The manic pace of natural gas development in many of the onshore, unconventional natural gas basins in the United States has been motivated not by the economics of the plays, but by a need to drill to convert leases from term to held-by-production status.
This has led to a large amount of irrational drilling activity by exploration and production companies, as they allocated capital to developments with a lower rate of return to protect large investments in leaseholds.

Some factors indicate that the industry is in the latter stages of that conversion, and that a year from now a more rational approach to drilling may lead the industry to lay down rigs - helping to balance the supply and demand fundamentals in the natural gas market.

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Here's What Major Players Are Saying

Chesapeake Energy (NYSE: CHK) said during its second quarter conference call that most of its acreage in the Haynesville Shale would be held by production by the middle to late part of 2011. The company indicated that after that time, it might start ramping down development in the Haynesville Shale if natural gas fundamentals remain weak. Chesapeake Energy has already cut its rig count in the Fayetteville Shale in half, as the company appears to be further along in holding acreage in that play.

EXCO Resources (NYSE:XCO) reported that by the end of 2011, the company's "key acreage" in the Haynesville Shale will be held by production. Petrohawk Energy, (NYSE: HK) another large player in the Haynesville Shale, indicated that most of its acreage will be held by production by the middle of 2011.

Some Have Already Convert To Held-By-Production Status

Some companies have already converted most of their acreage in some basins to held-by-production status. Newfield Exploration (NYSE: NFX) has 172,000 net acres in the Woodford Shale, and it has approximately 90% of that acreage held by production. The company has already cut its rig count in the Woodford Shale from nine rigs at the start of 2010 to four currently, and it estimates keeping production flat here with four rigs.

The fast development pace in the United States has led to rising costs and shortages for hydraulic fracturing and other oil services. This pressure will also ease once the involuntary drilling to hold acreage slows down.

A More Rational Drilling Approach Is On The Horizon

The development frenzy to hold acreage by the exploration and production industry is partially responsible for the weak fundamentals in the natural gas market. Once this passes, a more rational approach to development, based on the relative rate of return between competing basins, may improve the fundamentals for natural gas. (To learn more, check out our Oil And Gas Industry Primer.)

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Tickers in this Article: CHK, XCO, NFX, HK

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