Gas exploration activity in North America looks like it is in the doldrums. In the past 12 months, gas-directed North American rig counts have fallen by almost half. This is easy to understand. Since the beginning of 2010, front-month gas futures prices have fallen from USD 5.60/MMBtu to their current level of USD 3.60/MMBtu. I have a bullish view on the long-term future of natural gas. When accounting for all of the upside influences—environmental imperatives, relentless demand growth in the developing world, the potential of the domestic power sector, revitalization of the US industrial base, and downstream innovations such as gas to liquids (GTLs)—the picture looks positive. At the same time, I have a firm belief that continuing innovation will drive efficiency, making gas an even more attractive alternative and leading to more exploration and development. These indicators lead me to believe a second wave in the development of the North American gas business is on the way.
The first wave has been quite a ride. Only a few years ago, gas industry pundits assumed that new gas demand could only be met with imports. An entire subindustry was developed around the regasification, storage, and transport to market of imported liquefied natural gas (LNG). Today, LNG regasification facilities are largely idle. Instead of increasing, gas imports have fallen dramatically—from 12.6 Bcf/D in 2007 to less than 9 Bcf/D in the most recent 12 months.
Although gas production has increased dramatically, from just under 55 Bcf/D in 2007 to a current rate of 69 Bcf/D, the increases in production have been absorbed incrementally, without long-term structural adjustments in the US energy economy or significant investments in infrastructure. Existing gas plants displacing coal in the power sector and reductions in imports have absorbed more than 70% of the increase in gas production.
The United States is still a net gas importer, but the industry is now focused on developing export markets. Those markets are there. Demand growth in China is almost certain for a generation. If Japan follows up on its commitment to step away from nuclear power, new supplies will need to be found there.
Exporting gas will require us to adopt workable regulations, develop infrastructure, and change a mind-set. The United States is accustomed to thinking as an energy importer. As new sources are developed, we tend to guard them jealously and reserve them for domestic use. The Federal Energy Regulatory Commission approves the construction of LNG liquefaction facilities and the Department of Energy grants export licenses based on a “public interest” standard.
The public interest is a difficult thing to define, but we can define the puts and the takes and try to put some numbers around both of them. On the plus side are the jobs and follow-on economic activity resulting from more gas production. On the minus side, there will be upward pressure on prices to domestic consumers from increased demand. A recent study performed by the National Economic Research Associates (NERA) for the Department of Energy analyzed the impact of new export demand of up 12 Bcf/D (about 20% of current production, but less than the roughly 24 Bcf/D worth of export license applications currently pending). That study concluded that the majority of the impact will be on the supply side (i.e., higher production) although there will be some consumer impact. The study projects an initial 36% increase in prices, tailing off to less than 20% in the high-export scenario. On balance though, the benefits are positive. NERA estimates a net benefit in gross domestic product of USD 20 billion per year in 2020 in the most optimistic scenario. The higher the level of exports permitted, the higher the increase in net benefits.
I also expect further changes in the way that we use gas and coal to generate power. Recently, gas prices have produced a significant reordering of the power industry’s economics and the wholesale substitution of gas for coal. In 2007, 49% of the US power was generated from coal and 22% was generated with natural gas. By 2011, those percentages were 42% and 25%, respectively.
The power sector story is only beginning. What we have seen in the power sector in the past 5 years was the reshuffling of existing infrastructure, made possible by substantial overcapacity of natural gas-fired generation. When gas prices started to fall, the substantial overhang of gas-fired capacity enabled gas-fired generation to grow without any investments in generation assets.
Going forward, I think that the power sector will continue to be an even bigger tailwind for natural gas development. A large part of the US coal-powered generation fleet is reaching the age at which it will need to be replaced or repowered, including the installation of environmental upgrades. Those repowering decisions have been made even more complex than usual by the uncertainty regarding greenhouse gas regulation. No one who needs to retrofit a coal plant can be confident whether they will be able to run that plant economically in the long term. This leads me to expect that there will be a big push in the next few years to build more gas-fired plants. Those assets are environmentally advantaged and, given a stable gas price environment, economically competitive. The inevitable result of this is a push for utilities and other power plant owners to secure the necessary gas supplies and more exploration and development.
Another intriguing opportunity, probably just over the horizon, is GTLs. The chemistry for this has been around since World War II and at current fuel oil and natural gas prices, the economics are attractive. Historically, the obstacles have been the reliability of the capital cost estimates, uncertainty in the reliability of the operations, and the risks created by volatility in the price of the gas input and the fuel oil output. If the long-term economics are viable, the market will find a way to reduce and reallocate those risks in a way that enables the financing and development of GTL projects.
Will the next wave be driven, as the last one was, by off-the-charts increases in gas prices? Probably not. Make no mistake there will be upward pressure on gas prices. Increases in demand always produce those pressures. However, I think it is fair to say that the dynamics of gas pricing that we lived with before the shale boom, scarcity followed by high prices followed by frantic exploration and development followed by price collapse, are gone for a while.
Gas looks much more like a manufactured product now than it does a natural resource. We know where it is and we know how to get it, delivering the lowest barrel of oil equivalent cost with better surface solutions, subsurface solutions, and chemistry. It is just a matter of deploying the necessary people, assets, and material.
The pause in gas exploration and drilling is just that, a pause. The economics of gas are simply too good.
About the Author
Previously, Miller was senior vice president of global business development and marketing, where he was responsible for strategic account management, sales, marketing, commercialization, and global business and technical solutions for Halliburton.
Miller has also served the company as senior vice president of Halliburton’s Gulf of Mexico Region, vice president of the Baroid product service line, country vice president for Indonesia for Halliburton’s Energy Services Group, country vice president for Angola, business development manager for Venezuela, shared services manager for Venezuela, and director of financial reporting. Miller earned a BS degree in agriculture and business from McNeese State University and an MBA degree from Texas A&M University. Miller is a certified public accountant and a member of the Texas A&M University Look College of Engineering Advisory Council.