U.S. natural gas demand expected to out-pace production 3-1, says EIA

Major drilling slow to respond to prices, low inventories; EIA forecasting $4.80 an Mcf price for natural gas this year, up $1.90 an Mcf from the 2002 price

Petroleum News Alaska

Despite strong U.S. natural gas prices and storage levels approaching record lows, major drilling activity has been slow in responding to market fundamentals, leaving some industry analysts scratching their heads.

In fact, U.S. gas demand is expected to grow three times faster than production this year, according to the Energy Information Administration. EIA recently boosted its 2003 price forecast to an average $4.80 per thousand cubic feet, a whopping $1.90 an Mcf above the 2002 price average.

Others, including investment bank Salomon Smith Barney, have scrambled to adjust their forecasts as prices climbed above $8 an Mcf this winter. Salomon Smith recently raised its full-year 2003 composite U.S. spot gas price outlook to $5.60 an Mcf from $4.10 per Mcf, and to $4.50 an Mcf from $3.75 Mcf for 2004.

EIA now expects U.S. gas demand this year to increase by 3.7 percent to around 22.5 trillion cubic feet. But EIA also anticipates that production, down 2.8 percent last year, will grow by just 1.2 percent this year, despite strong prices and a corresponding increase in drilling.

There's no question North American drilling activity has picked up since commodity prices began to spike on winter demand and war jitters over Iraq.

In the United States, the rig count for February 2003 was 907, up 53 from the 854 rigs counted by oilfield service company Baker Hughes in January 2003 and up 82 from the 825 rigs counted in February 2002.

In Canada, the rig count for February 2003 was 554, up 76 from 478 counted in January 2003 and up 121 from the 433 counted in February 2002, according to Baker Hughes.

Devil in the details

In fact, the U.S. offshore rig count actually has declined from 123 in February 2002 to 111 in January 2003 to 109 in February 2003. Similarly, Canada's offshore rig count went from seven in February 2002 to three in January 2003 to four in February 2003. "The more profitable Gulf of Mexico market has been stagnant ... and showing little signs of imminent improvement," Salomon Smith concluded in a report to investors.

The investment bank has raised its 2003 U.S. rig count forecast to 950 from 890, including a 69-rig increase in the land market and a nine-rig decrease offshore.

Salomon Smith cautioned: "the majority of the rig count out performance thus far has occurred in the low end of the land market, the segment that typically produces the highest volatility and generates the least service company revenues."

Growing demand

ExxonMobil CEO Lee Raymond drove that point home at last month's Cambridge Energy Research Associates' CERA Week conference in Houston, Texas, warning that U.S gas is going the same way as U.S. oil production.

"If you don't have a place, you aren't going to drill," Raymond asserted. "Lower 48 prospectively is gradually eroding because fields are so mature. The U.S. is gradually slipping into a lack of sufficient gas supply to meet demand."

Raymond's prediction of a declining U.S. domestic gas production was shared by other CERA Week participants. Despite an expected infusion of Arctic gas from Alaska and Canada in the future, they believe the U.S. still would be hard-pressed to meet future demand for a 30 Tcf a year market.

"The question is how long can you hold production flat," one conference participant said, noting the sharp decline rate in many U.S. gas wells, particularly on the Texas Gulf of Coast.

Industry analysts believe it will take more imports of liquefied natural gas to help satisfy America's future gas demand, particularly before Arctic gas comes on stream around 2010. Other energy-strapped regions of the world find themselves in the same fix.

“LNG will play a vital role in Europe, and we have no choice in North America,” concluded another CERA Week participant. “We do see LNG as a cornerstone of the natural gas industry.”

Companies see huge gas potential in gulf’s ultra-deep formations

Petroleum News Alaska

Exploration and production companies are beginning to talk about exploring these “ultra-deep” targets on the shelf. But it also would require huge investments — up to $30 million or more per well — and more preparation time than current lease regulations would allow. The U.S. Minerals Management Service confirmed that an increasing number of companies are quietly lobbying MMS to extend the term limit on shelf leases beyond the current five years.

Companies are telling MMS they need at least seven years to prepare for the ultra-deep: five years to develop reliable seismic imaging of fuzzy prospects and another two years to push through exploration plans and line up equipment and drilling rigs.

MMS said it was “seriously considering” the request but also cautioned a lengthy process would be required to gauge industry support and to work out details. Nevertheless, MMS is definitely up to the task. A few years ago the agency stepped up to the plate with bold new incentives that suspended royalty payments on the first 20 billion cubic feet of gas production from shelf discoveries located below a geological depth of 15,000 feet.

The decision breathed new life into the aging continental shelf and transformed so-called “deep-gas” exploration into the shelf’s latest rage. That’s why the March 19 Central Gulf of Mexico Lease Sale 185 in New Orleans could prove to be a lucrative affair for MMS.

Majority of newly available blocks on gas-prone shelf

What's unusual is that a hefty 80 percent or 400 of the newly available blocks in Sale 185 just happen to be located on the gas-prone continental shelf. Typically, about half are located on the shelf and the remainder in deeper waters of the Gulf, which tend to dominate lease sales because of the potential for large oil reserves.

However, with the strong commodity price environment and bullish outlook for natural gas demand in the United States, explorers may be looking to load up on leases with deep and ultra-deep gas potential in the relatively shallow waters of the continental shelf, analysts said.

Independent hunting grounds

Newfield, a major natural gas producer on the shelf, recently acquired its ultra-deep stake from merger partner EEX. Newfield has dubbed the play Treasure Island, and actually received approval from EEX shareholders to form a separate unit trust, despite a warnings that exploring the 27 blocks making up Treasure Island would be an expensive and an "extremely risky" venture.

A well drilled to those depths would encounter extreme temperatures and pressures, requiring major drilling and seismic studies and geological work before drilling could begin, a Newfield spokesman said. He said the company likely would seek partners to share expenses before ever launching a drilling program at Treasure Island.

MMS said that because of extreme temperatures below 25,000 feet, reserves likely would be more weighted to gas than oil, with as much as 75 percent of the resource consisting of gas. And attempting to recover any oil at that depth would be "very expensive," the agency said.