Four reasons natural gas prices will not stay depressed

Today, in the Globe & Mail published an article by Jiri Maly a principal with McKinsey & Co. titled “Four reasons natural gas will stay depressed”. Mr. Maly raises four points that he suggests will keep natural gas prices “depressed”. However, Mr. Maly fails to put his points into the context of time. Instead he mixes past and present situations giving the reader a confusing outlook for natural gas.

The first of four points raised by Mr. Maly is “there has been a structural shift in the supply of natural gas away from conventional production, where individual wells target discrete pockets of natural gas, to unconventional sources, where many wells are required to unlock previously unrecoverable gas from rock formations such as shale.” This is true. And the end result is that there are higher natural gas reserves in North America. The US has estimated a 39% increase in natural gas reserves in the US due to shale gas and other unconventional sources. However, it still needs to be extracted. It is this recovered natural gas that impacts supply inventories and ultimately prices. While new shale gas discoveries have brought on more natural gas into the system which contributed to lower prices, natural gas producers have responded by starting to shut in as much as 50% of their current production. These cuts in production have yet to be fully realized in the down-stream supply inventories. Mr. Maly does not even mention these production cuts giving the impression that the conventional wells continue to produce along side new shale gas production which is simply not the case. On the exploration front, only 31% of the Alberta’s rigs are active, and drilling activity in the US is at a 7-year low.

But there is a more important impact of the  increase in natural gas reserves brought about by shale gas plays like British Columbia’s Horn River basin. This new abundance of natural gas fundamentally changes the way we look at natural gas as a long term resource and what role it will play in the long term energy mix of North America. As acknowledged by Mr. Maly, natural gas use to be viewed as a resource in decline. A resource that North America would have to import in order to meet domestic demand for natural gas.  That is no longer the case… which leads to the next point.

Mr. Maly’s second point “this robust North American gas production has been supplemented in recent months by higher imports of liquefied natural gas, or LNG, from Africa and the Middle East.” This is sort of true. A number of years ago when conventional sources of natural gas were looked to be in decline companies were engineering Liquid Natural Gas (“LNG”) plants on the coast lines of North America to import natural gas from other markets. However, the new abundance of shale gas has created a structural shift and changed the way we view natural gas as a long term resource. These LNG plants are now going to “export” LNG, and not import LNG. Case in point is Kitimat LNG in British Columbia which has entered into agreements with Korea Gas Corp.  and Gas Natural of  Spain where by each of these companies will purchase billions in LNG from Kitimat LNG over the next 20 years (See HRN: “Kitmat LNG signs deal with Korea Gas Corp. worth $20 billion” and “Kitimat LNG signs MOU with Spain’s Gas Natural”). Furthermore, Ms. Maly also fails to acknowledge the momentum (in the US) is not just about cleaner energy, but using energy from reliable domestic sources, and not from countries that are “unfriendly”. It is the key reason that Canada remains the number one supplier of oil to the US despite this oil being produced from oil sands which are often referred to as “dirty oil”.

The third point a ” major trend is U.S. energy policy.” Appears Mr. Maly is not aware of the most recent Nat Gas Act legislation in the US, or the $150 million recently approved by congress for research into natural gas vehicles. Part of the Nat Gas Act will double the tax credits for buying natural gas vehicles (up to $12,500 US) and building natural gas fill stations. US law makers want to see natural gas being used more in their energy mix in order to reduce foreign dependence on oil, and reduce green house gas emissions.  Point here is that the Nat Gas Act is a major piece of legislation that plays a big part in the US energy policy, and yet Mr. Maly does not even acknowledge it.

What he appears to acknowledge is the US coal lobbyists that have been working very hard and spending millions of dollars in the last couple years to promote coal as America’s abundant, affordable – and cleaner – resource as the solution to America’s energy needs (see HRN: “US coal lobbying money beats natural gas down”). And now with the increase in reserves and how natural gas is viewed as a long term domestic resource, natural gas is again getting attention as the abundant and affordable resource.  Natural gas producers have increased their lobby dollars realizing they have lost ground to the coal lobby in the last couple years. The difference being that natural gas is cleaner then coal. End of story. There is no proven technology that makes coal cleaner then natural gas. Instead what the coal lobbyists have done is to lobby for legislation that makes coal cleaner then it really is through carbon offsets. Which brings us to the next point…

Mr. Maly’s final point is  “the coal industry may prove to be more resilient to carbon dioxide regulation than previously thought.” Though carbon emissions do have an impact on those energy sources that will have favored government support they will have little impact on the actual commodity prices in the next year. Furthermore, we are seeing all of the fossil based fuels including both coal and oil sands claim that their carbon footprint may be lower then previously thought. Key word “may”. Unfortunately, as noted above, coal lobbyists are in fact making coal appear cleaner through the special use of carbon offsets. On an absolute basis, natural gas emits more then half the carbon emissions of coal.

On the point of technology innovation,  cleaner coal, cleaner oil sands and cleaner natural gas are welcome, encouraged and needed.  As it sits today, natural gas is the cleanest fossil fuel by far and therefore the most practical solution for reducing carbon emissions now.

Other comments… Mr. Maly fails to mention or believe that any improvement in the economy in the US and Canada would increase current demand levels. Few would agree with this point. Economic improvements will increase current demand levels. Natural gas demand may not return to pre-recession levels in the next year, but they will certainly increase from current levels and do so at a time when production cuts will begin to have effect on inventory. Add to this the potential demand increase from natural gas taking a greater share of the energy mix by increases in the number of natural gas vehicles and gas fired electricity plants.

The biggest problem with the article is Mr. Maly does not define “depressed”. Where Mr. Maly mixes historical information with the present market it is not clear where he stands. At $3.50 people generally agreed prices are depressed – especially if you are comparing it to $14. But the point is where are prices going. If natural gas goes from $3.50 today to $7 by the beginning of 2010, that would be a 100% increase. Pretty good increase (and return) but still arguably “depressed” compared to $14. Again, time context is important and we can no longer dwell on the historical peaks or the historical view of natural gas.

Prices will go up and down week to week. Looking at energy needs and the requirement to reduce carbon emissions, there is no more practical readily available resource today then natural gas. In the words of T. Boone Pickens “You cant beat natural gas!”. It will play a growing role in North America’s energy mix and a bridge to a cleaner energy future. Given these changes there is likely more upside then downside in the price of natural gas. Again, keep an eye on the inventory data in the US throughout August. And remember, supply will always fall faster then demand.

Globe and Mail: “Four reasons why natural gas prices will stay depressed”