Higher Capital Costs to Drive Higher Natural Gas Prices

The COVID-19 global pandemic has made 2020 an extremely tumultuous year for the U.S. oil and gas business. Producers are trying multiple approaches to grow value, including asset divestitures, consolidation, lowering activity levels, and even moving from oil to natural gas. However, the acceleration of environment, social, and governance (ESG) considerations has kept capital markets from showing much interest in funding oil and gas development.  

With less focus on the space, the cost of capital for producers may only go up from here. With rising capital costs, producers may be reliant on technology improvements to maintain current costs of production over time. In our latest Long Term Natural Gas Outlook, we examined potential natural gas price scenarios and drilling trends based on the impact of changing these variables. Here we frame how the cost of capital and technological advancement for reducing drilling and completion costs are key to the marginal cost of natural gas and therefore long-term gas price forecasts. 

Increased Productivity

The charts below highlight drilling and completion cost trends and well productivity trends from 2013-2020. The U.S. oil and gas industry has shown an impressive track record for productivity enhancements and reducing the cost of producing natural gas. The collapse of Henry Hub prices from 2015-2017, below $3.00/MMBtu, forced natural gas producers to increase efficiencies and innovate to survive. As highlighted in the chart below, the cost per lateral foot for wells in key gas plays has decreased between 25% and 55% since 2013.  

The majority of cost reductions coincide with the collapse in natural gas prices and increased pressure to exercise capital discipline. Furthermore, exploration and production (E&P) companies were also able to make strides in completion design and technology to increase productivity per lateral foot as well. Taken together, the average breakeven prices for these key plays have dropped by 50% and contributed to reducing the marginal cost of gas in the U.S. 

Cost of Capital and Long-Term Gas Prices

In addition to innovation, the cost of capital is a key variable with the potential to significantly impact long-term gas prices. The chart below highlights the impact on sub $2.00/MMBtu inventory if the internal rate of return (IRR) or hurdle rate is moved from 10% to 20%. While the total number of remaining locations remains the same, the breakeven cost and distribution change. The result in Appalachia is a 43% reduction in the total number of remaining drilling locations below $2.00/MMBtu. In Haynesville, a higher cost of capital would reduce locations by 64%. All else equal, this indicates higher natural gas prices will be needed to incentivize enough U.S. gas production to meet demand. 

Conclusion 

As the trends in ESG-focused investment continue to accelerate, the impact on oil and gas prices and investment will be meaningful. For a detailed analysis of the impacts of technology and cost of capital on natural gas prices over the next decade and beyond, request a sample of BTU Analytics’ latest Long Term Natural Gas Outlook. This report uses detailed inventory by play and breakeven estimates paired with a deep understanding of U.S. E&Ps to establish the marginal cost of U.S. gas production and prices through 2050. 

This article was originally published on the BTU Analytics website.  

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