Chesapeake Energy Corporation (CHK), EXCO Resources Inc (XCO) and The Biggest Reason Natural Gas Prices Could Surge

Since mid-February, natural gas prices have risen by a whopping 30%, accelerating a trend of generally rising prices that began after April of last year.

While much of this recent surge in prices reflects stronger-than-expected seasonal demand for gas, there’s one huge reason prices could rise significantly over the longer term — perhaps even triple over the next five years. Let’s take a closer look.

U.S. natural gas market conditions
The recent increase in gas prices marks a departure from the weak pricing environment that has persisted over much of the past few years. As advances in drilling technologies allowed energy producers to coax massive quantities of natural gas from shale fields, an oversupply steadily built up, contributing to severely depressed prices for the fuel.

In response, virtually every major U.S. energy producer curtailed gas drilling in favor of producing oil and, to a lesser degree, natural gas liquids. For instance, Chesapeake Energy Corporation (NYSE:CHK), the nation’s second-largest natural gas producer, reduced its gas-directed rig count from over 100 rigs in early 2010 to around 10 by the third quarter of last year. Similarly, EXCO Resources Inc (NYSE:XCO) slashed its gas rig count from 23 as of year-end 2011 to 7 as of the end of October last year.

But now, with gas prices above $4 per Mcf, some producers are either resuming or ramping up operations in gassier plays. For instance, Encana Corporation (USA) (NYSE:ECA) announced in February that it intends to increase its gas rig count in the Haynesville shale by three this year, citing the play’s recently improved profitability.

Yet others — including some of the lowest cost producers in the industry — are waiting for prices to recover further before they rush back into gas drilling. For instance, Devon Energy Corp (NYSE:DVN), whose mainstay was once natural gas, said it doesn’t plan on drilling for it at all this year. The company will instead be directing much of its capital budget toward drilling for liquids in the Permian Basin.

Not surprisingly, the number of rigs drilling for natural gas slipped to near a 14-year low last month. In fact, the current gas rig count is almost a fourth of what it was at its September 2008 peak.

But give it another three to five years, and these companies may be flocking to gas fields in droves, eager to extract as much natural gas as possible. The reason? Sharply higher prices brought about by lower-than-expected supply and higher-than-anticipated demand for the clean-burning fuel.

Shale gas well decline rates
The reason future supply may turn out to be much lower than anticipated has to do with how quickly production from shale plays may taper off. According to Arthur Berman, a Houston-based petroleum geologist and prominent shale gas skeptic, U.S. shale gas wells have decline rates in the range of 30% to 40% per year, as compared with conventional wells that decline at rates between 20%-25%.