The oil crash has distracted investors from the price action in natural gas, which at this point has to counts as a silver lining for producers.

There certainly haven’t been many others as the price of the benchmark natgas contract has dropped from $3.89 to $2.60 per million BTU over the last year.

At that’s natgas for delivery at Louisiana’s Henry Hub; at one of the most constipated chokepoints in the Marcellus, gas traded as low as $1.08/MMBtu last week. Pipelines will eventually curb the regional discounting, but perhaps not soon enough for some producers. And if some do go bust, that will be another silver lining for the rest right there.

Prices are not down because of lackluster demand: in June, U.S. natgas consumption was up almost 11% from two years earlier. It’s just that over the same span production was up 14%, and as a result there’s 16% more gas in underground storage than a year ago, and 5% above the five-year average.

An unusually warm winter could easily pressure natgas toward the 2012 NYMEX-traded low of $1.82/MMBtu. And while first liquefied natural gas exports from mainland U.S. are due by the end of the year, the initial trickle will not be enough to make a meaningful dent in stored reserves. Appetite for U.S. exports of natural gas liquids like propane and butane has also slackened given the dramatically lower price of crude, which competes with NGLs for fuel market share.

So there are lots of storm clouds about, any anyone investing in this sector can almost certainly count on a soaking or two beyond those experienced already. But nothing cures low commodity prices like low commodity prices, and here the early chain reactions are already apparent.

Start with the colicky high-yield credit markets, now effectively shut to all but the strongest drillers. Similarly, the private equity investors still willing to help the industry plug its persistent cash flow leak are now demanding terms that would make a loan shark blush.

The cash spigot has been turned off, and capital spending is declining as a result.

No shale basin has contributed as much to the current glut as the prolific Marcellus, known for the high initial production rates of its wells (and less, for now, for their dramatic rates of subsequent decline.)


Source: U.S. Energy Information Administration

Yet production growth in the Marcellus has for the moment run out of gas, with the number of rigs drilling new wells down to 69 in August, from 105 in December. As a result, the U.S. Energy Information Administration expects Marcellus to produce less gas for the third straight month in October as the contribution from new wells is outweighed by the declining output from those drilled previously.


Source: U.S. Energy Information Administration

So the basin that has driven recent growth in U.S. gas production has now stalled, at prices that make drilling new wells in most other regions at best a breakeven proposition.

And there’s another factor that seems likely to exert an additional drag on drilling in the near future. Gas producers on the whole have been much better hedged for 2015 than they are for 2016. Many see little reason to hedge against further downside at current prices. That means that every day at current prices brings closer the prospect of another cash squeeze once the hedges expire, further reducing companies’ the incentive to invest.


Source: SNL.com

How does one invest in gas drillers at this delicate stage? Very cautiously and selectively. It’s no accident that three of our gas-oriented recommendations — #3 Best Buy EQT (NYSE: EQT), #9 Best Buy Cabot Oil & Gas (NYSE: COG) and Peyto Exploration (TSX: PEY, OTC: PEYUF) are widely acknowledged as the three lowest-cost producers across North America. (A fourth, Antero Resources (NYSE: AR) is cheap, growing fast and staying exceptionally well hedged.) 

EQT leases prime acreage above the Marcellus wet gas sweet spot in southwestern Pennsylvania, while Cabot rules the dry gas sweet spot in the northeast of that state. Peyto drills comparably low-cost gas deposits in western Canada. These companies not only can earn an economic return amid the current slump but have the financial flexibility to outlast the competition and gas reserves that will reprice significantly higher on the next industry upswing.