Investors are subsidizing natural gas consumers. But it won't last.(Read article summary)
Investors have pushed so much capital into natural gas drilling that prices have collapsed, helping consumers. But the investor subsidy won't last as drillers pull back.
It isnâ€™t often that the worldâ€™s working stiffs get a chance to fleece rich investors. But thatâ€™s essentially what has happened as a result of the vast overinvestment in natural gas drilling in the United States. That overinvestment has led to a glut whichÂ last April pushed the price of U.S. natural gas down to $1.82 per thousand cubic feet (mcf), a level not seen since 2001.
Investors have essentially subsidized natural gas through huge loss-making investments, creating an oversupply that has sent pricesÂ significantly below the average cost of new production.Â That means consumers get cheap natural gas while investors kick themselves for not realizing that they were buying into a flawed conceptâ€”one that oil and gas consultantÂ Art BermanÂ has calledÂ â€śan improbable business model that has no barriers to entry except access to capital, that provides a source of cheap and abundant gas, and that somehow also allows for great profit.â€ť
The conventional wisdom is that prices are likely to stabilize between $3 and $4 per mcf and stay there for the rest of the decade as the natural gas drilling juggernaut continues. There just one problem with this outlook. The juggernaut has most definitely NOT continued.
Investors who helped to fuel the boom included hedge funds, wealthy individuals and institutional investors, all of whom chipped in a lot of money to finance the drilling of individual wells for what turned out to be meager payouts. None are eager to get burned that badly again.
In addition, the share prices of publicly traded drillers such asÂ Chesapeake Energy, Devon Energy, Encana, and Southwestern Energyâ€”who put an extraordinarily large proportion of their efforts and funds into finding natural gas (as opposed to oil)â€”have plummeted. That decline has for now made raising new capital through stock issuance a relatively rare event.
Furthermore, many drillersâ€”who borrowed heavily to help finance their drilling effortsâ€”now find themselves deeply in debt, groaning under the weight of interest charges and loan repayments. But, theyâ€™ve been unable to do much except sell assets to counter the devastating effects that low natural gas prices continue to have on their balance sheets.
Itâ€™s hard to imagine the same investors and banks deciding that for the rest of the decade, theyâ€™ll keep repeating what theyâ€™ve just done.
As for the drillers, they have moved on. They have already repositioned their rigs for drilling oil which is currently fetching a splendidly profitable price near $100 a barrel, that is, near the historically high levels seen since 2008. It turns out that even the natural gas drillers donâ€™t believe the natural gas story any more if we judge by their actions. Indeed,Â even the biggest booster of the cheap (but somehow profitable) natural gas forever narrative, Chesapeake Energy, has given up and turned its focus to oil.
So, where does that leave the working stiffs who heat their homes with natural gas, the utilities who burn it to make electricity, and the chemical manufacturers who use it as a feedstock for many chemicals including nitrogen fertilizer? They all face an uncertain future in which natural gas prices are likely to rise significantly,perhaps even returning to the double-digit nosebleed levels of 2008Â before gun-shy investors and drillers will dare to take the necessary steps to bring on significant new supply.
Which begs the question: What if drillers and investors wait that long to move back into the natural gas fields in force?
Petroleum geologist Jeffrey Brown ofÂ Export Land ModelÂ fame offered a startling response in a conversation at a recent conference I attended. The production decline rates of the shale gas wells that are providing the bulk of new U.S. supplies are so highâ€”60 percent in the first year and up to 85 percent by the end of the second yearâ€”that we may never be able to return to todayâ€™s production level.
That would certainly put a nail in the coffin of the natural gas abundance narrative.