At What Commodity Price Does NatGas Drilling Stop?

magic numberHow low might the commodity price of natural gas go before drillers really will quit drilling and wait for the price to go up? We’ll give you “the magic number” in a moment. But first, the (rather sketchy) rationale for how we calculate that number.

It seems almost every day we hear in the mainstream news that the low commodity price of natural gas is forcing drillers to suspend or slow drilling operations—especially in the “dry gas” areas of the Marcellus Shale. Contrary to what “everyone” seems to be doing, Shell, Chevron and others have said they will continue drilling regardless of the low price of natural gas. And more than one analyst has said announcements of drilling cutbacks by Chesapeake and others is so much hot air and that they will believe it when they see it.

With the commodity price of natural gas at new 10-year lows (just above $2 per 1,000 BTUs, or mcfe), and with inventories at all-time highs (2,479 billion cubic feet as of March 30), it begs the question of, “How low can it go before the drilling just stops?”

Good question, and no easy answer because you have to factor in the price drillers get for natural gas liquids. But MDN will attempt an easy answer anyway, and the answer comes to us courtesy of yesterday’s Chesapeake Energy announcement that they are selling off more assets to raise $2.6 billion in cash—to keep drilling. In the press release was this paragraph:

Chesapeake has also completed the sale of a 10-year volumetric production payment (VPP) to an affiliate of Morgan Stanley for proceeds of approximately $745 million, or approximately $4.68 per thousand cubic feet of natural gas equivalent (mcfe), for certain producing assets in its Anadarko Basin Granite Wash play. The transaction included approximately 160 billion cubic feet of natural gas equivalent (bcfe) of proved reserves and current net production of an estimated 125 million cubic feet of natural gas equivalent (mmcfe) per day. Chesapeake has retained drilling rights on the properties above and below currently producing intervals and outside of existing producing wellbores. Including this transaction, the company has completed 10 VPP transactions since December 2007 and, in doing so, has sold approximately 1.37 trillion cubic feet of natural gas equivalent (tcfe) of proved reserves for combined proceeds of approximately $6.4 billion, or approximately $4.65 per mcfe, which is approximately 300% more than the company’s current drilling and completion cost per mcfe.*

Did you catch that last sentence? Chesapeake says that $4.65 per thousand cubic feet (mcfe) is approximately three times (3x) their cost to drill and complete and retrieve natural gas. Doing the math, that means it costs Chesapeake, the second largest producer of natural gas in the U.S., approximately $1.55 per mcfe to produce the gas. As of this morning the natural gas commodity price is $2.11 per mcfe. If $1.55 is break-even, MDN reckons $1.55 is as low as the price can go before drilling completely stops. And the closer it gets to $1.55, the less drilling you’ll see.

So now we know “the magic number” when drilling stops: $1.55.

*Chesapeake Energy (Apr 9, 2012) – Chesapeake Energy Corporation Announces Three Oil and Gas Asset Monetization Transactions for Proceeds of $2.6 Billion