High Prices Despite Record Production

The price of natural gas in the U.S. has roughly doubled in less than a year. A hot summer that increases demand for air conditioning and draws down storage levels, or an active hurricane season, will lead to further spikes in natural gas prices.

Even with normal summer conditions, during a normal winter some analysts expect the delivered price of natural gas to spike to $15 per thousand cubic feet – over a 50 percent increase over last year. Distracted by $100 fillups and high oil prices, American consumers are largely unaware of the gas price shock awaiting them when they fire up their furnaces this winter. Consumers should brace themselves for some of the largest natural gas rate increases in memory.

These price increases have occurred despite the fact that U.S. natural gas production increased 6 percent from the first half of 2007 to the first half of 2008. Almost all of the increase came from shalegas plays in the Arkoma, Anadarko, Fort Worth, and Permian basins of the MidContinent Area. Yet despite the supply success, the U.S. natural gas balance is tightening. Demand for natural gas in North America is increasing at about 3 percent per year. U.S. industrial gas demand is up as manufacturers become more competitive due to a weak dollar. Robust fertilizer production and the surge in ethanol production have also contributed to increased demand. Also supporting the high price environment is the fact that North America is receiving fewer shipments of liquefied natural gas as supplies head toward markets like Spain and Japan, where they can attract a much better price. LNG imports were a key factor in building U.S. gas inventories to alltime highs before last winter, but imports have languished so far this year.

Why Gas Is the Only Game in Town

Roadblocks to building new coal and nuclear plants in the U.S. are fueling expectations for a natural gas boom. Dozens of proposals for new coal and nuclear plants have been shelved, cancelled, or delayed because of rocketing construction costs, financing risk, regulatory uncertainty, and public concern over global warming and toxic pollution.

Opposition is also rising to new coalfired power plants built without the capacity to capture greenhouse gas emissions. Citigroup Inc., JP Morgan Chase & Co., and Morgan Stanley have said they are uncomfortable financing new coalfired electricity plant construction because of the growing concern over emissions and potential carbon controls. Nuclear power projects are also losing steam, despite generous new federal incentives. By the end of 2009 the U.S. Nuclear Regulatory Commission expects to receive 21 applications to build 32 new reactors. So far it has received only four applications to build seven reactors. As states reject coal and nuclear plants, the power market will increasingly turn to natural gas. Ironically, the expansion of wind energy has provided a boost for natural gasfired generation as a backup resource when the wind fails.

The final push towards gas will come from programs to regulate carbon emissions. The U.S. Natural Gas Council predicts that a carboncapping system, such as the one Congress considered this year, could lead to a 20 percent increase in gas consumption over the next decade – an increase of almost 3 trillion cubic feet per year.

All of these developments point to a rosy future for natural gas, with high prices but not too high to destroy the steady growth in demand and adequate domestic supplies supplemented as needed by imports. Yet there is remarkable disagreement among analysts and companies as to whether this scenario will in fact transpire.

Clearly the wild card on the demand side is climate legislation, and with both presidential candidates supporting the idea, passage in some form appears likely. As discussed earlier, it could have a devastating upward impact on U.S. natural gas demand. The Department of Energy has warned that opposition to coal will double natural gas consumption for power generation, increase dependence on foreign energy sources, and send natural gas and power prices skyward.

Unconventional natural gas has led the way in the rapid domestic production increase. Between the first quarter of 2007 and the first quarter of 2008, more than half the increase came from Texas, where supplies grew by an exceptionally high 15 percent. Clearly, unconventional gas is a highcost resource play. A sharp decline in gas prices would make any of the unconventional gas plays uneconomic. Many wells drilled today require gas prices above $7 or $8 per million Btus to be viable, and exploration in emerging areas such as Pennsylvania’s Marcellus shale could be even more expensive. One analyst said that his gas model shows that normal summer weather would result in a gas price collapse and the shuttingin of production. That’s why producers constantly look over their shoulders at LNG imports. A flood of imports could push prices down, making much of the production uneconomic.

LNG is a doubleedged sword. In 2003, former Federal Reserve Chairman Alan Greenspan predicted LNG would create a “pricepressure safety valve” to stabilize prices. In almost all analyses, LNG fills the future supply gap when domestic resources peak. But many are adamant that there won’t be enough export capacity during the next 15 years to keep pace with world demand, as competition from other countries continues to limit U.S. gas imports. Others point to a dramatic expansion of gasification facilities that will increase exports to a possible 65 billion cubic feet per day in 2015, with the U.S. importing close to 20 bcf/d in 2025. Department of Energy officials admit that the global LNG market is one of the big unknowns.

So as the global economy slows, we may see a relatively sharp but brief drop as speculators get burned, and then a slow easing of prices until the economy recovers. But in all likelihood, it won’t last for long. We are in a delicate balance filled with many unknowns. High natural gas prices are here to stay.

Terence Thorn is a Houstonbased gas analyst.