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Is the Era of Abundant Long-term
Low-cost Natural Gas Truly Here?
by Bob Shively, Enerdynamics President
In the mid 1990s, I attended a speaking engagement by Larry Bickle, then CEO of gas marketing company Tejas Power. In the room full of natural gas producers and marketers, Bickle asked, “How many people think high gas prices are good?” When almost all the hands in the room shot up, Bickle said he thought they were all wrong. What was needed, Bickle argued, were long-term moderate gas prices that would allow gas to build its market share and become the dominant fuel choice. Unfortunately, the desire for stable prices was wishful thinking.
Since 1997, U.S. Henry Hub monthly spot prices have run as low as $1.72/MMBtu and as high as $13.42/MMBtu. But what we have not had is a stable price that facilitates long-term planning. As a result, any consumers considering a long-term investment with a value dependent on natural gas prices must first face the question of whether gas price volatility makes the investment too risky.
Henry Hub Monthly Spot Gas Prices since 1997
In May 2008, Henry Hub spot prices were $11.27/MMBtu. The market perception was that we had entered an era of tight gas supply and high demand, and that the market needed to learn to live with prices at these levels. Numerous companies rushed to complete multi-billion dollar investments in liquefied natural gas (LNG) terminals so that cheaper international sources of gas could be moved into the U.S. And many electric utility companies begin planning for new coal generation with the assumption that gas was too costly. The Energy Information Administration (EIA) projected that annual average prices over the next decade would range from $6 to $7.50 and that higher prices would hold down gas demand. Futures prices for the next year were in the range of $9 to $11.
Three short years, one economic recession and a gas shale boom later, Henry Hub spot prices started the month (May 2011) at $4.69/MMBtu. The market perception is that we now have 100 years of natural gas supply in the U.S. and that gas prices will remain low for a long time. Companies that rushed to complete LNG import terminals are now applying to FERC to convert them to export terminals to send U.S. gas to Europe, Asia and South America. Electric utility companies have halted almost all coal units not already under construction and have moved quickly to favored gas units. The EIA projects annual average prices over the next decade will range from only $4.48 to $4.87. Forecasters predict natural gas demand will grow steadily by just under 1% per year. Futures prices for the next year are in the range of $4.70 to $5.30.
So which is it? Should we be building gas-fired power plants and converting our cars to natural gas? Or should we be stocking up now on cheap gas to profit when the inevitable future high prices hit? It’s a great question, and, to be honest, no one knows the answer. Certainly no one I’ve heard is talking about $10 gas anytime soon. But despite all the folks talking about long-term $4 to $5 gas, there are a few others suggesting that a $6 to $8 range may not be so far-fetched. Let’s summarize some of the data on both sides of the argument.
Low Prices are Here to Stay
In the last few years, U.S. producers have begun to successfully exploit new shale gas resources. U.S. natural gas production in 2010 was at its highest level since 1973, and this year appears likely to hit an all-time high. A recent study by the Potential Gas Committee suggests the U.S. total natural gas resource base is 1,898 Tcf, which at current rates of use will last 80 years. Natural gas consumption in 2010 was at an all-time high, yet prices have still remained low. While the number of rigs drilling for gas fell precipitously in 2009, they have started to creep back up. And total current gas reserves are approaching their all time high. These factors have many predicting that we are in for at least a decade of low gas prices.
U.S. Dry Natural Gas Production (MMcf)
U.S. Natural Gas Total Consumption (MMcf)
U.S. Natural Gas Rotary Rigs in Operation (Count)
U.S. Dry Natural Gas Proved Reserves (Billion Cubic Feet)
source for above graphs: http://www.eia.doe.gov
Not So Fast
So is there anything looming that could turn the optimistic tide? In a word, yes. We need to realize that the 80 years of gas supply noted above is estimated total resource base*, not reserves. If a standard of current reserves is used, we probably have about 12 years worth of consumption in the U.S. This estimate isn’t much higher than the 10 years that was oft-quoted during the period of high prices in the mid-2000s.
In the case of shale gas, some industry experts maintain that many producers are making an insufficient profit at current prices. Drilling has continued partly because of investments by international players who have motives beyond pure profits (see U.S. Becoming Natural Gas Exporter? in Q1 2011 Energy Insider) and partly because the value of natural gas liquids has producers drilling based on selling liquids, not gas (see http://www.bentekenergy.com/InTheNews.aspx#Article3094). So drilling could fall and with it, supply. And while I believe that environmental impacts of drilling techniques such as fracking are manageable, there is certainly the possibility that public perception won’t come to that conclusion and that pressure to reduce drilling will grow.
As mentioned, demand is at all-time highs. Some major industrial consumers have recently indicated plans to ramp up consumption of natural gas, and natural gas generation capacity is expected to increase by 8% in the four years from 2010 to 2014, according to the EIA. Proposed export LNG terminals, which would access much higher gas price markets in Asia and Europe, could add an additional chunk of demand into the market. These factors coupled with the production issues described above suggest that in another year or two, the U.S. could face falling production and rapidly rising demand. And we all know what that does to prices!
So What to Do?
Certainly, history tells us natural gas goes boom and bust, and that these cycles can happen quickly. We’ve taught in our classes for years that your best position is to accept that you can’t know whether conventional wisdom is indeed wise or not. It is better to plan for uncertainty rather than a certain market outlook. Wise market participants develop business strategies that are well-enough hedged that they can at least survive, and hopefully do well, in a boom, bust or something in between.
Examples include Xcel Energy, which recently began to replace existing coal generation with over 500 MW of natural gas combined-cycle turbines. To protect rate payers against future gas price increases while taking advantage of current low prices, Excel signed a 10-year gas supply deal with Anadarko at an estimated price of $5.48/MMBtu. Another is major shale gas producer Chesapeake, which is actively seeking new markets such as LNG exports and even gas-to-liquids (GTL) (see http://www.pennenergy.com). These strategies seem much better than simply going along for the ride and letting fate determine the future.
* Resource base is the assumed total amount of gas, discovered or undiscovered, that can reasonably be expected to exist, while reserves are the more proven estimated quantity of gas that analysis of geologic and engineering data demonstrates with reasonable certainty is recoverable under existing economic and operating conditions.