Editorial comment

At this time in the oil and gas industry, there are many things going in the right direction for us, but there seems to be a negative tinge attached to each positive trend.

Oil boom but gas bust. Crude oil producers have been enjoying relatively high oil prices since mid-2010. Most forecasters expect price levels to rise steadily over the medium term in keeping with a slow global recovery. The U.S. Energy Information Administration (EIA) expects the WTI oil price to rise from $94.86/bbl in 2011 to $100.25/bbl in 2012, and as much as $105/bbl in 2013. In response to the current high prices and the expectations of a continued price rise, the industry has responded with a higher level of drilling and production activity. In fact, according to the Baker Hughes rig count, 59.4% of the rigs in the U.S. are currently drilling for oil.

As a consequence, U.S. crude oil production reversed a declining trend from 5.1 MMbopd in 2007 to 5.6 MMbopd in 2011. Over the next decade, continued development of shale oil, in combination with production recovery in the Gulf of Mexico, is expected to raise crude oil production to as much as 6 MMbopd by 2020. Globally, crude oil supply is sufficient to meet demand with OPEC production at 30.6 MMbopd. If you recall, the oil supply was expected to falter, due to potential disruptions caused by the Arab Spring.

Unfortunately, the oil price rise is occurring simultaneously with a severe drop in prices for U.S. natural gas, due to a combination of an unusually warm winter and a significant increase in shale gas production. In decades past, there used to be a 6x relationship between the WTI oil price and the Henry Hub natural gas price. As such, the Henry Hub price should be above $16/Mcf at this time. Increasing conventional and unconventional supply in the U.S. has broken this relationship. According to the EIA, the year 2011 brought the largest increase in marketed natural gas volumes in history. Daily production grew by more than 7% over 2010. As a result, the U.S. has 3 Tcf of natural gas, 21% more than it typically has in stock at this time of year. With gas below $3/Mcf, it is no longer economical to drill for dry gas in North America. In response to the localized low gas prices, Chesapeake Energy plans to reduce its dry gas-directed drilling rig count in 2012 from 50 to 24 rigs. In addition, Chesapeake is curtailing its gas production by 1 Bcfd.

Shale liquids boom but supply constraints. To take advantage of high prices, there is a drilling boom underway in the liquids-rich Bakken shale play in North Dakota and Montana, and the Eagle Ford play in South Texas. The boom is creating housing and manpower shortages in these sparsely populated areas that are not used to the influx of oilfield workers and rig equipment. The Houston Chronicle reports that the rental price for a dilapidated 4-bedroom house in Cotulla, Texas, reconfigured to house up to 12 beds, has shot up from $550 to $1,200 per month. In the small town of Tioga, North Dakota, the local radio station recently closed up shop and turned the property into a more lucrative trailer park.

Some of the oilfield service companies are experiencing logistical issues and supply constraints. Schlumberger has transitioned its fracing units from 12-hour to 24-hour days to meet demand in certain shale plays. Baker Hughes’ pressure pumping business, inherited through the acquisition of BJ Services in 2009, suffered “issues related to the availability, cost and transportation of materials, such as sand and gel,” according to CEO Martin Craighead.

Such are the vagaries of the oil and gas industry—ramping up and down sequentially, and as is the case right now, even simultaneously. On the whole, however, it is far better to deal with short-term problems than having the entire industry suffering through a downward cycle that we had expected just six months ago, due to the dark clouds of recession in the U.S., sovereign debt crisis in Europe and political turmoil in the Middle East. Now the dark clouds are overcast by the shining silver lining of high crude oil prices.