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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This is why it is essential to regulate coal out of the market. Otherwise it would set a hard limit to natural gas prices.
Which is rather inconvenient, as it increases the pressure to decrease cost of drilling through innovation. It is way simpler to limit production and push prices up, is not it?
Applying the principle of cui prodest it becomes crystal clear that the Great Carbon Dioxide Scare is backed by Big Oil (or rather, Big Hydrocarbon), contrary to murky allegations coming from the cAGW camp.
Just see their true color for yourself:
– British Petrol: Carbon Footprint Toolkit
– Chevron: Innovating California’s Future
– ExxonMobi: Global engagement on climate change
– Royal Dutch Shell: A carbon price for Australia – finally!
I’m a little confused about the point of this post. It’s not profitable to drill a gas well when the price is under about $4. The ability to make a profit seems to be a better predicter of drilling activity.
All right… Let’s correct a misconceptions here.
First, as someone pointed out, there is no such thing as a risk free rate of return. That said, the current proxy for risk-free rate, until the world finds something they deem safer, is the US treasury bond. The US has never defaulted, and truthfully has a lot of spending they could cut and taxes they could raise before it would have to. So when someone is evaluating what the risk free rate for a particular investment is, you take the production life of the asset and choose the US treasury bond that matches it. In this case, we’ll assume a 20 year production life which means the current risk free rate of return is ~2.5% (which contrary to a previous poster is trading at a premium to inflation.)
By definition, an “economic return” is one that exceeds it’s cost of capital. This cost of capital is always at some risk adjusted premium to the proxy for the risk free rate of return. The financing structure of the investment along with credit worthiness of the individual/company will essentially determine what that rate is. For a new NG venture, you are likely looking at close to 100% equity financing. Taking a quick survey, based on delevered betas of pure play natural gas companies, i would say the expectation is in the 1.2 * market risk premium area. Current thinking on what the standard market risk premium should be (what premium over the risk free rate should be expected for an asset that moves in lock step with the aggregate market) is somewhere around 6% (some do argue for 5%.) This means that, in general, new NG companies are expected to produce a 7.2% premium above the risk free rate of 2.5%, so 9.7%, which is basically spot on with what David used for his ROI assumption. Anything returning below this rate would technically be considered generating an “economic loss”.
If for whatever reason, a mature, stable company that issues investment grade bonds were to be highly levered, let’s say 70% debt financed, it is likely the required rate of return on new investments would be in the 6% range on a weighted average cost of capital basis. The absolute lowest you would go, for a 100% debt financed company, would be in the 4% range. That, of course, is provided you could find underwriters willing to issue bonds at investment grade rates for a 100% debt financed company that sells a commodity with high price volatility, which is unlikely. In that case, you are probably borrowing at high-yield rates, which probably puts you back in the 6-8% range on your 20 year debt. Overall, investors in this sector are likely to be seeking a 6-10% ROI, and depends primarily on debt to equity ratio.
The thing about wells, in general, is the majority of their costs are fixed. Once they are in the ground, you will continue to produce at market price so long as it exceeds the variable cost of production. As such, the price of NG moves towards the marginal cost of the last MSCF needed to meet demand. As the world moves out of the recession, and demand for various consumer goods rises, we will see a corresponding rise in NG costs due primarily to increased consumption for petrochem processes. From there, we will probably see a much more careful matching of production to demand, than what we saw when gas spiked in a relatively short time to $12/MSCF, such that new wells going into the ground will fetch a market price that earns a 10% ROI. I believe that number is currently somewhere around $5.00-$6.00/MSCF, and if you look at most long term industry outlooks for US NG prices, that is where they expect the price to head over the next 3 years and out into the foreseeable future.
David,
Any thoughts on conversion (cracking) of Gas to Gasoline/Diesel? Wouldn’t that broaden the market and help support the natural gas price?
_Jim says:
October 6, 2012 at 1:12 pm
There are a couple posts, the most recent is about a year old, see http://wattsupwiththat.com/2011/10/28/test-of-rossis-1-mw-e-cat-fusion-system-apparently-successful/ . That raised enough controversy from young physicists that Anthony banned more posts on the topic until there is a good third party review. That hasn’t happened. Also, things are a bit confused – I’m not sure what’s happened to the Ecats that were supposed to be selling now, Rossi’s interest in something that runs much hotter would be a much bigger story. Pretty much everything involving a Swedish organization’s tests that concluded the hot cat doesn’t work is unbelievable to bizarre. I couldn’t figure out exactly what’s going on with that nonsense.
All in all, it’s not time for an update other than a few drive-by notes. Besides, there are pleny of blogs and whatnot that do try to make some sense of the nonsense. Bottom line – not disproven, not available at Home Depot.
“Dave Worley on October 6, 2012 at 5:25 pm
David,
Any thoughts on conversion (cracking) of Gas to Gasoline/Diesel? Wouldn’t that broaden the market and help support the natural gas price?”
Methane can easily be converted to Methanol, and I would think EPA could be persuaded to allow it as a substitute for their ethanol mandate. The law would need to be changed to allow this though. Plus it might be worse for the engine than ethanol.
An ideal solution would be if a smart chemical engineer could find a catalyst for this reaction:
9CH4 + 7C => 2 C8H18
I.e. using methane plus coal to make a hydrocarbon with the approximate mol wt of gasoline. We have abundant coal AND now methane, so how about it all you chemE’s?
“SMC on October 6, 2012 at 5:07 pm
I’m a little confused about the point of this post. It’s not profitable to drill a gas well when the price is under about $4. The ability to make a profit seems to be a better predicter of drilling activity.”
If they don’t drill the lease before it expires they lose it, an exploration company with no leases to drill is a pathetic thing. Sometimes they just have to roll the dice and hope for better prices.
Steve R says
An ideal solution would be if a smart chemical engineer could find a catalyst for this reaction:
9CH4 + 7C => 2 C8H18
I.e. using methane plus coal to make a hydrocarbon with the approximate mol wt of gasoline. We have abundant coal AND now methane, so how about it all you chemE’s?
——————
Probably already done. Fiddling with the hydrocarbon distribution is a regular trick at refineries.
But it’s probably unnecessary. In this part of the world gas is cheaper than petrol and so a lot of people run dual fuel systems, albeit with reduced trunk space.
“Most importantly though is Westport’s ability to keep promises related to earnings. Its light duty division achieved a positive EBITDA one quarter earlier than promised. Its partnership with Ford (F) to produce popular Ford F-250 trucks with bi-fuel natural gas and gasoline engines is proving profitable, and it is planning a similar partnership with Volvo cars in the near future.
In the US, Clean Energy Fuels is steadily building out “America’s Natural Gas Highway,” a network of liquefied natural gas fueling stations that will allow a heavy-duty long haul truck to travel between nearly every major city in the lower 48 states. Royal Dutch Shell is working with TravelCenters of America (TA) to provide natural gas pumps at over 100 existing truck stops across the country. Liquefied natural gas requires far less tank space than compressed natural gas, allowing heavy-duty trucks to haul cargo more than 400 miles on a single fill up. making it their fuel of choice.”
http://seekingalpha.com/article/908501-expect-accelerating-revenue-growth-from-westport-innovations?source=yahoo
Berényi Péter,
Unfortunately, there are CAGW believers in the Oil industry just as there are everywhere else. There is really nothing wrong with using coal as long as it is scrubbed clean and especially if it is cheaper as it makes more sense to use it first instead of more expensive fuels. The CO2 Monster is just like Big Bird – it relies on government funding to sustain it.
Looking at Figure 6 confirms a long held opinion – That rig count drops faster and deeper when the price declines than the count rebuilds when the price increases. That should create an additional bias toward higher gas prices, and reduce the chances for reaching any kind of equilibrium.
Lazyteenager:
“But it’s probably unnecessary. In this part of the world gas is cheaper than petrol and so a lot of people run dual fuel systems, albeit with reduced trunk space.”
Unnecessary, but perhaps more efficient. The point of the thread is that natural gas is currently marginally profitable, which may result in less production. A steady, storable supply of fuel is essential to avoid spikes and valleys we see today. Conversion to a more valuable, more storable, more portable liquid fuel would add value, increasing demand and price stability. Surely building or converting refineries is more efficient than converting the entire fleet of vehicles.
The oil/ng industry lobbies for no coal, no nuclear, no anything esle to drive up the demand for petroleum based products so the price of their products increase to drive up their revenues to stock holders.
It’s a no brainer. Forget about it. You are going to pay more for everything.
Steve R says
An ideal solution would be if a smart chemical engineer could find a catalyst for this reaction:
9CH4 + 7C => 2 C8H18
Just because you can write an equation doesn’t mean it makes the slightest sense chemically.
Otherwise this would appear a fairly simple reaction to catalyse:
C (coal) –> C (diamond)
“highflight56433 on October 6, 2012 at 8:27 pm
The oil/ng industry lobbies for no coal, no nuclear, no anything esle to drive up the demand for petroleum based products so the price of their products increase to drive up their revenues to stock holders.”
Not sure I understand what you are saying…do you mean they do not lobby? Or they lobby against coal?
“he majority of players will eventually get a 10%-odd rate of return on being in the business.”
Man I know of dozens of industries that would KILL for a double digit rate of return! They’ll be producing gas at very affordable rate because of the uptake as more electricity suppliers switch to gas from coal and nuclear. We’re good for at least 50 years and if we don’t have our act together by then we’ll go through more price shocks.
@pochas re ITER and hot fusion. Ain’t happening in your lifetime. (ITER will, but nothing resembling commercial fusion power production.)
14 MeV neutrons do bad things. Tritium must be made. TANSTAFL
Mainly, fusion is more of an insurmountable engineering problem than physics problem and has been since the Princeton folks took apart their tokamak. The most important point I can make is that the notion that once it is worked out it will be CLEAN and INEXAUSTABLE is simply false. The equipment and buildings become radioactive waste, and lithium is already rare and highly useful in other applications.
“It’s not profitable to drill a gas well when the price is under about $4.”
As someone who has working interests in several current gas wells, allow me to say that’s not necessarily true. It all depends on your liquids (condensate, etc) production. If your liquids production is high enough, your nat gas is essentially free, The liquids pay the bills, the nat gas sales are just the gravy.
Now for pure dry gas wells, that $4 figure may well be true – but nobody’s drilling pure dry gas wells at these prices. To me this indicates that while nat gas is capable of short term spikes due to rising demand, any move towards $6 or above will bring on a flood of dry gas drilling and knock the price right back down again.
I don’t think the articles use of the phrase “profitless prosperity” makes much sense – it’s just going to be a low but steady profit market for a long time to come. Wonder of wonders, nat gas may even stabilize at the $3 – $5 range and stay there for a couple of decades once this all shakes out. (constant dollar figures, of course) Having a stable price would be just as good for consumers as it would be for producers – everyone would finally know what to count on and what to plan for.
Well it’s something to hope for, at least.
Berényi Péter –
you wrote:
“Applying the principle of cui prodest it becomes crystal clear that the Great Carbon Dioxide Scare is backed by Big Oil (or rather, Big Hydrocarbon), contrary to murky allegations coming from the CAGW camp.”
ain’t that the truth…oh, the irony.
Mooloo on October 6, 2012 at 10:03 pm
Said…….
“Just because you can write an equation doesn’t mean it makes the slightest sense chemically”…
I think it’s safe to say that You aren’t the smart chemE the world is looking for.
Gas at 3 or 4 dollars per thousand cu ft may not be profitable in the US, but liquefying it and selling it overseas at 15 to 18 would be.
It would also tend to keep the price of gas low in the US. Gas that could not be exported would be sold locally.
It appears that there is building interest in Canada to develop a high-efficiency, fluid fueled nuclear reactor technology that might initially be used to help recover oil from their tar-sands. The proposed design is a simplified version of the thorium breeder reactor, which is primarily fueled by uranium. The hot liquid salt operates at ambient pressure. And thus is thought to be much safer than current high-pressure, solid fueled reactors. These reactors continue to cycle the fuel through the reaction chamber, only removing the fission fragments, which decay to a stable state in a few hundred years by electron emission. This is an example of a technology that might replace combustible carbon as a primary energy source after that becomes too expensive to use as a fuel. This may not happen tomorrow, but we all know that it will, eventually.
David LeBlanc – Molten Salt Reactor Designs,
Options & Outlook @ur momisugly TEAC4
“Published on Jul 20, 2012 by gordonmcdowell”
32 likes, 0 dislikes; 1457 views; 19:46 min
“Candian David LeBlanc describes the benefits of liquid fuel Molten Salt Reactors over solid fuel reactors, emphasizing reactor design over any relative advantages of thorium or uranium.
“Come for the thorium, stay for the reactor!”
A very informed and informative article. Thanks.
A couple of points on fitting linear trends. As is the habit in climate science this is as easy to do as it is misleading unless there is a good reason to suppose there actually is a linear relationship.
I would suggest your figure 7 shows two very distinct ‘trends’: a rising trend below 6.5 MCF (units??) considerably steeper than the one you fitted; and more or less flat above that. ie there is a saturation point above which rig count is no longer linked to gas price. That is probably very significant.
Similarly, your figure 8 supports a linear trend above 1850 but around 1800 it seems to be donimated by other factors. There are huge variations in price around that production level.
Second point, in doing scatter plots, don’t forget these are not isolated data, they are time series. Don’t throw this information away by plotting isolated dots. Joint the dots to get the big picture.
If you do this you will almost certainly see the outlier are not oddities but form loops. These loops represent oscillations in the time series. You say you expect that kind of behaviour, linking the dots may show it.
There is a cluster around (1750 , $6 ) that seems to be the hay day max rig count.
Figure 4 also invites further analysis. It’s not entirely clear what you are plotting here but there seems a clear exponential decay in each shaded area. Fit a decaying exponential to each shaded area, or plot that on a log scale for y and fit linear, I think you will find they all converge towards 10 (whatever y is ?? ) around 2020.
Finally , if you use colour in the scatter plot to show progression in time you will see whether the oscillations are increasing or settling down. Time is a crucial factor in any such analysis. The scatter plots would be much more informative if you retained this information rather than removing it. It would be an interesting update if you could post such a modified version of figure 8.
Thanks again for an interesting article, it certainly puts a bit of perspective on how shade is affecting gas production in general.
David Archibald is always the prophet. But his “peak oil” dreams and visions are too rooted in the “known” – a better extrapolation would figure in the unknown innovative future techniques that will enhance both extraction and exploration. We do know there is a virtually unlimited amount of methane (methane hydrates) in the crust of the earth. If we somehow depleted the hydrocarbons available in shale formations – we would have barely dented the total methane. The future is unknown and unknowable; but David will keep trying to predict it. There is no Prophets Anonymous.
decay rate half-lives from figure 4:
70.71/32=2.2 years from 2010 on;
70.71/23=3.1 years form 2000 on.
after five half-lives production is down to about 3%, not much.
On that basis US gas is no longer going to be a significant energy source by 2020. Before that the price will rise.
Buy your cheap gas now, it ain’t going to last.