Natural Gas: Where Endless Money Went to Die

Wolf Richter's picture

Wolf Richter

The fiasco that is playing out in the natural gas industry doesn’t happen often in a free market, and when it does happen, it’s usually short—and brutal for all involved: namely, prices that are way below production costs. In most industries, hedging strategies might get market participants through the period, while unhedged production, a money-losing activity, gets slashed. If it lasts long enough, it causes a shakeout where less efficient or poorly capitalized producers, and their investors, get wiped out. It’s all part of the capitalist system that weeds out weaker elements through occasional sweeps of creative destruction.

As shortages crop up on the horizon, prices return to sustainable levels, and occasionally spike to once again unsustainable levels. For the survivors, or for lucky new entrants, the next step in the cycle has begun.

Alas, thanks to the Fed’s zero-interest-rate policy and the trillions it has handed over to its cronies since late 2008, the sweeps of creative destruction have broken down. Instead, boundless sums of money have been searching for a place to go, and they’re chasing yield when there is none, and so they’re taking risks, any kind of risks, in their vain battle to come out ahead. The result is a stunning misallocation of capital to the tune of tens of billions of dollars to an economic activity—drilling for dry natural gas—that has been highly unprofitable for years. It’s where money has gone to die. What’s left is debt, and wells that will never produce enough to make their investors whole. For that whole debacle, read.... Capital Destruction in Natural Gas.

But the money has dried up. And drilling for natural gas is collapsing. Last week, there were only 562 rigs drilling for dry natural gas—the lowest number since September 1999. A dizzying downward trajectory:



Producers, if at all possible, are switching to drilling for oil and natural gas liquids (priced like oil), still a profitable activity. Thus, capital is now being channeled to where it can make money. Drilling for dry natural gas will continue to decline as the long delayed sweep of creative destruction is scouring the industry.

The largest producer, ExxonMobil, given its monumental size and worldwide focus on oil, will weather the fallout just fine. But the second largest producer, Chesapeake Energy, is struggling. It’s trying to dump assets to raise cash to deal with its mountain of decomposing debt. Other producers that haven’t diversified away from dry natural gas are in a similar quandary. And at current prices, it’s going to be bloody.

At $2.53 per million Btu at the Henry Hub, the price of natural gas is up 33% from the April low of $1.90 per million Btu—a number not seen in a decade. But even if it doubled, it would still be below the cost of production. And if it tripled, it might still be below the cost of production for most producers. That’s how mispriced the commodity has become.

Misallocation of capital, and the resulting overproduction, is only part of the problem. The other part of the problem is horizontal fracking itself—a drilling method that extracts gas from shale formations. With nasty economics. It’s an expensive method. And once drilled, the well suffers from steep decline rates; after a year or a year-and-a-half, only 10% of the original production might still come to the surface.

The breakeven price for natural gas under these conditions—and it differs from well to well—is still partially theoretical since horizontally fracked wells have not yet gone through their entire lifecycle. Here is a detailed discussion and pricing model. The short answer: over $8 per million Btu. Even if that number is off, at the current price of $2.53 per million Btu, the industry is still near its point of maximum pain.

There are consequences. Power generators, having switched massively from coal to natural gas, are driving up demand. And production has finally seen a bend, a small one, in the curve that had set new highs month after month. Now, it’s declining. There is a lag between dropping rig count and production. The rig count estimates how many new wells are being drilled. Even if it dropped to zero next week, production would not immediately be impacted because the current wells would continue to produce. Production would then taper off as a function of decline rates per well—and in fracked wells, that lag is expressed in months, not years.

While the US doesn’t yet have LNG terminals to liquefy and export natural gas—in the global markets, LNG fetches mouthwatering prices between $10 and $15 per million Btu—it does have a pipeline to Mexico. According to BENTEK Energy (via the EIA), pipeline exports to Mexico hit 1,867 million cubic feet per day, a record in the seven plus years that BENTEK has been tracking it (by comparison, Chesapeake Energy produces about 2,575 MMcf/day).



Rising demand and exports are slamming into declining production. What was a record amount of natural gas in storage is coming down rapidly. Fears that storage would reach capacity towards the end of the injection period in the fall, and that natural gas would have to be flared, thus reducing its price to zero, seem ridiculous now. But prices, if they stay in the current ballpark, will continue to demolish producers, drive them away from dry natural gas, and cause financial bloodshed.

Until shortages appear on the horizon. But then, production can’t be ramped up quickly, regardless of what the price might be. Expect a spike and more mayhem, but this time in the other direction.

And oil, which has experienced a phenomenal production boom? In North America, the range of oil qualities and a raft of infrastructure nightmares are wreaking havoc with record price differentials, writes energy expert Marin Katusa in his excellent and informative.... Oil Price Differentials: Caught between the Sands and the Pipelines.

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unemployable's picture

Your article's title and main thrust underscores how cut off modern industrial mankind is from Nature ... it isn't Capital that has been and is being sacrificed, it is an entire living planet ...

OpenThePodBayDoorHAL's picture

ZH: best financial site ever. Great post and great comments. Yes I'm a fanboi

the grateful unemployed's picture

your supply demand case is good, if only it worked that way all the time. the spread between oil and NG is wide enough to suggest some kind of move to parity in BTU equivalents. oil can go to $50, but even at that price NG still has some room to appreciate. when a form of energy becomes primary, it gains value, and since NG is pretty maligned right now, there is room for greater acceptance, or universal applications in cars and trucks and time for the infrastructure to provide them (provided by taxpayers of course). i think we could probably run everything on NG including home electric generators, and be more energy efficient that we are currently.

and there are large areas of the planet where people still live without electricity and gas. so the bullish case, particulary LNG is there.


overmedicatedundersexed's picture

methane ice lies on the oceans floor waiting waiting peak nothing..we got energy but not brains

Hohum's picture


You seem to be a man that does not analyze net energy and does not think about methane's potential effect on the climate.

Do you have an idea of the capital cost to get that methane?  Or is it like a can of baked beans on the store shelf, ready to be taken?

overmedicatedundersexed's picture

hohum, net energy yep, more to extract than the squize worth the juice? energy is not in short supply brains are..environment today is what temp is the thermostat set at. the fact is after looking at enviromental issues

with one clear eye..there is constant change done by mom nature and by man now as part of nature- because you like clear blue water does not impress mom nature one bit. because you like clear blue sky does not impress mom nature one bit.

do you understand it's your own internal view of nature that is fantasy and the implications that results from it? 

those that understand your internal image use it against you,,think al gore.

the grateful unemployed's picture

i believe in the worldwide concept of peek-a-boo oil, that is nations downgrading reserves in order to maintain them. with the Fed pumping worthless dollars why sell what you have? oil for paper? those american con artists, they do it everytime.

once the cat is out of the bag oil reserves will suddenly return.

fockewulf190's picture

I'll tell you one thing, here in Germany we are having to sell kidneys for gas. The price just goes up and up and up. Sucks bigtime.

unemployable's picture

and you expect people to feel sorry for Germany which is exploiting it's European neighbors in a way that is so much subtler than military imperialism but ultimately leads to the same:  conquest & a Fourth Reich

deerhunter's picture

roadkill-  I bought UPL when it was 1.87 canadian dollars I think mid ninties,  rode it up to nice profit,  that was a real winner.  I think it did a 2 for 1 split shortly after I sold it.  My best pick ever from a junior mining newsletter. 

Zodiac's picture

You stated: "At $2.53 per million Btu at the Henry Hub, the price of natural gas is up 33% from the April low of $1.90 per million Btu—a number not seen in a decade. But even if it doubled, it would still be below the cost of production. And if it tripled, it might still be below the cost of production for most producers. That’s how mispriced the commodity has become."

This is incorrect for incremental production (i.e. the well and hookup costs are sunk).  The cost of production, including production and gas processing costs should be no more than $0.50/mmbtu  This is the number the producers are looking at to determine whether a well contributes incremental cash flow to cover things like, oh debt service.

For deciding whether to drill a new well, the full cost may be lower than the adusted HH price, but there are other considerations.  Sometimes producers will drill despite unfavorable economics to hold a lease; failure to drill would result in relinquishment.  Can't sell the gas on a lease to the Chinese if you don't hold it.

Actually, a large independent gas producer should put itself up for auction for sale.  The Chinese would probably overbid relative to the current value, but this would get peoples' mind straight about the long-term value of our gas resources in the ground as the market focus is always on the near-term.

If a major sale of our gas resources to the Chinese occurred, in 10 years someone will be writing on Zero Hedge something like this:  How could we, as a nation,have been so stupid to sell off valuable gas reserves to China when prices were at $2.50/mmbtu?  LNG exports were on the horizon, and conventional and non-conventional gas reserves have high depletion rates.  This is another error due to short-term thinking. 


Hohum's picture


Where in the world do you get $0.50/mmbtu?  Even if true,  those sunk costs have to be allocated for new wells because most NG wells give up most of their production in the first couple of years.

sangell's picture

There was a natural order in electricity generation until this gas glut came into being. Nuclear and coal for base load and NG for peaking plants. With gas fired plants taking on base load generation a hot summer and cold winter could really give us another Katrina like situation with soaring NG prices only this time coal might be in short supply too.

FERC needs to stay on top of this so we don't get caught up in a national version of California circa 2000.

Catullus's picture

Production would then taper off as a function of decline rates per well—and in fracked wells, that lag is expressed in months, not years.


It'd be great to see actual data and not someone's model on this.

michigan independant's picture

His information rings true for the political discussion so A+ for that. Investors with a light switch mentality as in if the issue crashes we will be in the stone ages anyway so we invested with the year 2020 vantage as pivot out in our opinion.

Flakmeister's picture

Not mentioned are the following facts

1) The glut is attributable to the NG associated with liquid plays. Those producers without "wet gas" plays are screwed....

2) The US is *still* a net importer of NG

3) The annual decline rate of existing wells is such that the production drop without any new drilling is equivalent to the production from Texas....

ZIRP has SFA to do with this, it was a matter of the leases bought and payed for 4-5 years ago.. Use it or lose it, with a lot of guys (i.e. CHK) thinking they could outlast the other guy....


Edit: If anyone is interested in something besides platitudes and hand waving

Is there really 100 years of Natural Gas?

Hohum's picture

100 years of NG is at current rates of consumption.  Change that to 3% rise per year and it's about 30.

falak pema's picture

Back in the seventies and eary eighties the US gas industry in texas invented the turboexpander technology to extract NGL from natural gas. It was a great winner as it could increase the ROI on gas investment considerably as the oil price went up between 1975 and 1983. It all collapsed after that, as Reagan's strategy of opening Saudi tap and energy discipline in Europe made oil prices soft for the next decade, making NGL marginal. Now its picked up again since 1998-2008 but with the frack gas mess, it should give a competitive advantage to those who have NGL rich wells. 

Turboexpanders ...they even were installed in the 1980s... back in the USSSSSSSR! I was there! 

HungrySeagull's picture

I think we got our NatGas from Iran by ship some time ago. I am not sure of the situation now on the East Coast. It looks like they are adding more LNG or trying to on our Ports.

If it is for Imports, great. If it is for Export... I don't think that would be great...

Shibumi2's picture

Wolf, I am involved in the electric utility sector and see first-hand the wholesale conversion to NatGas happening NOW. There is no PLAN B after 2015 due to the regulatory legislation enacted. I assume that the coal lobbyists will be very busy this election cycle.


How would one invest to catch the upside in pricing coming in the next 24-36 months? I don't have a lot of confidence in the companies drilling due to the mismanagement rampant.


Can one buy NatGas futures that far ahead? 

John Law Lives's picture

If you want to bet on a rise in NatGas prices, I would avoid the NatGas ETF known as UNG.  It is not a very good product for longs (imo).

HungrySeagull's picture

I am not sure how many rigs are operational on our Fayetteville Shale Play. However I can tell you that the gas truck traffic by which we measure how well or how hard the rigs are drilling has declined.

There is a great deal of money being spent shoving stuff down the hole to force gas up. (Fracking)

We use very little gas in the summer time and a little more in the winter.

I still say gasoline is cheaper than Nat Gas and will always be for motor vehicle use.

It's going to get very expensive for everyone very quickly in the next couple of years. Maybe expensive enough to shut down the heating system and simply plug in sufficient heating units in every room or install a fireplace and chop firewood.

The Firewood would be the best solution.

Vint Slugs's picture

Can one buy NatGas futures that far ahead?

Don't you ever look at the futures page of the WSJ?  Short answer for dufusses who pretend to have money to invest: Yes.  Why don't you talk to your creative investment banker and have him structure a plan for you that includes forward contracts in addition to exchange traded futures?

adr's picture

So all those years I paid under $2 per mcf for natural gas was provided at a loss for the big nat gas corporations? I find that hard to believe. The only profitable period was from 2004-2006 when nat gas prices exploded to above $14 per mcf and it cost $600 a month to heat your home during the winter? Somehow I don't think so.


That is the same thing as saying the oil companies were selling barrels of oil at a loss throughout the entire sub $2.00 gasoline period. Once again complete bullshit, but it is the story they wish you to believe.

Nat gas above $4 per MCF becomes a huge burden for the population. Just as gas above $2.00 a gallon.

gasmiinder's picture

The last time gas was under $2/mcf shale production was not a significant component of production.  The last time gas was under $2/mcf it was being sold below the cost to replace but not below the original cost to discover/produce.  Shale gas is now a large and growing percentage of the total gas being produced and these analysis about its cost to drill & produce are accurate.  It's been the "dirty secret" within the industry for years.  The "water cooler" discussions among frontline technical staff since 2005 have been "who believes any money is really being made in these plays".  The boom has resulted from vast supplies of capital without any technical knowledge of the industry. Driven by CEOs hyping the story on Wall Street and leveraging their companies to the hilt in order to get paid handsomely now before the truth becomes obvious.

Bottomline - there is a huge supply of NG in North American shales - if you're willing to pay $8/mcf.  I suspect that's the game the "natural gas renaissance" hucksters are playing.  Get large numbers of trucks running on it as fuel and LNG exports pumping and maybe you can get gas back to $8/mcf at which point shale drilling becomes economic.

janus's picture


you are just exceptionally bright.

now favorited and bookmarked.

the testosterone pit!

cry havoc,


otto skorzeny's picture

again-when a commodity is switched over from what it is currently doing a good, cheap job of doing(NG heating homes) to something that will drive up its  price(like fueling millions of cars) that commodity will skyrocket in price and ultimately the lower/mid class consumer will suffer. case in point- using corn to power our cars via ethanol that has caused corn prices to skyrocket, affecting food/livestock prices. and the subsidies (taxpayer $) to convert cars and fueling stations to NG will-for the greater part- be paid for by the taxpayer. for every action there is an = and oppsoite reaction. if its such a GDed great idea to convert to NG-let Exxon Mobil and the Big 3/semi truck industry do it on their own

adr's picture

Exactly, like I have said many times. Keep coal firing electric plants, keep nat gas for heating homes, and for god's sake stop using corn for fuel.

If speculators drive the wholesale cost of nat gas up again, the middle class will once again be fucked. Can you afford $600 a month to heat your house?

RoadKill's picture

I dont understand what TPs bias against Nat Gas is. Its ok to hate CHK and dozens of other irresponsible nat gas producers that care only about production growth instead of economics. But their are lots of guys that make $ at anything over $2 on an all in basis. XTO which XOM bought is one. UPL SWN WMB are others.

At these prices the GOM and Canada will get crushed, then prices will come rocketing back to $4 longterm shale economics and will probably go back into shortage the way cycles tend to work in nat gas - so we will se $6+ again, just not for more them 12 months or so.

You will be able to make a fortune in good nat gas stocks from here. Ive already ridden UPL from $18 TO $21. Im out now because I needed the capital to buy VXX at $15.75.

The only thing that will put a wrench in the gears are a renewed recession that drop electricity demand. If that happens we might see $1, but then the upside price will be $8-$10 because production wikl get destroyed.

imapopulistnow's picture

"I dont understand what TPs bias against Nat Gas is"

Just a guess:  If TP is a progressive, he (although unable to admit this to himself) has embrace an environmental religion to satisfy a fundamental human need that was once fullfilled through organized religion.

Hence resource conservation, renewalble energy, protection of the fragile ecosystems and species, reversing manmade climate destruction, etc. are the faith-based fundamental beliefs to which all other thughts and feelings are now subserviant.

In possessing that human capacity that we all have inherited, which is to selectively process data and information to first ensure that there is no conflict with our strongly-held fundamental religious beliefs, TP will only select data that either supports renewable fuel or discredits fossil fuel.  All data that indicates to the contrary is discarded.  Hence the bias.  Such is the nature of the human species.

duo's picture

time to start going long coal

Freddie's picture

Wow.  An almost free market in energy.  That pesky old supply and demand capitalism.  Obama, Holder and loads of unionized govt f**kwits and some posters here want to get rid of those free markets. 

unemployable's picture

Elected & cabinet level officials are not unionized.   There are no free markets.   There is no difference between Democratic & Republican administrations.   Stop being so credulous & exercise the organ behind your eyes before it atrophies

northman's picture

He doesnt want to get rid of the free markets. He is saying that ZIRP has allowed way to much capital to be allocated to an area that should have been cut off from new capital a long time ago. Now he is glad that the capital has dried up and the free market economics will start to straighten things out. Reading comprehension.

AurorusBorealus's picture

Boom-and-bust is not simply a matter of ZIRP.  This is where the author allows his bias to cloud his judgement.  There was not ZIRP during the American railroad boom (a comparable development), and far more money than was prudent flowed into railway construction (in the post-Civil-War era).  Although, I agree that ZIRP has not helped the matter any.

LetThemEatRand's picture

If you actually believe that this is the free market at work and not the destruction and/or manipulation of an energy alternative for political reasons, you are dumber than you[r icon] look[s].

imapopulistnow's picture

Convoluted conspiracy of the year award.  "Big oil pissed away hundreds of billions of dollars to bankrupt Solyndra and make Obama look bad."

psst.  9/11 was not an inside job.

DaveyJones's picture

now your energy (and human nature) ignorance is really showing.

THE DORK OF CORK's picture

Natural gas Locos - too little too late. ?

"ENGINE: An agreement to develop natural gas-powered locomotives has been signed by gas specialist Westport Innovations and Caterpillar, which will fund the programme. The..."

disabledvet's picture

find it odd that the author would claim such bubbles are "rare" after coming off easily the biggest bubble in history in the form of US real estate. I'm sure yours was far more fascinating because it was so noticeable. Not here in the States. The "mass of land" made the huge valuations seem "reasonable" because "it was in such a such a place." Natural gas, solar and the Cloud are THREE bubble that have burst here in the good old USA in just this year...and yet we are left to believe that someone "these things are unusual." What is unusual is in fact not having one...especially when the Fed wants to "let that activity slide" if you will. What is amazing is "we just had one"...what should be asked is "how is it possible to have even one let alone three" just after the bursting of the biggest on record? Devolving it down to "just the Fed" is unfortunately far from enlightening on what is a fascinating topic.

AUD's picture

The result is a stunning misallocation of capital to the tune of tens of billions of dollars to an economic activity

I think you might be able to apply this to iron ore as well. The iron ore miners are the few whose share prices have soared, while gold, silver, nickel.... have gone nowhere. Much of the multiple billions spent in mining has been in iron ore.

Like natural gas, iron ore has a low marginal utility, higher than the $ itself, but the $ is its own special category of misallocated capital.

imapopulistnow's picture

The only thing stunning is this mis-analysis.  The "misallocation of capital" conclusion is what the author wants to believe.  Of course the E&P crowd ovrshot and of course the real price of nat gas is well north of $2.50, but Mr. Market will fix it and in the mean time, our indsutrial base, cost of electricity and general living standards are benefitting enormously from this "misalocaton of capital".

Further, companies are not preparing to invest tens of $ billions on LNG facilities, pipelines, drill rigs, etc. because they collectively are unable to interprete production and flow rate models.  Eco-worshipers on the other hand?

slowimplosion's picture

"misallocation of capital"?  No, just a bubble that is completely typical in every way.  Johnny is making money making WhizGidgets so Jimmy wants a piece of the action.  Next thing you know Billy and Tom are in also and there are too many WhizGidgets floating around.

When you are a one-message-pony, every thing that happens is a variation on your event.

imapopulistnow's picture

no mor blogin til the coffe taks hold

falak pema's picture

when the onus is on investing crappy money anywhere, everywhere, its not surprising that misallocation becomes the middle name of every banksta promoted venture. The whole scene now stinks, and what is a crying shame is that it will make the big boys bigger in each industry. Its the small entrepeneur that gets caught in the deluge. These are the wages of sin : the central ponzi feeds itself in its crazy runaway momentum. Denial of reality is the ONLY issue possible to keep the ponzi moving on its hurtling course to nowhere.

Pinto Currency's picture


There has been surplus nat gas fom shale gas deposits and the price has dropped.

The rig count is indeed dropping and the surplus inventories will be drawn-down after which the price will rise and the rig count will increase.

Here's the natural gas inventory and yes the excess storage is coming down.  Not so sure that the inventory is coming down as quickly as this dramatic article indicates.

It's called the market.