Guest post by David Archibald
It would be churlish to not share Ric Werne’s joy over a lower gas bill. That said, I believe his post “Cheap Natural Gas, but wait – there’s more” is misleading. Let’s see what the charts say. First of all, the natural gas price itself:
Figure 1: Energy Information Administration (EIA) Henry Hub Spot Prices
The natural gas price bottomed in April this year at just under $2.00/MMBtu and is now $3.40/MMBtu. That is an increase of 70% from the low. More is needed because the average price to give a 10% rate of return in $4.50/MCF (1 MMBtu is very close to 1 MCF) as shown in Figure 2.
Figure 2: US Shale Supply Cost Curve
Most of potential US shale gas production is uneconomic at the current price. So why are shale gas wells still being drilled? A lot of acreage is “held by production” in which a well on the lease has to be brought into production in a certain period or otherwise it goes back to the mineral lease owner. The number of rigs drilling for gas is now down to one third of what it was at the peak four years ago.
Figure 3: US Rig Count 1987 – 2012
There were about 700 drilling rigs operating in the US a decade ago. That has almost tripled with most of the rigs looking for oil. So with the number of rigs drilling for gas continuing to drop, that will eventually be reflected in natural gas production. How that works is illustrated by Figure 4.
Figure 4: Steepening Decline Curves in Natural Gas Production
Back in 2000, the wells in production had a 23% decline over the following year. Now the decline rate is 32%. The treadmill has speeded up. To get a longer term perspective, let’s go back to the gas price.
Figure 5: US Natural Gas Price 1987 – 2012
Traditionally, the US natural gas price traded in line with the No 2 Fuel Oil price in energy equivalent terms, so the gas price tracked along with the oil price. If that still held true and with a barrel of oil being equivalent to 6,000 cubic feet of gas, the current oil price of $89.92/bbl would equate to $15/MCF. As shown in Figure 5, as the oil price started rising last decade, the gas price rose along with it until the “Shale Gale” hit. The relationship between gas production, gas price and rig count is shown in the Figure 6.
Figure 6: US Natural Gas Production, Gas Price and Rig Count 1987 – 2012
Rig count and gas price are closely coupled. There is a considerable lag from drilling to production. Drilling activity started rising in 2000 but production declined to 2005. Conventional gas production has continued to decline and the rise in production over the last six years has been due to shale gas.
Figure 7: Rig Count versus Gas Price 2005 – 2012
If we plot gas price relative to rig count, there is a strong correlation. All this is telling us is that higher gas prices draw in more rigs. It is a lagging indicator, like carbon dioxide in climate. High gas prices are the seed of their own destruction.
Figure 8: Production and Gas Price 2005 – 2012
Figure 8 has some predictive ability. For gas prices to rise to the price at which US shale gas on average is economic, production has to fall to about 1,700 billion cubic feet per month from the current level of about 2,000 billion cubic feet per month.
I expect prices and production to seesaw until an equilibrium is reached. Excluding the effect of liquids content, the US shale gas industry will be characterised by profitless prosperity – the majority of players will eventually get a 10%-odd rate of return on being in the business.
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Not sure if the point you are making is that prices will be rising or that supplies of gas are limited. The headline doesn’t seem to match the concision.
They probably can’t stop drilling. Investors put a lot of money into them on the basis of fracking enhanced production which dropping off and while production is a bit high, they need more activity to keep the money invested in.
I don’t see either a point or a conclusion.
There is nothing in this post that shows that existing shale gas wells are un-profitable. As long as they are bringing in more than their operating costs in revenue they will be profitable and have a positive ROI.
A positive ROI < 10% does not make something uneconomical. To be uneconomical ROI must be less than or equal to 0
I haven’t read this too closely, the dog is expecting a walk, but one quick note:
One thing to keep in mind is that oil wells often produce a lot of natural gas. I suspect that’s especially true with oil shales, but that’s getting well beyond my expertise. US oil production has started increasing and will continue, so estimates of the collateral natural gas should be added to any oil discussion.
Yes, by all means. There is hope for the fossilf fuel is evil crowd and they will use it. Just add to the costs of production.
While there is indeed a lot of commitment drilling and trickle production going on, there is also the volume of associated gas that comes with the new Tight Liquids plays (Eagle Ford and Bakken). The liquids production will also continue to affect gas supply.
What nonesense. Oil and gas are eventually interchangeable. You cant have $85 oil and $3 gas.So production doesnt have to fall for gas to rise. Gas will rise because its much cheaper on an energy equivalent basis.
Typo in the title; it should read “Cornucopia of Gas”.
Matt says: “A positive ROI < 10% does not make something uneconomical. To be uneconomical ROI must be less than or equal to 0"
Just to be pedantic: it's uneconomical if the ROI is less than the risk-free rate of return in the economy (which is near 0% right now because of federal reserve actions).
I think you need to be more specific about ‘Rig Count’.
In Fig 3, you make clear that you can separate out Gas Rigs and Oil Rigs in the count.
Figure 7 only makes sense if your Rig Count is Gas Rigs. looking at the data, it probably is, but it should say so. I would also color or shape the points based before or after 1/1/2008.
Figure 7 and 8 work better if Gas Price is on the same axis.
It might be interesting to plot Gas Rig Count against the 1 year Gas Futures price.
On Fig 5, plot 1 year Gas Future price as a separate series on the Gas Price (Henry Hub Spot).
This is called ‘Market Forces 101’. The gas became more plentiful so the price dropped as did the huge profits. Eventually, the price drops far enough and supplies seem secure enough more people purchase the gas or build gas fired generating facilities. This takes time. Therefore, initially there is a slight glut and prices fall, then the elastic demand bounces back and prices rise. Then eventually the base load power generation starts using the gas and the price starts to stabilize.
This is nothing to do with the quantity of gas still in the ‘shale’ waiting to be frac’ed. There is also an international aspect which is larger in other continents where ‘conventional’ natural gas suppliers have been trying to force the price up, and now have the ground fracked away from under them. Their response to more supply will be to try to keep in the market and drop their prices making fracking less attractive – although not unprofitable. Again this will reach a balance point and has nothing to do with the amount of gas available.
David is correct, but then starts excluding the liquids from the equation. That/s precisely what’s got people so excited about Eagle-Ford and several other plays, there’s a lot of paraffin holding liquids along with the gas. There is so much, that the gas is almost free.
We need to be careful when talking about energy production. The qualities of the well contents are critical – there’s a reason why Brent crude has a premium over Saudi, or West Texas Intermediate, and that’s the content. With gas it’s the same thing. All gas wells are not the same, thus the cost of production versus sale price varies a lot. Gas only plays are uninteresting, gas and liquids, much more interesting.
The Bakken Shale and others are oil plays, not gas. Since we import oil, this will have a much larger impact on our energy consumption than the gas has. We all can see what cheap gas has done, imagine the impact of much cheaper oil due to vast supplies. We’ll go through the shale oil, then take that technology and work through the tar sands. Baring political interference, there will be reasonably priced oil for hundreds of years.
That having been said, I’d prefer to use oil in recyclable products and get my power from electricity via low residue fission reactions. Directly generated inexpensive electricity is way more helpful than other types. I don’t see solar, geothermal, tidal, hydroelectric, wind, or any other currently existing technology delivering anywhere near the clean, safe, energy as LRFR for anywhere near the price.
Figure 4 is the key. The US is gambling very heavily on natural gas. I see a very dangerous cost increase in the near future and with the shackles we’ve put on the coal industry, expect to see significant, economy crippling increases in the price of electricity. Solar and wind will not save us. Hug a coal or uranium miner.
Dear Mr. Archibold,
I am delighted to see this article. As a professional energy industry investment researcher and lifelong student of energy and investing, my antennæ are extremely sensitive to instances of “Extraordinary Popular Delusions and The Madness of Crowds.”
Thanks to blaring media and Wall Street, it has become a universally accepted “truth” that natural gas supply in the U.S. is now infinite, inexpensive and unlimited.
The experience of a lifetime has taught me that when everybody believes something to be true, it’s time to be wary and proceed cautiously because ” ’tain’t necessarily so.”
I get really tired of two types of chicken littles: The peak oil crowd and the catastrophic AGW crowd. Fortunately, while the peak oil people continue to bluster themselves blue in the face, the industry just keeps finding more production, and the costs of the new applications keeps coming down. Sure, gas is not profittable at $2.00 an mcf, but where it once took $8.00 gas to make a profit from a horizontal shale well with multi stage fracs, it now takes $4.00. Thoses idle rigs will drive down drilling costs and lower those numbers some more. But wait-there’s more-
The liquid rich plays such as Eagle Ford and Utica produce at very high gas to liquid ratios. There will be pressure on the gas market with associated gas sold as a virtual by-product.
But wait-there’s more. Staggering quantities of gas are being found all over the world–the NW shelf of Australia, Mozambique, Turkmenistan. These are huge finds which can and will support huge LNG facilities. Then there is the fact that while organic rich shales are all over the world, there has been very limited production from them outside of the US. That will be changing soon. The world wide gas market will be well supplied, and the threat of our domestic gas price being driven up due to exports is over blown.
If only the the CAGW people could be proven wrong so quickly and thoroughly.
Can someone explain the intense feeling of schadenfreude. I feel, when I begin to hear of shortages and price increases due to self inflicted scarcity.
http://www.bbc.co.uk/news/world-us-canada-19853740
It all seems so much “reaping what you sow”… I guess. GK
Have the price graphs been adjusted for inflation? Especially important in the age of currency debasement via ‘quantitative easing’ ( aka money printing ). The graphs suggest the dollar cost of natural gas today is the same as it was in 1987. But today’s dollar would only be worth 50cents in 1987.
This is why the Saudis know very well that the real price of oil is just about $35 boe. With a thousand years of gas reserves in place guess what? You do the math.
A lot of base load coal power has been supplanted by gas – coal down from 52%
to 33% of power produced in the U.S. last time I saw any stats. Also one of reasons CO2 down 7%
last few years. Short sighted, now that fast reactors (Generation 4 reactors) are beginning to reach the stage of commercial deployment, beginning with Russia’s Rosatom and their BREST version (one of five architectures being developed by multi-nation consortiums). In essence, a fast reactor has no fuel supply concerns, now or ever. And the fuel costs for running such a reactor are practically zilch. Since these reactors are inherently safe, can burn our nuclear wastes,
producing easily handled wastes, are a barrier against proliferation,and have proven more reliable and cost effective than conventional reactors, utilities would find these very attractive alternatives to either coal or gas for their base load power. I predict that they will have the option of buying these BREST reactors within 5 to 7 years. It would be helpful to have an administration intelligent enough to get behind this technology in a PR, educational fashion, to convince the public of its many advantages.
Guest post by David Archibald
Misleading? I certain never intend to mislead except maybe an occasional troll. Misinformed, might be a better word, after all I’m a bit pusher, not a BTU pusher.
Lessee, from each section:
2012 FPO price $0.6919/therm. Fact, though I think I recycled the letter. BTW, that’s $6.92 per MMBtu, so the local utility sure isn’t getting any of that current $3.40/MMBtu. At some point another 50% drop just isn’t like that first 50% drop from 2009’s $1.2835/therm.
New businesses and jobs in the US? Well, if “500,000 New US Jobs By 2025” doesn’t happen, I’ll go visit Pierre. It’s only a few months’ job creation, but those jobs should spawn more jobs too.
Exporting LNG? danj said we’re exporting LNG now.
Domestic trucks running on LNG? I confess I haven’t seen either truck nor filling station, but New Hampshire is not on the major trucking routes. It doesn’t even get cold enough here to not need refrigeration to make LNG. But you knew that.
That leaves that Harvard discussion paper. While it’s focus is on oil (the title is Oil: The Next Revolution, it does make a number of references to the gas industry. In fact, given all the different plays it mentions, that’s likely the best example of a cornucopia of oil and gas fields in North America.
Thanks for hunting down better graphs of things like the US Natural Gas price. I would have but kept finding more topics to mention.
Oh – “If we plot gas price relative to rig count, there is a strong correlation.” A correlation of R^2 = 0.6083 is strong? Maybe you need to smooth the price curve a bit, but that would be misleading. 🙂
Thanks for the stats and facts David. I have been following the latest energy boom and another thing to keep in mind is economic contribution to individuals – increased employment for workers, engineers, geologists, et al, as well as increased personal wealth generation for investors, land owners, municipalities et al.
http://www.aei-ideas.org/2012/10/amazing-north-dakota-energy-facts/
It is all good. Compare to the pathetic contribution to our economy and energy generation as promoted by our current federal administration under Chu and Obama – investing public monies in nonsense like Solyndra while preventing energy extraction and slowing and stopping pipeline and infrastructure development (Keystone).
… can’t wait for the methane hydrate wells to come in. The world is afloat on a sea of methane.
The data presented here strongly supports is that there are strong & visible market forces between supply & demand at play in the natural gas market. The market was initially (in the mid 2000s) under supplied, prices were high so drilling increased to match that demand. Then, the market became over-supplied (late 2000s , partially due to the overall recession, partially due improved technology chasing shale gas plays) & prices fell in reaction to over supply. So, the drilling slowed down to reduce supply & get supply back in line with demand & now prices are responding to that by coming back up again. This is a beautiful & classic case of economics 101.
As such, the data argues there is no real constraint on the supply side of the equation at this point in time – the industry can supply what ever the economy demands. It is really the demand side of the equation driving the boat & the supply side simply reacts to that. Thus, the title of the article should drop the “No” & simply be “cornucopia of gas” because the data present suggests we currently can supply any amount of gas the demand the economy currently has.
If the ITER folks can meet their goal, (500 MW ouput for 50 MW input) the long-term future becomes a little less certain.
The fracking revolution (or more precisly the revolution in horizontal drilling + fracking) deserves to be an 11th chapter in the excellent book, The Doomsday Myth: 10,000 Years of Economic Crisis I first read this book back in 1985. It is a great rejoinder to the Club of Rome’s thesis. The authors, Texas A&M professors Charles Maurice and Charles Smithson, describe 10 episodes in human history where we were running out of a precious resource. Changes in “price” and “technology” quenched each crisis. Some chapters I remember:
Flint for arrow heads.
Bronze (my favorite, see below), we learn to work iron.
Greeks changed ship construction because of a shortage of wood.
We were running out of trees for heating. Enter coal.
We were running out of trees for railroads. Enter better engineering and creosote.
We were running out of oil (from whales). Come Pennsylvania.
Rubber from trees.
Running out of food. Green revolution.
1970’s oil crisis. Let price rise. Drill in deeper waters, far away places, build tankers.
The Bronze story, as I said was my favorite. At the end of the Bronze Age, iron was a known metal, but it was quite expensive. Archeologist have found silver rings with iron wire as orimentation, like we use diamonds. Bronze is a mix of copper and tin. Copper was local to Greece, but tin needed to be imported. The Phonecian pirates put a crimp in tin shipments for about 80 years. In that time the price of Bronze went up, Bronze recycling became common place, and metal smiths looked for alternatives. They found ways to smelt and work iron. In those 80 years, the price of iron relative to bronze dropped by a factor of 10,000. Thus began the Iron Age.
The book is a good read. Free Minds and Free Markets when combined give off great power.