Natural Gas

In a post about interest rates I wrote about being a little kid and over-hearing my grandfather (who was actually “grandfathered” in as a CPA because he was a practicing accountant before they had the exam) talk in the early 1980s saying that he thought interest rates “would never go below 10%”. At the time inflation was rampant (as Volker came in) and interest rates were in the 20% or so range, so this seemed like a valid observation. As we all know, interest rates have fallen to near-zero right now and even a “ceiling” of 10% (rather than a floor) seems far away.

Along the same lines, when I started in the energy business in the early 1990s, the “rule of thumb” of what a utility would pay for natural gas was about $2 / unit. The price would rise in the winter during the peak heating season and fall in the summer as utilities re-filled their storage, and it would vary around the $2 / unit mark, but not deviate too significantly. At the time there wasn’t a lot of vision forward on prices that I was aware of, but if you mentioned anything like the $14 / unit peak that was hit in 2005-6, you would have been laughed out of the room.

Today natural gas, propelled by innovation and “fracking”, has dropped to a price level that no one would have foreseen back in 2005-6. Per Bloomberg:

Supplies may reach a seasonal record of 2.4 trillion cubic feet in March, which is when heating demand usually ends and producers begin piping more gas into storage, Cooper said. Unless production falls or cold weather bolsters demand, prices will drop to $2.40 per million Btu, and perhaps below $2, as gas overflows storage caverns and clogs pipelines, he said.

To think that natural gas would return to 1990 price levels is amazing. Even using the government’s figures, which I think understate inflation dramatically, in the 21 years from 1990 to 2011, inflation makes the $2 in 1990 the equivalent of $3.51 today, per this inflation calculator.

What happened? Free enterprise and capital markets happened. Fracking and innovation allowed new natural gas deposits to be found in our country which brought forth huge reserves of US energy and drove down costs even while usage soared.

This low price for natural gas is not a short-term phenomenon. These reserves are significant and since natural gas is often found alongside oil, with oil at $100 / barrel the fact that natural gas is at a low price won’t impact it as much as you’d think because anything the driller gets is just profit on top of the huge profits for US sourced oil. The largest “threat” to low prices for natural gas in the US is actually the “high” price of natural gas overseas, because US drillers and pipelines can ship it to foreign countries in a liquefied (LNG) format if their high prices make it economical. Per this WSJ article:

(T)he current low natural gas prices are attracting market demand from around the world. There are already federal permits for 3 trillion cubic feet per year of natural gas exports, Apt said. “Will we export that bounty, and if we do, will that drive up U.S. prices,” he said. Natural gas sells for about $8 in Europe and $14 in Japan, but less than $4 here.

The real longer-term issue is whether other countries in Europe and Asia will also find large reserves of natural gas in shale just like they did in the US, and whether they will drill for it or avoid drilling out of environmental concerns. The French have already banned “fracking” but my (unproven) opinion is that this really says more about the power of the nuclear lobby in France, since the low price of natural gas has really been the final nail in the coffin of nuclear energy (along with the obvious issue of Japan) because it makes the plants un-economic to build. Likely the Ukrainians (smarting from Russia’s bullying over natural gas pricing), the Poles, and the Chinese will take up this technology in earnest and change the overall economics, even if countries like France are content to wait idly by.

As far as the US electricity industry, natural gas is causing coal plants to be mothballed or their owners to choose to not spend money on costly “scrubbers” to comply with EPA guidelines, changing the long term footprint of the US market. Since the nuclear boom was a “mirage” anyways (basically we will get a plant out of Southern Company and one in South Carolina, which won’t even keep up with likely decommissioning of units), this lower priced power is killing the market for new plants entirely.

For heavily indebted companies like Energy Futures Holdings (which bought up TXU assets in Texas), the low price of natural gas spells difficulties, since gas fired “peakers” set the “market price” for energy and with the price of gas at $2 / unit, not $8 or $10 / unit, they will make less money on their “base load” coal and nuclear plants which need to run all the time. Some of these utilities had a great summer in 2011 with high temperatures (especially in Texas) which helped to offset the increasing competitiveness of gas-fired generation.

The other key item to keep in mind is that when we buy US produced energy, we enrich our OWN country rather than sending wealth overseas, often to countries that despise us (and even if we don’t buy directly from Iran, the high cost of oil overall benefits them just the same whether or not we buy or someone else). The new innovative technologies have enormously benefited the United States, making us more competitive in business and reducing energy bills for tens of millions of households. And while energy companies do have “breaks” in the tax code to some extent, this innovation was not part of a government program and is in stark contrast to the failures of the Energy Department’s “research” and political backing of “green” energy which is likely to be a major campaign issue in 2012.

If only they’d unleash our oil companies in the US we would likely be able to dramatically increase our production and further reduce our dependence on foreign energy producers, while enriching our own country. The parable of natural gas is plain for all to see, which is that markets work if you let them, and that government intervention is usually far more harmful than inaction.

Cross posted at LITGM

16 thoughts on “Natural Gas”

  1. The expanded availability & lower price of nat gas is one of the few positives in the economy these days.

    I think US nat gas demand is going to expand dramatically….for power generation and export , as you mention, also for local transportation (truck and bus), and for chemical/plastics feedstocks. There’s also some talk about nat gas for long-haul rail: the volume problem can be addressed by putting a tender behind the locomotive in the old steam-engine style. And people still using oil heating are going to convert to nat gas when they can.

    It’s hard to imagine that sooner or later all of this isn’t going to have an upward impact on NG prices.

  2. Many of the electrical producers in Texas (NRG, for one) sell umder long-term fixed price contracts to marketing organizations which in turn sell to the distribution companies that own the “last mile” of wire and do the billing.

    If these producers have natural gas generation and buy gas on the spot market, they will do very well.

    What I think will happen is that the customers will not see the full effect of the price plunge any time soon. That is a price they pay for stablity in prices and supply.

    I too am skeptical of the LONG run price decline. Certainly there will be some as supplies have increased but how much of the price drop is due to demand reduction from a slow economy? Also, production costs for brand new extraction technology will increase once the “low hanging fruit” of easy gas have been utilized. That process may take a decade though.

    Of course, I reasoning from hope as I built nukes!

  3. 2$ per unit is less than 12$/barrel and apparently there are enormous potential reserves internationally. Also a short ton of coal will usually have anywhere from 20 to 28 units of energy so this is competitive with coal depending on distance from the mine. This looks to be VERY big over time.

  4. A big reason for the high runup in gas prices a few years ago was the lack of pipeline capacity. NIMBY keeps new lines from being built, just like a nuke plant, refinery, and transmission lines. With all the combined cycle power plants that had been built, the long distance pipelines were choked and teh companies operating them raised the price to use their pipes.

  5. It’s hard to imagine that sooner or later all of this isn’t going to have an upward impact on NG prices.

    There’s a lot of NG down there. So barring government intervention, admittedly a big assumption, it will probably be later rather than sooner although like all energy sources, pricing will be volatile in the short run.

    Once there are NG stations on I-80 and I-76 demand will grow for vehicles as well as NG.And don’t be surprised to see NG passenger vehicles as well. They are making more sense than electrics. It’s going to be a interesting couple of decades.

  6. One factor to consider: the decline curve for fracked wells is apparently not well-understood. So the total lifetime output of each of these new fields may turn out to be considerably less, or maybe considerably greater, than expected.

    As an investor, I have been liking pipelines, both oil and NG. One potential issue some have pointed out with the latter is that new NG developments, such as the Marcellus Shale, may reduce the need for gas transport over long distances…I think, though, that growing demand, coupled with the tendency of Northeastern politicians to shut down any form of practical energy development, will tend to minimize this phenomenon.

  7. All this suggests that the election of a sensible president (A Republican) will set off an economic recovery quickly. Maybe not Gingrich’s prediction of election night after the winner is announced but soon. The alternative is too horrible to contemplate.

  8. One point not mentioned is that the shale gas being developed is privately owned. The US is nearly unique in much or most of the minerals are privately owned, thus not subject to governmental confiscation, think Government oil companies in the rest of the world, most reserves were developed by the old seven sisters(Exxon, Mobil, Gulf, Texaco, BP, Shell and Chevron)and nationalized in the 70’s and 80’s. We in the US experience the same nationalization by government where the gov controls the resource, offshore, oil shale, Alaska, thus the shortage of oil. Note, while considered a blue colar industry the US oil and natural gas industry is a very high tech industry that leads the world in technology because it is a very competitive free market.

  9. the tendency of Northeastern politicians to shut down any form of practical energy development

    The majority of the Marcellus shale is in Pennsylvania, Ohio, West Virginia and Kentucky, largely in areas of coal deposits. These are states that are accustomed to extractive industries and need the revenue. Short of an environmental disaster, the governments are positively disposed toward development. That is why the industry is applying lessons learned fairly rapidly. For example, recycling of fracking fluid is increasing. No one wants to kill this goose.

    There is some shale in New York on the PA border, but it’s a relatively small portion and NY will remain pristine until it has chased the financial sector out of NYC.

  10. Companies are moving very quickly into eastern and south eastern Ohio to tap the Marcellus and Utica Shale deposits. I am going to a meeting at 1pm today at the local chamber to find ways to do business with these companies. Current leases are over $5,000 per acre plus royalties, so I’m hoping they start looking to drill in my backyard. We hope to find many business opportunities, which will mean more jobs for our company and a trickle down effect for our vendors. This is the way a free market should work.

    Point is a lot of money and jobs are moving into a very depressed area of the state. Our local technical college just graduated its first class of oil and gas techs (the only school in the state to have this program), for jobs that look to have a 30-40 year duration or longer. It’s a godsend and a windfall.

    Please, U S Government and environmentalist wackos keep out of the way.

  11. “the tendency of Northeastern politicians to shut down any form of practical energy development”

    I’ve just read that Rep. Markey (D-MA) wants the DoE to deny a permit to for an LNG export terminal.

    His argument is that this move is insulate the domestic market from global LNG prices which are likely to be higher. This will keep domestic gas prices lower than what they would be otherwise.

    I can not think of an analogous commodity where we limit exports to keep domestic prices low. Anyone with an example?

  12. Re Joe Wooten,

    I’ll certainly grant that there is interstate pipeline limitations that drive up the end-users’ price of gas.

    However, prices are quoted at the Henry Hub in Lousiana. So pipeline limits on getting gas to the Hub might drive up Hub prices but those are in Texas, Oklahoma, and Lousiana.

    I suspect that the pipeline limits you’re talking about are from the Hub north to the markets in the Northeast and Midwest. I don’t see those constraints affecting prices at the starting point, the Hub.

  13. The one blind spot in most ‘conservative’ publications among many since the ‘Gas Wars’ started in 2006 has been why Ukraine is entitled to cheaper gas than almost everyone else in Europe simply because A) pipelines cross its territory and B) historic victimhood. Shale gas has great potential in Europe but it’s been a bust so far in Hungary. There’s plenty of coal bed methane of course, in the UK and Germany’s old coal fields.

    Russia will cope with the shale gas revolution by simply pumping more oil. The real question is how much oil the U.S. will start pumping domestically or if gas will get so cheap that gas-to-liquids becomes viable.

  14. Whitehall..”I can not think of an analogous commodity where we limit exports to keep domestic prices low. Anyone with an example?”

    There was some talk several years ago about limiting scrap-metal exports in order to provide cheaper raw materials for the domestic minimill industry. Not sure if any of this actually happened.

    The best international example, of course, is China’s limitation of rare-earth exports in order to attract relevant manufacturing firms to their own country.

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