Why are North American natural gas prices so much lower than rest of world?

I’ve been involved in a reasoned discussion with an oil field accountant / attorney about US natural gas prices and total resource base. I thought that it would be worth preserving and sharing that discussion here so that it would not get buried. If you read closely between the lines, you will see why I have put this post into the ‘smoking gun’ category.

The discussion is associated with a Wall Street Journal article titled Nuclear Power’s New Hope: Small Reactors. I’ve rearranged the comments so that they flow in order; the blog software that the Journal uses limits how deep a reply thread can go.

Aside: I have removed some of my “signatures” and disclosures in the interest of getting rid of extraneous repetition. I retained the disclosure in my first comment. I’ve also taken the liberty of correcting some of the grammar / proofreading errors that can creep into internet comment threads when they cannot be edited. End Aside.

Kenneth llindsey Wrote: (in response to someone else’s comment):

Good points, just another example of government robbing the taxpayer. Nat Gas is so abundant that it nearly had to be given away this spring and summer when the storage almost reached capacity; and Washington wants to waste billions on nuclear, which is usually the most expensive energy. No wonder they can’t balance the budget. After sixty plus years, nuclear plants are still not economically viable on their own, its time to stop subsidizing losers. Maybe there should be a box on the tax form to allow people to pay more taxes if the want wind, solar and nuclear, otherwise let the free markets pick the winners.

Rodney Adams Replied:

@Kenneth

Nuclear plants are economical; they produce some of the lowest cost power on the grid. Here are the numbers for 2011 in cents per kilowatt hour:
Coal – 3.23
Gas – 4.51
Nuclear – 2.19
Petroleum – 21.56 (Mainly Hawaii, Alaska, Long Island and Puerto Rico)
Source: NEI Resources and stats page on US electricity production costs

The primary assistance that the $452 million spread over 5 years – with at least a one for one match from the company – will provide will be to defray the up-front fees charged by the US government to review license applications. The current cost of that regulatory service to an applicant is $274 per professional staff hour. The applicant has no ability to control the amount of time that the regulator decides to spend on the application and no ability to speed the process along by volunteering to pay for overtime or extra regulators to put reviews in parallel.

I will not argue with your assertion that nuclear plants are expensive, but at least part of the blame rests on the shoulders of the US government. It has tied down the industry with a number of special rules that have been purposely designed by people who do not like nuclear energy. Unfortunately, many of the people with the most logical reasons for disliking nuclear energy are wealthy and politically powerful – they sell natural gas, coal and oil in competition with nuclear energy and would like to do everything they can to hamstring their competitor.

Rod Adams
Publisher, Atomic Insights
Disclosure: B&W is my day job employer, but my thoughts about energy policy are my own. I do not speak for the company.

Kenneth llindsey Replied:

Rodney,

Your data cost of Nat Gas is incorrect in that it was based on cost of $12 per MCF not the current price of $3.50 per MCF (plus or minus 10%), which is why Coal and Nuclear Projects around the county are shutting down.

Rodney Adams Replied:

@Kenneth

No. My data for US electricity production costs was based on 2011 numbers. The price of natural gas fell from $12 per million BTU in June of 2008 to something close to its current level of $3.50 IN NORTH AMERICA. The world price for natural gas is more like $12-16 per million BTU. Do you honestly believe that the price differential between the North American market and the world market will remain in place for too much longer? Are you unaware of all of the projects that have been proposed to export gas from the US to that international market so that the extracting companies can obtain something closer to world prices for their product.

Kenneth llindsey Replied:

In 2011 the Nat Gas price was between $4.50 and $5.50; for the 1st 6 months of 2012 the price averaged $2.20. Most people outside of the energy industry do not know that we have about a six hundred year supply. Also, in North Dakota more Natural Gas is being flared off than is being used in the rest off the country as there is no storage or pipeline for the Nat Gas that is the byproduct of Oil Shale drilling. If you will read some of Yergin’s books you will see that, on balance, the oil and gas industry suffers more from oversupply than undersupply. Also, the jump to $3.50 from $2.50 was caused in part by the CME futures changing the contract this fall from End of Month to End of Next Month. Don’t worry, it will still take years to decommission the current 102 nuclear plants, but the bondholders may need to take a haircut. Also, numerous studies have shown that the price increase from exporting will be no greater than 10%, which is really not material as at $ 3.85 per MCF it is still the most inexpensive energy.

Aside EIA page shows that natural gas price to electricity producers ranged from $4.18-$5.66 for 2011 and from $2.79-$3.81 for first 9 months of 2012. End Aside.

Rodney Adams Replied:

@Kenneth

The Potential Gas Committee produces a biannual report on the amount of natural gas in reservoirs in the US. they put it into four categories: proven, probable, possible and speculative. The people on the committee are directly from industry and have many reasons to provide optimistic numbers.

In the widely touted report published in April 2011, which totals the resource base as of the end of 2010, the report said that there was a total future supply of 2170 trillion cubic feet of natural gas in the US.

Press Release

There were celebrations and loud proclamations about a 100 year supply right under our feet.

However, I have a questioning attitude and the ability to do arithmetic. I checked the Energy Information Agency, which is really good for providing historical information, even if their projections have some flaws. For 2011, the US consumed 24.3 trillion cubic feet of natural gas.

http://www.eia.gov/dnav/ng/ng_cons_sum_dcu_nus_a.htm

The arithmetic is simple 2170 TCF / 24.3 TCF/YR = 89.3 years – as long as we do not increase the rate at which we are burning the resource. The flared gas that you mentioned in North Dakota counts as part of the resource base total, but the flaring (waste) of that gas is not counted in the EIA consumption numbers. In other words, the clock is actually ticking faster than my simple estimate shows.

I’ve read most of Yergin’s work. He was a less conflicted source of information when he wrote The Prize: The Epic Quest for Oil, Money and Power in 1991, before he had established a lucrative consulting business called Cambridge Energy Research Associates and established a close relationship with the oil and gas industry.

Kenneth llindsey Replied:

Unless of course, the people in the industry or their clients would have to write down the balance sheet asset value of reserves in which case they have an economic motive to underestimate the total reserves. Historically, that reserve estimate you cited has been incorrect. On the other hand, I have worked in the Haynesville Shale, the Eagleford Shale and currently in the Marcellus Shale and discuss production levels with drillers and pipeliners etc. on an almost daily basis, and basically in this year, 2012, there have been little on no gas only wells drilled other than to fulfill preexisting lease or contract requirements, yet production continues to rise, so I stand by the earlier stated industry insider estimate of a six hundred year supply.

Rodney Adams Replied:

@Kenneth:

Now you are attempting to baffle with baloney.

Companies whose asset values are based on the value and size of their resource base do not have an incentive to underestimate the size of their resources. In fact, the incentives are quite the opposite.

I listened to the most recent ExxonMobil (currently one of the largest gas producers in the US after their purchase of XTO) analyst call. They were asked pointedly when they planned to write down the value of their resources since a substantial portion of their base cannot be economically produced at today’s low prices. The spokesperson on the call explained that SEC regulation allow them to use their own internal pricing models to estimate the selling price, so they had no plans to do any write downs. According to their internal projections, the price of gas will be high enough in the near future to make their resources economical to produce again.

In the meantime, they are reducing their drilling, contributing to the 50% fall in gas drilling that you noted. They did not believe that action would lead to continued increases in supply, however. Again, quite the opposite. By slowing drilling, they fully expect supply to fall and prices to rise – simple economics 101 concept there.

By the way, perhaps it is time for you to clearly acknowledge that you have a personal stake in this discussion, just as I do.

Kenneth llindsey Replied:

I have BBA in accounting, (plus additional completed majors in finance and political science) and worked as an External Auditor in the energy industry before becoming an attorney.
Further explanation of motives in the National Reserve Estimate: For an individual company; Companies generally write their inventories to near market value. Thus if the total national reserve estimate is understated, the per unit value of their specific inventory will be greater, as less supply means higher value. A number of companies such as BHP Billiton which took a $450 million charge against its $2.84 billion Fayetteville gas holding bought from Chesapeake, but I did not yet find the report of their writedown of the $12.4 billion Petrohawk Eagleford properties. Many companies such as Chesapeake, Devon, Petrohawk etc have sold their nat gas to majors & foreign based upon artificially higher market valuations due to the underestimated national estimates.
When Rex Tillerson stated he was losing his shirt on Nat Gas, he was referring to potential writedowns of Exxon’s reserves to market value, not to any real loss since the per unit MCF production cost for a frac well can range from $0.05 to $0.45, and the production cost for a straight bore hole well generally recognized at $2.50. Additionally, since Exxon is the largest chemical company in the U.S., the inventory loss was made up by the increased savings of nat gas as a feedstock. It is probably unrealistic to expect nat gas to trade outside of $3.50 plus or minus ten percent on a monthly average, although it may trade higher in the wintertime and lower in the spring and fall. The danger is that we may be giving away nat gas, (which almost happened earlier in the year when storage and pipelines reached capacity), thus causing a price crash to a $1 of less, but most of the producers have seen this pitfall and tried to cut production.

Rodney Adams Replied:

Are you trying to convince me that Chesapeake, Devon and Petrohawk were all able to sell overvalued properties to the majors? Do you expect people to believe that major petroleum producers like ExxonMobil, Shell, and Chevron are gullible investors that do not do their due diligence?

I have far more respect for their decades of experience and armies of accountants. I also have a little more cynical view of their histories of profitable influence on the energy market and their proven use of “price wars” to destroy potential competitors. Those price wars have nearly inevitably been followed by very profitable periods of rising prices as supply fell short of demand.

I am pretty sure that the main target of the current North American natural gas price war was something called the “nuclear renaissance” but coal has also been targeted. My analysis indicates that the majors are accepting low margins on their gas business in an effort to drive out some of those pesky independents who would not play along with their artificial market constraints.

Please do not get me wrong; I like low energy prices. I just do not believe that the natural gas suppliers like them anywhere near as much as consumers do. I believe they are perfectly capable of recognizing that the best way to drive up the price is to encourage more demand while they are slowing production capacity development.

Kenneth llindsey Replied:

It is not a question of gullible, nor would due diligence typically go beyond verifying the existence of the assets; it is merely that there is far more natural gas nationally available than anyone conceived was possible, and that information was not widely known beyond the field level. For example, Exxon bought XTO when the price was around $6.50 per MCF and then it dropped to $2.50 per MCF. Other purchasers of assets from the independents have seen similar drops. Of course, a major may have a 30 year timeline, while an indie may only have a 3 to 5 year timeline, thus a major can survive the lag till we are able to export our excess capacity; but at the moment gas only drilling has come to a virtual standstill.

Rodney Adams Replied:

@Kenneth

The missing link in your argument is the fact that total US methane production is about 10% higher than it was in 1970; the real culprit that has allowed gas prices to remain low has been the demand destruction caused by the Great Recession of 2008 and its lingering effects. The mild winter of 2011-2012 helped.

Sure, storage systems are full, but total natural gas storage capacity in the US amounts to less than 1/6th of annual consumption (4 TCF storage versus 24.3 TCF/YR).

Because natural gas is so explosive, it has to be transported away from extraction wells or flared off. Because gas nearly always gets produced – in varying proportions – anytime someone drills for oil, there are usually some extractors who will take almost any spot market price in order to get rid of what is essentially a waste product of their oil extraction efforts.

That explosive, difficult to store, and difficult to transport (without an installed pipe) nature of methane also leads to large price variability based on small swings in the balance between supply and demand. Price changes far more rapidly than most observers admit publicly, but the graphs are available on the Energy Information Agency web site. Here is a link to a post where I included one of those gas price history graphs:

Why do nuclear energy developers ask for predictable market prices

I have a public bet with one of my readers that natural gas being sold to US electricity generating customers will be trading for more than $10 per MMBTU for at least one month before the end of 2014. Would you like to make a similar wager?

You are right that the majors have much longer time horizons than the independents. They are playing a hand that requires some staying power. They have income statements that can support artificially low gas prices to drive out competition because they are selling oil at prices that are 5 times as high today as they were just 11 years ago. Their costs for established reservoirs have not increased by much more than the rate of inflation.

High oil prices are what enables ExxonMobil to “lose their shirt” on gas, yet routinely report quarterly, after-tax profits in the 11 digits.

Their long game is to convince as many electrical power producing customers as possible to build infrastructure that can only burn gas or distillate fuel oil (combined cycle gas turbines), convince Congress to fund infrastructure for CNG vehicles, allow LNG export, and then bank enormous profits as natural gas prices rise like they did from the period from 2000-2008. I can hear the spokesmen now, claiming that they are price takers, not price makers and that they are only selling their product for whatever price that the market is willing to pay.

We’ve watched this plot unfold at least once already. Are you old enough to remember the mid 1990s, when gas producers and their purchased pundits repeatedly told everyone that there was plenty of “cheap natural gas” to allow prices to remain bounded by normal inflation for at least 20 years? Do you remember what happened to the Independent Power Producers that believed the sales pitch?

I am old enough. IPPs went bankrupt. They could not afford to install and run their machines once gas hit about $8 per MMBTU. It kept on climbing to $14 before the sudden crash in the summer of 2008.

That drop did not happen because of a magical discovery of hydraulic fracturing matched up with horizontal drilling; it happened because our economy cannot survive with such a large portion of its output being poured into the pockets of multinational petroleum companies.