Common sense dictates that when commodity prices fall, there will be less financial incentive to dig stuff up. And when prices cross below levels where producers can turn a profit, activity should really grind down.
That's when it pays to go bottom-fishing. Because when demand inevitably picks back up, you'll be among the first to profit.
As of Sept. 21, there were 1,859 oil and gas rigs operating in U.S. energy basins. That's well below the peak of 2,031 set in September 2008, but more than double the trough of just 876 from the summer of 2009.
The number of rigs hunting specifically for natural gas has plummeted to just 454.
With just about every energy producer in the country abandoning dry gas fields such as Louisiana's Haynesville Shale in favor of oilier plays, the number of oil rigs in operation has surged to near a 25-year high of 1,402.
I cover at least a couple dozen North American energy companies in my Scarcity & Real Wealth newsletter, and pretty much all of them are shifting from gas to liquids to chase higher prices. This has been going on since the beginning of the year.
Chesapeake Energy (NYSE: CHK), whose drilling successes helped cause the very glut that sent prices tumbling, slashed its gas exploration budget by 70% back in January and reduced the number of gas rigs to 25 from 75.
It's not alone. Magnum Hunter (NYSE: MHR), for example, is directing at least 92% of this year's planned capital expenditures to oil.
Add it all up, and it's easy to see why gas-directed rig counts are testing new lows. The number of active gas rigs has plummeted 70% from the high-water mark of 1,606 reached in the summer of 2008.
But here's where it gets interesting...
You might think that a 70% drop in drilling activity would severely clamp down on natural gas output. But that's not the case. In fact, the U.S. Energy Information Administration believes that U.S. production will climb 4.2% this year from last year's record pace of 66.2 billion cubic feet per day.
Part of the reason is that vertical drilling rigs are being replaced by horizontal rigs, which unit-for-unit tend to bring up much more gas. There's also the fact that even in so-called oil shales, natural gas can still bubble up along with crude.
ConocoPhillips (NYSE: COP), for example, reports that two-thirds of its gas is associated with liquids production.
What this means for investors...
It's quiet enough to hear crickets chirping in most dry gas basins right now. Rigs and equipment have been moved elsewhere. Leasing agents have skipped town. Wells have been left unfinished and pipelines unconnected.
That may not be enough to lower production, but at the very least it's slowing the increase. In the meantime, Chesapeake and ConocoPhillips (among others) have also decided to voluntarily curtail production by over a billion cubic feet per day.
That is also mopping up some of the excess supply.
These moves, along with briskly rising demand from power generators, petrochemical makers and other users, should help slowly bring the market back into balance.
Action to Take --> My calls for a natural gas rebound earlier this year were a bit premature. But we're finally starting to see a rally.
After sinking to $1.90 per Mcf a few months ago, natural gas prices have jumped more than 70%. However, they could double from here and still be cheap in historical terms.
That's why it's so important that you start looking at ways to profit from natural gas right now. I think we'll see natural gas retake $4 per Mcf by the end of 2013, and by then, you should be positioned for a sustained boom in this sector.