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Tickers in this Article: HK, CHK, NFX, COG
Exploration and production companies are dealing with the collapse of natural gas prices in many different ways. Almost all are cutting back drilling, while others are also taking a less-direct approach to removing supply from the market by drilling the well but delaying completion until future periods, or producing at a much lower rate than is possible. Completion is defined as installing permanent equipment to enable oil and gas production from a well. (For a refresher on natural gas, refer to Oil And Gas Industry Primer.)

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Reducing Production
Chesapeake Energy (NYSE:CHK) recently announced it was reducing production by 13 percent, or 400 million cubic feet per day, to remove supply from the market. Unfortunately, no other operators followed suit with any formal production cuts.

Newfield Exploration (NYSE:NFX) said on its recent earnings call that it was "intentionally slowing" completions in the Woodford Shale due to low prices. The company has 165,000 acres under net lease here.

Different Motivations
Exploration and production companies have many motivations for doing this. The basic one is to remove supply from the market to stabilize prices. It is also a method by which companies can ensure that their returns match what they have promised investors. Although many unconventional natural gas wells produce for up to 30 years, typically they have extraordinary first-year decline rates. Since a large portion of the wells' total production is in the first year, it is critical that the company receives a high price for that production. If it doesn't, the economics and internal rate of return that the company modeled may not be achieved. Also, companies must sometimes drill on a leased acreage within a set time or risk losing it contractually. Drilling, but not completing, a well may satisfy the terms of some leases.

One problem with this strategy is that it may create the illusion of an improved balance between supply and demand, which, once prices rise to higher levels, may lead to a flood of supply coming on line. Not all companies willingly shut in production. Cabot Oil and Gas (NYSE:COG) said during its recent conference call that it has shut in some wells because the company is at its maximum pipeline capacity in the Marcellus Shale.

Petrohawk Energy (NYSE:HK) is intentionally restricting production at two of its Haynesville wells. The company is using a smaller "choke" size to gauge its effect on production and decline rates. The company may have chosen this time to conduct this new method because natural gas prices are so low.

Bottom Line
A common practice by exploration and production companies in the energy industry is to drill wells but not complete them, or to restrict production to levels below that which is organically feasible. Although these actions may lower supply and ease investors' concerns, it creates a huge "wall" of supply behind the pipe.

Find out which catalysts can turn struggling stocks around in our related article, Turnaround Stocks: U-Turn To High Returns.

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