Monday, April 30, 2012

US Natural Gas Price Nears $10 per Barrel Equivalence

While the average pump price of gasoline has held the attention of most Americans for much of this year, the price trend for natural gas has been equally dramatic in the opposite direction. Gasoline prices flirted with the psychologically important $4 per gallon mark for several weeks before receding to around $3.82 today.  Meanwhile natural gas prices continued their steady drift downward, briefly crossing $2 per million BTUs (MMBTU) before recovering slightly.  To put this in perspective, when the spot price of natural gas bottomed out at $1.82 earlier this month, it was selling for the energy equivalent of oil at $10.56 per barrel.  The last time oil prices were that low was during the Asian economic crisis of the late 1990s, and we're still feeling the consequences of that crash.  The longer-term impact of today's dirt cheap natural gas is likely to be quite different, however. 

Oil and natural gas used to be joined at the hip, and in the minds of many people they still are, even though the days when most US natural gas was a direct or indirect byproduct of oil production--either produced with oil or found by accident when a company was drilling for oil--are long past.  The vast majority of our gas comes from dedicated gas wells in fields that were explored because of their gas potential, with shale gas and other so-called "tight gas" increasingly dominating output.  The widely discussed shale gas revolution is the main reason natural gas is so cheap today, instead of costing over $10 per MMBTU as it would if shale gas hadn't happened and the industry's expectations about increasing LNG imports had materialized instead.  Unfortunately for producers, because the surge of shale production has coincided with a weak US economy that is still struggling to get out of first gear, post-recession, the shale gas bounty is turning into a temporary glut. 

Here's why the distinction between modern oil and gas production dynamics matter.  When oil prices crashed in the late 1990s due to the combination of weaker-than-expected global demand and growing production, producers cut investments and scaled back new projects.  Because of the time lags inherent in big oil projects the impact of those decisions was felt in the middle of the last decade, just as demand growth in the developing world hit its stride.  Other things were happening, as well, but there's a good case that $10 oil in the late '90s helped set up $145 oil in 2008 and contributed to the persistence of prices well over $100/bbl today.  So is the current natural gas price slump setting up a spike back over $10/MMBTU within a few years?  I think that's unlikely, though I do believe gas prices will recover somewhat. 

My reasoning involves several key differences between the oil and gas markets.  First, the gas lifecycle is much quicker, at least where pipeline infrastructure is already in place.  More than half of today's US gas production comes from wells drilled in the last 5 years. Gas drilling has already slowed, and more rigs are being redeployed to pursue much more valuable oil plays, but drilling could switch back to gas just as quickly. Then there's the underlying resource, which would support even higher gas production than today's for many decades.  Finally, we have the factor referenced by Chesapeake Energy's controversial CEO, Aubrey McClendon in an interview in this weekend's Wall St. Journal: new demand.

The only reason that additional demand from utilities, petrochemicals, transportation, and exports hasn't already sopped up the gas surplus and boosted prices is that all of these developments involve time lags of their own.  It will take time to build the new ethylene crackers announced by Shell and Dow Chemical.  Natural gas power plants have already ramped up output and seized market share from coal, but bigger shifts will require more gas turbines. Converting long-haul trucking to natural gas requires expensive modifications to trucks and new refueling infrastructure. Meanwhile the first liquefied natural gas export terminal just received the go-ahead from FERC. Yet while none of these things can happen overnight, and there isn't enough gas to push them all to their maximum potential in any case, they are all being propelled by the enormous driving force of natural gas at the oil equivalent of $12-20/bbl in a $100-per-barrel world.  The developers of renewable energy technology must also figure out how to compete with that, if they're going to prosper without fiscally unsustainable subsidies.

As scaled-back drilling and new demand mop up the current gas glut, only one thing can happen to prices.  The $64,000 question is how high they could rise and still keep the demand expansion going.  A return to $10 natural gas would halt the shift from coal to gas and stop the penetration of gas in transportation in its tracks, but it would also unleash an even larger wave of new production.  Mr. McClendon's latest guess for the medium-term price is between $3 and $5, and that sounds reasonable.  Even at the latter the BTUs in gas would still cost just $29/bbl.  We won't see oil at that price any time soon, so gas doesn't need to remain at $2 to create a world-beating energy advantage for the US.  If natural gas can fulfill even a portion of the potential we see today, we will soon need to rethink most of our assumptions of energy scarcity embedded by four decades of recurring oil crises.  That will be uncomfortable for some people.