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Natural Gas Prices Can’t Rise Soon Enough

June 29, 2016

Natural gas prices have dropped sharply over the past two years and while the prospect of paying higher prices for energy is not appealing, unless prices rise soon, the prices we pay later are likely to be much higher and for much longer than currently forecast. The chart below shows the decline in natural gas prices over the past two years. In response, a steady rise in production of U.S. natural gas stagnated and began declining over the past year.

One impact of very low energy prices is a U.S. energy industry that is in financial shambles, devastating industries that support oil and gas extraction and threatening the financial institutions that lend to energy-related industries along the way. In the first quarter of 2016 the largest shale gas producer in the world had negative cash from operations. Most other large producers similarly had revenues from the sale of oil and gas that didn’t cover operating costs much less capital expenditures like drilling and completion. Sympathy for energy companies isn’t expected and won’t be forthcoming but the result of consistently low energy prices is predictable, lower U.S. oil and gas production. The longer prices for natural gas remain very low, and the smaller and financially weaker the industry gets, the less likely production will be able to ramp-up as prices rise (as they most surely will) and that means even higher prices in the future and for a longer period of time.

The Importance of Shale Gas

The U.S. is increasingly dependent on shale gas. Conventional natural gas production appears to be in terminal decline as fewer producers are drilling those wells. Shale gas now represents more than half of all natural gas produced in the U.S. (and rising). Production of shale gas will have to continue to increase just to compensate for the decline in the production of conventional natural gas but recently shale gas production has also begun to decline.

The Marcellus and Utica shale gas regions (closest to NH) are relatively new sources of shale gas (production began in the mid-2000s). They, Marcellus in particular, are the kings of shale gas in the U.S.. Not surprisingly they have, on average, the lowest cost-of- production of any shale gas region in the country. As a result, production in those regions has been maximized and the percentage of U.S. shale gas that comes from the Marcellus and Utica shales is now almost 50 percent. That percentage probably would be even higher except for pipeline capacity that limits movement of gas from the region.

But even in these lower cost-of-production regions the lowest cost producers have a breakeven price of about $3.50-$4.00/MMBTU (the average of all producers in the regions is higher). Meanwhile natural gas prices in the U.S. have been below $3.00 since 2015 and below $2.00 in 2016. The average production costs in shale regions that have been producing longer is considerably higher (from about $5.00/MMBTU to more than $6.50). The impact of natural gas prices on the production of increasingly important shale gas is best understood by looking at the impact that prices have had on different shale gas producing regions across the country. The chart below shows changes in production from each shale play’s peak production to May of 2016, when spot natural gas prices were at $1.92/MMBTU. As economics would predict, the chart shows that production declines were greatest in the highest production cost regions and smallest in the lowest cost Marcellus and Utica Shale regions. On a percentage basis declines in production appear even more dramatic. Production has declined 50 percent in the Haynesville shale region of Louisiana and Texas since peak production occurred there in 2012. The Barnett (Texas) and Fayetteville (Arkansas) shale regions experienced production declines of 39 and 26 percent respectively since 2012. In contrast the lower cost Marcellus (0.4%) and Utica (2.0%) experienced minimal declines in production and only in 2016 when spot prices were under $2.00/MMBTU.

But here is the thing, like all gas and oil producing regions, the longer the Marcellus and Utica shales produce gas the more likely production cost will rise as increased withdrawals require production to move from core areas of the shale play to more marginal areas of production.

Prices and Costs Matter

Only in a fantasy world will U.S. production of natural gas continue to increase for decades with prices remaining near or below breakeven costs. In the real world prices and costs matter. I am a fan of natural gas and believe increasing availability in New England will benefit consumers and businesses but thinking that natural gas can be simultaneously cheap, abundant, and profitable defies the rules economics.

Unfortunately I think the U.S. Energy Information Agency is contributing to a fantasy by suggesting an almost unlimited supply of natural gas at low prices in their forecast of natural gas production and prices contained in the EIA’s 2016 Annual Energy Outlook (released in May). I respect the work of the EIA and regularly rely on the data they produce but this forecast seems to lack a fundamental grounding in economics.

At $6.00/MMBTU (in 2015 dollars)the U.S. will have an ample supply of natural gas for decades. At $5.00 (not reached until 2024 in the EIA forecast scenario) production is unlikely to increase by 50 percent as the EIA forecast suggest. At prices below $3.00 for long, as is the current case, production will decline significantly and supply shortfalls will require supplementing U.S. production with ever larger withdrawals from storage, increasing imports (questionable if that is possible) and/or a reconsideration of the exporting of natural gas. It is important to note that shortfalls in production don’t mean there won’t be enough natural gas, there is ample gas in storage to cover shortfalls for a while but prices will rise quickly as more gas is withdrawn from storage. Rising prices should prompt increases in production but things may be different this time, depending on how soon prices rise. The industry is smaller, financially weakened, and unlike a few years ago capital, as well as workers who were forced to leave the industry as it shrank, may not be as readily available to ramp up production as prices rise.

As we know too well from experience, natural gas supply shortfalls have more dramatic and especially harmful impacts on New England. New Hampshire and the rest of the country would be better off with a modest rise in natural gas prices now rather than face supply shortfalls and much higher prices in future years.

Categories: Energy, Natural Gas
Tags: Energy, forecast, gas production, Natural Gas, prices, Shale gas

Comments: 2 Comments

A Crisis of Our Own Making

December 29, 2014

Increased shale gas production as well as a December that is on pace to be the ninth warmest nationally since 1950 has natural gas prices in the U.S. plummeting by 18% in the last three months. Natural gas futures for January delivery fell to $3.144 per million BTU on the New York Mercantile Exchange. These all suggest that a crisis in the New England energy market caused by natural gas price spikes will be less than many predicted this winter.

To be clear, to this point the New England energy “crisis” has largely been a winter phenomenon. The chart below shows the weighted average price of natural gas for electricity generation in New England and the U.S. It shows, natural gas prices for electricity generation are roughly the same in New England and the U.S. with the exception of the winter months, when increased demand for home heating along with the region’s increased reliance on gas-fired electricity generation combine to exceed the capacity of the limited natural gas pipelines in the region. The result is a limited supply and exceptionally high natural gas prices for power generation in the region. As the chart shows, the premium (over average U.S. prices) paid for natural gas by New England power producers has increased each of the past several winters. Abundant supplies and lower prices nationally and a winter forecast of 11% higher mean temperatures compared to the Winter of 2013-14, will lessen but not eliminate natural gas issues or the larger issue of longer-term energy production in the New England region.

The chart below graphically depicts perhaps the most fundamental problem confronting the New England energy market, one that currently prevents the region from fully realizing the benefits of our nation’s booming production of natural gas. The chart highlights the dearth of natural gas pipeline capacity in the New England region compared to most other regions, including much more sparsely populated regions of the country.

There is a reason the chart shows a concentration of pipelines in Ohio, West Virginia, Pennsylvania, and other nearby (to New England) Eastern states. These states currently produce about 40% of the nation’s shale gas but they promise to produce an even greater percentage of the nation’s gas in the future. Together, these states (along with small amounts from states near them) hold over 60% of the proved reserves of shale gas in the entire U.S. according to the U.S. Energy Information Agency. Unfortunately, the chart also shows that the increasing number of pipelines emanating from the region don’t make their way into New England. When the U.S. was more at the mercy of the exigencies of the world’s energy suppliers than it is now, New England had someone to blame for its energy disadvantages. With an emerging abundance of natural gas so close by, it is more appropriate to ask ourselves why we don’t benefit from the boom in nearby production.

New England is not a region that produces its own fossil fuels but few areas of the country do and they still manage to avoid the sort energy “crises” that periodically plague New England. To the extent that there is an energy “crisis” we have nothing or no one to blame but ourselves. Natural gas is generally more expensive in New England but not always for electricity generation, except during a few months of the year when pipeline constraints are the culprit. New England is “retiring” older “base-load” power plants but so are many other regions – seven coal-fired power plants that I know of in Ohio and another five in Western Pennsylvania alone. But these are also states where new gas fired power plants or other generating facilities are being built to replace them and neither of these regions is straining their natural gas pipeline capacity by adding new, gas-fired power plants. I have done studies for three new gas-fired power plants in Ohio in recent years and although subject to just as much regulatory and public scrutiny, none of the facilities faced the kind of parochial opposition characteristic of most proposed projects in New England. I have also done work on a wind energy project in New Hampshire and it faced as much or more opposition as would any fossil fuel generating project. In New England it seems, any energy project with a public benefit is seen as synonymous with trampling some individuals’ rights.

Whatever the extent of the looming energy crisis in New England it is of our own making. If you don’t want renewable energy production (wind, solar, hydro etc.), gas-fired power plants and the pipelines needed to support them, or any other power producing facilities built, you have no right to complain about the availability or cost of energy in the region. Personally, I would like to see more renewable energy produced in New England and New Hampshire but that doesn’t mean we should refuse the benefits from a greater supply of natural gas. If we do, we will only put ourselves at a greater energy disadvantage than we already face. There are many reasons (aesthetic, environmental, etc. technical) why renewables are not a more favored option for generating electricity in the U.S. but most of the arguments in opposition are based on costs. Too often these arguments are made by ideologues, vested interests, and others with an agenda, most of whom have no idea of how to measure the true cost (levelized cost of energy or LCOE) of production by different generation sources or the hidden as well as direct subsidies provided to each.

Despite highlighting the increase in natural gas production this is not a post about the merits of hydraulic fracturing. In the coming years the benefit/cost calculus of “fracking” will be refined. This post is about whether New England will realize any of the benefits that result from an increasing supply of natural gas in the country. I have written before that I do not believe energy prices are the root cause of New Hampshire’s recent slower economic growth (we have had high relative energy prices during the state’s boom periods and New Hampshire is producing more goods and services with a lower energy content per dollar of gross state product than ever before). But even if not a savior, a more stable and abundant supply of energy resources at lower prices would have real economic benefits. Whatever your views of its merits, there is little doubt about the impact of the boom in shale oil and gas production on U.S. energy independence, it will no doubt alter the economic, fiscal and the international geo-political landscape of the country. In ten years it is quite possible that the only nation from whom the U.S. imports oil is Canada. Whether the shale oil and gas boom also alters the prospect for NH’s energy and economic future is less certain but is almost entirely within our control.