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.
