Diary of a Mad(Natural Gas Producer)man

From the BOE REPORT

Terry Etam

With all due respect to Ozzy Osbourne, a guy that lived the rockstar life; who drank enough alcohol to float an aircraft carrier; who took enough drugs to stun a small nation; who survived all that, raised a family, survived to age 76/counting, and is worth $200 million…that’s not a madman. That’s genius. Well played, sir.

The story of natural gas markets and producers, on the other hand, can righteously lay claim to the title.

Don’t take my word for it. Have a look at this chart that depicts US natural gas production (black line) and Henry Hub prices (orange) for the last quarter century or so:

In what industry, you might wonder, would producers accelerate production at such a rapid clip, while simultaneously driving prices into the toilet. You would not be crazy in asking that. Over the period of the arrows above, the industry gave a whole new meaning to the term “value destruction”. Investors did not care for the strategy much at all, surprise surprise.

The two arrows, in isolation, do make the market look crazier than 8^th Avenue at 7 pm (Calgary’s up and coming East Hastings proxy), and it is pretty bad, but, to be fair to the beleaguered participants, there is a bit of context that needs explaining.

First, the gradual increase in production from about 2006 onwards was the result of the high prices of 2002-2006, which spurred development and led to the unlocking of the US’ vast shale gas resource. High prices footed the bill for shale exploration and experimentation, which set the stage for future growth.

One of the biggest reasons for these wild trajectories is that the industry just keeps getting better and better at getting gas out of tough formations. (While there are many ways drilling and completions are improving, these advancements should not be confused with the simple act of drilling longer horizontals which is often viewed as an efficiency gain – it is a capital efficiency gain, no doubt, but not like an improved frac is – a longer lateral simply chews up the reservoir faster. One day in a decade or two we will look back and go, oh yeah, maybe that was significant…).

Those technological/fracking improvements drove the first waves of growth, but don’t completely explain the steepest part of the curve. Note in particular the pinkish shaded box, corresponding to roughly April 2017 to April 2021. Over that four-year period, the US added about 27 bcf/d, which is about 1.5 times Canada’s entire output, while prices fell from about $3.00/mmbtu to $2.00. That’s the sort of antics a guy like Warren Buffett really frowns on.

It’s true, those trajectories do look like the product of madness, but as with pretty much everything that has ever happened in history, we have to go back to the context of the times. In that period, an enormous amount of new natural gas pipeline infrastructure came into service, projects that had been kicked off some years before, in the 2014-15 timeframe, when it became clear that there was a market for all the new gas. Pipeline and gas plant builders needed volume commitments from producers to build the infrastructure, so once completed, producers did what they were obligated to do – fill up the pipe.

From a macro perspective, that kind of worked – the pipes did indeed fill up, but on the other hand the enthusiasm led to some pretty spectacular bankruptcies (hello, Chesapeake). Producers burned through vast piles of cash to flood a market that couldn’t handle the output.29dk2902lhttps://boereport.com/29dk2902l.html

The significance of this (over) development can hardly be overstated, in energy terms; in 2006 the US produced about 50 billion cubic feet per day (bcf/d); 18 years later it produces over 100 bcf/d. Early this century, some 20 years ago, the US was looking to construct LNG import terminals; 20 years later, the US is the world’s largest natural gas exporter. Now that truly is crazy.

Today, here in mid 2024, the future is murky. We know a few things: that the US (and Canada) are both capable of a lot more natural gas production. We know that demand is going to go up over the next half decade at a minimum, possibly by as much as 30 percent, due to new LNG export terminals and data center/AI demand.

What we don’t know is how easy it will be to build any new infrastructure to enable new volumes to get to where they need to be. We’re well used to this problem in Canada, of course, which is a basket case; it is a miracle that Coastal GasLink was built at all, and it is hard to imagine any entity having the intestinal fortitude to attempt any new greenfield interprovincial infrastructure, which is federally regulated, which means the ruling alliance would laugh you off Parliament Hill for even showing up with your briefcase.

The US is not far behind; the only significant interstate gas pipeline to go into service in the past few years has been the Mountain Valley Pipeline which was many years delayed by swarming activist attacks, and was completed at double the initial cost estimate (MVP was first proposed in 2014, and was scheduled to come onstream in 2018; it finally started flowing gas in 2024). A more realistic reading of the current US natural gas interstate pipeline system is this: In July 2020 the Atlantic Coast Pipeline, a large and critical new pipe that would have taken excess Appalachia gas to a thirsty US east coast, which was six years in planning, was shelved despite receiving a 7-2 vote of approval from the United States Supreme Court (from the project cancellation news release: “A series of legal challenges to the project’s federal and state permits has caused significant project cost increases and timing delays. These lawsuits and decisions have sought to dramatically rewrite decades of permitting and legal precedent including as implemented by presidential administrations of both political parties. As a result, recent public guidance of project cost has increased to $8 billion from the original estimate of $4.5 to $5.0 billion… This new information and litigation risk, among other continuing execution risks, make the project too uncertain to justify investing more shareholder capital.”)

To emphasize just how tough it is to actually build a new pipeline, Dominion Energy, one of the Atlantic Coast partners, took a $2.8 billion charge to earnings in cancelling the project. Think about that. A public company chose to eat a $2.8 billion loss rather than attempt to build a new, approved pipeline.

Of course, things are much more complicated than that oversimplification. Texas, for example, has no problems building pipelines within the state. A lot of gas is produced in Texas, and many LNG terminals are or will be located there too. So perhaps that aligns as a path for gas production growth. Similarly, AI data center owners are figuring out that they can build their data centers right alongside gas fields, bypassing a whole bucket of headaches – no interstate gas pipeline requirements, avoid grid transmission/distribution power charges, get the things built in months rather than years. So there’s another clear path between producers and consumers that might facilitate added production and consumption.

But it won’t be all that smooth. Big fields over time become smaller fields, and new developments may well be in other states. The inability to build gas infrastructure will haunt the economy in one way or another. Associated gas may or may not continue to flood the market, the amount of which available is as much a function of oil prices as anything else.

And then on top of this complicated business, layer in politics. One presidential candidate loathes hydrocarbons, and in past has supported a ban on fracking. The other candidate has sworn to cut energy prices in half, a promise which boggles the mind at the best of times, and causes cranial explosions if he’s including natural gas prices. He wants to cut those in half? See: chart above…not sure that is a well-thought-out proposal, not when it comes to natural gas anyway.

Add it all together and it is a market like no other, and it is mighty hard on the head. A wise colleague offered his own version of the above chart, a Rorschach-type interpretation that is probably a better fit for anyone involved in the natural gas business these days. The beast is obvious, if you play in this sandbox:

Whatever. Something will come up out of the blue to send the gas market into more spasms, and in a year gas prices will be fifty cents or twelve dollars or maybe both in one day. Don’t look behind the curtain please. We’re not well.

What the world desperately needs – energy clarity. And a few laughs. Pick up The End of Fossil Fuel Insanity,  available at Amazon.ca, Indigo.ca, or Amazon.com.