Saturday, December 31, 2011

Abundant Natural Gas Leads to Record-Low Prices; Natural Market Forces Will Correct the Oversupply

Wall Street Journal -- "U.S. natural gas prices fell to their lowest point in more than two years, underscoring how the nation's booming energy business is becoming a victim of its own success. Mild weather and oversupply have pushed the fuel's price below $3 (see chart above).

Prices for the commodity have been under pressure over the last couple of years, as new drilling techniques unlocked vast new stores of natural gas from shale formations and other so-called unconventional reservoirs. But in the last two months, the steady price decline has turned into a free-fall, as unusually mild temperatures across much of the U.S. have damped demand for gas to heat homes and offices.

Natural gas for February delivery settled Friday at $2.989 per million British thermal units, the lowest closing price for the commodity since September 2009 (see chart). It closed below $3 in the winter for the first time in nearly a decade.

"The sub-$3 levels for gas prices in the winter really point to the incredible amount of nonconventional gas that has come onto the market the last two years," said Gene McGillian, analyst at Tradition Energy in Stamford, Conn. "Our production levels, our mild winter and the gas we have in storage have combined to crush natural gas prices this month."

Natural gas traded as high as $13 per million British thermal units in July 2008. But in recent years, domestic production boomed, with horizontal drilling techniques and hydraulic fracturing, or "fracking," helping producers unleash a flood of gas from shale formations in Pennsylvania, Arkansas and elsewhere.

Natural gas production in the lower 48 states hit a record 71.3 billion cubic feet a day in October (see CD post). The bonanza has ushered in lower prices for many consumers and businesses. New Jersey's Public Service Electric and Gas Co., citing lower costs partly due to shale drilling, reduced residential gas rates on Dec. 1 by 4.6%, bringing to 35% the utility's total decrease since January 2009.

Shale drilling has also created jobs and the prospect of greater energy independence, while raising environmental concerns. But the fresh abundance of natural gas has also weighed on its price, undercutting the profitability of the business for energy companies.

Still, due in part to the structure of the business, the torrid pace of natural gas production shows few signs of slowing. Producers often have a limited time to begin drilling once they lease property, which leads many to drill wells regardless of commodity prices or risk losing their hold on reserves. Other companies are forced to drill by the terms of joint ventures they signed when the outlook on gas prices was rosier."

MP: Overall, the fact that the shale gas industry is "becoming a victim of its own success" is only a temporary "problem," and demonstrates that the price system and competitive market forces are working as expected: an abundant supply of natural gas leads to falling prices, which lowers the profits of producers, which then leads to automatic, self-correcting adjustments and responses as the natural gas market moves towards a new equilibrium.

Those adjustments might include: a) increased demand for natural gas as residential and commercial consumers shift from oil and electricity heat towards natural gas (see CD post), b) increased demand for natural gas by energy-intensive manufacturing companies that produce steel, plastics, chemicals, etc. c) increased demand for vehicles powered by natural gas, d) increased demand for natural gas for electricity generation, and e) reductions in the production of natural gas as it becomes less profitable and some producers shift towards shale oil.

All of those automatic adjustments (increased demand and decreased supply) will raise the price of natural gas over time, eliminate any economic losses currently being incurred by producers because of the low prices (and drive economic profits to zero in the long run), and the market will move towards a natural market-clearing equilibrium that eliminates the current "oversupply."

HT: Warren Smith

6 Comments:

At 12/31/2011 12:24 PM, Blogger Benjamin said...

Happy New Year!

Perry--"All of those automatic adjustments (increased demand and decreased supply) will raise the price of natural gas over time, eliminate any losses currently incurred by producers, and the market will move towards a natural market-clearing equilibrium that eliminates the current "oversupply."

I agree, but not sure about "eliminate any losses currently incurred by producers."

Some current producers will lose money and will lose money even even at higher prices. That's fine---no one is guaranteed a return on investment.

It may also come to pass that even better drilling techniques for natural gas are developed (globally, remember?), resulting in even lower natural gas prices, and many of the current producers will lose money and declare bankruptcy.

That's fine too.

I hope for everyone who risks capital, either as equity or lenders, makes money. But in free markets, you gotta roll with the punches.

If you want gushers of money permanently, go to the Department of Defense.

 
At 12/31/2011 12:25 PM, Blogger rjs said...

both iran & venezuela have announced their largest gas finds ever in the past month...looks like the gas glut is here to stay..

 
At 12/31/2011 10:17 PM, Blogger VangelV said...

Overall, the fact that the shale gas industry is "becoming a victim of its own success" is only a temporary "problem," and demonstrates that the price system and competitive market forces are working as expected: an abundant supply of natural gas leads to falling prices, which lowers the profits of producers, which then leads to automatic, self-correcting adjustments and responses as the natural gas market moves towards a new equilibrium.

There wasn't any real success. While there was profit to be made by drilling core areas when service companies in need of business were operating at low margins and prices for gas were high the energy return on the energy invested is negative for the non-core areas of most shale formations.

The value for producers comes from the ability to guess at reserves and the accounting rules that allow acquiring majors to hide their reserve declines by using a 6:1 ratio that is based on BTU content instead of the more than 20:1 price ratio. But this game only lasts for a while. Once the bubble bursts and the funding gaps can't be closed by easy financing or equity issues the shale production will collapse as depletion takes over.

This is a huge scam that is diverting attention from the real problem in the energy sector. We need to deal with the peak of conventional oil production in a meaningful way. When we hype non-solutions like shale we only allow the government more freedom to use regulations to harm coal producers and deep water drillers.

I would feel more comfortable drilling for gas in places like Mexico and Iran because we know that large gas fields should be there. The reason why we ignored them before was the lack of a market. But we will need that energy sooner rather than later because shale is clearly not an answer.

 
At 1/01/2012 10:15 AM, Blogger Hydra said...

both iran & venezuela have announced their largest gas finds ever in the past month...looks like the gas glut is here to stay..

+++++++++++++++++

Natural gas is hard to ship without pipelines. Cryogentic natural gas ports are hard to site, due to safety concerns.

I believe there are only ten or twelve in the US, most in LA and Texas

 
At 1/01/2012 10:27 AM, Blogger Hydra said...

the energy return on the energy invested is negative for the non-core areas of most shale formations

++++++++++++++++++++++++++++

You could use wind or solar to generate the energy you need to pressurize the fracturing fluid and the gas transmission lines. This is a use in which the intermittent nature of the sources might not make much difference.

Likewise, one could use cheap coal power to develop valuable cas sources, but either method is going tomake the gas a lot more expensive.

-------------------------------

Most of the energy used in producing wind or solar power is embedded energy used in the manufacture of steel and solar cells. As the cost of energy goes up, so does the cost of manufacturing alternatives.

An interesting theoretical question is how the energy return on energy invested works out for wind and solar installations.

One would have to guess that the energy return is not good since the price of wind and solar is so high, but that might not be the case if much of the cost of the installations is caused by things other than the manufacture of componenents (and travel involved n maintenanance).

 
At 1/01/2012 10:28 AM, Blogger Hydra said...

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