Monday, June 25, 2012

The Arithmetic of Shale Gas: Consumer Surplus from Technology of Shale Gas Exceed $100 Billion

It's been well-documented now that falling prices for natural gas (see chart above) and the resulting drop in utility rates have saved consumers billions of dollars (see CD posts here and here).

A new study by researchers at Yale University, "The Arithmetic of Shale Gas," provides some additional evidence of the consumer benefits of shale gas using a cost-benefit approach (where consumers include residential, industrial, commercial and utilities) here's an excerpt:

"The Henry Hub spot price in 2008 was $7.97 per mcf and in 2011 was $3.95 per mcf (see chart above) so that the difference in price over three successive years was $4.02 per mcf. Gas production in 2008 was 25.6 tcf so that the surplus to consumers by the price reduction from shale gas equaled $102.9 billion.

This very large amount of consumer gain—over $100 billion—from the new technology induced price reduction in gas is the elephant in the room. It comprised a substantial majority of total expenditures on this fuel nationwide. In past years those expenditures were limited by the higher costs of production of gas produced from vertical wells. These were in part producer surplus but most were the costs of sustaining well operations in the old technology. Even so it is startling to acknowledge that consumer benefits from the technology of shale gas drilling and new gas production can be expected to exceed $100 billion per year, year in and year out as long as present production rates are maintained."

The authors then account for the possible environmental costs to society and compare that to the consumer-savings of $100 billion per year:

"How then do we extrapolate individual disaster scenarios across an entire industry to determine the social cost of possible contamination from fracking in order to deduct it from the consumer surplus of $100 billion for each year? We consider that the reported instances of contamination from fracking relate, at most, to an extremely limited minority over hundreds of thousands of wells. Assuming the worst—that the accidents occur in one year; that the cleanup requires a new water well at $5,000; and that one hundred spills occur at $2.5 million per spill given then that the industry drills 10,000 new wells per year. The cost of frackwater contamination is $250 million. Economic benefits, as estimated in as limited methodology as is reasonable, exceed costs to the community by 400-to-1."

And they also estimate the consumer benefits of switching from oil to natural gas:

Replacing 1.0 million bbls per day of crude oil with the 6 billion cubic feet (bcf”) equivalent of natural gas, would generate approximately $25.6 billion ($70/bbl*1 million bbls*365 days) of consumer surplus for the US economy over one year." 

Note: There are also gains to shale gas producers from increased production, and while those are less than the gains to gas consumers, they are significant and are estimated be multi-billions of dollars per year.

Here's a Forbes article that summarizes some of the key findings of the Yale study. 

49 Comments:

At 6/25/2012 10:24 AM, Blogger Jon Murphy said...

That is one Hell of stimulus package

 
At 6/25/2012 10:49 AM, Blogger VangelV said...

First, didn't you post data that showed that 'consumers' were seeing only minor reductions in cost as their price only declined from around $14 per Mcf to $12 per Mcf? Most of the savings came from a fall in demand thanks to a warm winter, not a material drop in prices.

Second, the only way you will see a benefit is if prices stay low. But we have already seen a collapse in drilling activity because there is no way for producers to make a profit from tight gas in shale formations.

From what I can tell you are projecting a price decline even though the producers cannot make money from their activities. This is not an economic theory that I am familiar with so I would appreciate something that explains how this can happen.

 
At 6/25/2012 11:00 AM, Blogger Jon Murphy said...

First, didn't you post data that showed that 'consumers' were seeing only minor reductions in cost as their price only declined from around $14 per Mcf to $12 per Mcf?

True, but those savings account for about 5%, or just under $17B.

Second, the only way you will see a benefit is if prices stay low.

They certainly will stay below the peak in 2008. Probably will rise from their historically low levels now (no one is expecting the price to stay sub $3), but a range of mid $3-$5 is likely to be the new norm

 
At 6/25/2012 11:08 AM, Blogger Mark J. Perry said...

Residential gas prices have fallen from a monthly peak of almost $21 in 2008, to now below $10. On an average annual basis, residential prices fell by more than 22% between 2008 and 2011, from $13.89 to $10.80. Source: EIA

Note also in the Yale study, the marginal cost of production for producers is about $1.17 per mcf, and that includes production taxes.

 
At 6/25/2012 11:13 AM, Blogger Buddy R Pacifico said...

On consumer savings:

Most of the new electrical generating facilities (80%) will be powered by nat gas -- lower cost electricity in the future.

 
At 6/25/2012 11:17 AM, Blogger Hell_Is_Like_Newark said...

I went from paying about $1.75 per therm in 2008 to about $1.00 now. That is a pretty big drop.

My electrical rates, thanks to these idiotic green power programs, went up to about $0.18 per kWh.

It is now cheaper to generate my own electricity than to buy it from the grid.

 
At 6/25/2012 12:24 PM, Blogger juandos said...

Apparently even James Lovelock sees the upsides of shale gas...:-)

 
At 6/25/2012 2:49 PM, Blogger Rufus II said...

Feb production was down from Jan, and Mar production was down from Feb. April will be out in a couple of days.

You boys are in for a hell of a surprise along about February.

 
At 6/25/2012 2:58 PM, Blogger Rufus II said...

Marketed Production was

69,195 Billion cuft/day in Jan.

68,480 Billion cuft/day in Feb.

68,232 Billion cuft/day in Mar

EIA

 
At 6/25/2012 3:01 PM, Blogger Jon Murphy said...

This comment has been removed by the author.

 
At 6/25/2012 3:06 PM, Blogger Jon Murphy said...

Feb production was down from Jan, and Mar production was down from Feb. April will be out in a couple of days.

Yes, but production usually falls month to month during that period. On median, February production is 0.6% below January, and March is 0.8% below February, so the fact that production did fall tells us nothing. I would not be surprised if April's number is lower than March (historically, April tends to come in about 1.3% below March)

Some numbers to consider:

January production was 8.8% above January 2011.

February production was 9.4% above February 2011.

March production was 4.7% above March 2011.

Production for the first quarter was 7.6% above the same quarter last year.

Annual production (the 12 months ending in March) was 8.2% above last year and at a record level.

Now, Production will likely grow at a slower pace in the near term. Firms are shifting production away from NatGas and towards oil. Given the prices, I don't blame them. But right now, there is hardly anything unusual going on in natural gas extraction. We are currently in the seasonal decline period for NatGas extraction, so I really would avoid reading into the monthly numbers to shallowly. The mere fact that a monthly number is rising or falling, outside of context, is pretty useless.

Source: FRB G17 monthly release. NAICS: 2111111

 
At 6/25/2012 3:16 PM, Blogger ccsmith said...

Feb production was down from Jan, and Mar production was down from Feb. April will be out in a couple of days

EIA constantly revises production numbers. Six weeks ago, Jan, Feb, and Mar showed month-over-month increases in production, instead of decreases. These numbers won't be "final" for another couple of years.

 
At 6/25/2012 3:26 PM, Blogger Rufus II said...

No, Jon, if you'll click on my EIA link, and click on history you'll find that you have to go all the way back to 1999 to find a March that was only an itty bit below Jan (0.129 billion cuft/day.)

*Don't forget to divide the Feb Number by 29.

 
At 6/25/2012 3:44 PM, Blogger Jon Murphy said...

Rufus:

I don't like EIA. It's revised constantly, really out of date, and generally unreliable. That's why I am focusing on FRB data. It is still revised, but tends to be more current. Plus, EIA uses seasonally adjusted data, which is a whole other can of worms. I like the FRB NSA numbers.

Also, I am not a fan of the per-day numbers. Much too volatile. Monthly numbers, historically, are better indicators of overall activity than per day numbers.

 
At 6/25/2012 4:10 PM, Blogger VangelV said...

They certainly will stay below the peak in 2008. Probably will rise from their historically low levels now (no one is expecting the price to stay sub $3), but a range of mid $3-$5 is likely to be the new norm

Given the fact that all in the break-even cost for shale gas is around $7.50 I doubt that you will see a range of $3-$5. And if you take shale gas out of the picture prices will head much higher.

Keep in mind the depletion problem. The current costs for shale will not go much lower but are likely to head much higher. The reason is the rapid depletion from the core areas, which is where the $7.50 figure comes from. As marginal areas are drilled you will need much higher costs to break even.

 
At 6/25/2012 4:10 PM, Blogger Jon Murphy said...

By the way, Rufus:

If you'd like, I can run the EIA numbers and see what we get as far as seasonality, month-to-month changes, etc.

 
At 6/25/2012 4:12 PM, Blogger Jon Murphy said...

Given the fact that all in the break-even cost for shale gas is around $7.50 I doubt that you will see a range of $3-$5.

$7.50 is a long way off (if ever). Not likely going to reach that anytime in the foreseeable future. Companies will either have to adapt or go bankrupt. And the companies I've talked to have adapted.

 
At 6/25/2012 4:14 PM, Blogger VangelV said...

On an average annual basis, residential prices fell by more than 22% between 2008 and 2011, from $13.89 to $10.80. Source: EIA

That is not a big drop over 3 years when the spot price has fallen by 75%.

Note also in the Yale study, the marginal cost of production for producers is about $1.17 per mcf, and that includes production taxes.

They must be listening to different conference calls that that ones I sit in on. If the cost was $1.17 per mcf the shale producers would not be cutting their drilling activities and talk about funding gaps and asset sales. Perhaps these 'studies' don't include leasing costs, exploration, drilling, depletion, etc. I suggest that when the numbers are that far off you need to really examine them to figure out just what it is that they are talking about.

 
At 6/25/2012 4:19 PM, Blogger VangelV said...

Most of the new electrical generating facilities (80%) will be powered by nat gas -- lower cost electricity in the future.

That is not what the futures markets are saying. The PJM ELECTRICITY (MONTHLY) Jun 2016 is selling for $49.88. That is 45% higher than the PJM ELECTRICITY (MONTHLY) Jun 2012 contract.

 
At 6/25/2012 4:32 PM, Blogger ccsmith said...

On an average annual basis, residential prices fell by more than 22% between 2008 and 2011, from $13.89 to $10.80. Source: EIA

That is not a big drop over 3 years when the spot price has fallen by 75%.


This is because residential prices consist mostly of utility charges (distribution, administrative costs, metering), and not spot prices.

That is not what the futures markets are saying. The PJM ELECTRICITY (MONTHLY) Jun 2016 is selling for $49.88. That is 45% higher than the PJM ELECTRICITY (MONTHLY) Jun 2012 contract.

"Futures" prices are not reliable forecasts of future spot prices. They represent the current price of energy supplies that will be delivered in the future, nothing more.

 
At 6/25/2012 4:39 PM, Blogger Rufus II said...

Jon, I'm predicting the YOY Numbers will go Negative in June (if not in May.)

Come on, do you guys really think that "production" can hold up (especially in rapidly-declining fracked wells) when all the drillers are leaving? really?

 
At 6/25/2012 4:47 PM, Blogger VangelV said...

January production was 8.8% above January 2011.

February production was 9.4% above February 2011.

March production was 4.7% above March 2011.

Production for the first quarter was 7.6% above the same quarter last year.


I am sorry but given the depletion rates and the collapse in rigs drilling for gas there is no way to spin this in a way that would support the narrative that Mark has been selling. Now if we do have some Gulf area wells coming online we could see the levels hold up but it is clear that the shale gas contribution is going down.

Now, Production will likely grow at a slower pace in the near term. Firms are shifting production away from NatGas and towards oil. Given the prices, I don't blame them. But right now, there is hardly anything unusual going on in natural gas extraction. We are currently in the seasonal decline period for NatGas extraction, so I really would avoid reading into the monthly numbers to shallowly. The mere fact that a monthly number is rising or falling, outside of context, is pretty useless.

Nothing unusual? The producers in the shale sector were counting on $8 gas, not sub $3 gas. They are bleeding red ink on operations and have huge funding gaps that need to be closed. Their debt is exploding and they are cutting back on drilling. I would not call that normal.

 
At 6/25/2012 4:50 PM, Blogger VangelV said...

$7.50 is a long way off (if ever). Not likely going to reach that anytime in the foreseeable future. Companies will either have to adapt or go bankrupt. And the companies I've talked to have adapted.

Talk is cheap. I like to look at the balance sheets and the cash flow statements. They suggest that companies have not adapted to the lower prices because their costs are still much higher than the spot price.

 
At 6/25/2012 4:51 PM, Blogger VangelV said...

"Futures" prices are not reliable forecasts of future spot prices. They represent the current price of energy supplies that will be delivered in the future, nothing more.

They are a much better indicator than a wild guess made by people who have obviously missed some of the serious problems facing the gas producers and don't understand the scale.

 
At 6/25/2012 4:53 PM, Blogger VangelV said...

Come on, do you guys really think that "production" can hold up (especially in rapidly-declining fracked wells) when all the drillers are leaving? really?

That is what Mark has been suggesting. If you read the comments you find that more agree with him than with you and me.

 
At 6/25/2012 5:22 PM, Blogger Rufus II said...

We are Not in some sort of "seasonal" decline. You have to go all the way back to 1999 to find a March number that is not larger than the Jan Number.

 
At 6/25/2012 8:54 PM, Blogger Benjamin said...

Love the shale gas and oil.

Save $100 billion? All for it.

Of course, we could save $100 billion by cutting defense-homeland security-VA outlays by 10 percent.

 
At 6/26/2012 2:57 AM, Blogger Flickr Explorer said...

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At 6/26/2012 6:15 AM, Blogger marmico said...

I guess the cement guy at Lafarge would have no pecuniary interest in pumping shale gas, eh!

2008 marketed production was 21.1 tcf lowering consumer expenditures by $85 billion not $102 billion.

A typical gas royalty is one 6th so somebody on the producer side saw lower income of $14 billion.

State revenue collections on production have declined in the face of lower well head prices. The aggregate amount is unknown but Wyoming, which represents about 10% of domestic production, loses $113 million per year per dollar decline in gas well head prices.

The producers sell forward an unknown amount of production such that income is lower for both producers and investors on the other side of the trade.

Just a start to articulate the non environmental costs.

Three reasons why production is holding up as the rig count declines. The producers are drilling the "sweet spots"; there is a lag between drilling and well completions; and associated gas from increased oil production.

 
At 6/26/2012 6:36 AM, Blogger Jon Murphy said...

The producers in the shale sector were counting on $8 gas, not sub $3 gas. They are bleeding red ink on operations and have huge funding gaps that need to be closed. Their debt is exploding and they are cutting back on drilling. I would not call that normal.

None of that is true.

We are Not in some sort of "seasonal" decline.

Yes we are, according to the far more reliable FRB data.

Talk is cheap. I like to look at the balance sheets and the cash flow statements. They suggest that companies have not adapted to the lower prices because their costs are still much higher than the spot price..

Many of the smaller guys have. Few are facing financial issues. This is how markets work. The ones that cannot adjust to this will go bankrupt. The smaller, more nimble companies have already. The behemoths, not so much. This is how monopolies die a natural death in a free market. I never picked you, Vangel, as a market protectionist.

 
At 6/26/2012 7:01 AM, Blogger Jon Murphy said...

Now, could production fall going forward? All things considered, it certainly is a possibility. But that doesn't mean an immediate large jump in prices, either. We still have a large glut of natural gas in this country, which will keep prices down going forward. Considering the relevant economic indicators, I would be greatly surprised if average annual prices break the $4 barrier in the next two years.

 
At 6/26/2012 7:09 AM, Blogger VangelV said...

None of that is true.

That is what the producers have been saying. They can't make money at $5 and have to keep adding debt in order to keep drilling. The cash flow statements show that even after years of drilling and producing the producers are still unable to self finance. And with the rig counts falling the fact that the sweet spots of new formations are being developed will not offset the depletion. Production volumes from shale are falling and will continue to fall.

I think that you are getting sucked in with the aggregate numbers and fail to see the true picture. The average shale producer is losing money not because of some problem with operational efficiency when compared to the 'best' in the industry but because the shale areas being drilled do not have enough gas to make a profit. As Art Berman showed, the EURs are much lower than what the companies assumed and cannot be supported by the actual production data. This does not mean that shale gas is not profitable in the core areas of the better formation. It is very possible for a company that stuck to those to make a few bucks for a short period of time. But over the long term there isn't enough gas in the core areas to make a meaningful difference and support the kind of activity that Mark is touting. Over the long run prices have to go up above the cost of production in order to have any sustainable production activity. That means $8 gas, not $3-$5, if you count the lease costs, exploration costs, royalties, etc.

 
At 6/26/2012 7:17 AM, Blogger VangelV said...

Yes we are, according to the far more reliable FRB data.

Reliable FRB data. That is a good one.

Many of the smaller guys have. Few are facing financial issues. This is how markets work. The ones that cannot adjust to this will go bankrupt. The smaller, more nimble companies have already. The behemoths, not so much. This is how monopolies die a natural death in a free market. I never picked you, Vangel, as a market protectionist.

I have already said that if you are a smaller player and operating in the core areas you can make a buck. That is not because of efficiency but because you are in the right area. The problem is that you cannot keep production up unless you drill more wells and the core areas are very small. That means that the scenario that Mark is touting is not remotely plausible.

And I suggest that you rethink some of your assumptions. The 'smaller' companies have trouble competing for drills when the market is tight because the larger players, who have more money to throw around, get first dibs. If they are getting drills it means that demand for oil services in the gas sector is weakening.

 
At 6/26/2012 7:19 AM, Blogger marmico said...

Yes we are, according to the far more reliable FRB data.

What, Bernanke moonlights as a gas meter counter. The recent data is here. The last data point is March, just like the EIA. The EIA will report April data before the FRB.

The issue is the second derivative.

 
At 6/26/2012 7:44 AM, Blogger VangelV said...

Now, could production fall going forward? All things considered, it certainly is a possibility.

Given the drilling activity it is a given unless there is a large Gulf field coming on-line. The shale sector will show declines over the next year.

But that doesn't mean an immediate large jump in prices, either.

True. A declining economy could put downward pressures on gas prices. But that would also force most of the shale gas industry into bankruptcy, which means a much faster decline in production in the future.

We still have a large glut of natural gas in this country, which will keep prices down going forward.

A cool summer and warm winter could keep supplies high. But if you get a decline in production because of lower drilling activity and you get a hot summer and/or a cold winter you could be up to $8 gas very quickly. Keep in mind that the move away from coal could increase demand even as the economy weakens sharply. The problem for the shale producers is that the only way that they will be able to borrow consistently is by selling forward gas at well above $12 because they still have to deal with the massive debts that they have accumulated over the past three years.

Considering the relevant economic indicators, I would be greatly surprised if average annual prices break the $4 barrier in the next two years.

If that is the case you will see 75% of the shale gas drillers out of business.

 
At 6/26/2012 8:39 AM, Blogger Jon Murphy said...

That is what the producers have been saying. They can't make money at $5 and have to keep adding debt in order to keep drilling.

I have no clue what producers you have been talking to, but they aren't the ones I have been.

Reliable FRB data. That is a good one.

It's revised a lot less often (or as significantly) as EIA.

True. A declining economy could put downward pressures on gas prices

Too bad that's not the case. And don't give me any of this "massive inflation" or "government manipulation of the data for political reasons" paranoid bullshit.

Admit it, YOU ARE WRONG. There is NO DATA to support you. None. All you have is paranoid ramblings and phantom inflation. Vangel, you are often right on many things, but this is not one of them. Sorry.

 
At 6/26/2012 8:42 AM, Blogger marmico said...

It's revised a lot less often (or as significantly) as EIA.

Prove it!

 
At 6/26/2012 10:07 AM, Blogger VangelV said...

I have no clue what producers you have been talking to, but they aren't the ones I have been.

Look at the 10-Ks and pay attention to the debt on the balance sheets and cash flow statements. It is all there. And let us point out that when prices of gas were higher and the rush to lease properties began the companies were clearly talking about $6.50 - $9.00 being the break even point. Good old Aubrey made it clear that for his company, which was the biggest and best in the sector he needed $7.50. It was only after gas prices fell that the costs failed to include the lease costs, overhead, and proper depreciation. The trick was to use high EURs that could not be justified by the real time production data. But that trick could not change the cash flow reality and to stay in business the companies had to add massive amounts of debt on their balance sheets. No matter what the 'talk' this shows up on the balance sheets.

It's revised a lot less often (or as significantly) as EIA.

So what? The FRB is not very good at collecting any data. It relies on data that is gathered by others and often selects information that supports its narrative with little regard for the reality.

 
At 6/26/2012 10:09 AM, Blogger VangelV said...

Too bad that's not the case. And don't give me any of this "massive inflation" or "government manipulation of the data for political reasons" paranoid bullshit.

Admit it, YOU ARE WRONG. There is NO DATA to support you. None. All you have is paranoid ramblings and phantom inflation. Vangel, you are often right on many things, but this is not one of them. Sorry.


The pre-Boskin calculations support exactly what I have been saying.

http://www.shadowstats.com/alternate_data/inflation-charts

http://www.shadowstats.com/alternate_data/unemployment-charts

http://www.shadowstats.com/alternate_data/gross-domestic-product-charts

http://www.shadowstats.com/alternate_data/dollar-index-charts

 
At 6/26/2012 12:23 PM, Blogger bart said...

That is not a big drop over 3 years when the spot price has fallen by 75%.

Amen... and how much is it up over the last decade or three?

I can already hear the blindered inflation lies deniers. -g-



Peak cheap oil is alive and well, in spite of temporary drops mostly caused by a sick world economy.

 
At 6/26/2012 12:28 PM, Blogger bart said...

The pre-Boskin calculations support exactly what I have been saying.

http://www.shadowstats.com/alternate_data/inflation-charts

http://www.shadowstats.com/alternate_data/unemployment-charts

http://www.shadowstats.com/alternate_data/gross-domestic-product-charts

http://www.shadowstats.com/alternate_data/dollar-index-charts




I hear crickets...

 
At 6/27/2012 8:09 PM, Blogger Hydra said...

Replacing 1.0 million bbls per day of crude oil with the 6 billion cubic feet (bcf”) equivalent of natural gas,


==============================

If only it was that easy. Natural gas and liquid petroleum have substantially different uses. some liquid petroleum will be replaced, but it won;t be cheap to convert.

 
At 6/27/2012 8:50 PM, Blogger Hydra said...

This Week In Natural Gas Leaks and Explosions – April 23, 2012

http://www.naturalgaswatch.org/?p=1360

 
At 6/28/2012 4:49 AM, Blogger VangelV said...

This Week In Natural Gas Leaks and Explosions – April 23, 2012

http://www.naturalgaswatch.org/?p=1360


What do these sites suggest that consumers use instead of gas? Perhaps we need to go back to cutting down trees and burning them to get our heat. Or do they expect that the pipelines are over-designed even more than they are already and have consumers pay even more for their gas than they already do?

 
At 6/28/2012 12:44 PM, Blogger Ron H. said...

"What do these sites suggest that consumers use instead of gas? Perhaps we need to go back to cutting down trees and burning them to get our heat."

TREES! Are you kidding? Bite your tongue. Animal dung, perhaps.

 
At 6/28/2012 4:21 PM, Blogger Ron H. said...

""What do these sites suggest that consumers use instead of gas?:"

Oh, those sites don't have any suggestions, they just point out problems.

 
At 6/28/2012 4:41 PM, Blogger bart said...

Oh, those sites don't have any suggestions, they just point out problems.

How's the research going on capturing and using hot air from them, D.C, Brussels etc?

 
At 6/28/2012 5:56 PM, Blogger Ron H. said...

"How's the research going on capturing and using hot air from them, D.C, Brussels etc?"

Well, not so good. While the hot air is easy to identify, and there's vast quantities of it, it's nearly impossible to pin down, just like the teflon(R) coated folks who emit it.

 
At 9/13/2012 8:19 PM, Blogger garywacker said...

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