Low natural gas prices won’t stop drilling

Even as Wall Street analysts continue to ratchet down their 2012 forecasts for already record low wellhead prices, Fayetteville Shale producers don’t appear ready to completely halt cash-rich drilling plans in the Arkansas natural gas play – as least not yet.

“Lower gas prices will result in lower drilling activity, but not as much as many hope since most companies have drilling obligations,” said Fadel Gheit, managing director and senior energy analyst at New York-based Oppenheimer & Co.

DRILL BABY DRILL
Unlike in the past, when independent drillers literally shut down rig operations after gas prices dropped below so-called breakeven levels, producers can still make a profit in today’s low-price environment by continuing to drill.

According to the U.S. Energy Department, the glut of natural gas production and a mild winter have pushed spot prices to their lowest level in more than a decade. Natural gas working inventories continue to set new record seasonal highs and ended January 2012 at an estimated 2.86 trillion cubic feet (Tcf), about 24% above the same time last year, said the department’s Energy Information Administration (EIA).

“An exceptionally mild winter to date has pressured U.S. natural gas prices to levels below our prior expectations and below levels that are economically attractive for developing dry gas plays in the U.S., shale or otherwise,” the EIA said in its recent short-term forecast for 2012.

At the end of trading on Monday, the benchmark natural gas prices for delivery at Henry Hub, La., closed at $2.42 per million British thermal units (MMBtu). At the New York Mercantile Exchange (NYMEX), the March 2012 natural gas contract rose 6.6 cents per MMBtu for the week to close at $2.448 per MMBtu.

‘BREAK-EVEN’ POINT
Only five years ago, natural gas drillers were racing to purchase shale properties with spot prices as high as $13. At the same time, technology breakthroughs by oil service companies like Halliburton and Schlumberger opened the door for producers to use horizontal drilling and hydraulic fracturing to break through hard shale rock to release huge volumes of gas and oil reserves.

Since the summer of 2011, natural gas prices have plunged 50% from the 2011 peak of about $5.00 per MMBtu. At the time, some top energy experts were predicting that U.S. shale drilling operations would stall if prices dropped below the “unofficial” break-even point – between $5 and $6 per MMBtu.

Not today.

“They need the cash to stay in business,” said Gheit, one of Wall Street’s top energy forecasters.

The New York-based Oppenheimer analyst said natural gas drillers are now shielded from big losses by high-priced hedging arrangements, the industry shift to high-dollar crude and liquids content plays, or by mitigating risk in joint venture deals.

SOUTHWESTERN STRONGHOLD
In the case of Southwestern Energy Corp., the Fayetteville Shale leader’s prime leasehold position, attractive hedging arrangements and strong cash flow has kept the company’s drill bit engaged in Arkansas.

Yet, the Houston-based oil driller announced late last year it was expanding its highly profitable drilling operation to include liquid-rich plays in south Arkansas and north Louisiana, Pennsylvania and Canada.

Overall, Southwestern is targeting total gas and oil production of 570 to 580 billion cubic feet equivalent (Bcfe) in 2012, up approximately 15% from last year levels. Nearly 475 to 480 Bcf of the 2012 targeted gas production is projected to come from drilling activities in the Fayetteville Shale play, up from the 2011 projected production of 433 to 435 Bcf.

“I am excited about what lies ahead for Southwestern Energy in 2012. Our low-cost operations and financial flexibility, along with our significant positions in two world-class shale plays and our drilling in several New Ventures plays, give us the ability to create significant value for our stockholders,” Southwestern CEO Steve Mueller said during the company’s 2012 capital budget update on Dec. 19.

Last week, in a presentation to investors, Southwestern reaffirmed its 2012 capital investment of $2.3 billion in 2012, up from $2.1 billion in 2011. Of that total, the Houston-based driller plans to spend about $1.32 billion in the Arkansas shale play, slightly below last year’s budget.

At the time of Mueller’s statement’s on Dec. 19, the company assumed a NYMEX commodity price of $4.00 per Mcf of gas for 2012. In addition, the company has NYMEX hedges in place on more than half of its 2012 projected natural gas production at a weighted average floor price of $5.16 per Mcf.

“Our capital program is flexible and may be adjusted to correspond with significant changes in gas prices,” Mueller said. “Meanwhile, our hedges in place for 2012 provide a secure level of earnings and cash flow and our vertical integration gives us meaningful protection against higher costs in the future.”