We know the relationship between gas prices and drilling rigs is a strong one as shown by the historical pattern since 1987 with the exceptions of 1999 and 2006-2007. The latter period was in the early years of the gas shale revolution so producers were more focused on staking out land positions that required drilling wells to hold the acreage. In 1999, natural gas markets were just beginning to recover from the fallout from the collapse of commodity prices tied to the Asian currency crisis in 1998 but oil and gas companies' cash flows and desire to drill had yet to recover. Other than those two times, the relationship between gas prices and drilling activity has been consistent.

The consistent price/drilling activity relationship exhibited by natural gas also seems to hold for crude oil prices and oil drilling. It makes sense that these relationships exist because oil and gas prices are a key determinant in producer cash flows. Since producers usually reinvest most of their cash flows into new drilling, having more or less money available would seem to support changes in drilling activity.

Maybe more important than the relationship between oil and gas prices and drilling rigs seeking those resources is the relationship between natural gas prices and gas production. When we plot the gross withdrawals from all wells along with those just from dry gas wells against the price of natural gas, we find that there is a relationship. While some might argue that the changes don't appear significant (Exhibit 11), we would point out that the U.S. has been short of domestic supply so there was little incentive to limiting production unless it proved uneconomic due to the price. Declines in withdrawals may have also been a reflection of the depletion of existing well productive capacity that was not offset by new well production as fewer wells were drilled when gas prices fell. The point of this chart is that producers do respond to changes in natural gas prices even if only marginally. This would argue that the gas shale revolution and its demands for producers to continue to drill wells in order to hold the leases they have purchased has changed the natural response to low gas prices.

Eoin Treacy's view Natural gas prices at $3 are uneconomic for all but the lowest cost producers. However the peculiarities of US unconventional oil and gas leases mean that drilling is a necessity. This has contributed to higher production volumes despite declining margins. The situation is not sustainable in perpetuity and once demand returns to dominance a significant rally is likely to take place. However, there is currently no evidence to suggest the status quo is being challenged. A sustained move above $3.20 is the minimum requirement to question the progression of lower rally highs and suggest short covering is underway.