Checkmate for cheap unconventional gas
Shale reserves are not a miracle; they are a high-cost source of fuel, writes John Dizard
If you listen to the whisperings in the chancelleries of the great powers of Europe, or the musings of editorialists, US shale gas has become a key strategic asset in the chess game of global power. The US can move its gas castle to block the Russian knight from putting Europe in check?.?.?.?or whatever.
One would think this would put US natural gas exploration and production companies in a strong position, one made even stronger in the short term by a long, cold winter. Oh, and the tightening environmental restrictions on coal-fired power stations. It now seems that tighter emissions rules will lead to the shutdown of more than 60GW of coal-fired electric capacity by the end of next year. That would be about equal to peak electricity demand in the UK. Natural gas prices are up, and securities analysts are raising their price forecasts for this year and next. Wow. More shale gas fortunes, right?
Well, no – not yet, anyway. The share prices of primarily gas-directed US exploration and production companies are not doing so well this year, at a time when the macro prospects could not be better. Not only are there more equity sellers than buyers, but the junk-rated US E&P companies are selling nearly 80 per cent less public debt this year than they were by the same time last year.
Do natural gas investors and lenders know something other people
do not?
In the short term, as in the next year or so, yes, they do. It is going to take much longer, and require much more money, to get that unconventional gas produced than global strategists presume. Five years ago, investors and lenders were willing to believe any story about shale gas. Now the money people are probably more sceptical than they should be about the price prospects for natural gas, and the profits to be had from producing it.
Essentially, the shale gas boom of the past decade turned a set of engineering advances into a property bubble, in which investors were selling development rights to each other, intermediated by the exploration and production companies. The E&P promoters were spending multiples of their operating cash flow on buying properties and drilling them to show more production, then selling more stock and more debt, etc. Eventually, the promoters could not pedal fast enough. After the (temporary) fall of Aubrey McClendon, the most visible promoter, and chief executive of Chesapeake Energy, the most visible shale gas company, the investment world backed away from shale, even as the political world embraced it.
However, there really is a lot of “unconventional” gas to be produced by the North American industry, just at higher prices than the political class now assumes, and in places that are not adequately connected to pipelines. Unconventional gas is not a miracle; it is a high-cost source of fuel that requires a lot of technical skill, time and capital. You drill for it because there are not enough conventional gas resources on offer in safe places.
The curve of exchange traded futures prices for gas, which is one of the data series the lenders and equity investors crank into their now-less-optimistic models, is almost certainly lower than the realised prices will be. The US futures show a price sinking again next year, before slowly rising out in the decade. To a large degree, though, that is an artefact of the heavily borrowed gas producers being forced to hedge too much of their future production to meet lenders’ covenants. The large consumers on the other side of the trade, ie the utilities, can simply pass along price increases to a captive public, so they are not under equal pressure to buy future supplies on the exchanges. That is why low Henry Hub futures prices probably understate what gas will cost in years to come.
As the US and anyone counting on its gas exports will find out, inducing enough rigs and crews to produce more gas, and building enough processing facilities and pipelines to get it to where it is needed, will probably cost at least another couple of dollars per million British thermal units. Otherwise production will decline, or be trapped in under-connected areas such as parts of the Marcellus Shale in the eastern states.
And when prices for gas do rise in the years to come, they will, for a while, rise further than central planners or grand strategists would like.
Investors in pipelines and processing facilities will do well. Buyers of now-deflated natural gas properties will do very well. Those gas company management groups who come out on top in the industry’s coming merger and acquisition wave will do very, very well.
john.dizard@ft.com |
