×

Schork Oil Outlook: Where Is All This Gas Going to Go? 

Yesterday, the average pre-EIA report consensus was for an injection of around 60 Bcf. However, even though the actual injection was 13% above expectations, the NYMEX rallied in the wake of the EIA report’s release.

The market obviously did not rally upon receipt of news that underground storage is now 69 Bcf closer to capacity. Rather, the market is obviously rallying on events other than nearby fundamentals.

  • Occidental to Buy Phibro from Citigroup
64482442
Getty Images

Market area capacity constraints in the Producing Area and in the West are virtually unavoidable.

Where is all this gas going to go? No one knows, because no one has ever been in a market like this.

Therefore, no one can reasonably explain why the NYMEX is doing what the NYMEX is doing, i.e. the Henry Hub futures contract rallied upon hearing storage in the Gulf is now within 2.8% or 33 Bcf of capacity.

The question is not will gas displace gas, but rather, where and when will it occur?

  • Oil Rises Toward $72 on Positive Demand Outlook

In essence, gas is cannibalizing itself, yet the NYMEX rallied. We must respect this rally, even though we do not understand the whys and wherefores of its origin… especially because we don’t understand. We know the bulls have gotten some recent help by a cold air mass currently over the Chicago area and a bullish winter weather forecast. Yet gas is still getting into the ground. We also know the bulls are trying the spin the case of the precipitous drop in the rig counts, but gas is still getting produced regardless.

To wit, one of our readers, who runs the largest consulting firm specializing in the hydraulic fracture stimulation of oil and gas wells, observed last week…

“Activity level has really turned up. All of these horizontal projects are intense and the technology is moving very fast. One of the recent graphs [The Schork Report, September 9, 2009] showing the average gas rate per well compared to prior years tells a lot. I saw one in a Morgan Stanley report recently too. We have been waiting for the analysts to catch up with this fact. The rig count reduction as applies supply was misleading….. The oil and gas producers have been through these cycles many times and know how to tighten up and high grade projects… One extreme dictates another. I would be careful about a bullish gas stance next year and I have no faith in an increase in industrial demand…” Billy Aud, President of Integrated Petroleum Technologies, Inc.

There you have it… a view from the front lines… not Wall Street. High-grading, i.e. the shuttering of production at the fringe (less productive, low return plays) is skewing the drop in the Baker Hughes count.

The Carbon Challenge - A CNBC Special Report - See Complete Coverage
The Carbon Challenge - A CNBC Special Report - See Complete Coverage

In today’s issue of The Schork Report, we provide an updated version of the one Billy mentioned, demonstrating how vertical drilling used to account for ˜60% of production, but that amount has now decreased to ˜35%; while horizontal/directional rigs have taken the lion’s share, it’s basically a complete reversal.

The corollary to this is that since 2008 we’ve seen the amount of product produced by each rig increase almost 100%. That means the use of horizontal/directional rigs provides a higher yield and thus, we’ll need less rigs in the future.

  • Oil at $200, Stocks Can Keep Rallying: Jim Rogers

You’ll notice that the product per rig value is actually decreasing between 2005 and Sep 08, hitting a low point in the third quarter of 2006. Not co-incidentally, 3Q ‘06 was the same time that we had the highest number of vertical rigs.

In other words, there was an oversupply of inefficient rigs. This meant the rig count was increasing but production wasn’t, i.e. the vertical rigs increased the product/rig denominator without increasing the numerator accordingly. Thus, when these vertical rigs were taken off-line, the amount of product per rig increased because products remained roughly the same but rigs decreased.

Therefore, high-grading means less is more (not to be confused with Wall Street’s beloved malapropism… less bad is good).

_________________________

Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.