If Natural Gas Producers Are Shifting Resources to Produce More Oil and Electricity Producers Are Burning More Natural Gas, What Will Happen to Natural Gas Prices?

It is a widely repeated mantra in the business press that natural gas prices are low and expected to remain that way for the foreseeable future. The people who make these statements point to the above average quantity of natural gas in storage and to the “unprecedented” increase in the magnitude of the US natural gas resource base as reported by the Potential Gas Committee.

However, it is instructive to understand that the amount of natural gas that is in storage is less than 4 trillion cubic feet while the US consumes a little more than 20 trillion cubic feet each year. In other words, gas in storage is little more than a buffer quantity of inventory (roughly 70 days of consumption) to ensure that short term demand increases or production interruptions do not immediately affect customer deliveries.

The details of the Potential Gas Committee report are also instructive and not particularly reassuring. Here is a quote from the PGC’s press release announcing the availability of their biennial report. (The complete report is available for $495 or $970 with a CD-ROM version of the tables and graphs.)

Dr. Curtis cautioned, however, that the current assessment assumes neither a time schedule nor a specific market price for the discovery and production of future gas supply. “Estimates of the Potential Gas Committee are ‘base-line estimates’ in that they attempt to provide a reasonable appraisal of what we consider to be the ‘technically recoverable’ gas resource potential of the United States,” he explained.

The Committee’s year-end 2008 assessment of 1,836 Tcf (statistically aggregated mean value) consists of 1,673 Tcf of gas attributable to traditional reservoirs and 163 Tcf in coalbed reservoirs. Compared to year-end 2006, traditional resources increased by nearly 519 Tcf (45%), while coalbed gas resources decreased by 3 Tcf (1.9%), resulting in a net increase in total potential resources of 515 Tcf (39%).

That statement means that the appraisal does not include an estimate of the market price that would be required to make it economically attractive to produce the gas that is in US reservoirs; it is a summary of the “technically recoverable” resources. Also, it is worth noting that even that limitation still results in a total resource base that would be completely consumed in less than 100 years at our current rate of 20 TCF per year. That period would be dramatically shorter if we increase gas consumption by adopting frequent suggestions from T. Boone Pickens to replace gasoline and diesel fuel consumption in vehicles and Joe Romm’s suggestions to replace coal consumption in power plants.

Even without expanding natural gas applications, there is a good chance that today’s prices will be going up. Gas producers are not satisfied with the prices that they are getting; they have already reduced their drilling activity and are considering additional redeployment of their drilling equipment into reservoirs where there is a higher probability of producing oil. That decision will gradually reduce the production of natural gas. Here is a quote from a Wall Street Journal article published on January 2, 2010 titled Crude Awakening: Gas Producers Shift Focus:

But it isn’t as easy for smaller companies like EOG Resources Inc., one of the largest independent drillers. At EOG, gas accounts for about two-thirds of its North American production. Oil accounts for a third. Chief Executive Mark Papa said he expects a 50-50 split by 2011.

“The concept is that we are evolving EOG from a heavily weighted gas company into a more balanced company,” he said. “We are bullish on oil short term and long term.” In 2010, the Houston company expects to allocate 60% of its capital expenditure to oil-focused projects.

Questar Corp., which was exclusively focused on producing gas, is now putting 20% of its development capital into oil-rich projects, said Charles Stanley, chief operating officer of the Salt Lake City firm. The exploration would “enable us to receive oil prices and significantly enhance returns,” he said.

Mariner Energy Inc., of Houston, gets two-thirds of its production from gas yet also has indicated a change of focus to oil projects and “looked at a lot of deals,” said Chief Executive Scott Josey in a conference call in November.

At the same time that these companies are making decisions that will reduce the rate at which they are producing natural gas – which is what defines supply available in the market, no matter what the overall resource base is – electric power suppliers are gradually increasing their production of electricity from gas while reducing their production from coal. This shift is often being pushed as a quick and “cheap” way to reduce emissions. Here is an almost gushing example of that kind of thinking from a December 26, 2009 Associated Press article titled Natural gas could help in fight against global warming

An unlikely source of energy has emerged to meet international demands that the United States do more to fight global warming: It’s cleaner than coal, cheaper than oil, and a 90-year supply is under our feet.

It’s natural gas, the same fossil fuel that was in such short supply a decade ago that it was deemed unreliable. It’s now being uncovered at such a rapid pace that its price is near a seven-year low. Long used to heat half the nation’s homes, it’s becoming the fuel of choice when building new power plants. Someday, it may win wider acceptance as a replacement for gasoline in cars and trucks.

Natural gas’s abundance and low price come as governments around the world debate how to curtail carbon dioxide and other pollution that contribute to global warming. The likely outcome is a tax on companies that spew excessive greenhouse gases. Utilities and other companies see natural gas as a way to lower emissions — and their costs.

Those two trends – suppliers reducing production and customers being encouraged to increase consumption – are on a collision course. The almost inevitable consequence will be something that makes producers happy and increases the pain level for customers; prices will go up.

As I noted a few days ago, I believe that this calculus is part of what encouraged ExxonMobil to decide to purchase XTO, a US gas producer, for a total of $41 billion. (See ExxonMobil Bets That Natural Gas Prices Will Rise – Making a Similar Bet is Like Betting With the House) Here is a quote from XTO Energy and Exxon Mobil: The Natural Gas Price Question that includes an intriguing denial:

In a conference call with analysts Exxon officials downplayed the notion that snapping up XTO represents a bet on price movements. Neil McMahon, an analyst with Sanford Bernstein, put this question to management: “You feel very comfortable, it seems, in this transaction, going out and buying a U.S. natural gas company, wherein the price of gas is at this level. Is it fair to say that you are getting more and more bullish about the gas environment going forward?”

“It’s not a price play, obviously because we never do that. It’s an efficiency play. And as you know, we believe you get a lot of efficiency benefits out of scale, out of leveraging best practices and delivering them rapidly into the global portfolio,” Exxon Chief Executive Rex Tillerson answered. “
And that’s, really — that’s the important element. That’s the opportunity for us — now our people and we have to go out and capture it. And that’s where the value creation will occur.”

Here is my translation – if you work for XTO, be prepared to become an “efficiency” without a job. If you buy natural gas, be prepared to pay an increasing amount of money for it as supply fails to match demand. I do not know when it will happen or how high the prices will go, but natural gas markets have a history of moving rather rapidly as the balance between supply and demand shifts.

Additional reading

• Wall Street Journal – Seasonal Shivers Help Push Price For Natural Gas Up More Than 6%

Update: (Posted on Jan 3, 2010 at 8:08 pm EST) Quoted from the Wall Street Journal article above:

However, recent data from the EIA shows the brisk pullback in natural-gas drilling amid lower prices is beginning to cut into supplies, analysts said.

The number of rigs drilling for natural gas has fallen by 44% since a year ago, when the natural-gas rig count was at 1,347, according to oil-field services provider Baker Hughes.

“We are making some real progress in drawing down our storage surplus,” said Tim Evans, an analyst with Citi Futures Perspective in New York.