Replies to This Discussion

Permalink Reply by Les Bamburg on May 22, 2010 at 11:56

Fred, realize that many producers have most of their natural production "hedged" at prices of $6.00 to $7.00 per MMBtu in 2010 so do not necessarily want to restrict production. To the extent they do restrict production it will probably be in other areas of the country rather than the Haynesville Shale. Low natural gas prices primarily impact the level of drilling rigs operating.

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Permalink Reply by Les Bamburg on May 22, 2010 at 12:57

Jay, many operators have already hedged a chunk of their 2011 and 2012 production. Of course much if not most of today's drilling in the Haynesville Shale is economic at a $4.00 per MMBtu natural gas price.

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Permalink Reply by CB on May 22, 2010 at 23:43

Dream on. You're living in fairyland.

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Permalink Reply by Les Bamburg on May 23, 2010 at 2:44

Jay, my statement was "much" if not most. A lot of the acreage is already held by production. For example - Exco is already almost 100% HBP and most of the acreage in East Texas is HBP. Also some operators are drilling 2nd or more wells in sections (EOG) so I assume they must be close to 100% HBP.

I didn't say the current drilling was desireable but merely that it generates at least a 10% rate of return. I have run enough independent economic analysis to mirror various operators statements concerning the price required to generate a 10% ROR.

Also realize that a lot of the acreage has royalty rates less than 20% and taxes plus LOE may be less than 20%.

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Permalink Reply by Mac Davis on May 24, 2010 at 13:47

Is natural gas hedging somehow different from other forms of hedging?

As I understand it, if you have a hedge to sell natgas at $6 and spot price is $4, there's no need to produce any gas to take advantage of your hedge. Just leave your gas in the ground, and sell the contracts for $2. Or buy gas on the spot market at $4 and use your hedge to sell it at $6.

The economic benefits of throttling or not throttling seem to be independent of whether or not you're hedged.

Is there some economic benefit I'm aware of to selling gas just because you're hedged? It always seemed like window dressing to me.

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Permalink Reply by buzzy on May 24, 2010 at 14:25

I have heard some companies are now involved in "gas storage." Does anyone have any information on that? Are the companies selling the gas at the current price to a subsidiary and then reselling when the market is better? Or is it similar to hedging or am I completely off?

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Permalink Reply by Les Bamburg on May 24, 2010 at 15:21

Buzzy, typically there are two goups of companies that store natural gas - neither of which are producing companies.

The first group are gas utilities, power generators, etc that store gas when demand is low and withdraw when demand is high. Gas utilities withdraw in the winter to manage demand spike on very cold days.

The second group are gas marketers (traders) that buy and store natural gas when prices are low with the plan to withdraw and sell when prices are high for a profit.

Producing companies typically sell most of their natural gas as baseload at a fixed price for the month based on NYMEX futures or some published natural gas index.

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Permalink Reply by Les Bamburg on May 24, 2010 at 15:28

Mac, the companies need to generate the full income stream associated with selling natural gas at the equivalent of $6.00 per MMBtu. Otherwise they would only generate the income from the $2.00 per MMBtu non-physical transaction and would just be a market spectulator.

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Permalink Reply by Mac Davis on May 24, 2010 at 22:05

Les, if I understand your point correctly, you're arguing a slightly different issue than I am.

As I see it, your point is that they may still need to sell the same amount of physical gas for the revenue the sale generates, even if they're hedged. I agree.

I'm arguing that the presence of their hedges does not give them any extra economic incentive to maintain production if spot prices are low. A decision to raise or lower production would have the same economic impact to the company whether they are hedged or not. The marginal revenue of changes in production is related to the spot price, whether they are hedged or not.

For instance, suppose you are hedged for 2 million MMBTU units at $6. Spot price is $4.

Choice (H1) Produce 2 million units sell at $6, get $12 milllion revenue.

Choice (H2) Produce 1 million units, sell at $6, get $6 million revenue. Sell 1 million units worth of your futures contracts, get $2 million from the contracts. $8 million revenue total.

Difference $4 million revenue. 1 million units of gas still in "storage" in the ground.

Now, assume you aren't hedged.

Choice (U1) Produce 2 million units, sell at $4, get $8 million revenue.

Choice (U2) Produce 1 million units, sell at $4, get $4 million revenue.

Difference $4 million revenue. 1 million units of gas still in "storage" in the ground.

I don't see how the presence of hedges gives the producer any extra financial incentive to not cut production waiting for prices to improve later. Yes, the hedged company ends up with $4 million more in it's pocket, but the choice between maintaining or cutting production is the same for either company.

If the spot price is so low that it makes sense to cut production and "store" the gas by choking back the well, it makes sense even if you're hedged.

In fact, if they didn't have hedges in place, they might need to sell even more gas because they might be even more desperate for the short term cash from gas sales. That would suggest that having hedges in place could make companies even more likely to cut production.

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Permalink Reply by Les Bamburg on May 25, 2010 at 3:15

Mac, two factors to keep in mind. First, a producing company wants to be known as that - not as a trader of futures contracts or a speculator. Second, most producers utilize 3rd parties to handle their hedging activity so the buying and selling of financial instruments is out of their hands.

Bottom line is producing companies want to drill wells and produce oil & natural gas. Hedging is viewed as just a tool to lock in future natural gas prices and not a separate business. As long as they can produce commodity and make a profit everyone is happy.

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