APPI Energy Explainer: Natural Gas as a Byproduct of Oil Drilling

September 5, 2018

When we discuss natural gas production, we might not necessarily associate the process with oil rigs. They are, after all, separate commodities. However, the two are incredibly intertwined, especially in the United States. In this article, we’ll be explaining natural gas as a byproduct of oil drilling, specifically its impact on energy prices today.

At the time of writing, natural gas rig count has declined by about 88.4% from its peak in 2008. However, over that same period, natural gas production rose 52% and has continued to set records throughout 2018. While that might sound implausible, the explanation is rather simple: the price of crude oil increased.

Many natural gas fields are located rather close to oil fields, such that many wells produce both. While natural gas directed rigs might fall, rigs that drill both are more common. The Permian Basin, for example (the nation’s largest oil field and second largest natural gas field), produced 3.33 million barrels per day in oil and 10.7 Bcf/d of natural gas, a number expected to grow in the future. It accounted for 12-15% of total U.S. natural gas production from May of 2016 to May of 2018 but did not contain a single gas rig.

The logical conclusion is clear; the more oil we’re drilling for, the more natural gas we produce. That’s important because it means that natural gas production is not strictly a factor of the price of natural gas. In a closed system, one where natural gas production was solely confined to drilling for natural gas, there would be less incentive to produce natural gas when prices were low, and more incentive when prices were high. However, because a large percentage of natural gas production occurs as a by-product of oil drilling, natural gas production increases when oil prices are high too.

As we explained in our article on storage, this excess gas can be stored, utilized when prices are higher, and participates in a wide array of markets and considerations even while being stored in the ground. However, as it is a factor of supply, it still serves as a downward pressure on natural gas (and thereby electricity) prices.

On the subject of oil prices in the United States, a variety of factors are responsible for the price per barrel. The three main factors are supply (largely OPEC and the U.S. are major players in this arena), access to future supply (the reserve), and demand. While summer is not often considered a season of peak demand in natural gas, it is for oil. A variety of political events and weather conditions play major parts in all three of these factors. U.S. sanctions on Iran and concerns in Venezuela are both factors in the U.S’s current oil supply. The market’s response, of course, is to increase the value of oil, as it’s a reasonable assumption that the market will be bullish.

In summary, the increased production of oil is strongly driving the production of natural gas, leading to the peak production we’ve seen steadily increasing throughout the summer. This production, despite a continued deficit to the five-year average in natural gas storage, is keeping natural gas prices bound within a reasonable price range.

Each day, APPI Energy monitors the market and examines electricity and natural gas prices throughout the deregulated United States. We utilize this information to provide our customers with data-driven energy procurement solutions, designed to save time and create budget certainty for our customers. For more information, please call APPI Energy at 800-520-6685, or contact us online.