Gas Pains

The natural gas market has always been a roller-coaster.  It’s a very seasonal fuel, typically experiencing price spikes during the winter heating months.  So, it’s important to begin any discussion about natural gas with a statement of the obvious:  natural gas prices are very volatile.

A few years ago, natural gas prices exceeded $12/mmBtu (as measured at the market’s reference point, Henry Hub).  Since then, of course, the national economy has collapsed, with sharp declines demand from many major gas-consuming industries, so that gas prices even during peak months have fallen below $6/mmBtu — less than half their recent peaks.

One of the reasons for prices falling so low has been the opening of shale gas reserves across the country that had heretofore been beyond economic reach.  With the development of horizontal drilling techniques and hydraulic fracturing (a.k.a. “fracking”), a series of geologic basins — starting with the Barnett in Texas, and now the Marcellus in Pennsylvania — are being tapped to extract large quantities of natural gas that were known to exist but previously uncompetitive absent technological advancement.

The opening of these resources has led many observers, with only one example being the American Clean Skies Foundation, to make the case that natural gas should be the central platform for American energy policy and main leg of the American energy industry stool for the foreseeable future. 

The basic premise is that natural gas is much more plentiful under our own lands than formerly thought possible, while also being much cleaner than coal or even petroleum, so we should be using natural gas not only for power generation, but also for increased deployment of natural gas vehicles to displace the need for so much imported oil.  Since gas is so plentiful, it will be cheap to use natural gas as the primary fuel of choice in our economy.

I’m not against natural gas in any way.  It is plainly a much cleaner-burning fuel than oil or coal.  It is not subject to mountaintop mining practices that are devastating coal producing regions in Appalachia, as profiled in this recent story in the New York Times.  It does not produce the wastes or the worries that nuclear energy does, as evidenced so clearly of late at Fukushima in Japan.

But, I do worry that the forecasts of long-lasting natural gas abundance — and low gas prices — in the U.S. are wildly over-optimistic.  For instance, the most recent edition of the Powers Energy Investor analyzed production from the Fayetteville shale in Arkansas and concluded that its production levels had peaked and “natural gas demand will soon substantially outstrip supply and prices will skyrocket.  All the pieces are in place for substantially higher natural gas prices, however Mr. Market will recognize the incredibly strong fundamentals of the natural gas market only when he is ready and not a second earlier.”

In short, the concern is that shale gas resources may be subject to much steeper decline curves in production than is the case for gas from conventional wells.  Many industry cheerleaders are touting decades or hundreds of years of domestic natural gas supply, but may be doing so by extrapolating a few years of production from the seeemingly-abundant shale gas reserves and applying conventional decline curves that are not nearly so severe as real-world experience from the Barnett and Fayetteville shale resources have indicated.

Also, some of the environmental concerns about production of gas from shale formations via the use of fracking are likely to have some justification.  Last week, the New York Times reported that House Democrats have discovered substantial risk of carcinogens being dumped into water as a result of the use of fracking chemicals — very closely-held industry secrets by such oilfield service companies as Halliburton (NYSE: HAL) and Schlumberger (NYSE: SLB).

Defenders of the natural gas industry have claimed that the New York Times has performed a hatchet job on the shale gas industry in their reporting on environmental issues associated with water contamination from fracking.  Perhaps. 

However, I have recently talked with someone with direct business involvement in the fracking activity in the Marcellus — a self-avowed Republican — who was unequivocally damning in noting that environmental standards regarding water quality associated with fracking are essentially non-existent in Pennsylvania.  “They take the wastewater, put it in tanker trucks, and on rainy or snowy nights, they roll the trucks and dump the water on the road.”  The annual volume of wastewater — however clean or contaminated — that’s disposed of in this manner or otherwise without any control or oversight?  According to my contact, about three-quarters the volume of Lake Erie.

Between dealing with the environmental challenges seemingly associated with fracking, the probably overblown estimates of ultimately-recoverable shale gas reserves, and the push for more natural gas adoption in the transportation and power generation markets, it’s far from obvious to me that natural gas prices will remain at these levels for very long.

In the end, we must remember that natural gas markets have long been subject to booms-and-busts.  Note that, before natural gas prices broke the $10/mmBtu level in the mid-2000s, they had lingered below $2/mmBtu for much of the 1990s, and the natural gas industry was in a state of deep and enduring pessimism.  Then, in just the space of a few years, gas surpluses evaporated as demand steadily grew, and prices quadrupled.  What makes us think that another increase of $5-10/mmBtu couldn’t happen again?

I remember a cartoon from the late 1980s depicting a homeless man at a stoplight holding a cardboard sign that stated “Will Predict Natural Gas Prices For Food”.  Forecasting the future of the gas market is clearly a perilous game, and far be it from me to suggest I know what will happen.  But, as the history of the natural gas market has shown again and again, the future need not look anything like the present, and blindly assuming a continuation of current pricing levels and supply adequacy in the natural gas markets is by no means certain.  In fact, over the long-run, I’d bet against it.