Little-Known Phenomenon Could Send Natural Gas Prices Skyrocketing

David Fessler
by David Fessler, Energy & Infrastructure Strategist

Little-Known Phenomenon Could Send Natural Gas Skyrocketing

by David Fessler, Investment U Senior Analyst

Thursday, October 20, 2011

Every summer and fall, oil and gas drillers, producers and traders have one eye on what they're doing and the other one on something even more important: the weather.

They all know a major hurricane that tracks up through the Gulf of Mexico could have devastating effects on their operations.

And they have have plenty of reason to worry. Take a look at the graph below produced from data from the National Hurricane Center. It shows the tracks of all the hurricanes that formed between 1851 and 2005.

Hurricanes formed between 1851 and 2005

Plenty of them traversed the Gulf of Mexico, now a major offshore production region for oil and natural gas.

The most devastating of those were Hurricane Andrew in 1992, Katrina in 2005 and Ike in 2008. Together, they caused an estimated $137.1 billion in damages. A lot of that damage was to oil and natural gas infrastructure.

Hurricanes normally cause oil and natural gas production to be suspended until the weather system blows through. As a result, they all had an effect on the price of natural gas and oil, regardless of the amount actual damage

Higher Natural Gas Prices Coming? Depends on the Weather This Winter...

With the advent of more and more natural gas coming from onshore wells, the risks have shifted from summer hurricanes to winter chill. Let me explain.

Few folks outside of the natural gas industry are familiar with the term "wellhead freeze-off." It happens when the outside temperature drops below freezing in the vicinity of the wellhead.

At most natural gas wells, there's a small amount of water that comes out of the ground along with the gas. If it's below freezing, that water turns to ice inside the wellhead. If the cold snap persists long enough, it can completely shut off the flow of natural gas from the well.

There are three ways to fix the problem:

  • Wait for milder weather

  • Pump methanol through the pipes

  • Apply external heat

The last one has to be done very carefully. Open flames impinging on natural gas piping can have devastating consequences.

Back in January 2010, thousands of wells were knocked offline in Texas and Louisiana. This region is home to one-third of U.S. natural gas production, so the stakes are huge.

Since it rarely freezes down there, wellheads aren't built to withstand wellhead freeze-off. Back in January and February of 2007, 1.5 billion cubic feet per day (Bcfd) of supply was knocked offline.

U.S. Daily Dry-Gas Production

The above graph illustrates the point. As you can see, the disruption this past February, due to a wellhead freeze-off, rivaled that of major hurricanes.

The problem with supply disruptions due to freeze-offs, as opposed to those that come from hurricanes, is that they occur in the winter, when the demand for natural gas is at its greatest.

Profiting From Mother Nature

From my perspective, natural gas companies are increasingly a great investment. Natural gas use is on the rise, for a number of reasons I've previously discussed in this column.

But unlike supply disruptions that occur in the aftermath of a hurricane (which can last weeks or months), wellhead freeze-off disruptions typically last no more than a few days.

As production shifts from the Gulf of Mexico to more unconventional shale plays, long-term disruptions to our natural gas supply are becoming more short-term oriented.

That means companies like Chesapeake Energy Corporation (NYSE: CHK), Williams Companies, Inc. (NYSE: WMB) and Cabot Oil and Gas Corporation (NYSE: COG) won't be affected as much.

Most of their natural gas is produced from onshore wells. Newer wells have equipment installed that prevents wellhead freeze-off.

It's one more thing investors who are active in natural gas stocks should bear in mind when choosing a company to invest in.

Good investing,

David Fessler

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