Traders Skeptical that Chesapeake, Others Cut Gas Production

The commodity price of natural gas continues to hover near it’s 10-year low. That’s great news for consumers whose heating bills are lower, but not-so-great news for landowners with leases in the Marcellus Shale. Why? Because low prices mean it’s not profitable for drillers to go after shale gas. They are in it to make money, and if you lose money in mining natural gas, well, you stop doing it. And that’s what is happening in many Marcellus areas. Drilling hasn’t stopped—but it has slowed down.

Low commodity prices for natural gas also mean landowners fortunate enough to have had drilling happen on their property make less from royalty checks.

So when Chesapeake Energy and other drillers recently announced they will curtail drilling and slow or shut off the gas flow from already drilled wells, you would think that would have an impact on prices. Less supply, more demand, prices go up. Simple economics. But the people who watch the price of gas more closely than anyone, in fact the very people who determine what the price will be—commodities traders—are skeptical that Chesapeake and others have actually reduced the flow of gas. They want to see the proof—numbers on the spreadsheet and in SEC filings—before they will believe it.

North American natural gas producers face one big problem as they pledge to cut production to bolster prices: skeptical traders.

Led by No. 2 U.S. producer Chesapeake Energy, companies including Canadian producer Encana Corp and ConocoPhillips have pledged to knock a total of about 2 percent off domestic output.

But with scant evidence of where or how long cuts are being implemented, traders are wary. Natural gas prices are languishing within pennies of a 10-year low hit in January. Traders say prices will likely remain depressed until reductions can be confirmed in company earnings or government data, months from now.

Stockpiles are at record highs for this time of year and without supply reductions they may exceed capacity by the end of the summer. Such an unprecedented event would cause havoc by forcing producers to sell gas at extremely discounted levels, perhaps even to pay for someone to take it off their hands.

So producers have announced swift cuts in supply, reprising a strategy that helped temporarily stem the previous price crash in 2009. But looking back, traders say, those curbs appear to have lacked the impact that they had initially expected.

Chesapeake’s production actually rose in the second quarter of 2009 after cuts were announced, as increasing output from new wells more than offset the cuts it made at existing facilities, company data show.

The supply restrictions may have also been relatively short-lived. Chesapeake announced on April 16, 2009 that it would double the size of planned reductions to 400 million cubic feet per day — about 13 percent of the company’s output at the time. Reuters calculations, based on company data, suggest that the closures would have lasted less than a month at that rate.

Now that cuts have been announced again, traders say they want to see the evidence. So far, it’s been hard to find.

"The market doesn’t think there is a lot of production cutting going on," said Keith Barnett, executive vice-president at Springrock Production which forecasts U.S. natural gas supply.*

Drillers will need to back up their words with actions this time around (actual cuts in production), or they risk crying “wolf!” one time too many. Production cuts will mean short-term pain for landowners with wells and royalties, and for those who want to see drilling begin, but in the end it will mean long-term gain when prices finally rebound.

*Reuters (Mar 7, 2012) – Show, don’t tell: US natural gas traders question cuts