Debunking the myth of almost unlimited natural gas

With the development of shale gas wells, many consumers got the impression that our nation’s supply of natural gas is almost unlimited. But now that the price of natural gas is below the cost of production, output is going down, and that does not bode well for consumers.

After skidding below $2 per million Btu this winter, wholesale natural gas prices are now creeping toward the $3 mark. This upward movement is the result of below-normal volumes of natural gas going into storage for the winter heating season. The latest report, released Aug. 16, marks the 16th straight week where injection volumes lagged significantly behind the five-year average.

Notwithstanding this mild rebound, everyone in the energy industry, including the traders themselves, knows that $3 per MMBtu (million British thermal units) is well below the cost of producing natural gas, and cannot deliver a return that can support future drilling efforts. This is particularly true with shale gas, the so-called “game-changer” that industry flacks contended would topple King Coal’s reign over the electricity sector.

High-profile shale gas producers like Chesapeake Energy are now running out of ways of concealing their financial distress. Consider the following recent developments:

• Chesapeake Energy announced plans to reduce domestic gas production in 2013 by 8 percent.

• BHP Billiton wrote down $2.84 billion on the value of Fayetteville shale gas assets it had acquired in 2011.

• The most recent count of rigs drilling for natural gas in the United States is 495, down 70 percent from the record-setting levels seen in September 2008.

“Wrote down” is a fairly bloodless way to describe the loss of $3 billion; “carnage” is better at conveying the pain that now grips the natural gas sector. This begs the question: Why are wholesale natural gas prices still under the $3 per MMBtu level?

I believe that there are two reasons for this phenomenon. The first is that energy traders, like virtually everyone else in this country, are truly convinced that the United States is awash in shale gas, thanks to a brilliant industry-led public relations campaign. Lower prices help reinforce the popular belief that cheap gas will be with us for another century. Unfortunately, federal energy agencies and universities have also bought into this view of the supply picture big-time, leaving little room for skeptics and agnostics to influence public perceptions.

This overarching belief has been unintentionally reinforced by local and regional controversies over the practice of hydraulic fracturing solid rock to obtain the shale gas trapped inside. Virtually unheard of four years ago, “fracking” has vaulted into the public consciousness, and in doing so, sustains the society-wide belief that natural gas can be accessed almost anywhere in the United States.

Ironically, the myth of abundance that companies so carefully cultivated — and bankrolled — is now clearly working against their short-term interests.

The other factor that keeps prices so low is the traders’ fear of large demand swings. For example, the phantom winter of 2011-2012, which cut demand for heating fuel by more than 25 percent, creating a colossal oversupply that sent wholesale prices crashing. The supply pendulum is now swinging the other way, and more than half of the bulge has melted away. Assuming a continuation of smaller-than-normal injections, natural gas inventories should be in line with the five-year average by mid-December.

Traders attribute the ongoing reduction in inventories to a hotter than normal summer, prompting utilities to switch on more gas generators to meet system peaks. But weather isn’t the only thing that influences the storage picture; output does as well. But as long as traders and speculators subscribe to the myth of nearly limitless supply, they will discount the possibility that declining output is also responsible for lagging storage volumes.

The paradigm shift ushered in by the fracking phenomenon won’t go away easily. But in the not-very-distant future, the reality of reduced drilling activity and capital spending, along with rapid decline rates in shale gas plays, will bite deeply into natural gas supplies and cause yet another overturning of expectations in this sector. For electric utilities as well as end-users, the results will not be pretty.

Capital Times