Natural gas industry braces for impact
Today's Financial News - Posted October 7, 2009
If the news today is an indication of things to come, the next few months are not going to be pretty. If the big boys are preparing for the worst, imagine the fear from the debt-ridden little guys.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): And so it begins. Just yesterday, we here at the TFN offices got into a late-day discussion about the fate of the nation’s natural gas markets.
With prices remaining low and entirely removed from the recent commodities bonanza, the nation’s expanding natural gas drilling industry is headed for trouble.
Today we got the news that proves our theory.
ConocoPhillips (NYSE:COP), the third largest of the nation’s Big Oil players, announced it is cutting its capital spending budget by nearly 10% and is selling some $10 billion worth of assets.
Why the drastic moves? Thanks in part to stubbornly low natural gas prices, the company needs to make the cuts to shore up a leveraged balance sheet.
If you recall, just last week the company warned Wall Street to expect reduced earnings figures thanks to a 67% reduction in natural gas prices.
There was similar news yesterday from nation’s second-largest producer, Chevron (NYSE:CVX). The California-based company quietly announced all drilling has stopped at its Piceance Basin facilities in Colorado.
I bet you can guess why they plugged the well. Yep, you betcha, low natural gas prices.
Drill, baby, drill
So if the natural gas price conundrum is having this effect on the nation’s largest companies and their multi-billion dollar cash flows, what is it doing to the tiny, marginal players?
Early last month, Trident Resources gave us a glimpse of what is likely to come. Citing liabilities of nearly a billion bucks and assets worth just $10 million, the Canadian gas driller was forced to walk into bankruptcy court and ask for protection from its creditors.
Indeed, the same companies investors were pumping their money into when gas was soaring to record highs are now failing under the weight of massive debt.
Here’s the kicker that is really going to tear the gas industry apart.
That massive debt that was picked up over the past few years doesn’t simply go away now that prices have plummeted. Drillers still have to pay their bills. That means any bit of cash flow available is direly needed.
That is how we got to where we are today, with natural gas inventories across the country at record high levels and growing by the minute.
With bills to pay, drillers simply refuse to close the valves on their producing wells. If they do, they’ll go bankrupt. But until they slow the flow, the price they get for that gas will sink lower and lower.
Eventually, prices will get so low the weak will be shaken out of the market whether they like it or not. They won’t be able to produce enough gas even to make their weekly payroll.
One of many
I could pick on dozens of small drillers that are facing gale-force headwinds, but since Rex Energy Corp. (NASDAQ:REXX) recently expanded its drilling in the Marcellus Shale formation, which is the chief cause of the current market glut, I will put their issues in the spotlight.
With $70 million in liabilities, the $330 million company is one of the better positioned drillers in its category. But much of that debt is focused on bringing the company to the Marcellus Shale region. If the move does not pay off, Rex could be forced to pay on a dud for quite some time.
Common estimates put the break-even price for Marcellus Shale drilling somewhere around $3.70 per 1,000 cubic feet of gas. Right now, drillers are able to get that price from the futures market, but the overfilled spot market is not willing to spend so much.
With nearly $1.50 difference between spot and future prices, something has got to give. With inventories about to overflow, the spot price won’t budge an inch.
The common argument throughout the market is that typical winter demand will reduce supplies and bring the markets back in equilibrium. But remember, the markets rarely go with the crowd.
The speculators have gas prices going higher over the next two months, but the facts and economic laws show prices will be going lower.
If it happens, it won’t be good for drillers. ConocoPhillips knows it. Now so do you.
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