By Michael DeCaluwe, CEM
This winter, natural gas rates have continued their fall below the $2 per dekatherm price point. Weather and decreased production typically create a floor to gas prices. However, neither has been able to slow our run to historically low gas prices.
What’s Wall Street’s role in the market?
Typically, Wall Street’s venture capital firms invest in a company and assume an eventual payout.
- For example, think of Amazon, which lost money for many years even while its stock price went up. Wall Street was investing in the potential of the company to eventually make money.
Investors applied the “loss leader” strategy to the energy sector, but they haven’t seen the same results. Venture capital firms invested heavily in shale during the post-2008 boom. Yet natural gas rates have continued to decrease, and so have the returns from energy companies.
Debt-riddled and highly leveraged, many natural gas producers have been unable to produce a return for investors.
How did Wall Street get it wrong?
The biggest aspect of the natural gas market that investors didn’t consider is the decline rate in production at the well head.
Gas Well Decline Rates
A decline rate is the decrease in the amount of gas a well is expected to produce year over year. For instance the amount of gas that a shale gas well produces declines by an average of 70 percent in Year 2 versus Year 1.
The chart above illustrates why the loss leader approach to investing in the natural gas industry has led to big losses.
If these wells aren’t making money in Year 1, the rate of decline means they surely won’t be profitable in future years.
Producers have had to drill new wells to keep production and cash flow up to repay their creditors. This, coupled with the lower domestic gas demand, has created a vicious cycle that has resulted in today’s sub-$.20 gas pricing.
What happens now?
The party might be over for the natural gas industry.
Investors are starting to pull their money out of energy companies, and natural gas rates are at 20-year lows. Shale producers decreased spending by six percent in 2019 and are forecasted to decrease by another 14 percent in 2020.
The number of natural gas-directed wells also decreased by over 35 percent in 2019.
In spite of this decrease in investment and rig counts, gas rates have continued to fall in 2020. It could take a year (or more) of decreased investment in the market to affect natural gas supply.
How This Impacts You
As a buyer, it’s important to understand Wall Street as a market factor. Here are some articles that explain this concept in more detail:
- Natural Gas Trades and Wall Street (CNBC)
- Production Decline for Shale Gas Wells (Penn State Dept. of Energy and Mineral Engineering)
- Factors Impacting Natural Gas Trading (commodity.com)
If you’d like to learn about other macro factors affecting the markets, check out our February Chronicles of Nania or feel free to contact me.
About the Author
Michael has served as the Senior VP of Commercial & Industrial Sales at Nania Energy Advisors since 2007. He believes that listening to and understanding clients’ energy needs is vital to becoming a thought leader in the industry and forming a mutually beneficial business relationship. In his spare time, Michael enjoys being a dad, staying active, and playing basketball.
Michael can be reached at firstname.lastname@example.org or via phone at (630) 225-4552.