The Lifecycle of Domestic Natural Gas: From Boom to Overkill
Natural gas was first a boon for domestic energy producers and then an albatross. Hydraulic fracturing, or ‘fracking’, a process that cracks rock deep underground to release oil and natural gas, made production possible in many previously untapped shale fields, sparking a land grab that began a decade ago.
During President Barack Obama’s tenure in the White House, soaring production of natural gas from horizontal drilling and fracking has pushed supplies to record highs for many years. The boom in domestic production of both oil and natural gas even provided the United States with 84 percent of its energy requirements last year, the highest annual level since 1991.
The shale gas revolution swiftly changed the economics of natural gas. It prompted the industry to launch more than 100 new projects in the past several years — specifically aimed at taking advantage of low prices — with investments totaling billions of dollars and 50,000 new jobs created.
Not long ago, the domestic supply of natural gas was so limited that facilities were constructed in U.S. ports to import natural gas. However, fracking changed the supply situation. Now, the United States produces more natural gas than it can use. As a result, prices have plummeted to approximately $4 per thousand cubic feet.
In 2012, during the worst of the glut, the Henry Hub price dropped below $2 per thousand cubic feet. The spot price for gas is set in the New York futures market, based on trades at a Louisiana collection center known as the Henry Hub. Comparatively, the industry is generally profitable when gas is sold between $4 and $6.
Low prices — meaning cheap power — have also helped American manufactures; at $5 per thousand cubic feet, gas is equivalent to $25 to $30 per barrel of crude oil. But for natural gas producers, the glut of natural gas has posed difficulties. The fuel cannot be easily stored, unlike oil, and as a result, drilling is costing companies more than they can make selling the product.
Plunging prices, along with disappointing wells, have also spawned a series of write-downs of oil and gas shale assets, and oil companies are now exercising much more caution when purchasing land, which until recently was gobbled up. In particular, BHP Billiton (NYSE:BHP) and Royal Dutch Shell (NYSE:RDSA)(NYSE:RDSB) are slowing spending significantly. They are also redirecting their spending. Unable to justify the acquisition of more land because fields bought during the 2009 through 2012 boom remain below purchase price, they are developing current projects, analysts told Bloomberg. As a result, acquisitions of North American energy assets dropped to the lowest level since 2004 during the first half of 2013.
Even more revealing of current conditions is the fact that in the years between 2005 and 2012, oil and gas transactions ranked among the top two in deal values every year except 2008, when they were fourth. So far this year, oil and gas have not broken into the top five.
This slump many last for years, according to analysts, and it threatens to slow oil and gas production growth. Now, companies that built up debt when rushing to get their hands on shale acreage cannot depend on asset sales to fund drilling programs. “Their appetite has slowed,” Stephen Trauber, Citigroup’s vice chairman and global head of energy investment banking, told Bloomberg. “It hasn’t stopped, but it has slowed.”
When gas prices plunged to their 10-year low in 2012, many companies were forced to write-down the value of some of their assets. The discovery that fields thought to be rich in oil were actually less bountiful than expected also hurt. Shell, which has spent $6.7 billion acquiring North American energy assets since 2009, wrote down the value of its North American holdings by more than $2 billion last quarter. BHP said it would cut the value of its Arkansas shale assets by $2.8 billion during a May 14 conference presentation, adding that capital and exploration spending will “decline significantly” in the next few years.
Not only have producers decided to limit drilling in some fields, they have begun to sell disappointing properties, at lower prices than acquired, and pushed more investment dollars into storage terminals and gas processing plants. For example, in February, Chesapeake (NYSE:CHK) sold half of its oilfield in the Mississippi Lime formation to China Petrochemical for $1.02 billion. That deal was just one of three oil and gas transactions valued at more than $1 billion this year, according to data compiled by Bloomberg.
When supply eclipses demand, the only way to increase prices is to reduce the supply or increase demand. Reducing the supply is not an easy proposition for natural gas producers — their contracts on wells often require them to keep drilling in order to maintain the less. That is why natural gas producers, like Exxon Mobil (NYSE:XOM) have pushed the Department of Energy to speed up its approval of applications to export natural gas. Last month, the department gave permission to export to a facility owned partly by ConocoPhillips (NYSE:COP), a move that came two years after the first export license was granted to Cheniere Energy. Now, more than 20 applications are pending.
Approvals were delayed by two years because the Energy Department was waiting for studies on how gas exports would impact the economy to be finished. While oil and gas companies have argued in favor of exportation, as it would raise prices between 3 percent to 9 percent, American manufacturers expressed concern that prices would increase their costs. Some economists even worried that the increase in costs would cause manufacturers to leave the U.S., taking jobs out of the economy. But, in general, all reports have indicated that gas exports would benefit the economy, according to CNN.
“Our view is that the [Energy Secretary Ernest] Moniz review is most likely to be short and lead to the same conclusion as many reviewers of the issue — that LNG (liquefied natural gas) exports will provide a net benefit to the U.S,” Whitney Stanco, an energy analyst at Guggenheim Securities’ Washington Research Group, wrote last week in a research note seen by the publication.
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