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Workers change drilling pipes on the rotary table of a natural gas drilling rig near Towanda, Pa. (TIM SHAFFER/Reuters)
Workers change drilling pipes on the rotary table of a natural gas drilling rig near Towanda, Pa. (TIM SHAFFER/Reuters)

Chesapeake Energy cuts natural gas production Add to ...

North America’s major gas producers are shutting in production and cutting exploration drilling in an industry-wide effort to reduce a massive surplus that has depressed prices to 10-year lows.

Chesapeake Energy Corp. , the continent’s second-largest gas producer, said Monday it is immediately curtailing production by 500 million cubic feet per day, and is prepared to double that to one billion cubic feet per day. It will also reduce the number of rigs it has operating in natural gas fields to 24, or a third of the 71 rigs it employed in gas fields on average last year.

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Chesapeake’s move follows recent announcements by Canadian producers such as Talisman Energy Inc. and Encana Corp. that they are cutting back drilling in their dry shale gas plays and shifting resources to develop natural gas liquids or tight oil fields.

The announcement by the Oklahoma City-based gas giant had an immediate impact on prices on the New York Mercantile Exchange, with natural gas for February delivery jumping 9 per cent or 21 cents per million cubic feet to $2.55 (U.S.). That’s just off the lowest point that natural gas has traded in winter since 2002, and analysts say more production cuts are needed to give prices a sustained lift.

Shares of major producers also jumped. Chesapeake shares climbed 6.3 per cent on the New York Stock Exchange on Monday, closing at $22.88; while Encana shares jumped 7.4 per cent on the Toronto Stock Exchange, closing at $19 (Canadian).

But analysts said gas prices will remain under pressure. “In the medium term, the impact on prices will be somewhat muted,” Matthew Jurecky, director of energy research for New York-based Global Data Inc., said in reference to the industry’s plans to reduce supply.

“That’s just because of the mere existence of the vast gas reserves that they do have. These unconventional resources plays are viewed as gas storage, so just as easily as they cut production, they could ramp it back up.”

Producers will have to cut back further on their natural gas operations, said Robert Ineson, senior director for international gas for IHS CERA, a U.S.-based consultancy. The gas industry is now employing 800 rigs in the United States and Mr. Ineson said that will have to drop below 700 to achieve a better balance in supply and demand.

Companies have been shifting their efforts away from plays that produce just natural gas to liquids-rich fields that produce more valuable propane, butane and ethane, as well as oil. But many of those liquids plays also produce cheap natural gas in addition to the liquids, and that keeps new supply coming on stream.

The U.S. Energy Information Administration reported this month that U.S. storage facilities now hold 3.3 trillion cubic feet of gas, up 20 per cent from 2011’s already record high figure, as a result of a relatively warm winter and continued growth in production of shale gas.

“You have an awful lot of gas to absorb before the market rebalances at a price that is within spitting distance of the full-cycle cost of new drilling,” Mr. Ineson said.

He said the break-even cost of producing for natural gas continues to fall with ongoing improvements in the technology for drilling and hydraulic fracturing, and that cost is now well below $4 (U.S.) per thousand cubic feet of gas, and perhaps closer to $3. Any company whose cost per well is much above $3.50 per thousand cubic feet is going to have trouble making money.

For smaller gas producers, even treading water has become impossible. Many gas wells decline at 30 per cent a year as the gas is used up. That means the only way to maintain production is to keep drilling.

But for a mid-sized producer putting out 10,000 barrels a day of oil-equivalent gas, the cost of maintaining existing output would run $60-million (Canadian) a year, Eric Nuttall, lead portfolio manager for the Sprott Energy Fund, has calculated. At current gas prices, that producer is bringing in $12.8-million in annual cash flow.

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