Why Informed People Have Done a Pretty Lousy Job Predicting Natural Gas Prices
It has been a long couple of years for natural gas companies as prices have suffered as a result of the shale boom and the Great Recession since late 2008. And during this time I’ve been listening as closely as I can to the best minds in the business trying to determine when might be a good time to start buying natural gas companies.
And what I’ve learned is that none of the best minds seem to have a clue where natural gas is going, so how could I ever possibly know. Here are a few examples:
First up is Mark Papa of EOG Resources who is extremely well respected within the industry. Here are some comments he made during the 2nd quarter 2009 conference call:
Our view of the North American gas and oil markets is consistent with our previous earnings call, except that we've become more bullish regarding 2010 and 2011 gas prices. We still expect North American gas prices to remain quite low through year-end.
As you know, we've historically devoted a lot of work to developing domestic gas supply models and we think our current model is the most granular and best we've ever built. It's telling us that December 2009 domestic production will be 4.8 Bcf a day lower than year-end 2008 and this deficit will deepen further throughout 2010. When added to the Canadian supply drop of at least 0.8 Bcf a day, we expect the gas market to turn sometime early in 2010 almost regardless of what happens to LNG imports.
Everybody seems to be focusing on the supply growths from new horizontal plays, but the 800 pound gorilla in the room is Texas vertical gas production. This represents the largest single block of production in the U.S. 16.3 Bcf a day in December '08, and the rig count here has fallen from 450 rigs in January 2008 to 145 rigs today.
Our model shows production from this large segment of domestic production will fall from 16.3 Bcf a day at year-end '08 to 13.2 Bcf a day by year-end '09 and then 11.6 Bcf a day by year-end 2010 down 4.7 Bcf a day over two years. In my opinion, this is the most important well population that people should be focusing on if they want to understand what's going to happen to gas supply over the next 24 months.
Our financial hedge position is shown in our 10-Q and it's consistent with our macro view. About 47% of our July through December North American 2009 gas is financially hedged at $9.03, and we have only a small amount of first half 2010 gas hedged at $10.27. Based on our macro view, we'll likely remain primarily unhedged for 2010. Our oil view is that the 2009-2010 NYMEX is reasonably reflective of what oil prices will likely be. We're long-term bullish regarding oil and have no oil hedges.
Tom Gardner – Simmons & Co.
Mark, I'm intrigued by your gas macro comments. You mentioned you're encouraged about 2010 and 2011. Do I read from that that given the steep inventories that industry appears to have and their ability to grow production, do you think we're poised for a rebalancing and an overshooting going from a short position to a long position in 2012? And is there any thoughts on how industry might smooth out the highs and lows, so to speak, with respect to supply and demand long-term?
Yes. I mean, that's certainly a possibility. We just haven't forecast past 2011, Tom. As you know, I mean trying to forecast the gas market even more than 12 months out is a hazardous business. And we haven't focused at all on the demand side. We don't purport to be demand experts.
But what we have done is really sharpened our pencil on the supply side. And what we do see is that the next 12 to 18 months is, we believe, pretty well already cast in stone really kind of regardless of what happens to the go-forward rig count. And we think that the situation is that production is going to be falling quite a bit.
You may recall on our last earnings call pretty much exactly what we said is we said that we would have to endure another two or three EIA-914 reports, and we expected either the April or the May EIA report to be the first break of a significant decline. And indeed that's pretty much exactly what's happened. So we've got a fair degree of confidence in our model at this point, and the model is showing that we're now on the slippery slope.
Unfortunately, what's going to happen with the model is we think the July data or the June data, which will be the next data point to come out, will be pretty accurate. But then the subsequent two or three months may well be clouded by storage induced shut-ins or curtailments. So we're not going to have that much accurate data. But we think that it's pretty well inevitable that there's going to be a significant decline over the next 12 months in domestic production.
The key comment here being “we expect the gas market to turn sometime early in 2010 almost regardless of what happens to LNG imports.”. No sir. Didn’t happen.
Second, Mr. Henry Groppe of Groppe, Long and Littell who at age eighty-something has a long track record of accurately predicting turns in the oil market. I love Groppe, every decision that he makes is based on actual data that is compiled in a database perfected over 50 years. No Boone Pickens “gut feelings” for Henry, just data. Here is what he said in April of this year:
A contrarian makes another call - this time, natural gas
Apr 23, 2010
Globe & Mail -- Henry Groppe was a lonely voice when he forecast the right oil price. He's now going against the grain on another fuel, David Parkinson writes
When it comes to predicting the price of oil CL-FT, Henry Groppe has made a long career out of zigging when others were zagging. So why should he be any different when talking about natural gas NG-FT?
Mr. Groppe - the octogenarian patriarch of Texas petroleum industry analysts Groppe Long & Littell - doesn't buy the prevailing wisdom that New York Mercantile Exchange natural gas prices are dead in the water, stuck around $4 to $5 (U.S.) per million British thermal units even as demand recovers, awash in supplies and with much more on the way.
No, his analysis (and more than 50 years of experience) tells him that gas inventories are about to get a lot tighter, that new supplies are overstated, and that prices are headed north of $8 by the end of summer.
Why is he so sure he's got it right and most everyone else has it wrong?
Because, he contends, shale gas - the previously unattainable source of vast gas supplies that has been unlocked by new high-tech horizontal drilling advancements - is not the holy grail it's been cracked up to be. Not even close.
"Everyone thinks [shale gas] is going to solve all of our problems. There are very optimistic estimates about the economically recoverable volumes of gas from this new resource," he said in an interview last week in the Toronto offices of boutique fund manager Middlefield Capital Corp., where he's a long-time consultant and is special adviser to the nine-month-old Middlefield Groppe Tactical Energy mutual fund.
"That's dominating everyone's views about the gas supply picture - that we're going to be flooded with gas."
The reality, he argues, is that shale gas deposits are a tiny part of the North American production pool - and they are already depleting fast.
Mr. Groppe says that while the average depletion rate in conventional gas wells is about 25 per cent (in other words, if you didn't drill at all for new wells, production would decline by a quarter each year), shale gas shows even more rapid depletion - output tumbles, on average, 45 per cent in the first year for shale wells.
" We think that we're now having a continuous, rapid decline of gas in storage. By summer, it could get to be alarming."
Drilling of shale plays has recovered rapidly from the slowdown during the recession - indeed, the count of active horizontal drill rigs in the United States has ramped up to record levels - which, because of the high initial production volumes that are characteristic of shale wells, has flooded the market with supplies and fuelled expectations of continued rapid growth. But given Mr. Groppe's depletion numbers, the high drilling pace may also be serving to drain the resource in the major shale pools even faster than they would otherwise.
As for the shorter-term supply picture, Mr. Groppe notes that for all that horizontal drilling frenzy, shale gas accounts for just 6 per cent of U.S. natural gas production.
In the other 94 per cent - conventional gas - the rig count is 70 per cent below the pre-financial-crisis levels of September, 2008, as low prices and high inventory levels have convinced producers to keep drills idled.
"With that extraordinary drop in drilling, the [production] decline rate from all these [non-shale] sources is accelerating - and will be much more than offset whatever increases you get in shale."
Add to that the fact that consumption continues to grow as the economy recovers, and he believes the glut in gas will prove strikingly short-lived.
"We think that we're now having a continuous, rapid decline of gas in storage," he says. "By summer, it could get to be alarming."
"We would expect gas prices to get above $8 in the August-September range."
Why should we believe Henry Groppe? Well, he has a habit of disagreeing with the consensus view - and being right.
In 1980, when oil approached $40 a barrel and forecasters predicted $100 oil was inevitable, Mr. Groppe said crude would fall below $15 by the mid-1980s. It did.
In 1998, when crude dipped to barely above $10 and some prognosticators were hailing a new era of cheap energy, Mr. Groppe said oil was set to soar. By early 2000, it had topped $30 a barrel.
And two years ago, when it threatened to reach $150 a barrel and forecasters said $200 and more were just over the horizon, Mr. Groppe predicted we'd be back at $60-$70 in the second half of the year. By October, he was right again.
Now, he says, a slow-but-gradual decline in North American natural gas reserves - regardless of shale - means an average price in the $8 range is inevitable to trigger the "demand destruction" necessary to keep the supply-demand picture in balance. Eventually, he says, that price will creep up toward $10 by the end of the decade, as gas production slowly depletes.
Mr. Groppe credits his successes on a meticulous study of supply-and-demand details - something, he says, many of the people who disagree with him fail to do. He believes this is again the case in his critics' misplaced faith that shale plays will permanently alter the trajectory of North American natural gas supplies.
"When you take apart all the pieces from the bottom, there's absolutely no way for that to take place," he says. "We don't think any of them have done a detailed dissection of what's going on."
So Mr. Groppe predicted $8 by the end of summer 2010. Again, a big no sir didn’t happen.
And finally the controversial Aubrey McClendon of Chesapeake Energy. He of the $12 million map collection that he sold to the company almost immediately after losing most of his net worth through margin calls. But I digress. Say what you will about Aub, the fact is that he sees more data relating to natural gas production than anyone in the country. Chesapeake is the most active driller, he has to understand the decline curves of the shale plays better than anyone and has an top notch team around him to help interpret this data.
Has he faired any better at predicting a turn in his commodity ? I think you know what the answer is.
The Chesapeake April 2009 presentation was titled “The Fix is Underway”. And they were of course talking about the fix of “the best cure for low natural gas prices is low natural gas prices”. Here are a couple of excerpts from that presentation and a link to the entire thing:
"CHK sees U.S. natural gas prices at Henry Hub averaging $4-6/mmcf in 2009 and $7-9 in 2010 and beyond"
So there you have it. Three guys with access to more data than I could ever hope to have. Three guys with likely more brainpower than I could ever hope to have (I’m assuming this since then run successful companies and I write a blog on the internet !). And three guys who have had no clue where natural gas was going to go over the past couple of years.
The lesson from this ? If they can’t get this right, there is no way that I can so I won’t waste time trying. I’ll stick with oil which is much simpler to understand given the fundamentals driving demand and the decline rates on the world’s oil fields.
Full Disclosure: I own a couple of shares of CHK and some days want to buy more.