LEVICK | May 5th, 2016

What’s Next?: Conflicting Challenges Facing Energy Industry

What™’s Next? interviews Maria Sanchez, the Manager of Energy Analysis for Denver-based Ponderosa Energy, a division of energy industry consultants Ponderosa Advisors LLC. Ponderosa recently issued a report on the status of the energy industry entitled “Winter of Discontent,” which documents the production and marketplace challenges facing the U.S. oil and natural gas industry.

Q: Maria, to a layman, the findings in “Winter of Discontent” seem contradictory. Natural gas production continues to remain at a record high level despite record low prices. What does it all mean and is that dynamic likely to change anytime soon?

A: With Ponderosa Energy, we take our approach to an ultra-granular level by modeling every basin, field and well in the country. And in doing so, we believe it™’s important to look at the whole well and what it™’s producing. We look at oil, natural gas and natural gas liquids (NGLs) together as the price of one can have an impact on the production of the other.

But when you look under a microscope like we do, there are some top tier wells in top tier basins with acceptable drilling costs that still enable profits in today™’s environment, and thus, natural gas production has remained strong despite record low gas prices.

As a result of continued strong production levels and comparatively weak demand growth, we revised our previously crude price (WTI) forecasts down for example — basically we’re looking at a period of “lower for longer.” We are also expecting significant volatility between now and the end of 2016 as the market struggles to interpret global fundamentals and the implications for price. It will be a long road to recovery to say the least.

During the first two months of 2016, dry natural gas production posted significant gains despite a mild winter and record low prices. The Marcellus/Utica basin led the growth and remains insulated from low prices due to new pipeline expansion projects, significant well inventory, and protection from hedges.

Q: What™’s driving the downward pressure on prices? What does that mean from a macro-economic point of view and what should companies be doing about it?

A: In our report, Winter of Discontent, we put our proprietary data to work and found the global oversupply of crude oil, currently at about 1.8 MMb/d (IEA), will continue to put downward pressure on prices. The global supply of crude will outpace demand for a third straight year in 2016, and we expect the supply overhang will persist until late 2017. In short, we expect crude oil prices to remain below $50 through 2016 and average below $60 through 2017. Additional events expected to impact hydrocarbon commodity markets in 2016 include coal-to-gas switching, pipeline infrastructure additions, OPEC, China, volumes hedged and change in rig count.

Q: Does the Marcellus/Utica basin still hold the promise to transform America™’s energy picture?

 A: While hard to believe, natural gas production remains strong despite record low gas prices. This certainly seems counterintuitive. Most consumers, however, are certainly loving low energy prices in their monthly bills and at the pumps.

Places like the Marcellus and Utica shale plays in Pennsylvania and Ohio are still leading gains so far this year mainly due to low break-evens and strong hedging. Oklahoma™’s Anadarko basin has also shown strong results. We’re predicting continued strong growth for Marcellus/Utica this year (timed with additional pipeline expansions), but flat production in the Anadarko between now and the end of the year as announced rig laydowns materialize.

Production from the Marcellus/Utica represents almost 1/3 of all gas produced in the U.S. and because of low break-evens it™’s expected to continue growing, just at a slower pace. The Northeast region went from being a consuming area to producing thanks to the growth from the Marcellus/Utica.

Q: Maria, you make a convincing case that early 2016 was truly the “Winter of Discontent?” Is there a “Spring or Summer of Hope” around the corner?  Or is it going to take much longer for all of this to work itself out? 

A: A Spring (or Summer) of Hope could certainly be around the corner – it™’s just a matter of what year and what quarter you’re talking about. We expect short-term gas prices will remain low due to record storage levels. Current Sub-$2.00 prices will be necessary to incentivize coal-to-gas switching this summer, but prices will recover to $2.75-3.00 if/when winter 2016/17 shows up.

During the first two months of 2016, dry natural gas production posted significant gains despite a mild winter and record low prices. Natural gas is more local and depends on weather. Producers were ready to respond to a strong winter, but instead it was very mild. Prices this summer will remain weak to incentivize coal-to-gas switching demand and burn a lot of the gas currently in storage, which is at record high levels. Every November the market resets itself and prices recover during 4Q once heating load increases. Depending on weather over the rest of the winter, prices may or may not increase further.