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August 2015
September 2014
Lower for longer: How low-cost supply—and uncertainty in global
oil markets—affects the domestic natural gas complex.
Contents
Subtitle
(20 point bold
/ Summary
24pt — two line max)
Executive
U.S. gas production is likely to slow in the near term as oil-directed drilling hits the brakes, but the
2 Key Takeaways second row
Subtitle
wealth of low-cost inventory in areas like the Marcellus and Utica—as well as associated volumes from
3
U.S. Natural Gas Supply
14 U.S. Natural Gas Demand
oil-rich areas like the Permian—points to continued growth through the end of this decade and beyond,
aided by durable efficiency gains in the form of faster cycle times and improved recovery rates. Based on
our analysis of how drilling and completion costs are likely to trend given the competitive dynamics
36 Cost of Production and Marginal Cost
within the upstream-services value chain, along with our examination of well-level returns for each of
60 Summary and Investment Conclusions
the major producing areas in the Lower 48, we estimate that a midcycle price for U.S. natural gas of $4
64 Appendix
per thousand cubic feet will be required to meet the more than 20 bcf/d of incremental consumption we
forecast by 2020.
While the next few years will be challenging for exploration and production companies and services
firms, we expect cash flow, profitability, and returns on capital to approach pre-oil-crash levels by the
end of the decade, with a recovery beginning in earnest in 2017. Even with the prospect of ongoing
weakness in the domestic oil and gas markets, undervalued, cost-advantaged investment opportunities
remain.
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Key Takeaways
× Significant Low-Cost Resource Base Should Drive U.S. Production Growth: U.S. gas production is
likely to slow in the near term as oil-directed drilling hits the brakes, but the wealth of low-cost inventory
Mark Hanson, CFA
Sector Strategist, Energy
+1 312-244-7548
[email protected]
Stephen Simko, CFA
Director, Energy
+1 312-384-5448
[email protected]
Jordan Grimes
Sr. Commodities Analyst, Power and Gas
+1 312-244-7046
[email protected]
in areas like the Marcellus points to continued growth through the end of this decade and beyond. The
Marcellus is the single biggest growth driver in our forecast, adding 11 billion cubic feet per day (50% of
incremental volumes) through 2020.
× Plenty of Demand Tailwinds to Absorb Increased Supply: Increased gas consumption of 22 bcf/d by
the end of the decade should provide an outlet for this abundance of low-cost supply, driven by power
generation in the near term and pipeline and LNG exports in the longer term. Recent reforms to its
energy industry should boost Mexico's demand for gas (most easily supplied by pipelines from the U.S.),
and liquefied natural gas exports from the United States are set to start next year, with a meaningful
ramp-up in volumes likely through the end of the decade. U.S. industrial consumption should also
increase, given recent greenfield investments and natural gas' cost advantage in petrochemical
manufacturing.
× Services Pricing Likely to Trough in 2016: Given ongoing efficiency and productivity gains, and the
excess capacity that is expected to continue in the services market over the next several years, we
forecast per-unit services prices will trough next year at 25% below their 2014 levels, with a gradual
recovery thereafter as drilling and completion activity picks up.
× U-Shaped Recovery in Financial Health of E&Ps and Services: While the next few years will be
challenging for E&Ps and services firms, we expect cash flow, profitability, and returns on capital to
approach pre-oil-crash levels by 2020, with a recovery beginning in earnest in 2017.
× Reiterating Midcycle Natural Gas Price Estimate of $4/Mcf: Despite our expectation for continued
growth in demand, there is more than enough low-cost supply to justify our midcycle U.S. natural gas
price estimate of $4/mcf. Our estimate is based on an in-depth analysis of the competitive dynamics
between upstream and services firms along with an examination of well-level returns for each of the
major producing areas in the U.S. Without a significant recovery in oil and gas prices, U.S. production
will either be dramatically lower or services prices will experience additional downward pressure, which
would call into question the long-term viability of the domestic oil and gas complex.
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U.S. Natural Gas Supply
Executive Summary
× Low-cost supply from the Marcellus and Utica and associated volumes from oil-rich areas should drive
U.S. gas production to 94 bcf/d by 2020, up from 70 bcf/d in 2014.
× We expect domestic drilling to gradually recover starting in 2016, with rig counts ramping to almost
1,400 by the end of the decade.
× A continued shift toward horizontal development, along with faster cycle times and improved completion
methods, should translate into higher production volumes with less capital and equipment in the coming
years.
× As productive as they are, the Marcellus, Utica, and associated gas regions won't be able to fully meet
increasing demand. Drilling in higher-cost areas sets our $4/mcf Henry Hub midcycle price.
Introduction
Domestic natural gas production has been on a tear over the past several years—up 30% since 2009 to
more than 70 bcf/d—thanks to ongoing development of highly productive areas like the Marcellus and
Utica shales in the northeastern U.S. as well as associated gas volumes from oil-rich plays like the Eagle
Ford Shale in southern Texas. Though production growth is likely to slow in the near term as upstream
firms hit the brakes on oil-directed drilling, the wealth of low-cost drilling inventory in areas like the
Marcellus and Utica—aided by an eventual recovery in oil prices and a ramp-up in associated gas
production—points to continued growth in volumes through the end of this decade and beyond. We
estimate that most of this incremental production—primarily from the Marcellus, Utica, and oil-rich
areas like Texas, Colorado, and North Dakota—can be brought on line at prices lower than $4/mcf.
Our supply forecast incorporates our estimates of drilling and completion activity, per-well productivity
improvements, efficiency gains, availability of economic inventory, and the effects of a vertical-tohorizontal mix shift across the major producing areas in the U.S.
To continue reading the full 65-page report, please contact
[email protected]
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