This report was the first bit of truly good news for the bulls in well over a year; the implication being that we are finally beginning to see the knock-on from industry efforts to pare gas output.
However, before the bulls pop the champagne corks they should consider what has transpired in the market since September.
A lot of anecdotal information we gathered from speaking to clients back in September and October suggested that a good deal of production that was shut-in over the summer was sold into the NYMEX pre-winter rally.
… 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 graph in today’s issue of The Schork Report demonstrates 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.
If you’ll notice, 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)....The Schork Report – October 9, 2009
Thus, it looks like the high-graders are back… not to mention our friends to the north.
The EIA monthly summaries provide a more accurate look at working gas storage levels than the weekly survey.
We normally expect the weekly surveys to overestimate the actual levels, for instance Q1 2009 saw the weekly report over-estimate true values by 13 Bcf, while June saw a 12 Bcf overestimation. But interestingly the surplus has been decreasing for the last several months: July’s overestimation was 3 Bcf, August’s 1 Bcf and, as of September, the latest data available, the weekly survey overestimated the actual working gas in storage by 5 Bcf.
In absolute terms the difference is small, but the key take away here is that an increase in true demand was not picked up by the weekly surveys. Savor the implication, not just for its positive impression of the economy but because we may not be able to analyze the error for much longer. The DOE has drastically improved accuracy in weekly vs. surveys, as demonstrated by the graph of absolute difference shown in today’s issue of The Schork Report.
