Musings: Natural Gas Is So 2010; Now It's All About Liquids-rich Shale

Musings: Natural Gas Is So 2010; Now It's All About Liquids-rich Shale

Tuesday, April 26, 2011

Parks Paton Hoepfl & Brown

by G. Allen Brooks

Last week the Baker Hughes U.S. active drilling rig count hit 1,800, up 1.6% from the prior week and up 21.5% over the past year. These were notable achievements. The increases reflect the exploration and development fever that is gripping oil and gas companies. This should be good news for the country's oilfield service industry, but maybe even better news for consumers as the increased drilling should lead to higher oil and gas production, and maybe lower fuel prices. More production means the nation's economy need not import as much oil and gas from abroad, which could have a significant impact on our balance of trade and payments, and the value of the dollar.

The most notable bit of data about last week's rig count was that for the first time in nearly 16 years, the oil and gas industry is employing more rigs targeting crude oil prospects (913 rigs) than drilling for natural gas wells (878 rigs). Analysts and investors, keen to see higher natural gas prices, have seized on this switch in drilling focus as a signal that future gas production will soon stop climbing. Assuming that the nation's natural gas consumption continues to rise, the drilling switch portends a shrinking of the oversupply of natural gas. That should mean higher natural gas prices – the only question is when.

Those E&P companies that are leading the charge into the gas shale plays around the country will be happy to see higher natural gas prices. They continue to claim that they can be profitable drilling these gas shale plays at natural gas prices in the $4.00 to $5.00 per thousand cubic feet (Mcf) of gas. Their financial results suggest something different. They still proclaim the success of the gas shale revolution, a movement that is beginning to spread globally.

Slightly over two weeks ago, the Energy Information Administration (EIA) released an analysis of gas shale resources around the world. It was clear from the report that the EIA believes the domestic gas shale revolution will be embraced globally. The EIA report estimates that 32 countries with known gas shale resources have added 5,760 trillion cubic feet (Tcf) of technically recoverable natural gas to the world's resources. With the addition of the U.S. gas shale resources, the global total would swell to 6,622Tcf. For comparison purposes, the world's proven natural gas reserves as of January 1, 2010, were 6,609Tcf. The world's total technically recoverable gas resources were 16,000Tcf as of the beginning of 2010, so with the new gas shale resources added in, the world now has over 22,000Tcf of gas resources.

The 32 countries with gas shale resources span the world and are likely to become energy-headline locations before long. Most people are familiar with the gas shale drilling underway in Poland and China, but those are only two of the 32 countries that span the globe. China leads the world with an estimated 1,275Tcf of gas shale resources. In Europe, Poland is in first place with an estimated 1,867Tcf of potential reserves, followed closely by France with 180Tcf. Interestingly, France has announced it is considering banning the drilling of gas shale wells until a study of possible water pollution problems associated with hydraulic fracturing are investigated and proven false. Equally surprisingly is that Norway has nearly half the gas shale resources of Poland and France.

Exhibit 1.  Gas Shales Located Around The World

Source:  EIA

In South America, Argentina is highly prospective with nearly 90% of the total gas shale resources estimated to be in the United States. Brazil has about a third of the resources of Argentina with most of the potential resources located in the area close to some of the key manufacturing sites in the country. Surprisingly, Mexico has a huge potential with almost 80% of the estimated United States gas shale resources.

In Africa, the greatest potential source of natural gas from shales lies in South Africa, which has an estimated 485Tcf of resources. Libya, the site of the current civil war involving the country's crude oil reserves and production, has an estimated 290Tcf of gas shale resources. Algeria follows with nearly 80% of Libya's estimate.

While the world has lots of gas shale resource potential, it is in North America, and primarily the United States, where the gas shale revolution is in high gear producing substantial volumes of new gas production. According to the EIA, 2010's 4.87Tcf of gas shale production represents about 23% of total U.S. output, but it is projected to account for 45% of the nation's gas supply by 2035. The huge potential of gas shales in this country was first highlighted by the 2009 report of the Potential Gas Committee (PGC) at the Colorado School of Mines. In that report, the PGC estimated that there was about 616Tcf of gas shale resource, or about a third of the country's total resource potential.

Recently, Ken Medlock, a professor at Rice University, delivered a presentation about the gas shale industry at the American Association of Petroleum Geologists (AAPG) annual meeting. In his presentation he listed a timeline of potential gas shale resource estimates beginning with the 2003 National Petroleum Council estimate of 38Tcf. Two years later the estimate was raised to 140 Tcf and then in 2008 Navigant, a consulting company, estimated there was 520Tcf of potential reserves. The next year came the PGC estimate of 616Tcf and last year, consultant ARI estimated gas shale resources of more than 1,000Tcf. Mr. Medlock said there is a Department of Energy study underway with a May release date that will contain an estimate greater than ARI's estimate, likely putting it close to China's estimated 1,275Tcf of potential reserves.

All this potential gas has led politicians, investment professionals and E&P company executives to announce that the United States has in excess of 100 years of natural gas supply. In his presentation at the AARP, Art Berman showed that by reading the PGC report it becomes clear that gas shale reserves will likely only supply about 20 years of demand at the current 23Tcf of annual consumption.

Mr. Berman's pricking of the gas shale 100-year supply bubble should be having a greater impact, but instead the air is barely slipping out of the balloon. In fact, President Barack Obama has endorsed the huge potential gas supply mantra. In a recent presentation about the nation's energy situation, President Obama said, "We have a lot of natural gas here in this county." In doing so, however, he touched on the key issue now swirling around the gas shale revolution, which is the use of hydraulic fracturing to release the trapped gas from the formation President Obama's observation was, "The problem is…extracting it [shale gas] from the ground. The technologies aren't as developed as we'd like and so there are some concerns that it might create pollution in our groundwater, for

Exhibit 2.  Gas Shale Reserves Less Than 100 Years

Source:  Art Berman

Musings: Are Prospects for Natural Gas Shifting to The Plus Column?

Musings: Are Prospects for Natural Gas Shifting to The Plus Column?

Wednesday, April 13, 2011
Parks Paton Hoepfl & Brown
by G. Allen Brooks

"In terms of new sources of energy, we have a few different options. The first is natural gas." These were the words of President Obama in his remarks entitled A Secure Energy Future, delivered on March 30th at Georgetown University. For being the first of various energy fuel options, however, natural gas received precious little additional mention during the President's comments other than his view that "recent innovations" have given the United States "the opportunity to tap large reserves – perhaps a century's worth." Even the leader of the country has bought into the mystique of the super abundance of natural gas from shale that appears to be ubiquitous throughout North America.

The President cautioned his listeners, though, that the government needs to make sure that the oil and gas industry is tapping these shale reserves "without polluting our water supply," a bone thrown in the direction of environmentalists who seem to be losing in their efforts to restrict the burning of fossil fuels. In his comments, President Obama said he was asking Secretary of Energy Steven Chu to work with other federal agencies, various state governments, environmental specialists and the natural gas industry to "improve the safety of this process [hydraulic fracturing of gas shale formations]." President Obama made a point of mentioning that Secretary Chu has a Nobel Prize for physics. According to the President, "He likes to tinker on this stuff in his garage on the weekend." We're not sure whether that comment was to compare Secretary Chu to Bill Hewlett and David Packer who created a technology and commercial powerhouse company or to Christopher Lloyd who played Dr. Emmett "Doc" Brown in the 1985 film, Back to the Future. We must say we haven't met many physicists tinkering in the domestic oil and gas industry.

There appears to be a sort of Dr. Jekyll and Mr. Hyde outlook for natural gas. Recognized as a lower carbon, i.e., cleaner, alternative fuel choice that possesses significant energy and provides consumption flexibility to meet the multiple energy demands of modern society, natural gas should be in high demand. That demand should be further boosted by its current low price – the product of significant new supplies of gas and declines in energy markets needing it. The problem is that the financial crisis of 2008 has produced one of the most anemic economic recoveries since the Great Depression. The economic downturn and weak recovery has reduced energy demand. This, coupled with government mandates for increased use of renewable fuels in the utility sector, has created increased fuel-on-fuel price competition, in particular for coal and natural gas. But the real culprit has been the growth in supplies of new natural gas.

Exhibit 1.  Oil Prices Boosted By Geopolitical Problems

Source:  EIA, PPHB

At the same time gas prices were collapsing, explosive oil demand in the developing economies of the world, principally in Asia/Pacific, combined with geopolitical turmoil have driven oil prices significantly higher than where they would likely be absent the civil unrest in the Middle East and North Africa. As it appears, the political problems in Libya, and now Syria and Yemen, are not improving quickly and, in fact, could actually spread to additional Middle Eastern countries. The upward pressure on global oil prices is likely to increase in the near-term.

The price divergence between crude oil and natural gas has produced a profoundly distorted relative valuation of these fuels. The energy content of natural gas to crude oil is 5.6 to 1.0, or six to one for ease of figuring. The current West Texas Intermediate (WTI)

Exhibit 2.  Oil Trading At 25-times Gas Value

Source:  EIA, PPHB

crude oil price of about $112 per barrel suggests that a thousand cubic feet (Mcf) of natural gas should be valued at roughly $20.  Instead, the ratio of the price of crude oil to natural gas has expanded to about 25-times. As can be seen in the chart in Exhibit 2, between 2005 and 2008, this ratio averaged around 10-times. Since the beginning of 2009, the ratio has increased to an average of about 20-times. Given the run-up in crude oil prices and the prospect of only modest increases in natural gas demand, the oil to gas ratio is now moving closer to an average of 25-times. At some point the ratio will reverse. The question is what will have to happen before that trend reverses?

Most natural gas industry observers have focused on two trends in trying to understand market sentiment – the gas-directed rig count and the monthly gas production figures. The gas rig count is reported weekly by several sources and is being sliced and diced regularly by analysts trying to discern early movements in activity that may foreshadow declines in gas production, which presumably would lead to higher natural gas prices in the future. The problem is trying to ascertain how long in the future before gas prices might rise.