RP Siegel

Domestic Fuel Boom Could Become a Bursting Bubble

When you have a hot product that people are buying lots of, you want to try and sell as much as you can while the getting is good. That is clearly the case with natural gas right now, which at historically low prices is enjoying unprecedented success.

No wonder then that suppliers are trying to whip up demand even further to lock in commitments to natural gas infrastructure before the bubble bursts and prices float back up to historic levels, which they will much sooner than most people expect.

That’s why we’re seeing events like the Penn State Natural Gas Utilization Conference, which brought industry and government officials together to try and find new ways to increase demand for natural gas, which, of course, Pennsylvania has in abundance right now. In fact, there is so much gas available in Pennsylvania right now, supply exceeds demand, which is a problem if you’re a producer.

How Abundant Supply Becomes a Problem

According to Justin Carlson, a market analyst for Bentek Energy who spoke at the conference, some basins have had to pull back their production levels, in part because prices are not high enough. There are literally hundreds of idle wells right now that have been drilled but are not producing. Some are waiting for infrastructure to catch up. Others are waiting for higher prices. In order to increase demand, suppliers are looking to export their gas and pushing for construction of liquefied natural gas (LNG) terminals. If export can ramp up, that will help increase prices.

The problem with this scenario is that while there is a great deal of gas sitting underground, that gas will become increasingly difficult and expensive to extract as the wells deplete. That means that, while customers are expecting to pay very low prices for the gas, some of the wells will not be profitable to operate until prices go up.

According to David Hughes, a fellow with the Post Carbon Institute who spent 32 years with the Geological Survey of Canada, the explosive growth in natural gas is not economically sustainable. After studying production data for some 65,000 shale gas wells, using the industry standard DI Desktop /HPDI database, Hughes found that the vast majority of these wells are depleted within five years. As the wells deplete, new wells are required to maintain supply and these wells must be drilled at great expense.

In fact, given the high rates of decline of these wells and the thousands of new wells that will need to be dug to maintain supply, the cost that could well exceed the value of the energy extracted, not a very good business case. In the case of shale gas, Hughes estimates a cost of $42 billion per year to maintain production as compared to $32.5 billion worth of gas that was produced in 2012.

Meanwhile in the Marketing Department …

Meanwhile, the industry is aggressively marketing gas to industrial and utility customers based on today’s low prices, hoping to lock in future sales through capital infrastructure investments in gas-fired equipment which could be replacing coal or oil-fired predecessors, or possibly edging out renewables.

But those investments could ending up looking like adjustable rate mortgages in a rising-interest rate market, which if you will recall was the basis for the real estate bubble of 2008. A similar bubble could occur if large portions of the economy committed to natural gas were to see a sudden sharp rise in gas prices.

This scenario is entirely plausible, says both Hughes and Deborah Rogers, author of Shale and Wall Street: Was the Decline in Natural Gas Prices Orchestrated? Rogers alleges the gas companies, encouraged by Wall Street, overstated the size of their reserves by significant amounts.

The future is difficult to predict, but let the buyer beware. Sure, the current natural gas boom has been good for the local economies where the gas is being produced, and the low energy prices have been good for manufacturers too. But in the long run, energy consumers might be better off buying clean renewables. Once the equipment is installed, the cost of energy will never go up, and the environment will benefit as well.

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