Monday, January 16, 2012

Natural Gas

In a post about interest rates I wrote about being a little kid and over-hearing my grandfather (who was actually "grandfathered" in as a CPA because he was a practicing accountant before they had the exam) talk in the early 1980's saying that he though interest rates "would never go below 10%". At the time inflation was rampant (as Volker came in) and interest rates were in the 20% or so range, so this seemed like a valid observation. As we all know, interest rates have fallen to near-zero right now and even a "ceiling" of 10% (rather than a floor) seems far away.

Along the same lines, when I started in the energy business in the early 1990's, the "rule of thumb" of what a utility would pay for natural gas was about $2 / unit. The price would rise in the winter during the peak heating season and fall in the summer as utilities re-filled their storage, and it would vary around the $2 / unit mark, but not deviate too significantly. At the time there wasn't a lot of vision forward on prices that I was aware of, but if you mentioned anything like the $14 / unit peak that was hit in 2005-6, you would have been laughed out of the room.

Today natural gas, propelled by innovation and "fracking", has dropped to a price level that no one would have foreseen back in 2005-6. Per Bloomberg:
Supplies may reach a seasonal record of 2.4 trillion cubic feet in March, which is when heating demand usually ends and producers begin piping more gas into storage, Cooper said. Unless production falls or cold weather bolsters demand, prices will drop to $2.40 per million Btu, and perhaps below $2, as gas overflows storage caverns and clogs pipelines, he said.
To think that natural gas would return to 1990 price levels is amazing. Even using the governments' figures, which I think understate inflation dramatically, in the 21 years from 1990 to 2011, inflation makes the $2 in 1990 the equivalent of $3.51 today, per this inflation calculator.

What happened? Free enterprise and capital markets happened. Fracking and innovation allowed new natural gas deposits to be found in our country which brought forth huge reserves of US energy and drove down costs even while usage soared.

This low price for natural gas is not a short-term phenomenon. These reserves are significant and since natural gas is often found alongside oil, with oil at $100 / barrel the fact that natural gas is at a low price won't impact it as much as you'd think because anything the driller gets is just profit on top of the huge profits for US sourced oil. The largest "threat" to low prices for natural gas in the US is actually the "high" price of natural gas overseas, because US drillers and pipelines can ship it to foreign countries in a liquified (LNG) format if their high prices make it economical. Per this WSJ article:
(T)he current low natural gas prices are attracting market demand from around the world. There are already federal permits for 3 trillion cubic feet per year of natural gas exports, Apt said. "Will we export that bounty, and if we do, will that drive up U.S. prices," he said. Natural gas sells for about $8 in Europe and $14 in Japan, but less than $4 here.
The real longer-term issue is whether other countries in Europe and Asia will also find large reserves of natural gas in shale just like they did in the US, and whether they will drill for it or avoid drilling out of environmental concerns. The French have already banned "fracking" but my (unproven) opinion is that this really says more about the power of the nuclear lobby in France, since the low price of natural gas has really been the final nail in the coffin of nuclear energy (along with the obvious issue of Japan) because it makes the plant's un-economic to build. Likely the Ukrainians (smarting from Russia's bullying over natural gas pricing), the Poles, and the Chinese will take up this technology in earnest and change the overall economics, even if countries like France are content to wait idly by.

As far as the US electricity industry, natural gas is causing coal plants to be mothballed or for their owners to choose to not spend money on costly "scrubbers" to comply with EPA guidelines, changing the long term footprint of the US market. Since the nuclear boom was a "mirage" anyways (basically we will get a plant out of Southern Company and one in South Carolina, which won't even keep up with likely decommissioning of units), this lower priced power is killing the market for new plants entirely.

For heavily indebted companies like Energy Futures Holdings (which bought up TXU assets in Texas), the low price of natural gas spells difficulties, since gas fired "peakers" set the "market price" for energy and with the price of gas at $2 / unit, not $8 or $10 / unit, they will make less money on their "base load" coal and nuclear plants which need to run all the time. Some of these utilities had a great summer in 2011 with high temperatures (especially in Texas) which helped to offset the increasing competitiveness of gas-fired generation.

The other key item to keep in mind is that when we buy US produced energy, we enrich our OWN country rather than sending wealth overseas, often to countries that despise us (and even if we don't buy directly from Iran, the high cost of oil overall benefits them just the same whether or not we buy or someone else). The new innovative technologies have enormously benefited the United States, making us more competitive in business and reducing energy bills for tens of millions of households. And while energy companies do have "breaks" in the tax code to some extent, this innovation was not part of a government program and is in stark contrast to the failures of the energy department "research" and political backing of "green" energy which is likely to be a major campaign issue in 2012.

If only they'd unleash our oil companies in the US we would likely be able to dramatically increase our production and further reduce our dependence on foreign energy producers, while enriching our own country. The parable of natural gas is plain for all to see, which is that markets work if you let them, and that government intervention is usually far more harmful than inaction.

Cross posted at Chicago Boyz

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