Welcome to our series of posts on U.S. Gas Exports. Over the
next four weeks, we will discuss how the following factors have molded the
conversation around natural gas exports: increased domestic supply, international
pipelines, liquified natural gas (LNG), and international demand. This week, we
focus on how domestic supply will shape future export policies.
For those of you who’ve heard about the “U.S. Shale
Revolution” one too many times, I’ll keep the background relatively brief. The
oil and gas industry had two innovations that, when combined, allowed for low
cost extraction of high quantities of oil and gas. First came commercially-viable
horizontal drilling in the 1980’s. Drillers were historically limited to
drilling vertically, or straight down, so the new horizontal technology allowed
drillers to maneuver wells in any direction their hearts desired. The second
innovation was hydraulic fracturing, or the term “fracking” that everyone likes
to make unclever jokes about, e.g. what the frack, a fracking good idea, don’t
frack with my future or my cows will die and faucets will light on fire, etc. Anyway,
fracking allowed E&P firms to target shale reservoirs. Shale reservoirs are tighter
and less permeable, so you need to fracture the rock by pumping water, sand,
and evil corporate chemicals underground to release the oil and gas. Geologists
knew about vertically thin but horizontally vast shale reservoirs that contained
a lot of oil and gas, but a vertical well only gives you a thin layer of access,
and without fracking all the oil and gas is still stuck in the rock, so shale was ignored for a while and dubbed "unconventional". Then someone thought
to combine horizontal drilling with fracking, and lo and behold, the shale revolution.
Zooming in on natural gas only, producers have placed a
major focus on developing shale reservoirs since the early 2000s, and the
result is a huge surge in total U.S gas production. The growth is expected to continue,
as shown below in the lovely chart provided by the U.S. Energy Information
Administration (EIA).
As a result, the United States shifted from being a top
importer of natural gas to facing the possibility of becoming the world’s top
exporter in the future. A historical import-export chart, provided again by
the EIA, shows the rapid decline in net imports that has resulted from the
rapid increase of domestic natural gas production.
Looking forward, the combination of continued growth and
declining net imports means one thing – U.S. gas producers need to start
thinking about exporting unless they want to see domestic price realizations crumble (they don’t). The two best options on the table right now
are liquefied natural gas (LNG) and international pipelines to Canada and Mexico,
but we’ll dive deeper into those topics in the coming weeks.
Before everyone goes export-crazy, someone ought to check if
anyone else even wants natural gas. Luckily, the EIA is here to save us again
with another awesome chart that extends to 2040.
Fortunately for U.S. gas producers the answer is yes, people
are expected to want your product in significant quantities in the future. For
those of you too lazy to look back at the first chart to compare supply and
demand, I’ll summarize: in 2020 there’s roughly 130 trillion cubic feet (Tcf) global
demand with 30 Tcf U.S. supply, then in 2040 there’s roughly 200 Tcf of global
demand with 35 Tcf U.S. supply. I’ll stop on the demand side here, as to not
steal too much thunder from our upcoming post.
There’s still on piece of the supply puzzle missing and that
would be non-U.S. production. Thank the energy gods for the EIA, because they
have international production
forecasts that extend yet again to their favorite year, 2040.
Russia, China, and the Middle East are the behemoths that
the U.S. will compete with for exports, but the U.S. has some advantages.
Transporting natural gas is more difficult than transporting oil or other
goods. As a gaseous product typically stored at high pressures, trucking and rail are out of the picture and pipeline is usually the
easiest mode of transport. The U.S. has existing infrastructure near Mexico and
Canada, which will help in ramping up pipeline exports going forward. China and
the Middle East are relatively isolated in terms of pipelines, but Russia has a
geographic advantage in the European market.
The other export option is LNG, which requires converting natural gas to liquid form and shipping overseas in
thermally controlled freighters. This process is technologically advanced and requires
specialized shipping terminals, which gives the LNG advantage to countries with
advanced shipping infrastructure like the U.S. The Aussies are a formidable opponent
in regards to LNG exports as it’s their only option in the land Down Under, and
Qatar is the current global leader.
Now that we’ve got our bases covered, let’s move on to how
U.S. producers and those who finance them should craft their decision-making
processes. My advice is to make hay while the sun shines, and it seems like
U.S. firms are somewhat headed down that path. U.S. gas exporting sits on the
low end of the competitor cost curve thanks to the relatively
low cost of shale gas development and the competitive advantages related to transportation
outlined earlier. Since the global demand will be there, and the U.S. can
outproduce and deliver gas at lower costs than others, rapidly increasing U.S.
production is a value-adding proposition. The chart below shows how North
American investment by E&P firms has increased over the years followed by a recent dip due to the current price recession.
Although current prices and earnings for E&P firms have taken
a hit lately, firms should keep long term demand in mind and ramp up investments when they are able to do so. If not, U.S. gas producers run
the risk of international competition grabbing up market share. There are three reasons why market share could be easily be lost. First, recent innovations related
to the U.S. shale revolution and LNG facilities will eventually diffuse to others
and competitive advantages will erode over time. Second, the U.S. may be a
power player when it comes to production but is actually a small fry when you compare reserves. U.S. producers currently enjoy a disproportionate influx of
investment relative to reserves thanks to existing infrastructure and economic stability, but there
are big opportunities out there for investors willing to venture into non-OECD
countries. If only we had a way of visualizing how non-OECD countries dominate
in terms of natural gas reserves… you know where this is going. EIA chart
below.
This leads me to my third point on first mover advantage. Due
to the high capex, low opex nature of the industry and sunk costs yada yada, no
one is going to turn off their production once they’ve made the initial
investment. Once market share is acquired, it’s hard to lose, so being the
first to take advantage of a supply-demand imbalance is crucial.
To summarize the supply side of U.S. gas exporting, the U.S.
has found itself in a good position thanks to low production costs and access
to efficient methods of exporting. Domestic producers will need to act fast to
preserve their strategic advantages and market share. There are vast natural gas resources
outside of the U.S. that could be developed over time, so accelerating growth now
is the best method to deter other entrants and capture the most value in natural gas exporting.
Sources:
EIA 2017 Annual Energy Outlook
EIA 2016 International Natural Gas Outlook
Oil and Gas 360
There are several good points made here of a strictly economic nature, which I suppose is the assignment. However, it's absolutely impossible to discuss the merits O&G supply, particularly in the global economy, without getting into world politics and the impact of a growing movement towards clean energy, which means reduced fossil fuel usage.
ReplyDeleteThe other piece of useful information that is lacking is the projected long-term supplies of shale gas. I suppose that doesn't matter, at least for the next 20+ years or so, as it seems that the world demand is sufficient to use up the world's production. However, at some point, the wells will start to run dry, and that might not be far enough into the future for some nerd to finally figure out how to create and sustain a fusion reactor (fueled by water).
The post leaves me with a question: What is the ultimate position that you're taking? It seems that the position is that the US should begin exporting its natural gas. This begs the question, does the US not currently export natural gas? According to the EIA, we do: https://www.eia.gov/dnav/ng/ng_move_expc_s1_a.htm
The next question I have is about demand, particularly US demand. Does the US create enough demand to use up its own supply? While you make the point that there is enough global demand to motivate increased exports, isn't it still preferential for the US to use its own NG before exporting? I'm not sure what the answer is, because while we're a net importer of NG, we also export NG, and this confuses me.
Also, what are the relative rates of increasing demand vs. increasing supply. It seems intuitive that by opening up US NG supply to the rest of the world would increase demand and drive up prices, at least I think that's part of your argument. The problem then is this: What will be the US people's reaction to increasing NG prices at home resulting from selling more gas on the global market? Something tells me that such a proposition might be hard to overcome.
But back to the beginning on energy and politics. Control of petroleum products has been at the forefront of geopolitics forever it seems. And the US has had problems for decades with being energy independent, which has had massive influence on foreign policy. Now that we have this seemingly (but not really) endless supply of natural gas, you would suggest we offload it onto the world market? That might be awfully neighborly, but it's probably not practical.
In summary, there is a lot of good, interesting information here, but what's the point? Are you advocating for increased NG exports? It seems so, but why, other than "there's a market for it"? What will happen to prices? What's the payoff? Why isn't the US exporting more to begin with? What needs to change in order to make that happen?
Enquiring minds want to know.
Excellent questions Trey. In case other commenters are wondering the same things, I'll try to address your comments.
DeleteThe natural gas supply can be found in the last chart: World Proved Natural Gas Reserves. This accounts for economically recoverable natural gas that we are aware of today and can make a profit from extracting. It does not include future discoveries of natural gas or discovered natural gas that is uneconomic to recover with today's prices and technology. The chart itself shows total proved reserves of roughly 7,000 Tcf, or enough gas to satisfy 200 Tcf/yr for 35 years. This means there's plenty of gas to satisfy the demand to 2040, with room for upside in terms of supply.
The stance I'm taking, as discussed in the second half of the blog, is that investments need to ramp up rapidly and quickly for U.S. producers, or else international competition will do so in their absence. Based on the demand forecast, there's value in future gas exporting, the question is who'll take it. I might be biased, but I say the US.
You are correct that the U.S. is currently a net importer of natural gas, which is why the ramp up is needed to become a large exporter. In regards to the oddities of simultaneous imports and exports, two causes are existing contracts and geographic considerations. For example, Texas is a big gas producer, and we export gas via pipelines to nearby Mexico. At the same time, the gas-thirsty Northeast set up long-term contracts for LNG imports, so there's importing that also occurs. Due to the shale revolution, especially with the Marcellus/Utica plays in the Northeast, imports will drop over time and exports are expected to grow by some to-be-determined degree. And as you would imagine, domestic production will exceed domestic demand and imports should be minimized over the next few decades.
In regards to geopolitics, I chose to avoid it and take more of a politically-indifferent investor's perspective, but I think you bring up an excellent point. I agree energy independence will have an effect on foreign policy, and U.S. citizens may lose out on some amount of price benefits as exports increase. However, local use will always have a price advantage, since international transport costs can reach up to 50% of the total production and transport costs. In other words, U.S. citizens and firms will still see prices much lower than countries that are non-producing gas importers, and their concerns may not be as extreme as one might expect.
You also asked about why we aren't exporting more today. The answer is two-fold in my opinion. First, U.S. firms could have realized huge margins selling to Europe and Japan over the last few years, since the price difference far exceeded the transport costs, but producers couldn't get their growing supply of shale gas to those markets. As a result, a ton of money has been put into new LNG terminals and interstate pipelines that will eliminate the current domestic bottlenecks. This will be discussed in upcoming posts. Second, those bottlenecks created a domestic supply glut which hit prices then earnings of gas producers, and investments of the last two years slowed down. Most analysts expect investment levels to increase again, but I'm advocating for a more aggressive ramp up than the norm.
Lastly, on your question about the market for natural gas, that will be covered in our last post on the demand side of gas exporting.
Thanks for the excellent points and requests for clarification.
Nate
This comment has been removed by the author.
ReplyDeleteSimilarly to Trey, I too have been thinking about politics while reading your excellent blog post, Nate. For me, however, it was geopolitics in particular. One of the most lucrative markets for LNG exports by the US surely is the European Union and, as you mentioned in your post, they currently get the brunt of their natural gas needs via Russian pipelines. However, especially given the current political climate, European policymakers are very eager to reduce this dependency ASAP.
ReplyDeleteIn financial terms, this raises an interesting question. Would Europeans be willing to pay a price premium to avoid sourcing their NG from Russia? If so, that could surely alleviate some of the concerns about an upcoming supply glut you mentioned and the potentially precipitous price drop associated with it. This actually reinforces the argument you make in the end of your post: There's a lot to be gained for US producers by entering the market quickly.
Like Trey, I keep coming back to this idea that the us gas reserves may only be able to supply less than 10 0years of US demand and how that would be even less if we start exporting on a larger scale.
ReplyDeleteWhat I would like to see more of in future posts is how this change in movements of natural gas interacts with other sectors of the US economy.
Currently natural gas has displaced coal in electricity generation. This has left the country with a surplus of coal that we have been selling abroad. As natural gas prices go up domestically, could coal begin to make a come back? I'm wondering what policies may be put in place in relation to this?
Another question I thought about was the finite nature of these resources. Through environmental policies, I don't see a strong shift back to coal, but if demand for natural gas in the US continues to rise and we continue to export more natural gas, prices and depletion rates will increase. I was wondering (and this may be addressed in later posts) how companies set themselves up to address these concerns? Is there any thought to that now?
Finally, the low prices of natural gas have greatly bolstered the petrochemical and manufacturing industries triggering billions of dollars in new investments. How will the shift towards natural gas exports effect the expectations of those companies? Will it have any effect on their expansion? Or if prices remain low, I saw a prediction for 10% or less increase in price due to exports, will this have no effect?
Great summary/overview … what’s the position? Needs to be more of a position that “domestic supply will affect export policy” … “how SHOULD domestic supply affect export policy?” If you take a position on one side, what is the counter argument? Think of what makes a good Op-Ed … the writer is typically trying to *convince* not just inform.
ReplyDeleteToward the end you obviously do take a position … the U.S. should quickly develop export markets for the reasons you outline. What’s the contrary case? Or is this just obvious? (I’m not claiming your point is obvious). By the time you guys need to write your op-ed I’d like to see your case become more compelling.
Question? What’s the deal with Canada? Frackers? Implications one way or the other for U.S.?
I like your tone … “thank to the EIA.” Not quite the WSJ Op-Ed page style guide, but effective!
(BTW, my understanding is that hyd fracturing has been in use for decades … my Uncle Gary used to work for Dow Chemical in Sarnia Ontario (near Detroit) and they fracked then. I guess that the big innovations are horiz drilling and improvements in fracking productivity?
Very well written and kudos for effort.
Grading Rubric (badly formatted because comments don’t allow formatting)
Possible “grades:” Excellent (E), Very Good (VG), Good (G), Could be Better(CBB)
Takes a clear position: G
Substantiates the position: G
Informs the casual reader: E
Clarity/quality of exposition: E