01.13.14

Where are Natural Gas prices headed?

Posted in Uncategorized at 10:57 pm by Administrator

Having spent more than 25 years in the oil and gas industry I have seen my fair share of hydro-carbon price fluctuations. So it has not come as a complete surprise to me that the “shale gas” phenomenon has had such a dramatic impact on North American Natural Gas prices.

At the beginning of the 21st century Natural Gas prices were about $4.00/Million BTU and thereafter they rose rapidly to $8-$10/Million BTU in the years 2005-2007. The economic crisis that started in the fall of 2008 coincided with increasing production due to the success of shale gas development which translated into a very rapid decline in Natural Gas prices to just over $2.00/Million BTU in 2012. Since then prices have recovered somewhat to about $4/Million BTU.

The low prices since 2008 have resulted in a very predictable decline in the number of drilling rigs exploring for new natural gas reserves. The impact is displayed in the graph shown below.

There are a few very striking features of this graph.

First, the almost total elimination of vertical drilling rigs is interesting. In traditional gas fields widely spaced vertical wells are able to drain the reservoir efficiently because the gas flows quite freely through the rock. In technical terms this type of reservoir has relatively high permeability.

Reservoirs that consist of rocks with lower permeability cannot be produced very efficiently with vertical wells. It is much more efficient, although also much more expensive, to develop these reservoirs using horizontally drilled wells as shown below.

As horizontal drilling grew more common in the late 1990’s it was possible to economically produce reservoirs that previously had been difficult or impossible to exploit. These so-called “tight gas” reservoirs became an ever more important source of Natural Gas in North America.

Because “tight gas” does not flow freely through the reservoir rock these wells produce a lot more gas in the first year of production than they do in subsequent years.  In the industry this is known as the production decline rate.

While a decline rate in a high quality traditional reservoir might be 1-2%  (allowing fields such as the Groningen in the Netherlands which came on-stream in 1963 to produce for an estimated 80+ years) tight gas can decline at 10-20% or more annually.

The “shale gas” phenomenon is a variation on “tight gas” which involves the injection of high pressure fluids and chemicals into a horizontally drilled well to break apart or “fracture” the reservoir rock near the well bore.  After years of research & development fracking techniques have become standard industry practice and reliably result in significant production from shale reservoirs.

The exploitation of “shale gas” has increased dramatically since 2005 resulting in a glut of Natural Gas in North American markets.  This in turn has driven down the price of Natural Gas to near historic lows in constant dollar terms.  The Energy Information Agency forecasts that Natural Gas production in the United States will continue to increase for the next two decades based upon ever-increasing production of “shale gas”. They also forecast only modest increases in Natural Gas prices to the range of $7-8/Million BTU by 2035.

I am not convinced that this scenario is at all realistic.

The steep decline in drilling activity over the past 5 years is going to catch up with us at some point in the near future.  It usually takes a few years to tie new gas wells into the distribution system and put production facilities in place.  Therefore there is a lag between drilling activity and production.

The other difficult obstacle to overcome is the impact of rapid decline rates on total shale gas production.

Assuming a constant amount of drilling activity and discovery success the total production flattens out after about 15-17 years with a 10% annual decline and after only 10 years with a 20% decline, as shown in the graphic below.   As the amount of shale gas in production increases the annual decline eventually is equal to the annual additions made through drilling for new reserves (Gary Swindell has analyzed production decline rates in great deal in a paper published in 1998 and extensively updated in 2005).

As noted above drilling activity has not been constant over the past 5 years but has actually decreased pretty dramatically.  It follows that there will probably not be a large increase or in fact any significant increase in shale gas production over the next five years.

At the same time the older gas reservoirs will continue to decline at a slow rate as they have for decades.

Putting all these factors together it seems likely that Natural Gas supplies in North America will tighten up somewhat in the next few years.  This dynamic of gas “booms” and “busts” is one we have seen many times before and is primarily driven by commodity prices.

When prices reach lows such as they hit in 2012 drilling activity dries up, supplies tighten due to declines and prices go up.  Eventually prices go up enough for exploration companies to be willing to renew the search for new gas reserves.  That process takes a couple of years during which supplies tighten even more and prices go up further.  Eventually the balance swings in the opposite direction and supply meets or exceeds demand and prices soften.

The implications of this cycle are quite worrisome when put in the context of electricity generation.

The MACT regulations will force the closure of more than 40 GW of coal-fired generating capacity in the next few years.  This is firm and dispatchable generation that can be called upon at peak demand times.  No amount of solar and wind can replace that loss reliably without massive amounts of affordable energy storage which does not exist.

Utilities are struggling to come up with plans to replace the lost coal-fired generation capacity.  In many cases the current low prices are pushing utilities towards the construction of Natural Gas fired plants.

That cannot be considered to be a negative choice.  Natural Gas burns more cleanly than coal and produces about half of the CO2 per Watt of electricity generated.  But there are a couple of problems with a wholesale switch to Natural Gas.

For those truly fearful about climate change then the fact that Natural Gas produces CO2 will continue to be a problem.

Probably more important on a daily basis will be the potential impact on utility rates if Natural Gas prices escalate significantly.

There is a reason that more than half of the electricity generated in the United States up until the turn of the century came from the burning of coal.  Coal was and remains the least expensive energy source available.

Coal can also be stockpiled at a generating plant.  That may not seem important but congestion in pipelines can be a real problem when temperatures drop and both residential users and power plants are consuming Natural Gas at the maximum rate possible.  That was an issue in the NE part of the continent during the recent “Polar Vortex” storm.

My fear in all of this is that utilities will spend 10’s of billions of dollars building Natural Gas plants which will help drive prices up – and those price increases will be passed on directly to electricity consumers.

My hope is that this rather bleak future of higher prices and continued CO2 emissions will cause utilities and governments to consider putting more time and money into developing affordable energy storage solutions.  If we could store energy on a very large scale we could time-shift solar and wind generation to match our demand patterns.  That is, in fact, a requirement before we can move completely away from the burning of hydro-carbons to generate electricity.  There are other measures that we can pursue – many of which are described in my Sustainable Energy Manifesto.

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