Rig counts don't tell the whole story

Natural gas rig productivity is falling while natural gas demand is rising.

Anyone who invests in oil & gas looks to reported North American rig counts as a leading indicator of production growth or decline. During the past several years, rig productivity has improved as operators learn how to drill farther from a drill pad, and where precisely to drill. That growth in rig productivity was a concern for many since it appeared possible that the service industry would suffer even as output grew.

But that trend seems to have stalled. This chart (couresy of Darren Gee, President and CEO of Peyto Exploration & Development (PEY.TO) shows the flattening out of the rig productivity curve in Peyto’s own drilling and the declining productivity in three U.S. shale plays.

It is now July and there are a scant eighteen weeks until mid-November when natural gas typically stops being added to storage and begins to be withdrawn to meet demand. This year it will be a more marked upward shift than last year since current U.S. demand is being limited by the impact of the fire which shut down the 2Bcf per day LNG exports from the Freeport facility in Texas, but will see a sharp uptick as that LNG facility comes back on stream after repairs just as Europe sees the seasonal upturn in its natural gas requirements and supplies from Russia are limited and may actually be cut off.

The stage is set for firm prices for the winter with the possibility of very high prices. The risk of serious declines in natural gas demand even if the North American economy enters recession is relatively low in my opinion, and if there is a period of soft prices I believe it will be short-lived. Natural gas does not suffer the same “demand destruction” that can affect oil demand since most natural gas goes to essential needs such a electrical power generation, home heating and industrial usage. In a cold winter, demand will rise.

There is risk in every projection and mine are no better than your own, but I like the odds of a good winter for Canadian gas producers and the possibility of even greater demand from two new sources - first, the InterPipeline Heartland polypropylene facility has now started operation and I suspect will consume 35,000 Boe/day equivalent of natural gas and second, the Kitimat LNG facility is expected to be onstream some time in 2023 or early 2024. Between those two, Canadian demand for natural gas should rise two to three Bcf/day in a market that is about 17 Bcf per day at present.

The Heartland facility has a nameplate capacity of 525,000 tons of polypropylene per year with each ton requiring ~1.1 tons of propane, increasing demand for propane in Alberta from a current ~50,000 barrels a day to an expected ~85,000 barrels a day. The Kitimat LNG facility will initially consume 2.1 Bcf/day of natural gas and is expected to double that within a few years of startup. At 6.1 Mcf/Boe, that translates into approximately 300,000 Boe/day for Kitimat and 35,000 for Heartland.

In short, there are a few tailwinds for Canadian gas producers. Investors will benefit from looking past any short term softness arising from a likely recession or otherwise and exercise patience with their natural gas stocks.

Globally, investors were willing to all but write off natural gas stocks as prices fell to uneconoomical levels in 2020 and investors rushed for the exit doors as the pandemic took centre stage. How quickly investors forgot the gas prices in the early 2000’s when natural gas stocks were flying.

Prices rebounded sharply as the pandemic ended with Europe and the United Kingdom joining Asian consumers in paying prices double or triple those paid in North America, spurring sharp growth in LNG shipments around the world as gas consumers struggled to find supply and the Ukraine war curtailed some of the shipments from Russia. In a recent release, the International Energy Agency projected a sharp decline in demand for gas by 2025, a somewhat optimistic hope for an agency that seems more interested in promoting specious “climate change” narratives than in macroeconomic or microeconomic analysis. To be fair, the IEA sees a shift from natural gas to coal and oil in some markets and recognizes that for natural gas demand to fall there has to be alternative energy sources, so its release (unsurprisingly) promotes growth in “renewables”.

The IEA seems blind to reality. After decades of effort and trillions of dollars of capital expenditures, “renewables” have barely scratched the surface of worldwide energy demand and natural gas remains the source of about 24% of the world’s total energy needs. The idea that “renewables” could materially displace natural gas within two or three years is preposterous.

A more likely outcome is sustained growth in natural gas demand with growth at a slower rate but growth nonetheless. Tight gas markets will be with us for several years to come with the only short term relief being a worldwide recession which I suspect has already started. Short-sighted energy policies by United States, Canada, United Kingdom and Europe have created the shortage and their citizens will pay the price. I am long natural gas stocks and will keep adding as prices fall in the current sell off. To paraphrase Eric Nuttall in his comments on oil markets, this is a “generational opportunity” and I don’t intend to miss it.