North American natural gas producers face one big problem as they pledge to cut production to bolster prices: skeptical traders.
Led by No. 2 U.S. producer Chesapeake Energy
But with scant evidence of where or how long cuts are being implemented, traders are wary. Natural gas prices are languishing within pennies of a 10-year low hit in January. Traders say prices will likely remain depressed until reductions can be confirmed in company earnings or government data, months from now.
One of the mildest winters on record and an unyielding boom in shale gas production has pummeled natgas futures this winter -- welcome news for U.S. households and industrial users like Dow Chemical
Stockpiles are at record highs for this time of year and without supply reductions they may exceed capacity by the end of the summer. Such an unprecedented event would cause havoc by forcing producers to sell gas at extremely discounted levels, perhaps even to pay for someone to take it off their hands.
So producers have announced swift cuts in supply, reprising a strategy that helped temporarily stem the previous price crash in 2009. But looking back, traders say, those curbs appear to have lacked the impact that they had initially expected.
Chesapeake's production actually rose in the second quarter of 2009 after cuts were announced, as increasing output from new wells more than offset the cuts it made at existing facilities, company data show.
The supply restrictions may have also been relatively short-lived. Chesapeake announced on April 16, 2009 that it would double the size of planned reductions to 400 million cubic feet per day -- about 13 percent of the company's output at the time. Reuters calculations, based on company data, suggest that the closures would have lasted less than a month at that rate.
Now that cuts have been announced again, traders say they want to see the evidence. So far, it's been hard to find.
The market doesn't think there is a lot of production cutting going on, said Keith Barnett, executive vice-president at Springrock Production which forecasts U.S. natural gas supply.
While natural gas inventories are now declining more quickly than at the beginning of the winter and pipeline flows have fallen in some places, some analysts say the figures do not prove that cuts have hit the market yet. Colder weather has helped drain inventories, and many utilities are now burning more cheap gas instead of costlier coal. Less gas flowing through some pipes can be made up by higher flows elsewhere.
A Chesapeake spokesman said that more than 1 billion cubic feet per day (bcfd) of production had been cut this year by tightening the taps at producing wells, moving rigs to more lucrative oil plays and delaying the connection of freshly drilled wells to pipelines.
In aggregate, Chesapeake, Encana and Conoco, announced plans in the past few weeks to take about 1.35 billion cubic feet per day (bcfd) of output off the 67-bcfd U.S. market.
Chesapeake, which trades natural gas and is shouldering the lion's share of production curbs, first announced cuts of 0.5 bcfd on January 23, 2012, sending prices up nearly 8 percent. But the market barely reacted on February 21 when Chesapeake said it had lowered output by a total of about 1 bcfd, 16 percent of its daily production and about 1.5 percent of total U.S. supply.
After a brief rally in late January, prices at the New York Mercantile Exchange have fallen back to within a few cents of the low of $2.23 per million British thermal units (mmBtu) hit on Jan 23. Gas traded above $4 last summer.
Recently, observed pipeline flows have declined on a sustained basis, suggesting that the announced production curtailments are underway, Goldman Sachs analysts David Greely and Johan Spetz said in a note.
-Natural gas price: http://link.reuters.com/kub96s
-Chesapeake Energy flows: http://link.reuters.com/par76s
Even assuming the shut-ins have been imposed, some analysts say the oversupply caused by the prolific development of shale deposits is still growing. The U.S. government on Tuesday increased its 2012 production forecast for the second time since the production constraints were announced; it now expects output to climb 2.6 percent versus last year to a record high.
Other analysts who have poured over available pipeline flow data say it's impossible to be certain either way. While extensive analysis of pipelines shows a decline in flows in Texas and Louisiana since late January, lines elsewhere have shown increases.
For instance, declining production from Chesapeake wells in the Barnett and Haynesville shales in Louisiana and Texas has been partly offset by increased output in the Pennsylvanian portion of the Marcellus shale, according to Thomson Reuters Trading Analytics in New York, which compiled the data.
From the small sampling of the giant actual flows involved, it is hard to draw firm conclusions.
A court in Texas -- a state which produces about 10 percent of U.S. supply -- ruled in October that from the end of 2011 pipeline operators no longer had to report volumes on intrastate pipelines, meaning only flows between Texas and other states were made public.
Production cuts are currently impossible to prove, said Jon Ecker, a natural gas expert at Genscape, which monitors natural gas pipeline flows.
A TELLING HISTORY
Based on experience, the question may not be whether cuts are being made, but how long they will last.
In 2009, after Chesapeake announced cuts on March 2 and April 16, second-quarter output actually rose by 4 percent over the previous quarter as new drilling successes outweighed curbs elsewhere, according to company regulatory filings.
Moreover, a Reuters analysis of the data suggests that, after cutting more that it pledged in the first quarter, Chesapeake ramped production back up just a few weeks after announcing the second reductions.
A company spokesman who reviewed the Reuters calculations in this story said: Our decisions regarding the duration of curtailments are dependent on market conditions and we retain the right to adjust our production as we deem appropriate.
Chesapeake typically owns about 50 percent of a well's production while the other half goes to partners and royalty owners, the Chesapeake spokesman said. So reductions announced in company results represent about half of the total cuts.
Chesapeake said its average reduction was 74 mmcf per day, a total of 6.7 billion cubic feet for the entire second quarter of 2009. About 1.5 bcf of that should have occurred between April 1 and April 16, based on Chesapeake's one-half share of the initial 200 mmcfd curbs in place since March 2.
Therefore, the doubling of cuts announced on April 16, as prices continued to decline, could only have lasted 26 days at that rate, to May 12, given that the total cuts for the quarter amounted to just 6.7 bcf.
By mid-May 2009, natural gas prices had risen more than 40 percent from what was then a seven-year low but the decline resumed throughout the summer, as Chesapeake resumed pumping at full throttle. Third quarter production rose three percent over the second quarter and fourth quarter production jumped another 7 percent. The company confirmed in July 2009 that it was no longer cutting production.
In the past, those that shut in typically talked up a storm ... but when the data finally came in, little had actually been shut in, said Martin King, analyst at FirstEnergy, in a report last week.
(Additional reporting by Bruce Nichols in Houston; Editing by Alden Bentley)