Low natural gas prices are the bane of investors in North American natural gas. With consumption flat and supply booming, thanks to the new shale gas fields, there’s seemingly no end in sight.

The U.S. Energy Information Admin-istration recently forecast that natural gas prices won’t even reach $5 per thousand cubic feet — barely $1 per mcf above where they are now — for at least a decade. The EIA projects shale gas production growing from 14% of U.S. supply in 2009 to 45% by 2035. Consumers can rejoice, but not investors.

What if it weren’t so? Some think the EIA’s outlook is gibberish. Companies that can’t make money at today’s prices are bound to pull back on drilling new wells. And an idiosyncrasy in the nature of shale gas reservoirs is gradually tightening supply.

Numerous gas producers claim their particular play is profitable at $4 per mcf or even $3 per mcf. But those plays represent a small proportion of overall production. Further, they are based on so-called “half-cycle” economics, an analysis that leaves out costs such as land acquisition, seismic testing and previously built infrastructure. Using “full-cycle” economics raises the break-even price. This should place a cap on drilling rates, keeping them below the level needed to drive overall growth.

Arthur Berman, who writes a blog called the Petroleum Truth Report, estimates $7 per mcf as the break-even price in today’s big shale fields. “For shale gas production to double and reach 45% of total U.S. supply as the EIA predicts by 2035,” Berman recently wrote, “rig counts will have to more than double. This cannot happen unless gas prices rise substantially.”

The other factor is the way in which production at shale gas wells declines. Today’s horizontal wells completed with multiple hydraulic fractures come on at high initial production rates and are expected to tap large reserves. What’s not to like? The way they decline. All oil and natural gas wells produce less over time as reservoir pressure drops. Conventional wells decline at a steady rate of 20% or so per year, but shale gas wells decline in a different pattern: extremely steeply for the first few months, then steeply for another year or so before “turning a corner” to a much lower percentage decline, with the well often producing at low rates for decades. This is great for the producer, who can often recoup the well’s capital cost within a year. But it creates a severe “treadmill effect” for the supply basin as a whole.

Are shale gas wells being drilled fast enough that their flush initial production more than makes up for the aggregate production decline of North America’s hundreds of thousands of existing gas wells? Until now, the answer was clearly “yes,” because U.S. natural gas production was rising demonstrably, with ample stored supply.

But if enough producers cut their drilling, those big first-year declines could finally hit overall production. It would then require much more drilling — and capital — to close the gap. Nobody knows when this “turn” will come. But when it does, the price effect could be dramatic — for both commodity and share prices. IE



More of George’s articles can be read at www.drjandmrk.com.