The Dead Sea

While the mainstream media and much of the energy press has extensively covered the impact BP’s Macondo disaster is likely to have on the Gulf of Mexico’s (GOM) oil production, little has been written about its likely effect on natural gas production. With the GOM accounting for approximately 11% of total U.S. gas supplies and drilling activity substantially curtailed as a result the ongoing deepwater drilling moratorium, falling natural gas production from the GOM will have a major impact on U.S. supplies by the end of 2010. Increased reliance on onshore production (which is also declining) and imports from Canada is certain to greatly tighten the U.S. natural gas market over the next year. In this article, I will review the prediction I made in the December 2009 issue of my publication on the future of GOM natural gas production, provide historical drilling trends and discuss how falling production in the GOM will influence gas prices.

The EIA appears to be grossly underestimating the effect the Macondo spill will have on GOM gas production. In the EIA’s most recent monthly Short-Term Energy Outlook published on August 10, 2010, the EIA had the following to say about gas production post the BP spill:

“The offshore drilling moratorium is projected to reduce Gulf of Mexico production by 10 Bcf over the last 6 months of 2010 and 92 Bcf during 2011.” EIA Short Term Energy Outlook. August 10, 2010. Source: EIA

In other words, the EIA is predicting that the complete cessation of drilling in GOM for nearly two months and the recent resumption of only shallow water drilling is going to reduce production by an average of only 50 million cubic feet per day (mmcf/d) over the final 6 months of 2010 and by only 250 mmcf/d in 2011. With the GOM producing nearly 6 bcf/d currently, a 250 mmcf/d decline (4.1%) is absurdly small given the fall off in activity in the GOM, the natural rate of decline for offshore gas fields and the maturity of most GOM fields. To put this into context, since 2003, gas production from the GOM, with no moratorium in place, has been declining at approximately 8% per annum.

It would not surprise me if the EIA adjusts their outlook based on current information. Looking at the EIA’s most recent monthly 914 report on production data (published on August 30th), GOM natural gas production declines are accelerating. According to the EIA, production in the GOM federal waters for June 2010 (all of GOM which includes state waters is not yet available) was only 5.98 billion cubic feet per day (bcf/d). June 2010 production was down a whopping 4.8% from May and down an incredible 12% since February.

To get a better understanding of natural gas production in the GOM, I believe a brief historical review of GOM activity levels would be helpful.

There should be little doubt that the BP oil spill has ushered in a new era for the GOM. The peaking of gas production from the GOM in 1997 and its terminal decline over the past 13 years will be substantially accelerated by the drilling moratorium and subsequent slowdown in activity. The below table provides a very good overview of gas production and gas directed drilling activity over the last 16 years [the below table contains production from both federal and state waters]:

Source: EIA, Baker Hughes

The Baker Hughes GOM gas-directed rig count has averaged 18 rigs per week so far this year. After the BP spill, gas drilling in the GOM dropped off substantially and for the week ending 8/13/2010, there were only 12 rigs in the GOM drilling for natural gas. This level of gas directed drilling activity does not support anywhere close to 6 bcf/d of GOM production. It probably doesn’t even support 3 bcf/d of production unless the size of prospects currently being drilled are 5 to 10 times larger than those drilled last year. I find this scenario highly unlikely. Even before the BP accident and subsequent drilling moratorium, I was very skeptical that GOM production would remain stable. Below is a quote from the December 1, 2009 issue:

“Gulf of Mexico (GOM) natural gas production has been in a freefall during the last seven years. A nearly 20 year low in the GOM rig count ensures that declines will continue. At today’s gas prices, there is very little drilling for natural gas in the GOM and operators are having difficulty justifying the building of infrastructure to bring recent discoveries ashore…

Offshore wells, especially gas wells, are high pressure, high decline wells. Constant development of new wells is required to keep offshore production from heading into a violent downward spiral. The low gas price environment of the past year has put offshore production on exactly this trajectory. I expect GOM production to fall by 3 bcf/d by June 2011.”

Since December, production in the GOM has dropped approximately 1 bcf/d and should meet my prediction of a 3 bcf/d fall from December 2009 to June 2011. Look for gas production in the GOM to end 2011 at approximately 3.5 bcf/d.

So what does the ongoing massive drop in GOM production mean for the North American supply/demand balance and prices? With the GOM producing more natural gas than any state outside of Texas, it is difficult to see how the accelerating fall in natural gas production from the GOM does not dramatically tighten the North American supply/demand balance and push prices dramatically higher.

© 2010 Powers Energy Investor, LLC. Information presented in this article was obtained from sources believed to be reliable but accuracy, completeness and opinions based on this information are not guaranteed. Under no circumstances is this an offer to sell or a solicitation to buy securities suggested herein. The editor may have an interest in the companies mentioned. All data and information and opinions expressed are subject to change without notice.

By: Bill Powers, Editor, Powers Energy Investor - www.powersenergyinvestor.com