Until natgas prices improve substantially...stock prices aren't likely to move upwards meaningfully, anytime soon.
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Posted by Keith Schaefer on April 28, 2009
Thereis a lot of confusion amongst investors - both retail and sophisticatedinstitutional investors - about what the average break-even price isfor natural gas producers in North America.
I interviewed a couple Calgary junior gas company management teams to understand this better.
I’lltry to simplify their industry lingo, and explain what some of thetypical costs are for natural gas producers. After reading, I hopeinvestors can:
* 1. understand the stages oil & gas go through from the wellhead to the end buyer
* 2. roughly what each of them costs in terms of per barrel of oil or mcf of gas
* 3. have an idea on what the breakeven price - of an average natural gas producer
* 4. hear who three low cost natural gas producers are
I’ve used a Canadian example but the system works much the same in the US.
Aftercompany ABC drills a successful gas well producing 1 million cubic feetper day (1 mmcf/d). That’s a thousand thousands, and the price for onethousand cubic feet (mcf) that day at the Edmonton gas terminal, AECO,is CAD$3.40.
The actual price the company receives is reducedby the distance they are from the AECO hub - the transportationdiscount. The quality of the gas also influences the price - higherheating content (i.e. more liquids in the gas) means they receive ahigher price.
The gas from that well needs to get, at the endof the day, to the natural gas pipeline grid, which in Alberta is theNova pipeline system. So Company ABC they must first build their ownpipeline to connect their well to an intermediate-stage gatheringsystem. That pipeline could be a few hundred meters or severalkilometers, so that can be expensive. If ABC doesn’t own that gatheringsystem, they must pay a fee to whoever owns it. Cost: $0.30 per mcf.
Thegathering system is tied in to Nova at a meter station where Novameasures how much gas comes in to their system. Then it is transportedon another pipeline (cost: $0.50 per mcf) to a plant to have the gasprocessed (to get the gas to pipeline spec - remove water, carbondioxide, hydrogen sulfide etc. - cost: $0.90 per mcf) and to compressthe gas to get it up to pipeline operating pressures.
Now the raw gas and its associated fuels have been refined so Company ABC can actually sell them to an end user.
Butthe actual buyer of the company’s gas is the “marketer” - the middleman. Gas marketers (such as Enron, SEM Canada, Plains, Tidal, NexenMarketing, etc.) contract space on the Nova system and the large trunklines (Alliance, TCPL, etc.) to get the gas to the end users(utilities, industrial users, etc.). Sometimes companies get to choosetheir gas marketer, but if their intermediate stage pipeline is ownedby a marketer then they may be forced to use them.
Marketersget a reputation for getting the best gas price they can for CompanyABC on a given day. Pricing varies, but it is based on AECO spot prices(see
www.ngx.com).Each basin has its own spot prices, based on NYMEX with adjustments fortransportation cost (to get the gas to New York) and
currency exchange(in the case of AECO).
There can also be large price swingsin different basins if the supply is too large for the physical exportcapacity on the pipelines - “trapped gas” - or the inverse also. That’sone reason you see the natural gas prices so low in the major gasproducing areas of the Midwestern and Rocky Mountain states of the USA.There is a lot of gas fighting for pipeline space. NYMEX spot pricescurrently are about US$3.60, which is about C$4.50 but current AECOspot prices are $3.40, showing a $1.10 differential - that differenceis the transportation for the cost per mcf to get the gas from Edmontonto New York.
Ok, so transportation and processing costs arenow 30 + 90 + 50 = $1.70 per mcf - half of the wellhead price. Whatother costs are there? Royalties of course. Give Caesar his due. InAlberta this 1 mmcf/d well has a royalty of $0.70 per mcf, so CompanyABC now has $1/mcf left. Company ABC’s operating cost to maintain theirown well would likely be $0.20 per mcf, leaving them with about $0.80netback, or profit per mcf.
Administration - G&A - andinterest on debt could be as low as $0.50/mcf for a good producer (butmany are more like $0.70/mcf). We are now down to $0.30/mcf cash flow.
The visual math is $3.40-(30+90+50+20+70+50)=$0.30/mcf cash flow. And we’re not done yet.
Wehave not yet factored the cost of exploring for and drilling the well.The industry calls this Finding, Development and Acquisition, orFD&A. After reading dozens of comparative analysis spreadsheetsfrom various brokerage firms, I can tell you that best-of-breed naturalgas producers have $2/mcf FD&A.
According to Calgarybrokerage firm Peters & Co., only Storm Exploration (SEO-TSX) hadfinding costs under $2/mcf last year in their 34 company coverageuniverse, with little Berens Energy* (BEN-TSXV) right at $2 and TrilogyEnergy Trust (TET.UN) at $2.01/mcf. The median was $3.29/mcf. (The lowcost producers of any commodity have the best leverage when pricesstart to rise back to break even).
If you back in $2/mcffinding costs to the $0.30 cash flow (on $3.40/mcf gas) wehypothetically shown above, it intimates a $4.95 breakeven price forthe lowest cost producers. We really need to bump that up by 30 centsas well, because on a higher realized gas price the royalties would behigher. We are now at CAD$5.25/mcf breakeven price for natural gasproducers.
(Most analysts would argue that FD&A is thewrong number to use in calculating costs - the better number is a lineitem on the balance sheet that reads “Depletion, Depreciation andAccretion”. This is the cost to book proven reserves, and is a toughertest of costs. Only a handful of companies would have DD&A costsunder $4/mcf - making the breakeven price CAD$7.25/mcf.)
Thisis a very simplistic version of a natural gas company’s cost structure,with conventional vertical wells. And it uses an example of an averagesized well in the Western Canadian Sedimentary Basin; it is NOT anexample of one of the big wells (10 mmcf/d ++) that comes fromhorizontal drilling.
Southwestern Energy in the US, a majorgas producer, says that their large horizontal wells at their US shaleoperations do break even at US$3.60 gas - finding costs of $1.60 andoperating costs of $2/mcf. They added that at current prices, drillingmight be declining a bit but they see nobody shutting in production inthe big US shale plays. Depending on the hub, natural gas is in the$3.20 range at NYMEX and under $3 in some interior hubs.
Thisillustrates that nobody is making money at these price levels. Iparaphrase one quote I read on the web recently: At these low prices,it’s not a wonder that drilling for natural gas is down, it’s a wonderanybody is drilling at all.