The country's surge in natural gas production may soon be over.
Chesapeake Energy Corp. — which has billed itself as “America's Champion of Natural Gas” and is the country's second largest natural gas producer — said Tuesday that it has turned off the spigot and will see a 7 percent decline in its natural gas production in 2013.
“This will bring to an end our likely unprecedented public company record of 23 consecutive years of gas production growth, which has taken Chesapeake's gas production from 10 million cubic feet per day in 1993 to more than 300 times that level currently and in the process has helped transform the U.S. gas market,” Chesapeake CEO Aubrey McClendon said on a conference call with analysts Tuesday morning.
By the end of 2013, Chesapeake expects its natural gas production to drop by about 430 million cubic feet per day, or 14 percent, from its peak of 3.4 billion cubic feet per day this year.
“We believe this trend of declining gas production could continue as long as gas prices do not permit gas producers to earn an attractive return on the investments necessary to finish developing the big new unconventional gas fields that have led to America's greatly increased gas production over the past five years,” McClendon said.
Declining production is usually seen as a bad thing for the oil and gas industry, but not today, said industry analyst Fadel Gheit.
“Right now, analysts and investors should take gas production growth as a negative,” said Gheit, an analyst with Oppenheimer in New York. “For companies that are growing gas production, people should question why they are doing that.”
Chesapeake's stock price jumped $1.67, or 9.4 percent, to $19.37 on Tuesday, the day after the company reported nearly doubled second-quarter profits and increased oil production.
By the end of the year, Chesapeake will be using 100 drilling rigs, the company said Tuesday. Only eight rigs will be looking for dry natural gas, and that is only to meet lease obligations by having one producing well on each tract of land.
It is unlikely that the rigs will return to areas of dry gas anytime soon.
“You have to not only generate an attractive return, but you have to generate a return that is competitive with your other returns,” McClendon said. “So, it's not do we make money at $4 gas or $5 gas? It's do we make as much money drilling a gas well at that price compared to what we make drilling an oil well at $90 a barrel. And so that's, I think, a part of the equation that's missing from most people's analysis of the gas market going forward.”
Gheit agreed with McClendon's analysis, but said he doesn't expect producers to return to natural gas in large amounts until the price tops $6 per thousand cubic feet.
The price of natural gas settled at $2.96 per thousand cubic feet on Tuesday, up 5.6 cents on the day. Crude oil settled at $93.67 per barrel, up $1.47 on the day.
“There is no conspiracy. Money will go where it is treated best,” Gheit said. “With oil prices above $90, no matter how efficiently companies operate, they just can't reach the return of oil with less than $6 gas. It's like a cyclist racing somebody in a car. No matter how good of a cyclist you are, you're not going to beat the guy driving a car next to you.”
While Chesapeake's natural gas production is expected to soon decline, oil production is up 88 percent over the past year and is expected to continue rising sharply.
But even with all of Chesapeake's efforts to move away from natural gas and toward oil, crude represents only 13 percent of the company's total production. That number is expected to rise to 35 percent by 2015, Chesapeake said.
Morningstar analyst Mark Hanson had hoped to see Chesapeake's natural gas production begin falling sooner.
“We were surprised to see the company increase both its capital expenditure budget and projected gas volumes for this year, despite ongoing curtailments and commentary on last quarter's call that suggested the pace of spending would slow in subsequent periods,” Hanson said.
Gheit, however, said it takes time to so drastically change the direction of a company the size of Chesapeake.
“Many companies have very little option but to produce natural gas,” Gheit said. “It's like if you hate your job, but you still have to work to make ends meet. They do what they have to do.”