Editor’s Notebook: Too Good To Be True?

November 2012, Vol. 239 No. 11

Cheap and abundant, cleaner power generation, new jobs, profitable refineries, returning petrochem plants, the good news about natural gas just keeps on coming, or does it?

Have you thought as to what shape the natural gas business is in these days? For every upside there is a downside, and so there is with natural gas as indicated in an Oct. 21 article in The New York Times which pointed out that while consumers and to a lesser extent gas-fired utilities – along with early investors – have been big winners – not everyone has profited from the shale boom, especially producers and investors now suffering from this extended low-price environment.

It was time for me to call my good friend Bruce Bullock, executive director of the Maguire Energy Institute at the SMU Cox School of Business, for his perspective.

Part of the problem was created by the industry’s amazing success record which has minimized geologic risk associated with the shale play, resulting in very few dry holes being drilled, he says.

“I think they underestimated how prolific some of these plays were, and didn’t envision as many people getting into the business as did. You also have to look at the broader economic situation with zero interest rates for the last five years that made it relatively easy for any number of people to borrow money and get into these smaller independents early on. Then they found more than they expected and that encouraged even more people to get into it,” Bullock says.

So it’s become a question of production cost vs. selling price which is where the producers and their investors are coming up short. Bullock sees the natural gas business undergoing a new cyclical phase in which the producers will exert their muscle and dictate how much gas will be available.

It’s akin to manufacturing which typically employs a “just-in-time” production scenario in order to maintain reasonable prices. “They will much more easily be able to adapt production needs to meet market demand,” Bullock predicts.

One overlooked but important systematic issue is the three-year leases many producers have, obligating them to drill now or lose the lease. Bullock expects this too will shift to a just-in-time situation that will affect future lease terms. Producers will be able to more easily adjust their drilling once they hit dry gas by either ramping it up or down quickly; and if liquids are available – focus on that – as they’re already doing in the Eagle Ford Shale.

In the Marcellus Shale, drillers are moving west toward the Utica Shale which is also seen as more of a liquids play. To date, the resource base is not as prolific as was hoped, Bullock says.

Barring further game-changing technology that could drop prices even lower, Bullock expects to see a gradual turn upward into the $4-5 range over the next several years. He’s more optimistic than most.

LNG exports could do much in removing the glut, but it’s unlikely to be a big factor in the near-term because of the lengthy time required to build these costly facilities. Similarly, it won’t be until at least 2015 that enough petrochemical plants are online to consume the gas.

The pipeline business should stay stable providing prices remain relatively low for natural gas, liquids and the availability of crude oil continues to grow. “As these petrochemical markets begin developing, we’re going to need a way of getting that to market – as long as we don’t run into regulatory and local concerns.”

Which segues into Bullock’s final point.

“I hope the industry doesn’t take its eye off the ball in terms of working with some of these local communities because we continue to see concerns expressed and anti-drilling ordinances popping up here and there. They are a lot more difficult to defend against than to go after the EPA. It’s easy in a down cycle in some of these basins to ignore that. But I view it as an opportunity to make some friends.”

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