Call growing to increase natural gas production

Posted: Thursday, April 25, 2002

Knox Energy Inc. of Columbus, Ohio, drilled 10 new wells in the first half of 2001, shortly after natural gas prices reached all-time highs. When prices collapsed in the second half of the year, though, the tiny father-son business couldn't afford to tap any new wells. Now, after months of inactivity, Knox is ready to drill again in the gas-rich region east of the state's capital.

Also stung by the drop in prices, Ocean Energy Inc., one of the country's largest petroleum producers, cut its domestic drilling budget by a third, or $200 million, compared with last year. ''But that doesn't mean I'm not bullish on prices, or the need for supply,'' said Ocean's Chairman and Chief Executive James Hackett.

Although the nation's inventory of natural gas is at record high levels after a mild winter and a long period of weak industrial demand, the slowdown in drilling appears to have come to an end. As prices edge higher at a time of year when demand is normally low -- and as evidence of an economy in recovery grows -- natural gas executives say they are getting ready to expand production once again.

''We're being cautious because a lot of us got surprised by the strength of the downturn over the last nine to 10 months,'' said James Hackett, Ocean's chairman and chief executive. Yet Hackett said he will reconsider the company's $400 million domestic drilling budget at the end of June in anticipation that it might need a little boost.

It's no secret that price is the ultimate predictor of drilling activity and Knox president Jerry Jordan said that if natural gas trades consistently above $3 per 1,000 cubic feet -- as it has for roughly a month -- he'll be able to pump enough cash from existing wells to finance new ones. ''It depends on how fast the economy recovers,'' he said.

To be sure, enough ambivalence exists about the economy, weather forecasts and even the quality of the industry's supply data to make executives leery of fattening the existing surplus.

The uncertainty has caused price volatility in recent weeks and kept the industry from charging ahead with -- or even suggesting -- aggressive drilling anytime soon. Instead, there has been a ''toe-dipping effect,'' said Skip Horvath, president of the Natural Gas Supply Association in Washington.

Perhaps the broadest indicator of drilling activity in the United States is the weekly count of active rigs, which has increased in two out of the last three weeks after steady declines since September. There were 610 rigs actively drilling for natural gas on April 12, compared with 942 a year earlier, according to Baker Hughes Inc., a Houston-based oil services company that tracks industry data.

''The fact that the rig count has dropped off so much means there's less supply that will come onto the market in the future,'' said Lee Fuller, a policy analyst at the Independent Petroleum Association of America. The country could face a ''potential (supply) problem next winter if rig counts don't start rebounding,'' he added.

For the moment, supplies are ample. At the end of the home-heating season on March 31, the amount of natural gas in storage in the continental United States was 44 percent higher than the previous 5-year average at that time.

There is no question natural gas producers have a fine line to tread in 2002 as they attempt to correct the miscalculations of 2001. Waiting for higher prices before drilling again might help their bottom lines, but executives and analysts acknowledged the industry is also under pressure to produce enough fuel between now and the end of the year to avoid the type of political scrutiny and consumer backlash that followed price spikes in 2000.

Whether the amount of natural gas produced increases, or merely stabilizes, in the near future -- even if rig counts rise from current levels -- is difficult to say. Because of the fast pace at which the country's natural gas wells are being depleted, companies have to increase the amount of wells they drill each year by more than 25 percent, on average, just to keep production levels flat, according to various industry officials.

The last time the industry received the signal to increase production, it came across loud and clear: the price of natural gas soared above $10 per 1,000 cubic feet in the winter of 2000-01 and, as a result, electricity prices skyrocketed in certain parts of the country. This time around, however, executives and analysts say the beacon is being transmitted more faintly.

Aside from economic considerations, future natural gas production depends on factors as finicky as international politics and the weather, both of which can affect prices.

For example, if crude prices were to rise as a result of instability in the oil-rich Middle East or in Venezuela, the world's fourth-largest supplier, industrial demand for natural gas in the United States could increase. It fell sharply last year as fertilizer and other chemical manufacturers moved their plants overseas to avoid the high price of natural gas; similarly, utilities switched to cheaper fuels to produce power.

A hot summer could also put a pinch on supplies. While only about 15 percent of the country's electricity is generated by natural gas, air conditioners require large amounts of power. A spell of warmer weather this past week in the Northeast and Midwest pushed natural gas prices higher on spot markets.

The recent upswing in fuel prices has sent shares of Ocean Energy and rival Anadarko Petroleum Corp., roughly 15 percent and 10 percent higher, respectively, since the beginning of February.

Even if higher prices induce more drilling this summer, there's no telling whether the industry will be able to keep pace with demand if the economic recovery is more robust than expected and temperatures get back to normal next winter.

As Buddy Kleemeier, chief operating officer of Kaiser-Francis Oil Co., in Tulsa, Okla., put it: ''Supply is an ox. It doesn't go up very fast or down very fast. What moves faster is demand.''

Executives and analysts said May will be a particularly important month to watch in terms of supply and demand. That is when the industry traditionally begins to replenish the country's supply of natural gas in preparation for the following home-heating season.

The rate at which the nation's underground storage fills up during late spring often determines how much new production is needed to meet winter demand. However, officials said gauging the rate of replenishment this spring will be harder than ever since supplies are already so high.

Natural gas supply data is also being eyed cautiously these days as the job of monitoring it shifts hands next month to the Energy Department from the American Gas Association, which is relinquishing its role after more than 8 years as a widely-respected source. The government will make its first weekly report on May 9.



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