Over the last decade, the US has witnessed a significant increase in its oil and natural gas production, which is backed by the development in fracking technology. Televisory’s previous blog (Movement in crude oil prices and its impact on the US oil-gas players) on crude oil discussed the demand-supply dynamics of the black liquid in the country. In this blog, Televisory focused on the development of natural gas industry and present scenario succeeding the huge fall in gas prices in the past few years.
The major change in the US natural gas industry came in the year 2000 when the Mitchell Energy and Development Corporation started fructifying over its hydraulic fracturing technique in Barnett Shale (Texas region). The success of this technology and development of better horizontal and vertical drilling mechanism led, the other players to drill gas and oil wells in the different parts of the nation. This resulted in a strong increase of gas and oil output, during the last decade. The actual production figures for gas depicts that the total US supply increased at CAGR of 2.7% from ~60 BCFPD to 76.45 BCFPD between 2006-15 (Source: US Energy Information Administration [EIA]). The share of shale gas in total gas output increased from under 6% in 2006 to over 50% in 2015-16. The CAGR growth in gas output from shale backed formations stood at 16.8% and 31.5% in the past 5 years and 10 year period (2006-2015). An increase in the domestic production has also helped the country to attain self-sufficiency in natural gas with net imports, reducing to ~2.5 BCFPD in 2015 as against ~10 BCFPD in 2006 (Source: EIA data). As per the government estimates, the country might become a net exporter by 2017.
Source: EIA and Televisory’s Research
Although Barnett Shale was the initiator of this revolution in the US, there were other regions which saw huge investment and a dramatic change in how people view drilling and fracturing technology. The major ones are Eagle Ford, Haynesville, Marcellus and Utica, etc. As per the available data for 8 months of 2016, these regions mark nearly 2/3rd worth of total gas production from shale.
Source: EIA and Televisory’s Research
The country recorded a significant increase in gas output from shale backed sources, the consumption pattern too witnessed structural changes over the period. The natural gas consumption in the US grew at a CAGR of around 2.7%. This was nearly similar to increase in production with increasing supply getting absorbed primarily into power generation along with commercial and industrial segments. A consistent rising production of gas kept the prices in a range-to-lower status for the most part of the last decade and especially in the foregone 5 years. The power generation in the US which was historically dominated by the coal witnessed a gradual shift towards gas. While usage of coal was coming under pressure amidst tightening of policies over carbon emissions, increase in natural gas production provided power producers with a positive switch which become cost efficient and was also much cleaner than the coal.
Source: EIA and Televisory’s Research
The key point to note is, that the producers managed to maintain a decent increase in natural gas (NG) output despite stable to lower prices. This was backed by two major factors, consistent enhancements in technology, which helped to keep expenses lower and another being, development of shale wells in the region, which gave out mix fuel, for instance, both gas and oil. As NG prices stayed low, major producers continued their gas supplies, while high oil prices were aiding in the extra cushioning, until late 2014 when oil too started tumbling down. The movement of natural gas (Henry Hub) prices as shown in the below chart depicts the underperformance on NYMEX crude oil benchmark. Televisory has indexed the gas and oil prices at 100 in Jan. 2000, an identical time frame when the production boom in natural gas started shaping up (Barnett Shale). NG prices recorded a huge swing between the year 2000 to 2008, while these have broadly remained low since then and significantly underperformed against crude oil prices.
Source: Bloomberg Data and Televisory’s Research
In order to cover the above point, Televisory took data of 12 companies in the US, with 6 pure-play gas producers (higher share of production and revenue from gas) and the remaining six had a mix of production and revenue sharing from gas and oil. In total, the gas producers had an average gas production share of ~87% and the balance was in crude oil and other liquids. These were namely, Chesapeake Energy, Cabot Oil and Gas, Southwestern Energy, Range Resources, WPX Energy and Consol Energy. The other 6 had a higher share of crude oil and other liquids with an average production share of ~60% while the balance was on the gas.
Source: Bloomberg Data and Televisory’s Research
The figures reflect, that the companies which had a mix of crude oil and natural gas revenues performed better against the pure-play gas development and sales. The average EBITDA margin comparison of the companies in pure-play gas stood at ~18% during the past 5 years’ time frame against the other 6 wherein EBITDA margin stood at an average ~30%. The same was the case for net profit margin, which stood at an average of minus 8.6% (gas based) against the other group 2.7% (mix of gas and crude oil).
Source: Bloomberg Data and Televisory’s Research
Source: Bloomberg Data and Televisory’s Research
On the leverage side, the debt-equity ratio for companies stood at an average of ~0.4x, for a mix of gas and crude oil companies against 0.9x for pure-play gas companies. The numbers over EBITDA/interest expenses too depict a very similar movement. Moreover, based on the point on mix fuel producers, crude oil prices have lately stabilised after a huge slide in the first half of 2016. In case oil prices rise further, that could incentivise oil producers to enhance production and indirectly also add an output for gas as many wells produce both oil and gas. Furthermore, if this happens, it could additionally turn negative for pure-play gas producers in the US in the near term.
Therefore, to summarise, the pure-play natural gas players are not in their best shape currently and with continuous rising production levels along with subdued price scenario domestically, the situation is expected to further worsen. In addition, the US government policies to curb natural gas exports, with an exception of Mexico and Canada, where producers can export to an extent, with no major leeway seen from the export-import policy for gas prices to recover and stabilise, production is needed to be capped. According to the data for the first 8 months of 2016, nil production growth was witnessed as compared to the same period in 2015. For the year 2016, gas production growth is expected to reduce to 1.3% (average 2.8% growth 2011-2015) and 2017 might observe a further reduction in growth rate to ~0.5%. On the demand side, residential and consumer sector usage of natural gas stays highly cyclical (winter demand for heating), while more stable and consistent performers are industrial and power generation sectors. As stated above, the demand for gas for power generation is rising wherein a gradual shift is being witnessed from coal to gas. Nevertheless, for power producers apart from the environmental concerns, a major incentive to move towards gas is its consistently subdued prices. In case there is a sharp increase in gas prices, then most likely a shift towards gas may get postponed. This is conjugated with the fact that coal prices too have dropped sharply in the last couple of years, making coal a cheaper fuel compared to gas and could impact the shift moderately.
Thus, net-net, any change in broader structural fundamentals of the natural gas market in the US should come in from producer’s side, where the race to utilise the technology and continue with higher production needs to be capped. Although Televisory cannot comment on any change in export policies, in case, the US government allows some breathing space, then this could become a triggering point for the overall growth of the industry.
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