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Stronger Natural Gas Still Lacks Allure

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US natural gas prices have begun to strengthen as oil prices have begun to drop, but both remain far from levels that would prompt exploration and production companies to shift capital back to gas from liquids.

For the past few years, with Henry Hub natural gas trading mostly in the $2.00-$4.00 per million Btu range, higher-priced and higher-margin oil and liquids have been the target of choice for US onshore drillers. But as natural gas prices have recently edged above $4.00/MMBtu and West Texas Intermediate oil prices have dipped below $90 per barrel, some analysts are questioning at what price levels gas drilling might look appealing, and oil or liquids drilling less so.

Returns on either natural gas or oil drilling in US onshore vary widely on a play-by-play basis, and a large part of that variation comes down to the cost of operations.

"Some people can make money in a $4.00 gas world, and some people are doing it," said ConocoPhillips president of Lower 48 and Latin America Don Hrap at the Independent Petroleum Association of America's Oil and Gas Investment Symposium in New York on Wednesday. Hrap noted that the San Juan Basin, which spans parts of Colorado, Utah, Arizona and New Mexico is "really low-cost".

But the recent shifts in oil and gas prices are not prompting a change in ConocoPhillips' drilling strategy in the San Juan Basin. "Before we'd accelerate gas, I might accelerate more of the liquids," Hrap said. "It's not because our gas couldn't make money, it's just I think we can make more money."

Fellow independent Devon has "some guarded degree of optimism on prices and what could happen on gas", chief executive John Richels said at the symposium on Tuesday. The company used a $4.00 per thousand cubic feet (Mcf) - roughly equivalent to $4.00/MMBtu - price to develop its 2013 capital expenditures budget, and is using $4.25/Mcf as a base for 2014 and $4.50/Mcf thereafter. (Related: Devon Confident on on Keystone Pipeline)

But as long as oil remains in the $90/bbl range, it will outcompete gas in Devon's portfolio. "Even at $4.10, while we make a very good return on the Barnett and Cana [shales], we make equally good or better return at $90 oil in these oil plays."

If oil were to dip below $75/bbl, the landscape might begin to change. "A lot of areas today in North America require an oil price probably north of $75 bucks in order to create the kinds of returns that you'd like to see," said Richels. "If oil were $75, $70, my guess is that our liquids-rich gas plays at $4.10 gas and some reasonable liquids play would look pretty good as well."