(Reuters) - A steep drop in natural gas prices is squeezing the profits of producers such as Southwestern Gas Corp (SWX.N), EXCO Resources EXC.N and Quicksilver Resources KWK.N, which may need to shut wells, raise cash, cut staff or seek merger partners in the coming year.
Spot natural gas futures dipped below $3.00 per million British Thermal units on Friday, the lowest level in more than two years, as a glut of gas from shale fields across the United States pushed inventory levels to historic highs.
Market forecasters expect prices to remain weak in 2012, after falling nearly 40 percent since June — a boon to major users of the fuel, such as chemicals and industrial companies.
Large gas producers including Exxon Mobil Corp (XOM.N) and Chevron Corp (CVX.N) have the deep pockets to ride through the low prices, but many of their smaller competitors are likely to suffer as they are heavily reliant on dry gas.
Shares of Exco and Quicksilver have lost about half their value in the last six months, far worse than the 5.4 percent drop in the NYSE index of natural gas companies .XNG.
Southwestern’s shares have fared better, since the company has hedged half its natural gas production by buying protection at around $5 gas. Still, the company’s projections show that low natural gas prices will cut sharply into both profits and cash flow.
Typically, gas producers respond to price drops by reducing spending on new wells, shrinking the amount of gas that enters the market and helping to turn prices higher. But analysts say more drastic action may be needed in 2012, including well shut-downs, spending cuts or even employee layoffs, as well as asset sales or full mergers with stronger peers.
“They’ll muck through a couple ugly months of bad spot pricing as long as they see some hope in the strip,” said Dan Morrison, senior energy analyst at Global Hunter Securities, referring to NYMEX futures “strip” prices. “When the whole strip melts down, that’s what really alters behavior.”
Weak gas prices have sparked chatter some companies could seek mergers or sell off assets.
“On the transaction side, you’ve always got the opportunistic guys, saying oil is at a relatively high spot in the last couple of years, and gas is low, so I’m going to chase the gas right now,” said David Knox, senior vice president for negotiated transactions at the Oil & Gas Asset Clearinghouse in Houston.
EXCO earlier this year explored a sale but found no suitable buyers. It has said it may raise funds by selling its gas processing assets.
The company may find a willing buyer in its joint venture partner BG Group Plc BG.L, according to Michael Hall, analyst at Baird Equity Research. The companies are currently partners in the Marcellus and Haynesville shales.
That may hinge on whether BG decides to pursue a vertical integration strategy to help fulfill the long-term gas export deals it recently signed with Cheniere Energy Inc (LNG.A), Hall said in a note to clients earlier this month.
Shale fields, such as the Marcellus in Pennsylvania and West Virginia, the Haynesville in Louisiana, Fayetteville in Arkansas as well as new fields in Ohio and other states, have pushed average 2012 prices for natural gas futures on the NYMEX near $3.30 this week, well south of the $4 mark that gas producers often cite as the benchmark to deliver healthy industry returns.
Southwestern has said cash flow from operations in 2012 could fall more than 14 percent when calculated using a $3.50 gas price, compared with gas at $4.50 per Mcf. By the same measure, the company’s net profit falls more than 20 percent with $3.50 gas.
Southwestern’s output is 100 percent gas, EXCO’s production is 98 percent gas and Quicksilver’s production is 82 percent gas, according to data from Bernstein Research.
Projections that gas prices will stay low have helped many other industries that rely on gas to produce chemicals, fertilizer or electricity.
Steel maker Nucor Corp (NUE.N) has cited low natural gas prices as a key driver behind its move to build a new steel plant in Louisiana, and electricity producers have announced plans to build dozens of new gas-fired power plants to replace aging coal-fired generators.
“We have already seen companies that are in the chemicals, steel and aluminum and fertilizer industries either plan for new facilities or to restart old facilities,” said Paul Cicio, the president of the Industrial Energy Consumers of America, a lobby group in Washington.
Each $1 drop in natural gas prices cuts costs for Dow Chemical (DOW.N), DuPont (DD.N) and other U.S.-based chemical makers by a total of $3.7 billion annually, according to the U.S. Department of Energy.
For an industry that only five years ago saw little future in investing in U.S. operations, the new price paradigm is a game changer that the American Chemistry Council, an industry trade association, estimates will drive $25 billion in investments in new facilities.
Royal Dutch Shell Plc’s (RDSa.L) Shell Oil Co and Dow are the two biggest names planning new chemical plants. LyondellBasell (LYB.N) plans to improve its use of natural gas in its production, and fertilizer producer CF Industries (CF.N), which uses natural gas to make nitrogen, is planning to increase production.
“We have an opportunity in several of our U.S. facilities that will allow us to take advantage of lower costs using ethane from natural gas streams and some other NGLs,” said LyondellBasell spokesman David Harpole.
“U.S. ethylene plants are (now) second only to the Mideast in production costs.”
Reporting by Anna Driver in Houston and Braden Reddall in San Francisco; additional reporting by Ernest Scheyder, Jeanine Prezioso and Matt Daily in New York, writing by Matt Daily and Anna Driver, editing by Matthew Lewis