Shale Gas Wells-The Supply Contraction Nightmare

Growing Financial Success

SHALE GAS WELLS-THE SUPPLY CONTRACTION NIGHTMARE

NATURAL GAS

Here is chart of the major U.S. shale Natural Gas wells that have been gaining so much attention as of late for the magnitude of supplies that exist within these structures. My first reaction is that this is super news for our goal of moving away from foreign Crude Oil dependence. The bad news is that unless prices for Natural Gas rise substantially from current depressed levels, these Natural Gas deposits will remain in the ground. There is plenty of every commodity at the right price. I guarantee you if corn prices went to $20/bushel we would have a surplus of corn the following year that would feed every livestock animal and their future offspring for the next 50 years!!!!!

My bullishness on Natural Gas is not based on a recovering economy or an increase in the demand for Natural Gas over the next 12 months. My expectation is that the economy will continue to languish and demand for Natural Gas will remain depressed. My bullishness on Natural Gas is based on the high likelihood of a complete supply collapse over the next 12 to 18 months. Here is how I look at the situation.

The Natural Gas rig count dropped to a new post crash low of 682 last week down from 1606 rig count in September of 2008. Does anyone really believe that the rig count can drop by almost 60% in less than a year and NOT have an effect of dramatically lowering future supplies? The even more powerful reason to expect a complete bust in future Natural Gas supplies are from following the DNA of how quickly a shale Natural Gas well depletes. Take a look at the following graph of the Haynesville Bossier shale Natural Gas well structure from the Natural Gas exploration company EnCana.

This is actual well performance from their own data. As you can see at the beginning of production, flow rates are very high near 15/mmcf to 20/mmcf per day. After that within the first 6 months time, the flow rates have fallen dramatically too under 5/mmcf per day. So to maintain steady production of these kinds of shale formation structures, exploration companies must constantly be starting up new wells every 6 months to overcome the dramatic depletion rates of these types of shale Natural Gas structures.

With rig counts dropping by almost 60% in less than a year and still dropping, it is my view that there is no way that this can be achieved. There are numerous other examples of other shale Natural Gas formations that show very similar impressive initial flow rates and then exhibit crashing depletion rates. If anyone would like to see more data on other shale Natural Gas wells please e-mail me and I will be more than happy to provide the data.

The very well known energy analyst Matt Simmons has estimated that at the current rig count and at the current rates of depletion for existing shale Natural Gas wells in production, that Natural Gas supplies could fall by 25% over the next 12 to 24 months. Unless one is willing to project that the demand for Natural gas will fall an additional 25% from current depressed levels, we will have an acute scarcity of Natural Gas that will necessitate much higher prices to compensate.

Top notch energy analyst Charles Maxwell from Weeden and Co. sees Natural Gas prices starting to rise heading into the winter time and rising through the majority of 2010 as a result of this fall off in supply due to these rapid depletion rates and due to the dramatic collapse in rig count. He made the comment that it takes quite a bit of time to ‘ramp up’ drilling activity to reverse natural gas deliverability declines once they start. In his view, Natural Gas prices would need to see $6/mmbtu to $8/mmbtu and stay there for an extended period of time to restart the Natural Gas exploration engine.

Of course this does not account for any supply shocks that may occur due to extended extreme heat, hurricane disruptions in the Gulf of Mexico or an overly cold winter. It also does not account for a demand side shock should the economy rebound more aggressively than my current depressed expectations.

Any such surprise supply/demand shocks would create an outright panic in Natural Gas prices reminiscent of the price spikes seen consistently over the last 10 years.

10-year Spot price Futures Chart of Natural Gas

The spikes seen in 2000, 2003, 2004, 2005 and 2008 all took spot prices to a minimum of $10/mmbtu and as high as $16/mmbtu. History has a way of repeating itself. The last time we had a recession coupled with a similar dramatic reduction in rig count due to a collapse in spot prices was in back in the summer of 2002. I believe we are in a similar position today as we were in June of 2002. The following year in 2003 Natural Gas prices tripled. In fact, if you look at the timing of all the price spikes over the last 10 years, they all occurred and reached major peaks during the winter months from November through March timeframe. In each case, the best time to have bought was the preceding summer: that is where we find ourselves today.

If I was a farmer, I sure would be thinking about locking in fertilizer Nitrogen prices at current depressed levels. If I was an investor, I sure would think that the odds were strongly in favor of a huge return over the next 12 months in Natural Gas. It would seem likely that next year at this time Nitrogen prices would be much higher given the strong probability that Natural Gas prices will be much higher by then.

Short term we have a glut of Natural Gas and that glut will keep growing during the typical inventory building stage of the summer. That is the opportunity for investor to buy in cheap to see beyond the daily bearish media reports and look ahead to the supply/demand shock that is waiting out ahead in 2010. The only way you ever get a chance to buy a commodity cheap is to buy when there is a current glut that is temporary. If you wait to buy a commodity when supplies get tight, you will consistently be buying commodities at high prices when most of the easy money has already been made.

I may be dead wrong about Natural Gas prices going higher and I have been wrong about many things in my investment career but I believe the evidence is compelling that the probabilities of an exceptional return at current depressed Natural Gas prices are very high indeed.

Have a great day

Shawn Hackett

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Have a great night and may your future investment decisions be prosperous ones.

Shawn Hackett