Oil, Natural Gas, Fracking, and Market Movement

We reported here on an article that suggested the United States could one day become the new "Saudi Arabia of energy." One could justifiably view such a claim as dubious—but who knows? The energy future of the US seems to lie in the future of nontraditional sources. The explosion in fracking wells in recent years is viewed as a prime mover. If the process proves environmentally sound it will open up huge reserves of both oil and natural gas. The US would also benefit from being the technology leader in this area, generating considerable revenue for those able to transition the expertise to other countries. The issues involved with the fracking process were discussed in To Frack or Not to Frack.

Two recent articles discuss interesting developments in the oil and natural gas arenas. The first is by Mathew Brown in Bloomberg Businessweek: Fracking is Flopping Overseas. It seems that the geology gods have smiled on the United States.

"U.S. gas deposits within shale fields are among the world’s cheapest to exploit, thanks to accommodating geology. European basins tend to be smaller and occur in shapes that are less cost-efficient to access, says Pawel Poprawa, formerly a geologist at the Polish Geological Institute. Projects in parts of the Northeast U.S. can turn a profit selling gas for $3 per million Btu. In Poland, the cost is likely closer to $9. That’s bad news for ExxonMobil, Chevron, ConocoPhillips, and other companies that grabbed 109 licenses in Poland in recent years in hopes of a U.S.-style gas gold rush."

Fracking costs have also been projected as being very high in a number of other countries. Not only does the US have the best technology—they also seem to have the best shale. Consider this chart provided in the article.

The US should benefit greatly from this cheap source of gas in the long run.

"The relatively slow development of shale abroad should benefit the U.S. Japanese utilities were paying $20.87 per million Btus for Yemeni gas in January—eight times U.S. gas prices at the time. The bigger the price gap, the greater the profit for shippers of gas from the U.S."

The second article points out that in a commodities market, a "glut" of product is not necessarily a good thing. Roben Farzad provided an interesting article in Bloomberg Businessweek: High Oil Prices Fuel the Gas Glut. It would seem that so much natural gas is being produced that the market price is falling below the cost of producing it. This seemingly paradoxical result arrives because the gas and oil supplies have become more tightly coupled.

"One reason: Oil drillers produce gas as a byproduct, and with oil prices high, oil drilling is in gear. ‘It’s very attractive to drill for oil, so that will continue,’ says Grubert. ‘Associated gas from oil wells will offset reduced drilling specifically for natural gas.’....Gas pumped as a byproduct of oil and other liquids will represent 75 percent of the increase in natural gas production this year and as much as 90 percent next year, according to Barclays research. Such byproducted output, as it is called, will probably keep rising as long as oil remains above $75 a barrel, the bank says."

What effect has this had on the market for natural gas?

"There’s an unprecedented price gap in the energy patch. Oil has traded above $100 a barrel since February, while natural gas prices have dropped below $2 per million British thermal units—from $4.85 in June of last year. A divergence like this ‘has never happened before,’ says Duane Grubert, an energy analyst with Susquehanna Financial Group. The last time natural gas prices were this low, in 2002, oil was at $20 a barrel."

With predicted high supplies and low prices, hard times have fallen on gas producers who were expected to benefit from the abundance of shale gas.

"Natural gas producers are cutting production in hopes of bringing down supplies and therefore increasing prices. The industrywide gas rig count fell by 23 last week, to 624, the lowest in 10 years, according to driller Baker Hughes. Yet production keeps growing."

"Shareholders are feeling the pain as well. Chesapeake Energy, the second-largest gas producer in the U.S. after ExxonMobil, has seen its stock fall 50 percent since August 2011. Shares of Canada’s largest producer, Encana, have fallen 50 percent in 11 months. The price of natural gas is ‘ridiculously bullish for U.S. consumers,’ says Raymond James analyst J. Marshall Adkins. ‘But the producers? At $5 natural gas, everyone was making great money. At $2, it’s hard to make any profit’."

It will be interesting to see how this plays out. If fracking can be carried out in an environmentally sound manner, the US should be able to lower its oil imports considerably, while at the same time being able to ramp up natural gas exports. Both developments should do wonders for our balance-of-payments deficit.