Kodiak Oil & Gas Corp (USA) (KOG), Chesapeake Energy Corporation (CHK): The Surprising Paradox of Record U.S. Natural Gas Production

Editor’s Note, Related tickers: Kodiak Oil & Gas Corp (USA) (NYSE:KOG), Chesapeake Energy Corporation (NYSE:CHK)

Most people probably know that the past few years haven’t been kind to natural gas producers, who saw prices for their product plunge to a decade low last spring. In response, most decided to curtail gas drilling as much as possible in favor of drilling for oil.

This tendency of energy producers to avoid the out-of-favor commodity is perhaps most evident in the U.S. rig count data. Over the past year and a half, the number of rigs drilling for natural gas has plunged by more than half. Yet U.S. natural gas production continues to shatter records.

Last year, total marketed production came in at 25.3 trillion cubic feet, the highest ever level of output. And production continues at astonishing levels of just under 65 billion cubic feet per day. What explains this paradox?

The nature of oil and gas wells
There are at least two important factors to consider here. The first has to do with the technicalities of drilling for hydrocarbons.

Despite industry jargon characterizing individual wells as “oil wells” or “gas wells,” most wells actually produce a mixture of crude oil, natural gas liquids, and dry gas. Some plays, such as the Marcellus or the Haynesville, produce much more natural gas and gas liquids than oil, while others, such as the Bakken and the Eagle Ford, crank out much higher proportions of crude oil.

Many drilling rigs have been migrated from plays that produce mostly dry natural gas to those that produce greater proportions of oil and gas liquids. Still, these liquids-rich plays give off substantial quantities of so-called “free” gas as an associated byproduct of liquids drilling. In some plays, much of it is collected and marketed, while in others, like the Bakken, much of it is flared off and wasted.

Drilling efficiency gains
The second, and more important, reason why gas production has continued at record levels despite the plunge in gas-directed rigs has to do with the massive efficiency gains that have become a common feature of the industry.

If you sift through energy producers’ quarterly conference calls, you’ll notice just how staggeringly frequent some of these gains are, occurring not just year over year but each quarter and, in some cases, each month.

Not only are operators able to drill wells much faster than before and, in some cases, cheaper than before, many have been able to increase production while employing the same or fewer number of rigs. For instance, Bakken operator Kodiak Oil & Gas Corp (USA) (NYSE:KOG) reported a drastic reduction in the number of spud-to-rig release days, which were down to the low 20s in the fourth quarter, as compared with nearly 35 in the year-earlier period.

And in the Eagle Ford shale of Texas, quicker movement between wells helped Chesapeake Energy Corporation (NYSE:CHK) slash the number of days it took to get from one well to another. In the fourth quarter, the company said it averaged just 18 days to move rigs between wells in the play, down from 26 days just two years earlier.