in 1997.  That is a large drop.

(Oil and gas wells decline in production every year – in Canada about 20% per year. After 5-8 years most wells are uneconomic and are taken off production. So an “IP rate” is simply the industry standard way of saying how big a well is; how much it is flowing.)

But Canadian brokerage firm Peters & Co. estimated 2008 IP rates on natural gas wells at 440 mcf/d, up some 20% – most likely due to horizontal drilling (HD). As I wrote in an earlier article, HD wells are up to 400%-700% more productive than conventional vertical wells in certain (horizontal lying) oil and gas formations, as they can access much more of it.

It will be interesting to see if this higher production rate is a blip of a continuing downtrend, or a new uptrend.  Although the number of wells drilled in Canada was down 1600  in 2008, the number of HD wells drilled was up.

Get Ready for more CAPEX cuts

For months I have been reading research reports from analysts on oil and gas companies using prices that in my mind were way too optimistic – they went from using $11/mcf to estimate 2009 cash flows $9 to $8 to $7 and lately I have seen some $6.50 gas.  Everybody has run the numbers for $5 gas, but at the time nobody believed they would really need to use those low numbers.

But they are now.  Gas is just above CAD$5 and US$4/mcf, and while gas storage levels are still within the five year ranges, sentiment is bearish for many of the reasons I outlined in my earlier posts – lots of new low cost supply, industrial demand dropping off etc.

So analysts and management teams are again revising downward their 2009 cash flow expectations. And sentiment is changing among management teams and analysts.  While some companies had scheduled to spend more than their cash flow on capex (capital expenditures – the money they spend exploring and developing new production), now I see people saying we are only going to spend cash flow, regardless of what it is, and not take on any new debt, even though they have room on their banklines to do so.  The press releases have just started – XYZ Company – Capex Reduced.

In the natural gas futures market on NYMEX, only the December price is above $6 right now.  The market is pricing in that while demand destruction has been in full force for months, supply destruction is only now starting to catch up.

Rig counts are down, and still falling, but that production decline takes time. I don’t see supply destruction catching up to demand fall-off before halfway through 2010 – unless the global economy really turns around.

Analyst reports with greater than $6/mcf gas are not realistic.  Analysts and management teams are again reducing cash flow and capex expectations. It could mean another wave of target price downgrades.

This will bring investor opportunity – probably mid-summer.